A startup requires a huge amount of money, but the revenue it generates is insufficient. With low profits and huge expenses, startups need funding to survive. Finance is essential for startups to survive and provide stability and stable running of the business processes, making it essential for achieving goals, short-term and long-term activities, and meeting financial requirements.
In the beginning stages, expenses of startup companies' tend to go much ahead than their earnings as they center themselves on developing, testing and making their idea marketable. In many cases, they need financial support from commercial banks or credit unions, local banks, or nonprofit organizations. However, easy and quick access to financing for startup enterprises has always been a challenging issue for economists and entrepreneurs to address. Funding gaps are common in startup enterprises due to their special characteristics and lack of collateral or revenues, making it difficult to obtain bank financing.
Indeed, access to finance for startup firms is a major issue of debate, due to the focus on how sources of finance are acquired and how constraints are encountered when applying for financing.
In Ethiopia, the growth of startups is increasing from time to time. Ethiopia's startup ecosystem ranks among the top 100 in the world (StartupBlink, 2020). However, it is facing access to finance problems due to several reasons in different stages. For instance, while bootstrapping, the founder negotiates with family members and friends to convince them to invest in his or her idea. Startups don’t have the opportunity to convince commercial banks and get loans to start their businesses.
Micro Finance Institutions (MFIs) are given to serve the poor and those entrepreneurs excluded from the formal financial institutions due to high collateral requirement that cannot afford. The startups can be included under the MFI’s financial services, but they are being challenged to get sufficient finances due to different reasons, such as a high interest rate, complex office bureaucracy and other requirements like personal savings and groupings.
To sum-up, startups need money, but they frequently lack it due to unique circumstances such as lack of considerable revenue or adequate collateral, which makes it challenging to get bank financing. MIFs are provided to help the underprivileged and those who cannot access banks; however, it can be difficult for startups to secure sufficient funding for a variety of reasons, namely high interest rates, convoluted office procedures, and individual savings and groups. Therefore, the purpose of this study was to assess the feasibility status of Startup Financing in Ethiopia.
1. Narrow banking: Delivering Safety and
Competition to the Market for Large
Deposits
James McAndrews
CEO, TNB USA Inc.
December 2018
2. TNB DEPOSITS ARE NOT INSURED BY THE FDIC
Overview
2
Deposit markets, both retail and wholesale, are not perfectly
competitive.
The FDIC guarantees deposits up to $250,000, providing safe
deposits to retail depositors.
There are well-known costs to deposit insurance.
Larger depositors are rate-sensitive and flighty. The interaction
between them and private-sector suppliers of short-term
runnable securities is a major financial stability risk.
Narrow banks offer a vital way to improve competition and
financial stability.
3. TNB DEPOSITS ARE NOT INSURED BY THE FDIC
Interest on reserves
3
Congress authorized the Federal Reserve Banks to pay interest on reserves in the Financial
Services Regulatory Relief Act of 2006.
“The Board strongly supports proposals to allow payment of interest on demand deposits and
on the required and excess reserve balances that depository institutions maintain at Federal
Reserve Banks. ..These legislative proposals are important for economic efficiency:
Unnecessary restrictions on the payment of interest … on reserve balances distort market
prices and lead to economically wasteful efforts to circumvent them…”
Payment of interest on reserves would offset cost of payment of deposit interest on corporate
accounts. “The higher costs to banks will be partially offset by interest on reserve balances…”
In other words, the interest was intended to be passed-through to depositors. (Quotes from
Governor Meyer’s May 12, 1999 testimony.)
Payments were implemented in October 2008 to steer interest rates in the context of ample
reserve balances.
“During normalization, the Federal Reserve intends to move the federal funds rate into the
target range set by the FOMC primarily by adjusting the interest rate it pays on excess reserve
balances.” FOMC, Policy Normalization Principles and Plans, September 16, 2014
4. TNB DEPOSITS ARE NOT INSURED BY THE FDIC
Lack of competition in retail deposit rates
4
5. TNB DEPOSITS ARE NOT INSURED BY THE FDIC
Lack of competition, retail (cont.)
