Assistant treasurers are struggling with banks’ new customer valuations under regulatory pressures.
AT30 members have taken notice of how regulations are pressing banks to change their behaviors in order to meet government-imposed financial hurdles. This in turn is changing how banks value their clients. Members also discussed payment technology and capital structure.
1) DF + B3 + QE = Trouble for Cash Management. Banks are so severely penalized for breaches of regulatory compliance that they will turn away certain deposits at quarter end to ensure they meet capital and liquidity ratio requirements.
2) Capital Structure: Cash and Credit. The question of how much cash should be on the balance sheet is really only part of the bigger question of how much liquidity do I need in the worst-case scenario and what is the appropriate mix of sources for that liquidity?
3) Assessing Client Value. Banks are pushing more holistic relationships to bolster the value equation, but members believe banks still have to earn their business. More members than banks are behind terminations of relationships.
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Counterintuitive Regulations
These days, banks are exhibiting some bizarre behaviors. 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.
One group member 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, a time deposit was clearly stickier than operating cash.
DF + B3 + QE = Trouble for Cash Management
Bank regulations have been on treasurers’ radar screens for years, but now things are getting real. The capital requirements on banks from Dodd-Frank and Basel III are affecting product offerings and how they do business, including never-imagined negative interest rates and rejecting cash deposits. 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. This affects the cash management strategies treasurers can utilize for their global activities and which banks they should rely on.
Key Takeaways
1) 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 it 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 that it will not pursue that goal. Regulators are motivating banks to fundamentally have (1) less leverage, (2) more liquidity, (3) more capital, and (4) less ability to do 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.
2) What have we done? Chris Paton, Managing Director and Head of Global Liquidity Product Management at BAML, says regulators are “overwhelmed.” The big regulation of 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.
3) 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. With interest rates so low and the yield curve so flat, the borrow-short-lend-long model is not productive. “Banks need to have a plan B for hitting earnings targets without any rate increases,” Mr. Paton noted.
Outlook
With many more regulations still to be written, there is no reason to believe the environment will improve, and it is quite possible additional counterintuitive 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.
Bank Interoperability and Emerging Payment Technology
In the immediate aftermath of the financial crisis, many corporates explored the idea of creating parallel banking set-ups to be able to continue operations seamlessly if a key bank ran into trouble or was downgraded to a point where policy would no longer allow business with it. At the time, these efforts were abandoned due to cost and lack of true “plug & play” compatibility. Now, with increased standardization in communication channels and messaging formats, might there be an opportunity to revisit the idea to enable a more nimble response to RBS-type business exits or better service offerings elsewhere?
A slight majority of members use SWIFT for payments, reporting and other activities, but no one believes this technology enables them to make a quick turnkey switch from one bank to another. Most concur that while file formats are very similar between banks, they are different enough that switching banks would require the normal amount of IT interaction and file testing and therefore offers little benefit. Both BAML and members agree that you have to get the right IT people from the company and the bank in the same room to communicate.
Capital Structure – Cash and Credit
When growing cash balances are returning nothing, it is prudent to ask how much you should keep on hand. The answer depends on many variables, such as location of the cash, borrowing capacity, and prospective M&A activity. And when you return it to shareholders, what method is best? For those in the debt markets, what approaches are being taken to optimize bond and CP issuance? This session sought to answer a key question among members: “How much cash should be on the balance sheet?”
Key Takeaways
1) Cash vs. liquidity. The question of how much cash should be on the balance sheet is really part of the bigger question of how much liquidity a company needs. Liquidity comes in several forms, of which cash is only one. Other sources of liquidity can include short-term debt such as CP and revolvers and receivables.
2) Imagine your worst liquidity crunch. Generally, considerations should include: (1) maximum working capital requirement by currency, (2) downside scenario for rolling 12-month operating cash flows over the next five years, (3) largest total payment obligations (capex, dividends and debt repayments) due within any 12-month period over the next five years, and (4) contingent obligations.
Once you have monetized these variables and any others of significance you can employ them in the following liquidity formula:
3) Cash vs. debt. This liquidity planning process also requires determining how much of the liquidity should be cash and how much should be debt in a stress scenario. There are numerous considerations here such as how much cash you have and generate and your credit rating and tolerance for downgrade.
Right-sizing the debt then drives your decisions on how many banks to include, what banks they should be and how much wallet you have to spread with them. Also included is the type of debt to utilize — revolver, CP or bonds. Each has functional and bank-relational elements to consider.
Outlook
The answer to the question of how much cash to keep on the balance sheet is not quite the right question. How much liquidity does a company need in a stress scenario, and of that liquidity, how much should be cash, is the better question. Stress scenarios are inevitable whether they are macroeconomic or of one’s own making. Consequently, that context is appropriate for the analysis.
How to Be a Valuable Bank Client
With banks’ evolving valuations of clients, what should corporates do to stay on the preferred list? BAML listed three areas they encourage members to focus on:
- Align and consolidate deposits and payments. 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.
- 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.
- Invest in off-balance sheet products. According to BAML’s Head of Technology, Media, and Telecom Corporate Banking Jeff Rothman, “Credit is no longer the issue at the bank. Managing the balance sheet is the issue. There is a cost to taking deposits. The bank has to hold six percent of their capital against it.”
Assessing Client Value
There is a shift in business that banks prefer and don’t prefer. Clearly, if banks are losing interest in certain cash balances and depository business, companies that bring that business are likely less desirable. Leading a session on what makes a valuable customer in the eyes of the bank, Jeff Rothman, Head of Technology, Media, and Telecom Corporate Banking with BAML, emphasized the need for a lot of communication and collaboration between corporations and their primary banks.
Key Takeaways
1) Clients (and banks) need to see the big picture. Mr. Rothman 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. Mr. Rothman noted that there are many 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.
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. One member advises his banks to not over-commit to the revolver if he doesn’t think he can provide sufficient ancillary business. And if banks decide the relationship isn’t working for them, then this company is happy to “return them to prospect status.”
2) Undesirable business. One member asked Mr. Rothman if credit is really a loss leader. “Yes” was the resounding answer. “Unfunded revolvers are a negative return” because capital has to be reserved. Other loss leaders include banking center deposits and vault services, plus the age-old service of lockbox processing. One example of an innovative new product that will contribute to the displacement of undesirable business is digital disbursements, a technology consortium of five large banks that utilizes payee cell phone numbers and email addresses to issue payments. BAML and members were quite enthusiastic about this product.
Outlook
“Something has gone terribly wrong with the system.” That 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 long way 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.
Conclusion
After several years of warnings from banks that financial regulations are going to have a radical impact on the historical norms of banking products, services and relationships, the fall meeting of the AT30 confirmed that those changes are arriving. Higher fees used as a disincentive, reduced or eliminated service offerings, and limits on cash balances are all behaviors that customers such as AT30 members would never have imagined just a year ago. We can expect more significant alterations to the traditional banker/client model as banks focus primarily on managing their balance sheet.
Hopefully, banks will continue to develop innovative solutions to longstanding problems such as digital disbursements to eliminate the expensive overhead associated with one-time payments.