New liquidity rules prompt mutual back scratching between banks and corporates
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New liquidity rules prompt mutual back scratching between banks and corporates

The ground-breaking liquidity coverage ratio (LCR) has triggered a quiet revolution between banks and corporates in liquidity management practices, with both seeking more price-competitive products as new regulations begin to bite.

The new Basel III liquidity framework is set to come into force in 2015, but ahead of implementation banks are finding new ways to manage corporate cash, which brings benefits for themselves and their clients. The framework requires banks to maintain a 30-day LCR, designed to ensure there is sufficient high-quality liquid resources on hand to survive an acute stress scenario lasting for one month.

The ratio identifies the amount of unencumbered, high-quality liquid assets an institution holds that can be used to offset the net cash outflows it would encounter under a short-term stress scenario.

The advent of the new rules is leading to a revolution in the relationship between lenders and corporate treasurers, with the former aiming to persuade companies to change their behaviour in respect of liquidity management and the latter redeploying excess liquidity to generate returns, based on consultations with banks.

After years of cautious investment and improved earnings, companies are in a particularly strong cash position, with the top 50 global companies holding around $1.9 trillion in cash, according to an estimate in October by Bank of America Merrill Lynch.

Michiel Ranke head of investment services, international liquidity and investment management, RBS Global Transaction Services

Michiel Ranke, head of global product development i-LIM and FX at RBS

“There is a much better mutual understanding between the bank and the client as to what they need,” says Michiel Ranke, head of global product development i-LIM and FX at RBS in Amsterdam. “We are moving into a new world of behavioural balances.” The LCR assigns a range of run-off rates to different types of liabilities. Each dollar of assumed run-off requires an offsetting dollar of liquid assets, and the rules provide explicit run-off assumptions for liabilities and haircut assumptions for liquid assets.

Banks understand that deposit liquidity risk is largely due to unexpected run-off and the key idea behind behavioural balances is to assess client behaviours that correlate to the likelihood of run-off.

That means modelling the customer relationship, cash-management practices and usage of non-deposit products, such as credit and transaction services, with the understanding that overstatement of deposit run-off risk results in excess liquidity buffers and reduced earnings potential.

The customer relationship is key because various categories of deposits attract different run-off assumptions. For example, wholesale deposits without attendant transaction banking assume 75% run-off, whereas wholesale deposits with transaction banking are subject to only 25% run-off.

Under Basel III, you need to have daily cash management or custody business from a client to be able to partly use the client's deposit for funding,” says Sigrun Eggen Fredriksson, head of transaction banking at SEB in Norway. “Previously it was the case that all deposits were valuable but now it’s a case of which deposits are good from a funding perspective, thus we want to pay more for valuable deposits and less for those that are less valuable to the bank.”

To attract longer-dated deposits, banks have launched an array of account options in the recent period, typically with 35-day or 95-day call options embedded and often combined with incentives to leave the cash on deposit for longer. Barclays, Société Générale, Lloyds and RBS are among banks to have launched 95-day accounts, often with floating rate balances tied to Libor.

In the US, banks with global businesses are offering managed rates to corporate clients, one banker said, giving them the ability to either provide certainty over a prescribed term or respond to the need to attract liquidity when wholesale markets are under stress.

Banks are also spending much more time talking to clients about cash management, often helping upgrade forecasting processes to ensure that treasurers are not sitting on excess cash that could be put on account. In addition, with the rising cost to banks of providing overdrafts, it makes sense to help clients release cash from internal processes.

“We are talking to clients about improving the accuracy of their forecasting and to make sure they do not leave working capital tied up when it could be better employed elsewhere,” says Eggen Fredriksson.

Alongside those conversations are regular reviews of deposit rates, previously a decision that would be taken as seldom as once a year. That is partly because of increased volatility in the funding markets.

“Currency rates can be extremely variable and that means that the cost of wholesale funding can move substantially over a short period,” says Eggen Fredriksson. “Of course when funding in the wholesale market is tougher you are going to find it easier to justify pricing up deposits and when you have excess funding the deposit rates go down again.”

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