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Lesson 2 of 4 11–14% of the exam

How banks fund themselves short term

Banks fund loans mainly with deposits (checking, operational, savings and certificates of deposit), then with wholesale money: unsecured interbank loans, central bank funds, commercial paper, asset-backed commercial paper and repos. Profit comes from the net interest margin between what assets earn and funding costs.

6 min cram, 24 min full read. Based on the 2027 CFA® Program Level I curriculum, Fixed Income, Learning Module 4. Also part of the 2026 curriculum, so it applies to the November 2026 exam too.

Tailor this to you: take the self-assessment

Before this: Short-term funding for companies: credit lines, secured loans and commercial paper

On the exam

  • Compare short-term funding alternatives available to corporations and financial institutions

Compare short-term funding alternatives for financial institutions. Expect: which deposits are most stable; negotiable vs non-negotiable CDs; what the central bank funds market is for; how asset-backed commercial paper works and where it sits on the balance sheet.

How deeply to learn each part
Know the idea
Understand it in general. It frames other topics, but you will not calculate with it.
Use it
Understand it well enough to solve a question with it. Recognize when it applies.
Memorize
Learn it by heart. The exam will not give it to you.

You know this one. The full lesson is folded away. The takeaways, formulas and checkpoint below are your quick refresher, and the checkpoint is a fair test of whether you still do.

You tested strong here. The full lesson is folded away. The takeaways, formulas and checkpoint below are your quick refresher, and the checkpoint is a fair test of whether you still know it.

Cram mode: the one-screen version of this lesson. Switch to Full for the explanations, worked examples and interactives.

Where does a bank get its short-term money?

A bank sits between savers and borrowers. Most of its assets are loans and securities; most of its liabilities are deposits and short-term borrowing. It earns its living from the gap between the two.

Where a bank gets short-term funding
Bank short-term fundingborrow short from many places to lend out
  • Deposits Memorize core funding, from households and firms
    • Checking (demand) accounts Use it no maturity, little or no interest, stable thanks to attached services
    • Operational deposits Use it from clearing, custody and cash management, relatively stable
    • Savings deposits and CDs Memorize often a stated term; CDs pay interest at maturity
  • Wholesale funding Memorize raised from other institutions and investors
    • Interbank market Use it unsecured loans, overnight to one year, priced off a reference rate
    • Central bank funds market Memorize surplus-reserve banks lend to short banks at the funds rate
    • Commercial paper Use it about 60% of issuance is by financial institutions
    • Asset-backed commercial paper Memorize issued by an SPE, backed by loans, bank backup line
    • Repos Use it secured interbank borrowing, next lesson
  • Last resort: discount window Memorize central bank lends against collateral at a higher rate, with oversight
Assets what the bank lends Liabilities and equity where the money comes from Central bank reserves Short-term loans Securities boughtunder resaleagreements Long-term loans Checking andoperational deposits 2 Savings deposits andCDs 3 Interbank borrowing Central bank funds 4 Commercial paper 5 Securities sold underrepurchase agreements Long-term debt Equity 1 Assets yield 6.2% − funding costs 2.9% Net interest margin 3.3%
  • Deposits: stable in normal times
  • Short-term wholesale: can vanish in stress
  • Long-term debt and equity

4Central bank funds market

Bank A surplus reserves Bank B short of reserves reserves, overnight at the central bank funds rate Central bank last resort, higher rate

5Asset-backed commercial paper

Bank SPE special purpose Investors 1 · sells short-term loans 2 · issues ABCP cash cash backup line of credit from the bank

Off the bank's balance sheet: it gets cash and holds less capital. Investors get a liquid note backed by loans they could not buy directly.