5
6. TNB DEPOSITS ARE NOT INSURED BY THE FDIC
Lack of competition, wholesale deposits
6
The federal funds rate lagged well below the rate of interest paid on excess reserves, 2009-2013.
7. TNB DEPOSITS ARE NOT INSURED BY THE FDIC
Why didn’t deposit rates track the rate of interest on
excess reserves?
7
For retail depositors:
there is a long persuasive literature that suggests depositors’ “switching costs”
inhibit interest rate competition among banks.
For large, or wholesale, depositors (a broad market that includes the Fed Funds
market):
Garratt, McAndrews, Nosal (2017) suggest that counterparty credit risks result in
supplier-determined risk limits that confer market power on banks.
Duffie* and Krishnamurthy (2016) suggest that segmented markets as well as
search and monitoring costs result in low deposit rates relative to IOER and broad
rate dispersion. Armenter and Lester (2017) suggest that matching frictions
contribute to imperfect competition.
Bech and Klee (2014) suggest that bargaining power is skewed in favor of banks
rather than to depositors.
*Darrell Duffie is a director of TNB USA Inc.
8. TNB DEPOSITS ARE NOT INSURED BY THE FDIC
How would the Fed raise rates?
8
The Fed has in fact created a narrow bank, called the Overnight Reverse
Repurchase Agreement Facility (ON RRP), and expanded an existing one,
called the Foreign Repo Pool (FRP).
“…when we were at the zero lower bound, we weren’t able to rule out the possibility that initial
increases in the policy target might not translate one-for-one into increases in money market
rates…ON RRP, which is offered to a broad selection of counterparties that includes money market
funds, is intended to intensify competition in money markets…” Potter, (SOMA manager, FRBNY)
April 5, 2017
“Market forces keep the federal funds rate in the FOMC’s target range by allowing a wide range of
counterparties to price trades against the alternative option of investing with the Federal
Reserve.” Logan (Deputy SOMA manager, FRBNY), May 4, 2018
“As a long-standing service to foreign central banks, foreign governments, and international
official institutions, the New York Fed runs and overnight investment facility known as the foreign
repo pool…Use of the pool has grown…to about $247 billion on February 17 [2016]” Potter,
February 22, 2016
9. TNB DEPOSITS ARE NOT INSURED BY THE FDIC
Passthrough to wholesale rates has improved
with the ON RRP and the expanded FRP
9
“We have now seen in practice that changes in administered rates can effectively
move market rates—both because effective competition helps bring administered
and market rates closer together and because the mere existence of administered-
rate facilities, like the RRPs I mentioned earlier, can affect competition…” Potter,
May 4, 2016
10. TNB DEPOSITS ARE NOT INSURED BY THE FDIC
ON RRP a better floor on the Fed Funds rate
10
Harry Browne, Yale
University, April 4, 2018
11. TNB DEPOSITS ARE NOT INSURED BY THE FDIC
Financial instability and large depositors
11
“a key threat to financial stability: the tendency for private-sector financial intermediaries
to engage in excessive amounts of maturity transformation—i.e. to finance risky assets
using dangerously large volumes of runnable short-term liabilities.” Greenwood, Hanson,
and Stein, 2016
Shadow liabilities: MBS,
ABS, GSE liabilities, CP,
repos, MMMFs, MTN,
discount notes, ABCP,
CMOs, CDOs, CDO-
squared, Option Notes,
VRDOs, ARS,…
Net liabilities are
calculated to eliminate
double counting.
From Adrian, Ashcraft,
Boesky, and Pozsar,
Shadow Banking, 2010,
FRBNY 458
12. TNB DEPOSITS ARE NOT INSURED BY THE FDIC
Institutional investors are flighty
12
From Schmidt, Timmermann, Wermers, “Runs on Money Market Funds,” 2015, SSRN
The MMMF run following the Reserve Primary fund breaking the buck was centered on
institutional investors.
13. TNB DEPOSITS ARE NOT INSURED BY THE FDIC
Institutional investors are rate-sensitive
13
From Banegas and Tase, 2016-079, Board of Governors of the Federal Reserve System.
Note the large increase in reserves held by FBOs after the FDIC assessment base change, about
a $400 billion increase from April to December, 2011.
