🏦 NONDEPOSIT LIABILITIES AND THE $($AFG$)$: WHEN BANKS NEED TO BORROW LUNCH MONEY

Imagine a bank as a well-dressed professional—smart blazer, sharp tie, shiny shoes—who pays their bills using two pockets: the Deposit Pocket and the Nondeposit Pocket. Now, most of the time, the Deposit Pocket is full because people trust the bank with their savings. But when times get tough or customer loans increase faster than deposits, the Nondeposit Pocket has to come to the rescue.

This is where our story begins—with Nondeposit Liabilities and their cousin, the Available Funds Gap $($AFG$)$.

🧾 The Customer Relationship Doctrine: No Excuses!

Let’s be honest: if a customer asks for a loan and you say, “Sorry, we don’t have enough deposits,” it’s like a chef saying, “We’re out of food.” That just doesn’t fly.

According to the Customer Relationship Doctrine, a bank should fund any profitable loan that strengthens its customer relationship—even if it has to borrow elsewhere to do it. That’s where nondeposit liabilities come in.

So the next obvious question is: What kinds of nondeposit funding are available, and how do banks manage them?

🔁 Liability Management: A Daily Game of Juggling

Liability Management refers to the daily process of raising funds from nondeposit sources. It’s like managing your wallet when you’ve maxed out your primary bank account. You start checking credit cards, borrowing from friends, or—if you’re desperate—selling your collectibles.

Nondeposit liabilities are interest-rate-sensitive, meaning their cost can change with the market. So while they provide flexibility, they also bring interest rate risk.

Which leads us to ask: What are these mysterious nondeposit sources?

💸 Sources of Nondeposit Liabilities

Here’s a quick tour of the bank’s “Plan B” funding menu:

Federal Funds $($Fed Funds$)$: Short-term interbank loans used to meet reserve requirements. Usually overnight. Simple and fast—like borrowing sugar from your next-door neighbor.
Repurchase Agreements $($Repos$)$: Like a pawn shop for bonds. You “sell” your securities today and “buy” them back tomorrow. Collateral is key here—no trust without some security.
Discount Window Borrowing: When a bank goes directly to the Federal Reserve for a loan. It’s like going to your strict-but-reliable parent.
- Primary Credit: For the well-behaved kids.
- Secondary Credit: For the slightly rebellious.
- Seasonal Credit: For farmers and businesses with seasonal cash needs.
FHLB Advances: Loans from the Federal Home Loan Bank, backed by mortgages. Reliable and long-term.
Negotiable CDs: Jumbo Certificates of Deposit $($e.g., $1 million$)$, typically bought by institutions. Not your grandma’s \$500 CD.
Eurocurrency Deposits: U.S. dollars held in foreign banks. Useful for international needs. Think of it as offshore storage.
Commercial Paper: Short-term debt issued by large corporations. Like borrowing from a well-off friend with a term sheet.
Long-Term Debt: Capital notes or debentures with maturities of 5–12 years. These are backup plans, not everyday solutions.

So now that we know where money can come from, the next logical question is: How does the bank know how much it needs to borrow?

📉 The Available Funds Gap $($AFG$)$

The Available Funds Gap is like looking into your fridge before a dinner party. Do you have enough food $($funds$)$ to serve everyone $($loans and investments$)$?

The formula is simple:AFG = current and projected loans and investments − current and expected deposit inflows and other available funds

Example:

Ravens Bank expects:

\$100 million in new loans
\$15 million in securities
\$30 million drawn from existing credit lines
\$75 million in new deposits

Total funding need: \$100 + \$15 + \$30 = \$145 million
Deposits: \$75 million
AFG: \$145 − \$75 = $70 million

If the bank wants a 10% safety cushion:

$($1.10 × 70 = 77$)$ → It needs to borrow $77 million

But why add a cushion? Because sometimes customers surprise you by withdrawing more, or taking out loans earlier than planned. It’s the banking version of “expect the unexpected.”

🤔 Why Is All This Important?

Because without a clear understanding of nondeposit liabilities and the $($AFG$)$, a bank might:

Run out of cash
Miss out on loan opportunities
Pay more than necessary for funding
Expose itself to interest rate shocks

So now we ask: How do banks ensure these borrowed funds are managed efficiently and not too risky?

Well, that’s where asset-liability management $($ALM$)$, risk-weighted assessments, and regulatory stress testing step in. But that’s a tale for another time…

🎯 Final Thoughts

Nondeposit liabilities are like a backup generator: you hope you don’t need them, but you’re thankful when they’re there. They bring flexibility but must be used wisely due to their sensitivity to interest rates. Meanwhile, the $($AFG$)$ acts as the bank’s flashlight—showing when and how much to borrow.

So next time you hear a bank talk about “funding gaps,” you’ll know: it’s not about potholes—it’s about smart borrowing.