From the March Special Report issue of Treasury & Risk magazine

Cash Flow Management in a Basel III World

The global standards laid out in Basel III were developed to shore up the global financial system, and consequently attention has been focused on the implications for banks. However, the implications of Basel III will also be profound for companies. In particular, new liquidity standards will change how certain deposits are valued by banks. Specifically, banks must now make assumptions about the stability, as well as acceptable liquidity sources and levels for each deposit type.  These changes could impact the rate of return banks are able to offer on a company’s long-term investment cash.

Companies will therefore need to rethink how they invest surplus cash to obtain acceptable yields, while maintaining the liquidity and level of security they require. Additionally, companies must make sure their cash flow management and forecasting moves cash through the company efficiently and predictably in order to facilitate efficient use of surplus cash.



The link between Basel III and companies’ cash flow management is not immediately obvious to many corporate treasurers. It is widely appreciated that Basel III is one of the most important regulatory changes to have emerged in recent years as governments, central banks and regulators work to bring greater stability to the global financial system. However, the general perception is that the impact of the regulation’s principal measures — increased capital reserves, improved liquidity and restricted leverage — will be isolated to the banking sector. In reality, the impact of many Basel III measures are already being felt by companies as banks change their operational behavior in advance of the start of implementation in January 2015.

Perhaps the most important impact of Basel III for companies relates to changes in the treatment of companies’ deposits. Banks are now required to make assumptions about how stable cash is as a source of funding, and the amount and nature of liquidity that must be held in reserve against potential outflows. Specifically, while short-term operating cash will remain valuable to banks (as it only requires 5%-25% of the deposit value to be held aside in high-quality liquid assets1), longer-term investment cash will be less sought after by banks on their balance sheets, since it requires assumptions of up to 100% depending on the type of firm and the nature and tenor of the deposit.

As a result, yields on bank demand deposits for investment cash — which are historically low because of low interest rates — are set to remain that way to offset the associated loss of liquidity value for banks. Alternatively, companies seeking an acceptable return can explore a range of term and investment products. Treasurers can work with investment experts to assist in aligning products that fit within their investment policy and risk appetite. With companies continuing to maintain high cash balances, it is more important than ever to stay focused on how that cash is invested and recycled.



The most important tool in a corporate treasurers’ arsenal is cash flow management. In today’s regulatory environment, corporations must amplify their cash flow management efforts and be able to account for every dollar of liquidity.

Centralization and consolidation — through automated liquidity structures such as physical cash concentration and notional pooling — are at the heart of any efficient cash flow management strategy. However, it is important for companies to take a holistic view of their liquidity management. Some banks offer a range of additional services that can deliver significant efficiencies to working capital management, including enhanced payable/receivable management, multilateral and multicurrency netting, FX deal monitoring and execution services/exposure management and intercompany loan administration.

While sophisticated liquidity management structures and technologically advanced  solutions, such as multilateral and multicurrency netting, have an important role to play in improving liquidity management, it is the routine task of cash flow forecasting that plays the most crucial part in facilitating companies’ response 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. As companies look for more attractive investment options for their longer-term investment cash, clear insight into cash flow will be indispensable.



One reason for the increased importance of cash flow forecasting in the Basel III era, is that a possible destination for investment cash following the introduction of the regulation may be longer-term deposit accounts. A number of banks have developed longer-term deposit products that can benefit from lower liquidity requirements, such as notice accounts, evergreens and stable deposit accounts with tenors or notice periods of 30, 60 and 90 days.

However, locking cash up for long periods requires a corporation to know with certainty that it will not need immediate access to that cash for the tenor or notice period. That knowledge is only possible if an effective cash flow forecasting model that clearly segments cash into defined liquidity buckets is in place. With a strong forecast, companies can strive to retain access to their liquidity as and when required, and prepare for the unexpected. This practice is similarly reflected in the current and evolving regulatory environment, which is intended to stabilize the global financial system by creating guidelines to increase liquidity and prepare for the unexpected.

At the same time, as companies may decide to lock up deposits for longer in order to gain higher yields, they are also looking at options to increase their investment in short-term government bonds, commercial paper, other marketable securities and — most importantly – in money market funds (MMFs). Such funds, which are typically AAA-rated, are already an important investment instrument for corporate treasurers, but their attractiveness is expected to increase markedly following the introduction of Basel III as banks adjust to the liquidity rules.

Investing in MMFs does not generally carry the same sort of liquidity risk as longer-term deposits: many MMFs have daily access to funds and even enhanced products have notice periods of no more than a few days. However, MMF investments do potentially carry greater risk than deposits. First, there is counterparty risk associated with the fund provider. Second, MMFs expose an investor to the credit risk of the underlying securities in a fund: companies need to do their own due diligence rather than solely relying on ratings.



Only once a company has a full understanding of its cash flow and liquidity requirements is it in a position to be able to invest surplus cash. In order to effectively manage the risk associated with any investment, companies must devise — and follow — a clear investment policy that incorporates their requirements for liquidity, investment horizon and appetite for risk, as well as the availability of resources to manage that investment.

A central focus of any investment policy must be the understanding that every investment decision is a balance between security, liquidity and yield. Increased potential returns inevitably require an investor to accept a higher risk in the form of either lower security or less liquidity.

Understanding the risk appetite – the balance between security, liquidity and yield – is a critical component of a robust investment strategy. Risk appetite varies company–to-company, but typically comfort with the desired level of liquidity and security is addressed in the investment policy first, prior to shifting the focus to yield. Until recently, most companies placed the greatest emphasis on security and were happy to accept low returns. Now, the weight of cash on many companies’ balance sheets, coupled with improving market conditions, means companies are ascribing greater importance to yield.



The changes in the banking world in response to Basel III will have important consequences for corporations’ cash flow management and investment strategy. While Basel III may seem remote to the day-to-day tasks associated with cash flow management, it should prompt companies to re-examine their existing liquidity and working capital arrangements. Most importantly, it should encourage treasurers to work with their banking providers to seek improvements in the core task of cash flow forecasting.

As part of a concurrent review, treasurers must also take a fresh look at their companies’ investment policies. Circumstances have changed in recent years — few banks and sovereigns are now AAA-rated, for example — and it is important that any investment policy reflects such changes. Most importantly, any reworking of an investment policy must consider a corporation’s liquidity requirements and its risk appetite. Understanding the compromise between risk and reward has always been critical when making investment decisions, but as the liquidity and investment environment evolves in response to Basel III, it will become even more important.


1 High quality liquid assets include cash, sovereign debt or other high-grade securities.

“Bank of America Merrill Lynch” is the marketing name for the global banking and global markets businesses of Bank of America Corporation. Lending, derivatives, and other commercial banking activities are performed globally by banking affiliates of Bank of America Corporation, including Bank of America, N.A., member FDIC. Securities, strategic advisory, and other investment banking activities are performed globally by investment banking affiliates of Bank of America Corporation (“Investment Banking Affiliates”), including, in the United States, Merrill Lynch, Pierce, Fenner & Smith Incorporated and Merrill Lynch Professional Clearing Corp., both of which are registered broker-dealers and members of FINRA and SIPC, and, in other jurisdictions, by locally registered entities. Merrill Lynch, Pierce, Fenner & Smith Incorporated and Merrill Lynch Professional Clearing Corp. are registered as futures commission merchants with the CFTC and are members of the NFA. Investment products offered by Investment Banking Affiliates: Are Not FDIC Insured • May Lose Value • Are Not Bank Guaranteed. ©2014 Bank of America Corporation


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