14. TNB DEPOSITS ARE NOT INSURED BY THE FDIC
Narrow banking is a shock absorber.
14
The ON RRP supported financial stability:
“…in October, 2016, …the entry into force of new SEC rules for money market
funds…They could also make prime funds…less attractive…Substantial amounts were
expected to come out of prime funds and into government-only funds…
The size of the reallocation ended up being quite a bit larger than most had
expected…about $1 trillion of assets had migrated from prime to government funds by
late 2016….
The good news is that the ON RRP facility served as a shock absorber for overnight
rates…government funds, increased their use of ON RRP during the transition. Because
of the availability of ON RRP, government funds knew that would be able to temporarily
place some of the new funding they received at the ON RRP facility….As a result of this
elastic provision of a risk-free investment opportunity, overnight secured and unsecured
rates were only modestly affected by these large flows.” Potter April 5, 2017
15. TNB DEPOSITS ARE NOT INSURED BY THE FDIC
Why should we care? Financial Stability
15
Greenwood, Hanson, and Stein (2016) make the argument that “[b]y expanding the
overall supply of safe short-term claims, the Fed can weaken the market-based
incentives for private-sector intermediaries to issue too many of their own short-
term liabilities.” They suggest that the Federal Reserve’s ON RRP facility, or Fed-
issued bills, perform that task.
This suggestion ignores the possibility of narrow banks, designed for the purpose of
providing a safe deposit facility to large depositors, to accomplish this task. Instead,
it suggests a further entanglement of the federal government in competition versus
banks.
16. TNB DEPOSITS ARE NOT INSURED BY THE FDIC
Why should we care? Pass-through of IOER
16
Gagnon and Sack (2014) also recommend that the Fed expand the role and
importance of the ON RRP in monetary policy implementation. They suggest
several reasons:
o “It enhances the integration of financial markets…
o It could save taxpayers money…
o It maximizes the benefits of quantitative easing…
o It could mitigate shortages of Treasury collateral…
o It provides a useful reference rate for financial markets…
o It improves the efficiency of liquidity management for the financial system…
o It appropriately ignores the quantity of money…
o It accords well regulatory changes …
We believe that the most appropriate choice may be to set the IOR and RRP rates
equal.”
17. TNB DEPOSITS ARE NOT INSURED BY THE FDIC
Problem: The Fed is not intended to compete
with banks.
17
“During normalization, the Federal Reserve intends to use an overnight reverse repurchase
agreement facility and other supplementary tools as needed to help control the federal funds
rate.” FOMC, Policy Normalization Principles and Plans, September 16, 2014
“In addition, a number of participants noted that a relatively large ON RRP facility had the
potential to expand the Federal Reserve’s role in financial intermediation and reshape the
financial industry in ways that were difficult to anticipate…Finally, a number of participants
expressed concern about conducting monetary policy operations with nontraditional
counterparties.”
“The appropriate size of the spread between the IOER and ON RRP rates was discussed, with
many participants judging that a relatively wide spread— perhaps near or above the current
level of 20 basis points—would support trading in the federal funds market and provide
adequate control over market interest rates.” FOMC, Minutes, June 17-18, 2014
“Participants generally agreed that the ON RRP facility should be only as large as needed for
effective monetary policy implementation and should be phased out when it is no longer
needed for that purpose. Participants expressed their desire to include features in the facility’s
design that would limit the Federal Reserve’s role in financial intermediation..” FOMC, Minutes,
July 29-30, 2014
18. TNB DEPOSITS ARE NOT INSURED BY THE FDIC
Alternative: Private-sector narrow banks
18
Private-sector narrow banks can accomplish the objectives of increased competition for
pass-through of IOER, integration of money markets, taxpayer savings and other benefits
suggested by Gagnon and Sack, while at the same time providing systemically safe deposit
facilities for flighty wholesale depositors as suggested by Greenwood, Hanson, and Stein.
Narrow Banks assist in all these desired ends. In particular, narrow banks can improve
deposit market competition by expanding the set of depositors to include institutions not
eligible for the Fed’s ON RRP facility. Increased competition would raise deposit rates for
depositors of other banks.
