Short-term liquidity management is essential to long-term strength and stability. Funding is a fundamental part of this. Recent regulations have been created to ensure that banks have stable sources of funding, which are critical to banking system resiliency. The resulting measures have signaled to corporate treasurers that placing cash with banks now means lower risk and greater security.
A primary outcome of the regulations is that banks are placing a more discerning lens on the kind of deposits they take and subsequently how they capitalize against risk for certain types of deposits. This, in turn, impacts how both companies and financial institutions plan for and manage their short-term liquidity.
What makes cash balances reliable funding? The answer can be parsed three ways:
|Quality looks at deposits generally, more finely distinguishing between operating and non-operating balances.||Consistency considers the day-to-day reliability of balances.||Timeliness measures stability throughout the day (i.e., intraday).|
These are distinct yet mutually reinforcing aspects of reliable funding. Regulatory-driven changes related to each will likely affect your balance management and funding practices.
Regulatory focus on balance quality continues in 2016. Banks must ensure they have sufficient high quality liquid resources to survive an acute stress scenario lasting 30 days. What are termed operating balances by the regulations are considered more stable despite being liquid, since they link to daily business flow and are less easy to withdraw suddenly. Therefore, the placing of your operating balances promotes the short-term resilience of a bank’s liquidity risk profile.
The net effect is that banks want to attract operating balances. To ensure your deposits qualify, banks must quantify the relationship between your deposits and your transactional activity. Any funds not immediately supporting payment flows for daily operations must be treated as non-operating balances.
Your non-operating balances are less valuable to banks, because they must be placed in High Quality Liquid Assets (HQLA). This excludes them as a funding source for a bank’s larger asset books and attracts FDIC and capital charges, among other costs. Within the U.S., the Federal Reserve introduced guidelines in December 2014 that subject Global Systemically Important Banks (G-SIBs) to higher capital costs for non-operating balances than non-G-SIBs.
Certain deposit products will be decidedly less attractive for banks to offer, particularly in the U.S. where differences in regulatory treatment, including G-SIB capital requirements, have curbed some short-term investment alternatives. Those with less than 30 days duration are most impacted, including Money Market Deposit Accounts, time deposits, hedge-fund deposits, Fed Funds traded and certain types of liquid regulatory cash.
In light of the effects of quality as a measurement of stability, you may need to:
Regulators consider sound sources of bank funding less likely to erode a bank’s liquidity position. A sustainable funding structure decreases the risk of bank failure and the potential knock-on effect of broader systemic stress. The net stable funding ratio (NSFR) measures this sustainability. Consequently, banks value customer deposits with a stable core as a source of reliable funding and contributor to the NSFR.
As banks more finely analyze your operating balances predictability serves as a key indicator of consistency. The very nature of operating balances is that they fluctuate from day-to-day, which is different from balance volatility. Spikes in deposits that relate to out-of-the-norm, non-repetitive events create day-to-day volatility, and banks must classify these funds as non-operational balances. For example, pre-funding your account to cover a large payment creates unevenness at the time of deposit and cash outflow. This qualitative difference in the treatment of your balances has a quantifiable impact on how banks view your operating cash and how you must manage it on a daily basis.
The challenge for companies becomes two-fold: how to even out daily operational flows, fluctuations, which have differing degrees of variability depending on the underlying business, and how to manage true balance volatility.
One way to achieve consistency and manage balance fluctuations is to consolidate operating flows with fewer cash management providers since a portfolio effect can accrue with larger consistent balances.
To address balance volatility, expect your banks to suggest tools to help you manage your flows. Prefunding is one such tool. In the case of a large M&A transaction, for example, your bank will likely work with you to coordinate the timing of transaction funding to minimize volatility.
In response to the impacts of consistency as a component of stability, you may need to:
Intraday liquidity (IDL) is defined as the cash or liquid assets available to meet payment obligations plus intraday limits (uncommitted credit lines [IDL]) and is increasingly in the purview of regulators and banks.Banks must actively manage their cash positions and related risks on a timely basis throughout the day under normal and stressed conditions as part of the smooth functioning of payment and settlement systems. U.S. regulators view IDL as vital to payment system liquidity. As a result, balance stability considerations must include intraday limit utilizations.
Today, intraday mismatches between payments and liquidity exist as there areneither explicit capital charges for intraday liquidity, nor is there a substantial short-term liquidity supply. This treatment is changing, however, as regulators consider formal reporting requirements of key IDL metrics for banks. The result is to increase IDL transparency and potentially the cost of its usage in the future.
Mismatches between your cash inflows and outflows require banks to deploy IDL. Payment prioritization and timing are essential to matching cash flows throughout the day. Banks will look to corporations to self-fund their accounts during the course of each day.
Increasing bank operating deposits in your deposit account to support payments can facilitate balance sheet stability and reduce the use of intraday bank credit lines. Reviewing sources, uses and timing of funds is crucial, and pre-funding accounts can greatly relieve IDL pressure. This may require your treasury group to change its investment practices where short-term and overnight placements divert liquidity from where it is required.
As IDL comes more into focus as a driver of balance stability, you will want to measure and analyze your IDL usage and change the way you manage IDL. This means you may need to:
Since 2008, quantitative easing programs and interest paid by the Fed on cash reserves bolstered Central Bank reserves and flooded the financial system with liquidity. As the Fed unwinds these effects, the U.S. banking system will gradually return to normal liquidity levels. Reduced market liquidity will further drain bank reserves and overall market cash balances.
This dynamic will introduce a fourth dimension to the equation for active cash management as it could further compress market liquidity management demands. This will heighten the emphasis on quality, consistency and timeliness as interrelated, mutually reinforcing aspects of banking system resiliency. Market participants will need to focus even more attention on their liquidity management strategies.
Promoting a sound banking system will necessitate changes in how banks define, measure and manage balance stability. Given the interconnectedness between a bank’s own stable funding and the balance management practices of its clients, these changes logically will affect corporate liquidity management demands on both participants. The market is beginning to experience the impact of distinct yet interrelated reform measures under Basel III and other regulatory measures. The effects will intensify as market liquidity continues to normalize.
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