Optimal Funding Tenors

Rene Reinbacher

Since the financial crisis of 2008, funding matters have received considerable attention from financial institutions. This concern can be easily understood by observing that spreads for unsecured long-term borrowing have dramatically increased,¹¹This increase is reflected, for example, in the 5Y iTraxx for senior financials, which increased from 40 basis points (bp) prior to 2008 up to 360bp. even for the leading global financial firms, having a large impact on the accrual cost of their unsecured balance sheets.

Also, as banks painfully realised during the crisis of 2008, the infinite liquidity assumption – the ability to always raise money – does not hold for any financial institution, and the business model of lending long term (mortgages), borrowing short term (deposits) and earning the carry implies a considerable liquidity risk.

This chapter focuses on funding requirements for uncollateralised derivatives. For such trades, the main paradigm is that the mark-to-market (MTM)²²The MTM is computed with respect to a specific reference rate. needs to be funded at all times, and all funds need to be raised using the firm’s unsecured funding rate (see the section starting on page