  1. Net interest margin. The bank earns on its assets and pays on its funding. With loans and securities yielding 6.2% and funding costing 2.9%, the NIM is 6.2% − 2.9% = 3.3%.
  2. Operational deposits are sticky. Money kept for clearing, custody and cash management stays put in normal times. Other large demand deposits can leave quickly, so the bank must hold liquid reserves against them.
  3. Negotiable vs non-negotiable CDs. A non-negotiable CD can be cashed early only with a penalty. A negotiable CD can be sold to another investor before maturity; large ones are wholesale funding.
  4. Central bank funds. A bank with surplus reserves lends them to a bank that is short, usually overnight, at the central bank funds rate the central bank targets. Borrowing from the central bank directly is the last resort.
  5. Commercial paper and ABCP. Financial institutions issue most commercial paper. ABCP is a two-step route: the bank sells loans to a special purpose entity, which issues paper backed by them.
Banks borrow short from many places to lend long; the mix decides how they cope with stress.
Read the diagram as text

A bank balance sheet. Assets: Central bank reserves, Short-term loans, Securities bought under resale agreements, Long-term loans. Liabilities and equity, from deposits through short-term wholesale funding to long-term funding: Checking and operational deposits, Savings deposits and CDs, Interbank borrowing, Central bank funds, Commercial paper, Securities sold under repurchase agreements, Long-term debt, Equity. Net interest margin: assets yield 6.2%, funding costs 2.9%, NIM 3.3%.

Central bank funds market: Bank A, with surplus reserves, lends overnight to Bank B, which is short of required reserves, at the central bank funds rate. If no bank lends, Bank B can borrow from the central bank against collateral at a higher rate.

Asset-backed commercial paper in two steps. Step 1: the bank sells short-term loans to a special purpose entity and receives cash. Step 2: the entity issues ABCP to investors, who pay cash. The bank gives the entity a backup line of credit.

Box sizes are illustrative, not data.

The net interest margin is what the bank keeps: the return on its assets minus the cost of its liabilities.

Net interest margin Use it
NIM=rassets−rliabilities\text{NIM} = r_{\text{assets}} - r_{\text{liabilities}}
Rearrange itNet interest margin: solve for margin, asset return or funding cost
The question asks for
A bank's loans and securities yield 6.20% and its funding costs 2.90%. Its net interest margin is closest to:

6.20% − 2.90% = 3.30%

Net interest margin3.30%

On your calculator
  1. 6.2−2.9=
  1. 6.2ENTER2.9−

ENTER enter (on the HP, puts the number on the stack)

Which deposits are the stable core?

Household and commercial deposits are the primary short-term funding for most banks. Checking accounts have no stated maturity, pay little or no interest and can be withdrawn at any time. Even so, balances are stable in normal times, because the bank attaches services to them: fee rebates, uncommitted credit lines and so on. For large depositors, operational deposits generated by clearing, custody and cash management are also relatively stable. Other large demand deposits are less attractive, because rules require banks to hold liquidity reserves against them.

Savings deposits are held for non-transactional purposes and often have a stated term. A deposit with a set maturity and interest rate is a certificate of deposit (CD). CDs typically mature in under a year and pay interest at maturity.

Certificates of deposit
Certificate of depositfixed term (under one year), interest paid at maturity
  • Non-negotiable CD Memorize paid to the first depositor, penalty for early withdrawal
  • Negotiable CD Memorize can be sold in the market before maturity
    • Small-denomination Know the idea aimed at retail investors
    • Large-denomination Use it wholesale funding from institutions

A non-negotiable CD pays principal and interest at maturity to the original depositor, with a penalty for early withdrawal. A negotiable CD lets the holder sell it in the open market before maturity. Large-denomination negotiable CDs are a common source of wholesale funding from institutional investors.

What is wholesale funding?

Wholesale funding comes from other financial institutions and investors rather than from depositors.

