Cash & Liquidity Management

Making the Most of Your Cash Under Basel III Businesses need to review their core banking relationships, fully understand the regulators’ new deposit definitions and be vigilant in their cashflow forecasts and account structures.

Making the Most of Your Cash Under Basel III

by Steve Everett, Global Head of Cash Management, RBS

Steve EverettNew liquidity rules could increase the cost of cash management and dent returns on corporate deposits. As a result, companies will require more sophisticated working relationships with their core banks. The rules, updated in January and due to be phased in from 2015, are part of the Basel III regulation which aims to ensure banks have enough capital and liquidity in reserve to prevent a future financial crisis. They are designed to ensure banks have a sufficient cash buffer in place to cover numerous and sudden withdrawals.

While January’s announcement actually lightened some requirements, the Basel III method for working out this buffer, the Liquidity Coverage Ratio, is still based on somewhat conservative assumptions for corporate deposits. This could lead to greater costs for banks and lower returns for their corporate customers. Across the industry these rules will fundamentally change the economics of many financial products. Banks will need to respond by reviewing product pricing and focusing on their core clients. Corporate deposits in general are likely to attract relatively lower returns than in previous years.

This means that companies will need to take a broader, more holistic approach to their banking relationships when managing cash to ensure a mutually beneficial partnership. It may encourage them to spread their business across fewer banks – a challenge considering the trend in recent years to work with more to spread counterparty risk.

Some potential good news is that the Basel III rules only apply to cash that can be withdrawn within 30 days. In the UK, it is currently 90 days under the country’s regulator, the Financial Services Authority. Although it is not yet confirmed whether the 90-day rule will disappear completely, this change will potentially drive new products and pricing at banks to encourage contractual terms longer than 30 days while reducing the counterparty risk involved for deposits.

A key factor in the new regulation will be the simplistic split of deposit types – they are either operational or non-operational. According to Basel III, corporate operational deposits can relate to payment clearing arrangements or a company’s working cash used for payments, collections and the day-to-day running of their businesses. Non-operational deposits involve ‘surplus’ money that is not needed for immediate daily activities. Businesses tend to use those for liquidity purposes and short-term investments and they tend to be more rate-driven.

Operational deposits are considered ‘stickier’ because companies use the money constantly and are likely to keep doing so even if another crisis struck. The interest rate a company gets on a deposit will be heavily influenced by which of these two categories it falls into, so it is vital that banks and businesses fully understand the regulator’s definition of them.

In terms of the amounts involved, Basel III requires banks to hold a liquidity buffer against 25% of all their corporate operational balances. The January announcement reduced the non-operational balance requirement to 40%, down from 70% previously – another positive change. In both cases, however, these percentages are likely to represent an increase from what is required under current, local liquidity requirements.

Another challenge is the complex set of tests required to classify deposits, which could see some of them classified as non-operational even if the money is used for day-to-day purposes.

For example, if the bank cannot clearly articulate what portion of the balances on an account are operational, or if the interest rate offered appears to encourage surplus cash being placed in that account, the regulator will classify it as non-operational – costing the bank more.

With both positive and challenging developments, banks are actively positioning themselves and their customers to be ready for these measures while continuing their dialogue with industry bodies and regulators.

While global liquidity standards will certainly level playing fields, the costs and returns involved in cash management are clearly changing. Businesses need to review their core banking relationships to get the best value overall, fully understand the regulators’ new deposit definitions and be vigilant in their cashflow forecasts and account structures.

This will help them to ensure they continue to make the most of their money.

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