Refinancing is the generation of liquidity or the raising of money through commercial banks in order to then provide loans to industry or private persons.1 Refinancing costs are dependent on the current market interest rate and the liquidity costs of a bank. The market interest rate is based on the current interest rates for the fixed interest for a loan. The interest rate is derived from reference rates such as Euribor or the swap rate. The liquidity costs are the interest expenses for the procurement of liquidity by the bank for the duration of the liquidity commitments for the respective loan. They are dependent on the type of collateral for the loan and the credit rating of the respective bank. The higher the bank’s credit rating and the higher the loan’s collateral, the lower the liquidity costs.2
This transformation process is one of banks’ original activities. They act as a (financial) intermediary between capital supply and demand. The bank accepts deposits and grants loans. The transformation functions of a bank include the lot size transformation, maturity transformation and risk transformation. By successfully integrating all these functions, the bank is able to remain liquid in the long term and to issue loans. Lot size transformation means that individual deposits by savers and the loans issued by the bank do not have to be in the same amount. Rather, the bank forms pools of offsetting deposits and loans.
With maturity transformation, the bank controls the structures of the assets and equity/liabilities sides of its balance sheet. The loans issued are on the assets side, while equity/liabilities side includes deposits by savers. Maturities generally match one side and not the other. Rather, loans are normally issued on a long-term basis, while savings deposits can often be cancelled at relatively short notice. By structuring their assets and equity/liabilities sides, the bank must ensure that there is no risk of liquidity or earnings difficulties at any time.
While borrowers’ repayment obligations entail some uncertainty, savers demand a guaranteed repayment of their deposits plus a reasonable return. In risk transformation, through measures such as portfolio management, credit monitoring, equity liability or incentive-based contracts, the bank must compensate for the uncertainty of default in order to guarantee the repayment of the deposits due at all times.3
In addition to refinancing from savings deposits or borrowing through central banks, banks lend each other money for refinancing or place bonds on the capital market. To refinance property loans, mortgage banks issue mortgage bonds, in which investors can participate by buying into the bank’s loans.4
The goal of the refinancing of investments by companies or other investors is also to recover the funds invested at more favourable conditions than those received from the original investment. A common reason for refinancing by property companies is the expiry of a loan that was borrowed for a property with a longer holding period than the original term of the loan.
Potential refinancing providers for companies include banks, the capital market or other capital providers (e.g. private equity).