Earnings credit rate (ECR) programs, a long-time feature of U.S. business banking, are heading overseas. Banks are preparing to offer the products outside the United States in response to customer demand and because they think it will help them to comply with new measures of deposit stability to be imposed by Basel III.
ECR arrangements provide companies with implied interest on their balances that they can then use to offset their bank fees. Banks that are expanding ECR outside of North America include Bank of America Merrill Lynch, Citibank and J.P. Morgan Treasury Services.
While compensating balance arrangements have occurred informally outside the United States before now, “a more formal mechanical process is what some banks are beginning to roll out in response to Basel III,” according to Greg Kavanaugh, head of the global liquidity product team at Bank of America Merrill Lynch.
“We’re aware of several global and regional banks that are experimenting with ECR outside of the U.S.,” added David Robertson, a partner and director at consultancy Treasury Strategies. “Basically they’re piloting it to their largest and most sophisticated clients.”
ECR evolved after Reg Q, enacted in 1933 amid the Great Depression, barred U.S. banks from paying interest on companies’ demand deposits. Banks instead offered to forgo fees for the services they provided to companies if companies held a certain amount of deposits at the bank. In the 1970s, when interest rates began to rise, those arrangements were formalized as the earnings credit rate, Robertson said.
Now Basel III’s emphasis on the stability of banks’ funding is leading U.S. financial institutions to offer ECR more widely. Basel III measures funding stability with two ratios, the liquidity coverage ratio for short-term funding and the net stable funding ratio for long-term funding.
“As banks prepare to comply with Basel III, Treasury Strategies is doing a lot of modeling of how different products combine to make deposits more or less volatile,” Robertson said. “What ECR does is, it says, ‘This client is holding $10 million of balances to pay for services and I can prove those are sticky because they’re getting this earnings credit rate.’ These balances are driven by the relationship. In fact, the client is holding these balances specifically to pay for the transactional relationship,” he said.
Erin Oswalt, who heads global revenue management for the global transaction services unit at BofA Merrill, said that the deposits involved in ECR arrangements “are closely tied to core operating activity—core payments and receivables. From a funding perspective, operating cash is a great funding source for a bank because it tends to be very stable over time,” said Oswalt, pictured at left.
BofA Merrill has also seen increasing interest from multinational companies in using ECR outside the U.S., Oswalt said. “Clients are increasingly global, increasingly looking to how to leverage best practices from one region to another, and generally looking to use more centralized practices. So they’re looking for more consistency from their bank in billing methodology.”
BofA Merrill plans to roll out an ECR program “in a number of regions” outside the U.S. in the next six to eight months, Oswalt said.
J.P. Morgan Treasury Services will also offer ECR outside of North America, starting with the local in-country introductions of ECR in the Europe, Middle East, Asia and Latin America regions and then linking it to a global ECR infrastructure shortly thereafter.
ECR benefits both corporate customers and financial institutions, according to Chris Foskett, global head of treasury services sales at J.P. Morgan. “It enables companies to consolidate banking fees across the globe, leverage the value of their balances and, ultimately, reduce the expense of banking services,” he said.
In North America, J.P. Morgan has expanded its ECR offering by allowing companies to use the implied interest on their balances to pay for a wider range of services, such as merchant servicing fees and interchange. Traditionally, ECR could only be used to offset fees related to the bank account, including wires and ACH charges. “We are looking at new applications of ECR with a multitude of the firm’s investment and corporate banking products,” Foskett said.
Michael Berkowitz, North America head of liquidity management services and corporate market management for Citi Treasury and Trade Solutions, said Citi, which already lets corporates use U.S. ECR balances to offset fees outside of the U.S., is in the process of allowing them to use balances outside the U.S. to offset fees.
At the same time banks are considering offering ECR overseas, the 2011 repeal of Reg Q raises the prospect that its use may decline in the United States. But even though banks introduced interest-bearing checking in the wake of the repeal, companies have been sticking with ECR.
“The corporate client base hasn’t really changed their behavior,” Oswalt said. “They haven’t wanted to move away from ECR.”
That reflects the “convenience and ease of use” ECR offers treasury departments, she said. “It’s not just the math of the credit and the rate, it’s also that they don’t have to dedicate resources to managing the day-to-day flows. They can enjoy that full liquidity, have the cash when they need it but still get a return on idle balances,” Oswalt said.
Treasury Strategies’ Robertson, pictured at right, agreed that U.S. companies haven’t shown much interest in the interest-bearing checking accounts banks rolled out, but noted that banks have offered companies a better rate on ECR than on interest-bearing checking.
“There was no point for a company to get interest checking,” he said, but noted that that may change as interest rates rise. “In a higher rate environment, I think we’ll see much more adoption of interest checking.”
John Grout, policy and technical director at the Association of Corporate Treasurers in London, questioned how much interest treasurers outside the U.S. would have in ECR.
“I can see an advantage for the bank but I don’t see an advantage for the company,” Grout said. “It’s less accounting for the company but most corporates would much prefer to have clarity – clarity of what the charges are, clarity of what the interest is.”
Robertson said that while banks can probably sell ECR to U.S. multinationals familiar with the product, other companies might be more reluctant. Many executives in other countries won’t be familiar with ECR, he said, and suggested the product will only take off overseas if banks use some promotional muscle.
“You’re going to have to invest some time as a bank to explain how it works,” Robertson said. “To some extent, I think whether it takes off depends on whether any bank out there is going to promote the heck out of it and use it to promote new client relationships.”