Riding the Basel wave

Feature | 27 March 2017

Andrew England looks at how banks and their corporates are finding ways to jump through Basel III's liquidity hoops and remain commercially viable

The effects of Basel III regulations, aimed at stabilising the global financial system and preventing another crisis like that of 2008, are commonly assumed to have been confined mainly to the banking sector. In reality, the effects on corporates are similarly profound, and bank-client relationships are now entering uncharted territory.

In light of Basel III's liquidity and leverage stipulations, banks are reassessing how they manage their balance sheets, while corporate clients are revisiting their banking relationships and the way they manage cash in the face of higher prices and and expanding range of services.

But instead of banks hunkering down in the face of change or shying away from corporate business, new techniques of measuring and monitoring liquidity are giving them an advantage, and some banks are beginning to generate new fee income. By helping clients manage their cash more effectively through cashflow forecasting and various liquidity solutions, banks are finding ways to ride out the sea change and secure a sustainable and profitable future for themselves and their clients.

Liquidity and leverage ratios changing the game

Making sure the right cash is in the right place at the right time (the basics of cash and liquidity management) can be relatively simple. But Basel III has changed the picture for bankers and corporate treasurers in unprecedented ways, and things are now looking significantly more complex.

For example, the leverage ratio makes certain types of loan products less attractive for banks to offer their clients, with shorter term transactions and riskier investments preferable. Meanwhile, the liquidity coverage ratio (LCR) - implemented to ensure the availability of reliable funding sources in the event of isolated bank stress events - is altering the bank-client relationship because banks are being required to categorise and consider the type of corporate deposits they are accepting.

Operational deposits are considered a relatively 'sticky' source of funding that is unlikely to be suddenly withdrawn from the bank, whereas non-operational deposits are classified as a form of short-term wholesale funding that has the potential to rapidly evaporate. Non-operational cash, according to Basel III, has to be backed by high-quality liquid assets (HQLA) that can be converted easily and quickly into cash in private markets in the event of a 30-day stress scenario.

Although HQLAs provide security, liquidity and reliability in a stress event, those benefits come at a price: limited or negative returns. Compared to the return potential for operating deposits used to fund loans, the return on non-operating deposits deployed against HQLAs is significantly less, limiting return potential for both the bank and the client. The rate of return banks offer to their corporate clients is therefore liable to change, and banks are already aligning their options against the deposits that have the best liquidity treatment, affecting how they price and position specific types of deposits, and to which types of clients.

The other side of the coin

In order to comply with these new regulations, some banks have withdrawn or scaled-back certain products and services. A few have even turned away corporate client funds. But many are turning such matters of compliance to their advantage.

Because banks need to get better at collecting and managing information on liquidity, this data (and the processes and technology used to capture it) will give them a new set of advantages. With rapid advances in data science and technology, banks are beginning to offer their corporate clients new services, and in turn, replacing lost interest with new fee income.

Monitoring client cash on their balance sheets is one area in which banks have improved their capabilities. Instead of simply calculating whether to accept or turn away clients' money, banks are providing more options by helping their corporate clients invest their non-operating deposits in investments off the balance sheet. One of the ways they're doing this is by providing automated sweeps of excess cash into money market funds and separately managed accounts.

Banks are therefore creating new products and services that allow them to remain competitive with end-to-end cash solutions for their clients, increasing the 'share of wallet' of corporate client business in the process.

Nevertheless, multiple currencies, countries and regulators (accommodating country-specific requirements and 24/7 operations in different time zones) and various other risk factors, mean that the industry landscape for liquidity and cash management has reached an unprecedented level of complexity. Any new bank products and services must therefore have sophisticated cash and liquidity management solutions underpinning them. Solutions must also be flexible or easily customisable so that they can be tailored to specific corporate requirements, whether to meet new strategic objectives, or to accommodate evolving regulations or changing market dynamics.

Cashflow forecasting is key

While sophisticated liquidity management structures and technologically advanced solutions are important, it is the relatively routine task of cashflow forecasting that plays the most crucial part in helping corporates respond to the new environment ushered in by Basel III. Only by knowing where cash is, and when it will be needed, can companies use it efficiently. And as cashflow forecasting provides a flexible way for banks and corporates to differentiate between operational and investment cash, it is vital for companies looking for more attractive investment options for their longer-term investment cash.

To demonstrate where a cashflow forecasting solution might be useful, consider the example of new longer-term, high yield deposit products. In light of demand from corporates, many banks have developed products such as notice accounts, evergreens and stable deposit accounts with tenors or notice periods of 30, 60 or 90 days, to meet Basel III requirements on cash outflows and benefit from lower liquidity requirements.

But locking cash up for long periods requires a corporation to know with certainty that it will not need that cash within the given tenor or notice period. An effective cashflow forecasting solution is therefore needed that allows cash to be segmented into defined, flexible liquidity or tenor buckets.

These enable companies to predict their cash positions on specific future dates so surprises are avoided and any necessary corrective actions can made quickly. Some additional integration with complementary bank services to streamline these corrective actions, and aggregation of data from multiple systems, would also then be required.

Although it is a key aspect of financial management, cashflow forecasting can be a challenge for corporations, and any new tools today must be able to handle a high level of complexity. As cashflow forecasting increases in scope, banks and their corporate clients will need to work together to avoid any financial and delivery pitfalls that may await.

Looking at liquidity

Liquidity solutions are another way corporate treasurers can manage cashflow. For short-term cash, there are a number of options available such as cash concentration, notional pooling, intercompany loans, and instant access savings accounts.

Minimising or offsetting banking fees is another way returns can be increased. To do this, organisations can use a managed earnings credit rate (ECR) as one component of a balanced compensation programme, as it allows businesses to offset bank service charges against their deposits, which they have immediate access to throughout the day.

Sweep accounts that automatically invest excess money from an account are another option that enhances a company's earnings potential. These come with the advantage that they can be tailored to a company's specific needs, with some designed for firms seeking maximum return on investment, and others focused on providing the maximum security or the lowest risk exposure.

A joint effort

Basel III and the introduction of the LCR means that regulators now require an unprecedented level of information, and banks will need to spend more time understanding details right down to the transaction level. But their focus on determining the impact of the LCR on their own balance sheets means they are well positioned to help corporates adapt to these changes too, and they are already developing the methodologies and technologies required.

This expertise can help corporates manage their working capital and excess deposits more effectively, and the importance of banks understanding their clients' objectives will necessitate deeper relationships than ever before. Through close collaboration and sharing knowledge and resources wherever possible, banks and their clients can adapt and thrive in the post-Basel III climate.

Andrew England is head of strategy at iGTB

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