With the economic environment much more complicated that 20 years ago, many banks and thrifts have turned to wholesale markets to help offset the volatility that has been inherent in retail activities.

By diversifying in both the wholesale and retail arenas, financial institutions can improve their services to customers, enhance profitability, and maintain balance sheet stability.

Lending institutions have a basic challenge in working with retail customers. They offer borrowers the opportunity to prepay or refinance their loans, or both, yet they cannot revoke or "refinance" certificates of deposits, a major source of funding to support lending activity.

A Tough Sell

In the current low-interest-rate environment, it is difficult for banks to attract new CDs, though refinancing activity is rampant.

Should interest rates rise in the next several years, institutions that rely strictly on retail deposit funding may be forced to offer higher rates on short-term CDs, while they continue to accrue income at lower rates from their assets. This is the same combination that led to the thrift crisis of the early 1980s.

Regardless which direction interest rates move, however, wholesale banking can benefit financial institutions.

In fact, any diversification from a wholly retail strategy to a mix of retail and wholesale activities would be a more conservative approach to banking and place the bank in better control of its asset-liability mix.

Link to Capital Markets

Wholesale banking, by definition, involves raising and investing funds via the capital markets rather that raising and investing money on a retail level, as a community bank would normally do.

Superregional and money-center banks can issue debt in the capital markets to help fund their positions and manage the duration match (or mismatch) of their balance sheet.

While community bankers do not generally have access to the capital markets, they do have access to similar wholesale funding via membership in the Federal Home Loan Bank System.

By using Home Loan bank borrowings, known as advances, community banks can lengthen the duration of liabilities. Those advances require no FDIC premium, and are offered at attractive spreads to the Treasury marker. Borrowing can be used to purchase securities with more predictable prepayment profiles than a retail loan might provide.

A Better Mix

Financial institutions do not necessarily need to keep the assets they produce. A better mix of assets may be available via the capital markets. Bankers can entertain both fixed-rate securities and fixed-rates loans with maturity ranges that, absent a matched-maturity funding, would never otherwise be considered.

Thus, by borrowing funds at a wholesale level to support loan growth or investments in capital markets assets, the bankers has largely insulated the balance sheet from the market risk problems posed by retail banking.

Needless to say, this wholesale approach is not intended to, not could it, replace the community nature of retail banking. The two concepts are not mutually exclusive; indeed, they support one another.

When loan demand is weak and/or deposit flows are flat (like-today), the availability of cost-effective funding and credit-risk-free assets (at a positive spread) provides great comfort to asset-liability managers.

When to Push Retail Side

Conversely, when loan demand is good and deposit flows are strong, the retail franchise can, and should, be pursued to its fullest.

Obviously, the value of a bank's franchise is a function, at least in part, of its local market penetration and its image in the community. To the extent that the banks serves its community with attractive loan products and competitive savings rates, its image in that community will be favorable.

The ability to offer these products, however, is determined by earnings, liquidity, and capital. These critical measurements can be greatly enhanced by the use of various wholesale-banking strategies as a supplement to local loan-deposit activity.

In order to be able to continue funding families and businesses, as it has done successfully for 60 years, institutions will need to maintain operating flexibility in an ever-changing economic environment. Wholesale banking will help them operate more profitably, and better serve their customers, in the years ahead.

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