Because of their safety, narrow banks pose deposit market competition to the largest
banks, and, like the ON RRP, would not attract retail deposits.
Narrow banks can reduce money market segmentation and should reduce the role of risky
forms collateralized short-term credit, such as ABCP, VRDO, ARS, etc. that proliferated prior
to the global financial crisis.
19. TNB DEPOSITS ARE NOT INSURED BY THE FDIC
What risks or concerns have been identified?
19
Cecchetti and Schoenholtz (2018): “we worry that they would shrink the supply
of credit to the private sector…”
Martin, McAndrews, and Skeie (2017) show that, where interest on reserves and
“perfect” intermediation of interest on reserves (akin to narrow banks) are
present, increases in the quantity of reserves provided by the central bank
generally have no effect on bank lending.
“…lending volumes in secured and unsecured money markets have been stable,
suggesting that the Federal Reserve’s facilities have not displaced activity in the
private sector.” Potter, February 22, 2016
Furthermore, the transmission of the ON RRP rate into retail deposit rates has
been extremely muted, suggesting that narrow banks aimed at wholesale
depositors will not affect bank funding or lending, but will instead reduce bank
rent—a subsidy.
20. TNB DEPOSITS ARE NOT INSURED BY THE FDIC
What risks or concerns have been identified?
20
Cecchetti and Schoenholtz (2018): “we worry that they would… aggravate
financial instability during periods of banking stress.“
Narrow banks will not reduce the availability of government-only MMMFs or
too-big-to-fail banks, who are the usual recipients of inflows in times of stress.
Further, narrow banks add little inflow capacity relative to the existing
alternatives under stress:
It requires days to acquire a new deposit customer, so no “overnight” runs
into narrow banks;
Existing depositors can be throttled if that would benefit stability.
How do the Fed’s narrow banking facilities handle this risk?
“We address the risk of sudden surges in take-up in a couple of ways. For
example, we can employ vigilant market monitoring to detect any such shifts and
allow the FOMC to formulate a response. We also use per-counterparty caps,
and can use an aggregate cap.” Potter, Feb 22, 2016
21. TNB DEPOSITS ARE NOT INSURED BY THE FDIC
The Case for Private Sector Narrow Banks
21
TNB USA Inc. was designed to pay higher than currently available interest rates on the
safe deposits of institutional investors. It would improve competition in the deposit
market and other money markets, strengthen to transmission of monetary policy, and
improve financial stability.
The legislation and Federal Reserve actions instituting the payment of interest on
reserves were fundamentally predicated on interest being passed-through to
depositors. The introduction of IOER removed the much reviled “reserve tax,” but was
not intended to become an affirmative bank subsidy to the large banks. Narrow banks
are an important component of the efficient payment of interest on reserves, as the
FOMC’s statements about the necessity of the ON RRP, a narrow bank in all but name,
demonstrates.
The time has come to allow the formation of private sector narrow banks—not just
public sector narrow banks—as is indeed allowed and required under federal and state
law.
Editor's Notes
…[M]oney market funds, particularly government funds, increased their use of ON RRP during the transition. Because of the availability of ON RRP, government funds knew they would be able to temporarily place some of the new funding they received at the ON RRP facility while they were looking for new investment opportunities, and prime funds knew they would have access to a very secure and liquid overnight investment as they increased their liquidity to meet an uncertain level of redemptions.”
“ recent shifts in the Treasury’s cash holdings have coincided with efforts to expand the issuance of Treasury bills, and foreign reserve holders might in some cases use the foreign repo pool as a substitute for Treasury bills. Greater and more elastic supply of ultra-low-risk assets through these channels likely helped smooth out the effects of the expansion of government money market funds”
Potter: Money Markets at a Crossroads: Policy Implementation at a Time of Structural Change. April 5, 2017
“To begin with, we are now firmly off the zero lower bound. After seven years at very low levels, the federal funds rate is now trading at 91 basis points. As shown in (Figure 2), the distribution of overnight federal funds activity is now quite distant from zero, in comparison to the period before liftoff. (Figure 3) shows a similar presentation for the triparty repo market, similarly revealing that traded rates are now consistently well above the zero bound and largely above or at the ON RRP offer rate.