  • The interbank market is short-term borrowing and lending among financial institutions, on a secured or unsecured basis. Unsecured loans run from overnight to a year at a rate tied closely to a market reference rate. Banks build credit risk into the rate and set counterparty limits.
  • Banks must hold reserves at the central bank, and some run short while others hold a surplus. The central bank funds market solves the imbalance, at the central bank funds rate . Central banks target that rate (or a range) through open market operations or interest paid on reserves.
  • A bank that cannot borrow from other banks can borrow directly from the central bank as a last resort at the discount window . This requires posting collateral, may bring greater oversight and restrictions on the bank’s activities, and costs more than the central bank funds rate.
  • Commercial paper: large financial institutions dominate issuance, around 60% of the annual volume. They use it for short-term needs and sometimes to fund longer-term assets such as loans, so they face rollover risk too.
  • Asset-backed commercial paper (ABCP) is a secured form of paper.
  • Repurchase agreements are the most common secured interbank borrowing, covered in the next lesson.

How does ABCP work?

  1. The bank agrees to transfer short-term loans to a special purpose entity (SPE) in exchange for cash.
  2. The SPE issues ABCP to investors, with a backup credit line provided by the bank.

The financing is not recorded on the bank’s balance sheet. The bank gets cash when the paper is issued and cuts its capital cost by providing undrawn backup liquidity in place of holding the loans to maturity. Investors buy a liquid, short-term note paid from a loan portfolio they could not otherwise reach.

The market grew fast before the global financial crisis, partly because short-term notes were being used to fund long-term assets. Many issuers could not roll the paper at the peak of the crisis and numerous SPEs failed. Afterwards, ABCP went back to funding mainly short-term, generally high-quality loans and receivables.

Go deeper Why liquidity rules treat deposits differently

Rules that require liquidity reserves look at how likely a deposit is to leave in a stress. Retail balances and operational deposits tied to services are sticky, so they count as more reliable funding. Large demand balances held for no particular service can leave overnight, so the bank must hold more liquid assets against them. That is why the same dollar of deposit is worth different amounts to the bank.

Go deeper The ABCP freeze as a rollover case

ABCP is a clean example of rollover risk. Short-term paper funded long-term assets. When investors stopped buying new paper, maturing paper could not be repaid from new issuance, and sponsors’ backup lines were called on. No figures are needed: the lesson is that matching a short funding source to a long asset only works while the market stays open.

Go deeper How the central bank steers the funds rate

The central bank targets the funds rate by adjusting the supply of reserves through open market operations, or by changing the interest it pays on reserves. Repos are a common tool for temporary changes. This links bank funding to monetary policy, covered in the economics topic.

Memorize this

MemorizeFunding terms

SourceKey fact
Checking / demandno stated maturity, pays little or no interest, stable with services attached
Operational depositfrom clearing, custody, cash management, relatively stable
Non-negotiable CDcannot be sold, penalty to withdraw early
Negotiable CDcan be sold before maturity
Central bank funds ratebetween banks, targeted by the central bank
Discount windowfrom the central bank, last resort, higher rate, collateral

Memory hook Funds rate is a bank-to-bank rate; the window is the central bank as lender of last resort, so it costs more and comes with scrutiny.

Know it cold NIM = return on assets − cost of liabilities. ABCP: bank sells loans to an SPE, the SPE issues the paper, the bank provides the backup line, and it is off the bank balance sheet.

Where a bank gets short-term funding
Bank short-term fundingborrow short from many places to lend out
  • Deposits Memorize core funding, from households and firms
    • Checking (demand) accounts Use it no maturity, little or no interest, stable thanks to attached services
    • Operational deposits Use it from clearing, custody and cash management, relatively stable
    • Savings deposits and CDs Memorize often a stated term; CDs pay interest at maturity
  • Wholesale funding Memorize raised from other institutions and investors
    • Interbank market Use it unsecured loans, overnight to one year, priced off a reference rate
    • Central bank funds market Memorize surplus-reserve banks lend to short banks at the funds rate
    • Commercial paper Use it about 60% of issuance is by financial institutions
    • Asset-backed commercial paper Memorize issued by an SPE, backed by loans, bank backup line
    • Repos Use it secured interbank borrowing, next lesson
  • Last resort: discount window Memorize central bank lends against collateral at a higher rate, with oversight
Certificates of deposit
Certificate of depositfixed term (under one year), interest paid at maturity
  • Non-negotiable CD Memorize paid to the first depositor, penalty for early withdrawal
  • Negotiable CD Memorize can be sold in the market before maturity
    • Small-denomination Know the idea aimed at retail investors
    • Large-denomination Use it wholesale funding from institutions
Net interest margin Use it
NIM=rassets−rliabilities\text{NIM} = r_{\text{assets}} - r_{\text{liabilities}}
Quick example

Assets yield 7.15% and funding costs 3.60%. 7.15% − 3.60% = 3.55%.

