From the September 2014 Special Report issue of Treasury & Risk magazine

Banking On It

The stricter capital requirements soon to hit banks are likely to raise the cost of credit. They might also strain companies’ relationships with their banks.

No relationships are more important to corporate treasurers than their relationships with the banks that provide them with credit. But companies’ ties to their banking partners could be strained in coming years as large banks adjust to the new capital requirements set forth by Basel III. At the same time, companies’ growing use of SWIFT and other services to link to their banks may make it easier for corporate treasuries to shuffle their banking relationships.

The implementation of Basel III capital requirements is expected to push the cost of credit higher and make banks a little choosier about which companies they offer credit. Meanwhile, Basel III’s liquidity coverage ratio, which evaluates a bank’s ability to fund itself over a 30-day period of financial stress, puts a premium on companies’ operational balances—such as those associated with payroll or accounts payable—on the grounds that such deposits will be stickier. Short-term deposits that are not linked to operations will become less attractive to banks, since banks will be required to hold more reserves against those deposits. And Basel III’s leverage ratio could limit the total amount of lending banks are able to do.

Different countries will implement the Basel III capital requirements in different timeframes; in the United States, the rules start to kick in at the beginning of next year.

Mark Webster, a partner at consulting firm Treasury Alliance Group, expects the environment created by the new capital requirements to focus treasurers’ attention on credit. “As a corporate, I need to be very sure where I’m getting my funding,” he said. “And I need to make sure credit will be available when I need it, because there’s going to be a reduced supply of it as these regulations kick in and borrowing costs will go up.”

So far, though, the cost of credit hasn’t budged. “If you look at any data in the syndicated loan market, pricing has tightened and capacity has grown,” said Anne Clarke Wolff, head of global corporate banking at Bank of America Merrill Lynch. “It feels like many banks around the world are focused on deploying excess liquidity more so than concerned about the implication from a capital charge perspective.

Anna Clarke Wolff, Bank of America Merrill Lynch“Typically in the loan market, it takes a very high-profile transaction to show a fundamental re-pricing or a philosophical shift,” added Wolff, pictured at left.

The new capital requirements will affect different types of deposits and bank offerings differently.

“Any facility that represents a liquidity backstop to some other type of vehicle that could potentially be shut off in time of crisis will be more impacted than facilities for more operational or term-out purposes,” said Dub Newman, head of North America Global Transaction Services at Bank of America Merrill Lynch.

Newman said the impact of the new regulations will become clear by the middle of next year.

An increase in credit costs could potentially discourage corporate treasurers from negotiating as large a credit facility as possible, Webster said. Historically, a treasurer who estimated that her company needed a $5 million operating line from a bank, but knew the company’s financial strength and credit ratings were strong enough to qualify for $10 million, tended to ask for the larger facility. The commitment fee on the entire facility was minimal, and the company would pay interest only on the part of the facility it drew down. Now that banks will be required to count the entire committed line toward reserve requirements, treasurers should rethink that approach, he said.

“We’re telling corporates, ‘Take a look at what you really need and be more reasonable about what you’re asking for,’” Webster said. “The banks don’t want to tie up a lot of extra funds that are never going to be used; they’re going to be kicking up their fees on those.”

But Wolff said that while the changes may suggest it’s time for treasurers to reduce the size of the credit line they request, “the dynamic remains that it’s fundamentally cheap insurance.

“It would be the exception, not the norm, that we see people reduce the size of facilities,” she said.

Dave Robertson, a partner at consultancy Treasury Strategies, predicted that going forward, banks will offer more of their customers advised, or uncommitted, lines of credit rather than committed lines. With an advised line, the bank is saying, “‘If everything looks good, we’ll lend you this money,’” Robertson said. “That’s different from a committed line. Those who don’t want to pay for it aren’t going to get a committed line. Those who want it are going to have to pay for it.”

A Collateralized World

Matthew Dunn, DeloitteMatthew Dunn, a director in the treasury risk management practice at Deloitte, said that to some extent the impact of new capital requirements will depend on the corporate customer’s industry. For example, he said, hedge funds that borrow short-term from banks are likely to see prices rise because the banks are going to have to hold high-quality liquid assets against those loans.

Banks may also respond to the new capital requirements by asking corporate customers for collateral as part of more transactions, he said.

“We are going into what they refer to as a ‘collateralized’ world,” said Dunn, pictured at right. “If I’m going to do a transaction with you, I want some collateral in return. It’s not only driven by regulation, it’s driven by the risk management issue.”

Dunn cited the example of wire transfers that banks execute for corporate customers. “If a bank looks at how many high-value payments it makes a day and runs some type of stress scenario, it would be required to hold some type of security against that,” he said. If it turns out the bank needs to hold a certain number of Treasury bonds against those payments, “holding Treasury bonds is going to cost money,” Dunn said. “So the bank can either ask clients for bonds as collateral or add that to the cost.”

Banks are dealing not only with the advent of stricter reserve requirements, but also with the growing cost of complying with an array of new regulations.

“The one thing that is really starting to stretch banks is the regulatory compliance costs,” Dunn said. “How do they pass those costs on to their clients? A lot of this regulation hasn’t become effective yet. Over the next three years, as that cost starts bleeding to the bottom line, how do they recoup that or charge their client base more money?”

Webster said compliance costs give banks a reason to value larger corporate customers more than smaller ones. “Let’s say I’ve got a relationship with Company A that’s worth $100,000 in business a year and a relationship with Company B that’s worth $10,000 a year,” he said. “My regulatory costs as a bank to deal with A and B are going to be roughly the same. I’d much rather get $100,000 than $10,000.”

