Funding markets are markets in which debt issuers borrow to meet their financial needs. Banks have access to funds obtained from the retail market, which are the deposits from their customers. However, these financial institutions also need to raise funds from the central bank, interbank deposits, and certificates of deposit.
Central Bank Funds
The central bank funds market allows banks with a surplus to lend these funds to other financial institutions for maturities of up to one year at the central bank funds rates. In the US, this is often referred to as the Fed Fund’s rate.
The interbank lending market is a market in which financial institutions extend unsecured loans to one another. Most interbank loans are for maturities of one week or less – the vast majority being overnight loans – and are contracted at the interbank loan rate.
Certificate of Deposit
A certificate of deposit (CD) represents a specified amount of funds on deposit for a specified maturity and interest rate. CDs are an important source of funds for financial institutions. Non-negotiable CDs pay deposit plus interest rate at maturity and a withdrawal penalty is paid if the funds are withdrawn before the maturity. On the other hand, a negotiable CD allows any depositor to sell the CD in the open market before maturity.
Withdrawal penalties can be imposed on:
A. Negotiable and non-negotiable certificates of deposit
B. Negotiable and non-negotiable certificates of deposit and interbank deposits
C. Non-negotiable certificates of deposit
The correct answer is C.
Only non-negotiable certificates of deposit have a withdrawal penalty that is paid if the funds are withdrawn before maturity.
Reading 51 LOS 51i:
Describe short-term funding alternatives available to banks