The news earlier this year that RBS was downsizing most of its corporate banking business globally and retrenching cash management operations to core profit centers in the UK and Ireland caught many by surprise1. RBS’ reasons for abandoning this part of its business were the source of much speculation, including that:
- RBS had significant losses in 2014
- It is majority owned by the UK government, as a result of nationalization in 2008
- Global market share outside the UK was eroding
What wasn’t often discussed was that RBS made an astute business decision in the face of upcoming Basel III compliance. It is quite likely that RBS saw that costs to support its corporate clients in a post-Basel III environment would make profitability within corporate banking impossible to achieve.
To understand this further, it is important to understand the basic tenets of Basel III that relate to corporate treasury. The most impactful to corporate clients is the Liquidity Coverage Ratio (LCR). The LCR requires that banks hold sufficient “high quality” liquid assets to meet all the bank’s net cash outflows over a 30-day window. To understand their liquidity needs for a 30 day scenario, there are two categories of corporate deposits banks evaluate: operating and non-operating cash.
- Operating cash is fairly obvious by its name. It is the cash within accounts that is used to run the business – such as for payroll or supplier payments. Some of operational cash is insured by programs such as FDIC, but in general operating cash is utilized every day and features a relatively low runoff rate. Banks can assume that a maximum of 25% would leave the bank in a 30-day window
- Non-operating cash has an equally indicative name and is essentially the excess cash balances that are most likely to be moved around. Since it isn’t required to support daily working capital needs, non-operational cash is typically mobilized in search of yield, meaning that the runoff factor will be higher. In corporate treasury, it is often calculated closer to 40%.
Why do these categorizations matter? It is because according to the LCR within Basel III, banks must hold enough high quality liquid assets as collateral to offset the potential net cash outflows for a 30 day period. High quality liquid assets are expensive collateral for banks to hold, so this increases the costs that banks must incur to hold a corporate’s deposits. The costs increase further for non-operational cash because of the higher expected runoff rate.
Going back to our RBS example, a large component of their corporate cash management deposits would have been non-operational cash – meaning they would have had to incur high costs to add sufficient collateral to meet the LCR provisions. This wasn’t viable, so (we assume) they made a smart business decision: abandon the deposits and refocus resources on more profitable segments.
Obviously RBS is in the minority – most banks have not dropped anchor and gone on their way. But that doesn’t mean that banks aren’t already – or soon will be – calculating just how viable your cash balances are to them.
This begs the question: what can I do as a (proactive thinking) corporate CFO or treasurer?
- Understand your cash balances – separating into operating and non-operating cash is an absolute must.
- Know what is important to your bank – banks care about two time periods: 30 days (for the LCR) and one year (for the Net Stable Funding Ratio or NSFR). Corporates need to think of these timeframes when planning how to manage their cash
- Perfect your cash forecast – the old excuse that I’m cash rich so I don’t need to forecast goes out the window. Cash rich = excess non-operational cash = banks do not want it. Banks will want 31-day guaranteed deposits, for example, and will reward such commitments.
Establishing cash certainty will drive two things:
1. better rewards from banks – by aligning to their requirements
2. ability to mobilize cash to alternative investments – such as money market funds, repos, or more strategic investments (all which require more certainty in your availability of cash for long periods)
By being proactive, you can not only anticipate your bank’s behavior but also make your organization’s cash balances a much more attractive prospect for your bank.
1. With 7th Straight Loss, R.B.S. Announces a Major Downsizing – New York Times, February 26, 2015