By Bryan Richardson
Finally saying hello to the long-awaited consequences of Dodd-Frank and Basel III, some banks are saying good-bye.
Bank regulations have been on treasurers’ radar screens for years, but now things are getting real. As noted in the takeaways from 2015, the capital requirements on banks from Dodd-Frank and Basel III are impacting product offerings and how banks do business, including never-imagined negative interest rates, rejecting cash deposits and shockingly, telling good customers to take some parts of their business elsewhere. This change in infrastructure is resulting in new client-valuation models and philosophies at the global banks and uncertainty among corporates about product sustainability and relationship stability. All of this, in turn, affects the cash management strategies treasurers can utilize for their global activities and which banks they should rely on.
At a September meeting of The NeuGroup’s Assistant Treasurers’ Group of Thirty (AT30) sponsor Bank of America Merrill Lynch, described in raw detail the dramatic impact these regulations are having on global banks, which went a long way in explaining some of the more bizarre behaviors banks are exhibiting lately. Notably, many members have been asked to take their deposits elsewhere, particularly on the last day of a quarter when banks need to report certain capital and liquidity ratio levels. Some members have also been informed by their banks that certain types of services are being eliminated, greatly reduced, or re-priced with enormous increases. Such services include banking center deposits and vault services.
The shifting sands of global banking. It is presumed that regulators are seeking to simply ensure a safer financial market. And depending on what you define as safe, their plan is working. Some believe the market is safer if the mega-banks are smaller, more liquid, or have the right customer base. And indeed banks are reacting in sometimes shocking ways in response to these regulatory incentives. JP Morgan has said they will kick out $100bn in deposits. HSBC and Citi have made similar claims. Wells Fargo has said it is simply too tough to be a global bank and they will not pursue that goal. Regulators are motivating banks to fundamentally have (1) less leverage, (2) more liquidity, (3) more capital and (4) do less business with other banks, governments and hedge funds in favor of more business with regular companies and consumers. And they are driving this shift by setting harsh financial targets for the banks.
What have we done? Experts say regulators are “overwhelmed.” Basel III is not actually a regulation but a guideline by which countries are to write their own regulations. Naturally, the guidelines are subject to interpretation by each jurisdiction. The US position is to let everyone else write their regulations first and then one-up them with even tougher regulations. There is still much regulation to be written and it all requires some study and evaluation prior to finalizing. Of the rules already written, many have imposed more burdens on banks than regulators can monitor or manage. One example cited at the AT30 meeting: since July, banks have had to report their Liquidity Coverage Ratio (LCR) (enough high-quality liquid assets to cover cash outflows for 30 days) on a daily basis. This reporting is a huge burden for banks to produce but also for regulators to monitor. Regulators are also reviewing how employees are compensated and incented to ensure they are not motivated to engage in risky behavior.
What is a “sticky” deposit? One AT from a large pharmaceutical firm cited a situation where a time deposit was maturing and the bank was reluctant to renew it because the term of the deposit was in a tenor that worked against the bank’s liquidity ratio. The bank wanted the company to simply convert it to operating cash because regulators viewed that as more “sticky” since it is considered money required for operations. However, the member argued that a time deposit was clearly more sticky than operating cash. This illustrates the point that a lot of the regulations are counter-intuitive. Another member from a global consulting firm added that because of the negative interest rates in Europe, they are keeping only bare-minimum deposit levels in their euro pool.
It’s tougher to make a buck. Aside from the added overhead of regulatory compliance, making a profit in the banking business is downright tough. Banks historically make money by borrowing short and lending long. With interest rates so low and the yield curve so flat, this model is not productive. Banks need to have a plan B for hitting earnings targets without any rate increases.
Assessing Client Value
The logical extension of the regulatory discussion is how it will impact banks’ approaches to valuing their large corporate clients. There is clearly a shift in business that banks prefer and don’t prefer. For banks that are losing interest in certain cash balances and depository business, companies that bring that business are likely less desirable. Members were curious to know what makes a valuable customer in the eyes of the bank. Thus, there needs to be a lot of communication and collaboration between corporations and their primary banks.
Clients (and banks) need to see the big picture. Jeff described for the group the way they are viewed by the bank. Because of the increased capital requirements imposed by regulations, credit approval now also includes capital approval. The bank has to build the business case around the overall relationship to justify the credit extension and corresponding capital reserve, aside from establishing credit-worthiness. Jeff noted that there are a lot of bank service buying centers within large companies and treasury should be aware of them. He went on to explain that their client bankers have to have credibility internally which comes from accurate projections of client business. “It is important for clients to look at the full suite of banking services and drive business to their credit banks,” he noted.
From the client perspective, members take the view that banks still have to earn the business they are requesting and be realistic in their expectations.
Undesirable business. Is credit really a loss leader? The answer is “yes.” That’s because unfunded revolvers are a negative return as capital has to be reserved. Other loss leaders include banking center deposits and vault services, plus the age-old service of lockbox processing. Most surprisingly, however, is how cash deposits have gone out of favor, particularly at the end of a quarter. AT30 members shared numerous stories about banks calling clients at the end of the quarter asking them to relocate certain amounts of cash elsewhere.
What is the bank’s advice to clients? Here are four areas for members to focus on, according to BAML:
1. Align and consolidate your deposits and payments. As noted above, banks are happy to hold some types of deposits, specifically operating balances, but are not interested in high-volume low-value banking center or vault deposits. They are looking to reduce operating costs, so fewer transactions are better.
2. Improve cash-flow forecasting. One might wonder why a bank cares about your forecasting activities. The reason comes down to the cash deposits issue. Banks do not want to be surprised with an unexpected influx of deposits at quarter end or any other time that might be inconvenient. Quality forecasting enables the customer to communicate their cash-flow expectations to banks.
3. Invest in off-balance sheet products. Credit is no longer the issue at banks, managing the balance sheet is the issue. There is a cost to taking deposits. A bank has to hold 6 percent of its capital against it.
4. Collaboration. A higher level of open communication between the bank and customer is recommended. The bank is looking for a holistic relationship with a lot of touchpoints,” he noted.
Outlook Dismal
With many more regulations still to be written, there is no reason to believe the environment will improve, and it is quite possible additional counter-intuitive rules will be imposed. Banks are now more interested in managing their balance sheets than their credit portfolio, as that is what is being measured. Consequently, members can expect banks to continue to have unusual behaviors as they adjust to these new regulatory parameters driving their business.
“Something has gone terribly wrong with the system” was the lament from one member who had been told by a bank that certain depository services would no longer be provided. Indeed, it is illogical to see banks refusing deposits and to hold cash. Such is the world where over-zealous regulators are responding to political pressures rather than pursuing economically sensible reforms. Just as regulations are a longway from being completed, so upheaval in the banking system is likely far from over. Add this to the low-rate environment and banks will be struggling for the foreseeable future and passing their pain on to customers.