What is Funding Risk and Which Metrics Best Measure It?

Funding risk is the risk that a financial institution may not be able to obtain funding in the short-term or long-term markets or that it may have to pay higher rates for funding, which can affect its profitability and financial stability. This type of risk can arise from various factors, including changes in market conditions, credit ratings, investor sentiment, or regulations.

Several metrics can be used to measure funding risk, including:

Funding liquidity ratio: This ratio measures the level of liquid assets held by the bank relative to its total liabilities. A higher ratio indicates that the bank is better able to meet its funding obligations.

Loan-to-deposit ratio: This ratio measures the level of loans extended by the bank relative to its deposits. A higher ratio indicates that the bank is relying more on funding from loans rather than deposits, which can increase funding risk.

Net stable funding ratio (NSFR): This ratio measures the level of stable funding sources relative to the bank's long-term assets. A higher NSFR indicates that the bank has more stable funding sources, which can reduce funding risk.

Liquidity coverage ratio (LCR): This ratio measures the level of high-quality liquid assets held by the bank relative to its expected net cash outflows over a short-term period. A higher LCR indicates that the bank is better able to meet its short-term funding obligations.

Interest rate gap analysis: This analysis measures the difference between the interest rate sensitive assets and liabilities of the bank. A negative gap indicates that the bank is more sensitive to changes in interest rates, which can increase funding risk.

Overall, measuring funding risk requires considering multiple metrics to assess the bank's ability to meet its funding obligations under various market conditions and scenarios. Financial institutions should use a combination of these metrics to ensure that they have sufficient liquidity and funding sources to maintain their financial stability and growth.