Certain features of the financial system likely provide support to interest rates near zero. These include the availability of physical cash and a behavioral aversion by some money market investors to investing at negative rates. They also encompass certain unique features of money markets in the United States, such as legal and regulatory incentives applicable to money market funds and the inability of the Federal Reserve to remunerate deposits held by government-sponsored enterprises.
Accordingly, when we were at the zero lower bound, we weren’t able to rule out the possibility that initial increases in the policy target might not translate one-for-one into increases in money market rates, as reduced uplift from the zero lower bound could have offset some of the policy tightening. In addition, one might have also worried that various money markets might not move together as rates rise, meaning that, for example, a larger spread might emerge between secured and unsecured rates, or between overnight and term instruments, than had historically been the case. I will discuss some evidence on these issues later on.
The second development, in October 2016, was the entry into force of new SEC rules for money market funds. These new rules require, among other things, a floating net asset value for institutional prime money market funds, provide for liquidity fees and redemption gates for prime funds, and establish more stringent rules for portfolio diversification and financial reporting for all money market funds.11 Many of these reforms are aimed at least in part at enhancing financial stability, and in particular at addressing the potential for runs on prime funds to intensify financial stress. They could also make prime funds, which can hold a broad spectrum of money market assets, less attractive to investors who desire an investment opportunity with a fixed net asset value or who are concerned about redemption fees or gates.
Our contacts in the money market fund industry could foresee, based on their own business plans and discussions with their clients, that these reforms would lead to a substantial shift in money market fund assets. Substantial amounts were expected to come out of prime funds and into government-only funds, which generally hold Treasury securities, repo against Treasury collateral, or similar ultra-low-risk assets. As a result, this reallocation was expected to bring about somewhat lower rates on Treasury bills and repo backed by Treasury collateral, and somewhat higher unsecured rates.
It is important that the monetary policy implementation framework take note of changes to the broader financial market landscape, including its regulatory structure, and adapt as necessary in response to such changes. Ahead of the reforms, our focus, which I discussed in a speech in early 2016, was on whether the reforms would have an impact on the transmission of monetary policy that might require such adaptation. In particular, we wanted to observe whether markets remained sufficiently competitive to allow for robust control of rates, and see whether the shifts in volume—particularly the anticipated upswing in demand for government-fund-eligible assets—would impair competition.12 We also wanted to see whether linkages across markets remained strong enough to ensure that policy was transmitted in accordance with the FOMC’s forecasts, especially given prime funds’ broad investment scope, and their ability to reallocate across markets according to relative value.13
The size of the reallocation ended up being quite a bit larger than most had expected. As shown in (Figure 4), about $1 trillion of assets had migrated from prime to government funds by late 2016. This resulted in a major reallocation of the investments held by the money market fund industry, shown in (Figure 5). This reallocation had far-reaching effects on the structure of money markets, as described in a recent blog by some of my New York Fed colleagues.14 For example, banks that were relying on the funding by prime funds had to find other institutions that would be willing to lend to them. Government funds, which received large inflows, had to place the additional funds they had received, for example into Treasury or agency securities or into repo. Such a large change in funding flows could have created significant movements in money market interest rates.
The good news is that the ON RRP facility served as a shock absorber for overnight rates. As shown in (Figure 6), money market funds, particularly government funds, increased their use of ON RRP during the transition. Because of the availability of ON RRP, government funds knew they would be able to temporarily place some of the new funding they received at the ON RRP facility while they were looking for new investment opportunities, and prime funds knew they would have access to a very secure and liquid overnight investment as they increased their liquidity to meet an uncertain level of redemptions. As a result of this elastic provision of a risk-free investment opportunity, overnight secured and unsecured rates were only modestly affected by these large flows, and overnight markets continued to move as intended following changes in the FOMC’s target for the federal funds rate. That said, the runoff in prime fund assets did leave an imprint on term unsecured rates, although some of this has retraced recently as markets have adapted. I will return to this later.