On your calculator
  1. 7.15−3.6= 3.55
  1. 7.15ENTER3.6− 3.55

ENTER enter (on the HP, puts the number on the stack)

How it is asked

  1. Sellable fixed-term deposit

    A fixed-term deposit that can be sold before maturity is a ...

    Negotiable CD. Trap: non-negotiable CD (fixed term, but withdrawal only with a penalty).

  2. Short of reserves

    A bank is short of required reserves tonight. Where does it first borrow?

    Central bank funds market. Trap: discount window (last resort, higher rate).

  3. ABCP structure

    In an ABCP program, who issues the paper and who provides the backup line?

    The SPE issues; the bank provides the backup line. Trap: bank issues; loans stay on balance sheet.

  4. Net interest margin

    Assets yield x%, funding costs y%. NIM?

    x − y. Trap: dividing, or using the loan rate only.

Exam traps

  • Saying asset-backed commercial paper stays on the bank's balance sheet. It is off balance sheet, with the bank as sponsor and backup provider.
  • Confusing the central bank funds rate (between banks) with the discount window rate (from the central bank, higher).
  • Thinking non-negotiable CDs can be sold. Only negotiable ones can.
  • Treating all demand deposits as equally stable. Operational and retail balances are the sticky ones.

Checkpoint

4 exam-style questions. About 90 seconds each.

  1. 1A depositor wants a fixed-term bank deposit that can be sold to another investor before maturity. This is best described as a:

  2. 2A bank that is short of required reserves at the end of the day would most likely first borrow:

  3. 3In an asset-backed commercial paper program, the bank sponsor most likely:

  4. 4A bank's loans and securities yield 5.80% and its funding costs 2.35%. Its net interest margin is closest to:

Key takeaways

  • Deposits are banks' core funding. Operational and retail deposits are the most stable.
  • CDs have a fixed term of under a year. Only negotiable ones can be sold before maturity.
  • Wholesale funding: interbank, central bank funds, commercial paper, ABCP and repos.
  • ABCP moves short-term loans off the balance sheet into an SPE, backed by the bank's liquidity line.
Net interest margin Use it
NIM=rassets−rliabilities\text{NIM} = r_{\text{assets}} - r_{\text{liabilities}}
Quick example

Assets yield 7.15% and funding costs 3.60%. 7.15% − 3.60% = 3.55%.

On your calculator
  1. 7.15−3.6= 3.55
  1. 7.15ENTER3.6− 3.55

ENTER enter (on the HP, puts the number on the stack)

All Fixed Income formulas, every lesson

Practice exam-style questions on Fixed-Income Markets for Corporate Issuers

Questions about this lesson?

Where this comes back

Questions candidates ask

What is the central bank funds market?

The market where banks with surplus reserves at the central bank lend them, usually overnight, to banks that are short, at the central bank funds rate. The central bank targets that rate.

What is asset-backed commercial paper?

Short-term notes issued by a special purpose entity and repaid from a pool of loans or receivables. The sponsoring bank usually provides a backup liquidity line, and the financing sits off the bank's balance sheet.

What is a negotiable certificate of deposit?

A fixed-term deposit that can be sold in the market before it matures. A non-negotiable CD can only be redeemed early at a penalty.

Spotted an error? Tell us and we will fix it.

  1. Short-term funding for companies: credit lines, secured loans and commercial paper
  2. How banks fund themselves short term
  3. Repurchase agreements (repos)
  4. Long-term funding: investment-grade vs high-yield issuers

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