In Wake of NIRP/ZIRP and Basel III: Down is Up and Up is Down

By Ursula Conterno

How market conditions compounded by regulation changes are changing the banking industry and balance of power between corporates and banks in their cash management relationship. 

It’s still fresh in our memories: a time when banks valued corporate cash deposits and actually competed for them. After all, deposits were the foundation on which the banking business and financial intermediation were built. Banks marketed different liquidity structures to attract corporate cash. And cash was one more tool on the treasurer’s belt to manage their banks’ share of wallet while balancing counterparty risk.

What a difference a crisis makes. Nowadays, it’s a new and different reality according to discussions heard at The NeuGroup’s Global Cash and Banking Group (GCBG) and Tech20 Treasurers’ Peer Group’s (Tech20) latest meetings. Low or negative interest rates (ZIRP and NIRP) and changes in regulations are making deposits too expensive for banks to hold; and complicated structures are becoming increasingly costly and unprofitable, and possibly headed to extinction. At the same time, corporates are holding more cash than ever in an environment in which too much cash reduces their negotiating power.

Accepting deposits has become expensive…

At the last GCBG meeting in May 2015, sponsor Deutsche Bank highlighted the fact that “recent steps in monetary policy have resulted in an unprecedented landscape of negative rates for many European currencies,” which have spilled over to traditional corporate investment options like money market funds and sovereign yields. In this context, European banks have to pay for overnight deposits held with the ECB or get very small and sometimes negative returns on alternate investments.

… and Basel III jacks up the price

Basel III introduced new Liquidity Coverage Ratio (LCR) requirements to ensure banks have enough liquidity to manage a cash run-off in a 30-day period. This means that the expected run-off rate will need to be offset by the bank holding low-return High Quality Liquid Assets (HQLA). The run-off rate varies depending on the industry sector of the depositor (corporates vs. financial institutions), the term of the deposit (under 30 days vs. over 30 days) and the usage of the funds (operating vs. non-operating), with little clarification on how to define the latter, which in turn leads to different interpretations from bank to bank.

Also, Basel III introduced a new leverage ratio to prevent banks from over-leveraging their balance sheet. Although not fully implemented yet, both changes increase the cost of holding the deposits and providing financing in the long term, and banks are already preparing for that.

There are implications for corporates too

As Dan Blumen from Treasury Alliance Group put it at the recent EuroFinance conference, “Something big is happening to banks’ balance sheets—and that has to be big for you.” In other words, the buck is not stopping at the banks. According to Mr. Blumen, the first items to be affected are likely cash management services such as cash pooling and concentration, and also short-term funding and investment. In terms of borrowing, he expects corporates to see a more direct link between risk rating and cost, while long-term lending is becoming more challenging.

As discussed in a previous online article (see “The Cash Manager’s Challenge”), enough treasurers have by now experienced banks turning away the company’s cash when it is too sizable for them to manage under new liquidity requirements; or paying more for cash in jurisdictions where they need liquidity (often in higher-yielding currencies where it is more difficult to pool). Banks are fighting an ongoing battle with the types of deposits they want and those they don’t.

While most cash-pooling structures offered by banks (and their underlying operational deposit accounts) have so far survived the LCR rules, their survival has not come without the additional costs in capital or liquidity charged by the banks offering them. In addition, they are still going to be tested by the Net Stable Funding Ratio (NSFR) rule and other ongoing bank regulation interpretations in jurisdictions around the world, as well as to various forms of ring-fencing to prevent too much liquidity from leaking across borders.

These measures will make cash-pooling structures, and especially the cross-border variety, more costly for banks to provide over time. Further, under the new rules, the operational nature of notional cash pools is harder to justify. Also, some banks may not be able to net opposite sides of notional pools anymore and may require cross guarantees, effectively increasing the cost of these structures. In this environment, it is hard to see how notional cash pooling will be able to survive.

Until that happens, there are some actions that treasurers can take in the short- and long term (see box below).