MMFs: Basle II could reshape European overnight market

Money market funds could be an attractive alternative to inter-bank deposits under Basle II, according to a report commissioned by specialist MMF provider, AIM Global.

Because they are corporate entities, MMFs are currently 100% risk weighted in Europe. Under Basle II’s internal rating based (IRB) approach, MMFs will be collective investment undertakings. AAA money market fund risk weightings will drop to 20%. Capital requirements could be as low as 15% for banks under the foundation IRB approach, or even to 2% for banks using advanced IRB.

In the past, banks have used MMFs to get cash off their balance sheets. “We hope banks will start to look at MMFs as both on- and off-balance-sheet tools,” says Marc Doman, managing director, AIM Global. “A bank might not just see them as a way of lowering its capital employed but also as a way to fund a more diverse spread of loans or investments. They will have a dual role.” The potential flow of funds from banks into MMFs is huge. The UK and eurozone overnight market is worth $3.2 billion equivalent. “Smarter European bank treasurers already want to make money on deposits and to diversify themselves away from European banks under UCITS 3 by using MMFs.”

Advanced IRB lets investors look through funds to underlying assets. “The biggest practical problem in getting a low risk weighting is the look-through,” says Doman. “We need to know how often a bank needs to be advised on what assets are in an MMF, and to what level of detail.”

Larger inter-bank deposit players could take advantage of the changes to develop their own MMF funds. Smaller banks could offer MMFs to clients via white labelling. But it’s hard to predict in detail how different banks will use MMFs under Basle II.

“This makes sense,” says Richard Harding, senior manager, capital raising and term funding, group treasury, at RBS Financial Markets. “But if you’re a big bank you probably use MMFs anyway or, like us, you are a provider of funds but not a big user of them because you see them as products for the smaller investor.”