Third, for some time now we have been keenly focused on the impact on the structure of money markets that ensues from higher balance sheet costs for financial institutions.15
When I refer to balance sheet costs, I mean costs that are primarily related to the size, but not the composition, of a financial institution’s balance sheets. One example of such a cost is the leverage ratio, which is a requirement that a bank has, at minimum, capital of certain percentage of its overall assets.16
The leverage ratio was introduced as a simple non-risk-based backstop to the risk-based capital requirements and sets an amount of required capital that depends exclusively on the size of the balance sheet, plus off-balance sheet exposures for the largest U.S. banks, and does not depend on the composition of the balance sheet or the risk of those exposures. The use of explicit, numerical minimum leverage ratios as part of the capital regulation of insured depository institutions and bank holding companies (BHCs) and their broker-dealer subsidiaries has a long history in the United States, dating back to 1981, but in recent years the scope of their use has broadened considerably as many large broker-dealers were not subsidiaries of BHCs prior to the financial crisis.17 The U.S. intermediate holding company (IHC) operations of foreign banking organizations including their broker-dealers will also be subject to the leverage ratio requirements starting on January 1, 2018. Finally, reflecting the lessons learned during the financial crisis and recognizing that excessive leverage could be built up from off-balance-sheet exposures, the leverage exposure definition was expanded to include off-balance sheet exposures. This new leverage ratio is called the supplementary leverage ratio and applies to the largest U.S. institutions.18
Balance sheet costs tend to make it more expensive for financial institutions to act as intermediaries in money markets.19 If these costs are economically large in the context of the ultra-low-risk, ultra-low-margin world of money markets, this could operate to reduce dealers’ incentive to make markets and act as financial intermediaries, so long as the leverage ratio is the binding capital requirement relative to the risk-based capital requirement for such firms.20,21
In calculating the leverage ratio, all assets, including cash held at the central bank, are included. Because of the large outstanding stock of reserves in the system, this might have the effect of making the leverage ratio more binding for some firms. In addition, the effect of the leverage ratio is further magnified by dealers’ inability to “net” across similar transactions on a bilateral basis with different counterparties for accounting and capital purposes. Netting is generally allowed so long as the transactions have the same counterparty and settlement date.22 The “same counterparty” requirement could in theory be met via the implementation of a central counterparty (CCP). However, for several money markets that are important to the transmission of monetary policy, no CCP has been implemented to date. For example, there is still no CCP in the United States for the repo market, and there is also no CCP for foreign exchange swaps. The regulatory capital benefit from the implementation of a CCP for the repo market might be reduced by regulatory requirements for some arrangements, such as those associated with the provision of committed liquidity to the CCP. The implementation of a CCP raises other important policy issues that would need to be carefully considered.
The fourth and final development: money markets have been impacted by increasingly large shifts in the Treasury’s cash management practices, as well as the cash management of a number of foreign official holders of dollar reserves. (Figure 7) and (Figure 8) show the behavior of the Treasury General Account—the Treasury’s “checking account” at the New York Fed—and balances in the New York Fed’s foreign repo pool, which is an overnight investment opportunity made available at market rates as a service to eligible foreign official and international account holders.23
Large shifts in these cash management practices can impact monetary transmission in a couple of ways. First, although we are not now conducting monetary policy via a reserves-scarcity framework, in the assessment of some analysts, changes in the stock of reserve balances still matter to pricing in money markets over a medium-term horizon.24Largely as a result of fluctuations in these balances and in ON RRP take-up, reserves have ranged widely since the start of 2016: from as low as $1.85 trillion on January 4, 2017, to as high as $2.5 trillion on March 9, 2016.25 If the shifts in reserves are large enough, they can affect money market rates. In addition, changes in Federal Reserve balances of the Treasury and of foreign official accounts are often associated with offsetting shifts in other components of their cash management programs. For example, recent shifts in the Treasury’s cash holdings have coincided with efforts to expand the issuance of Treasury bills, and foreign reserve holders might in some cases use the foreign repo pool as a substitute for Treasury bills. Greater and more elastic supply of ultra-low-risk assets through these channels likely helped smooth out the effects of the expansion of government money market funds that I noted earlier.”