Banks “are looking toward moving to larger relationships,” he added. “And in some cases they’re going to Company B and saying, ‘We’re going to shut down this relationship; we’re not making enough money.’”

Webster argued, though, that the new capital requirements’ favored treatment for operational cash could end up forging tighter relationships between banks and corporate treasury functions because banks will need to make sure they are familiar enough with a company’s business and cash flows to back up their classification of company deposits as operational cash. “The relationship need goes up even more,” Webster said.

Craig Jeffery, managing partner at consultancy Strategic Treasurer in Atlanta, said that while the financial crisis put banks in the driver’s seat, the balance of power has since shifted back toward corporates.

“When the financial crisis hit, it went very rapidly from a buyers’ market to a sellers’ market,” he said. “The power was all on the bankers’ side.

“Over the years, it’s moved back toward a buyers’ market again,” Jeffery continued. “It’s not as thinly priced as it was pre-financial crisis, but the pendulum has swung heavily and consistently onto the buyers’ side. There has been a lot more capital that needs to be deployed, and a lot of companies tend to be cash-rich.”

Blaise Scioli, director of treasury services at e5 Solutions Group, which works with companies on implementing SAP financial and treasury applications, predicted that an increase in the cost of bank credit will encourage companies to broaden their sources of funding.

“Facilities are going to become more expensive, even short-term facilities,” he said. “And there’s going to be a move away from them, especially among corporates who have the ability to, say, issue commercial paper.”


Safety in Numbers?

Jaime Ryan, e5 Solutions GroupPrior to the financial crisis, many corporate treasurers focused on consolidating the number of banks with which they did business, hoping to cut costs and become more efficient. But the crisis called that trend into question as it underscored the possibility of bank failures.

“Before the credit crisis, people put more eggs into one basket,” said Jaime Ryan, co-founder and managing principal at e5 Solutions Group. “Now they want to be able to diversify their risk.”

As a result, Ryan said, “where they’re drawing the line as far as the number of banks is probably higher than what they would have targeted five or 10 years ago, when they wanted to get down to one global bank.” Treasury teams “that did get down to one global bank, they’re the ones that are opening up to more relationships,” he added.

But others said that companies’ push to consolidate banking relationships is still going strong.

Bank of America’s Newman noted that many corporate treasuries have made progress in consolidating their ERP and back-office systems. “That enables them to work with fewer banks,” he said. “They also understand every incremental bank and every incremental account costs them money from an oversight perspective, and they are very focused on reducing the number of bank accounts and ultimately the number of banks.”

Dub Newman, Bank of America Merrill LynchNewman added that while there are still a fair number of corporate acquisitions, “treasury departments never increase.

“They may buy significant assets, but the number of people in treasury is flat to down,” said Newman, at left. “The way they do that is by the ability to manage information and data, and the way to do that is decrease the number of banks and accounts.”

Strategic Treasurer’s Jeffery cited “a long trend of people rationalizing and consolidating” their banking relationships. But he also noted a number of factors pushing corporate treasuries in the opposite direction.

Companies add banks because “they acquire somebody who has banking relationships, or they have a large need for capital or they have a need for additional capabilities, particularly globally,” Jeffery said. “Or they’re looking for diversification to help reduce counterparty exposure.”

In the end, the factors that lead treasuries to add banks or eliminate some of their banking relationships may offset one another. Jeffery said that over the years, Strategic Treasurer surveys show “the number of relationships stays relatively consistent.”


Counterparty Credit Risk a Concern

The financial crisis also produced a greater interest among corporate treasuries in tracking the credit risk posed by counterparties, including the company’s banks.

“We’ve definitely seen that get added to almost every client implementation,” Ryan said, adding that he is also seeing previous clients that didn’t initially implement credit risk management systems coming back to add that capability to their treasury systems.

Calculating the counterparty credit risk posed by a company’s banks can require some work, since a company may well have multiple exposures to a single bank, ranging from a credit facility and bank accounts to derivatives used to hedge risks, supply chain financing arrangements, or holdings of a bank’s commercial paper in the money funds the company invests in.

Credit ratings are a traditional measure for gauging credit risk, but counterparty credit risk monitoring can also look at a bank’s credit default swaps, the prices of its stock or bonds, and the information in its quarterly financials.

Treasuries implementing credit risk management systems are usually pulling in streams of market data from providers like Bloomberg and Reuters to use in calculating counterparty credit risk, Ryan added.

Webster said that while there’s still an assumption that certain banks are too big to fail, company executives realize that if they have a single bank, and that bank ends up being forced to merge as a result of financial problems, they could face operational difficulties. Even a company with two banks that saw one of those banks fail and merge with the other could run into problems, he said. “From an operational point of view, I want to originate wires from more than one bank so that if something happens to Bank A’s wire room, I also have Bank B.”

The deterioration in banks’ credit ratings since the financial crisis suggests companies should be monitoring their bank counterparties more closely, said Jeffery. But a survey conducted earlier this year by Strategic Treasurer and Bottomline Technologies showed that just 36% of companies formally monitor the credit risk posed by their banks.

“The vast majority of organizations don’t seem to be able to adequately analyze their exposures at the level or frequency they think they should,” Jeffery said. “They need more of a risk framework and then they also need technology and data.”

About 20% of the companies surveyed said their most urgent issue was aggregating the data, he noted, while another 20% cited the need for knowledge, transparency, and visibility as most crucial in terms counterparty credit risk monitoring.


Down to One Pipe

At the same time that new regulations are altering the environment for obtaining credit, SWIFT has simplified the technology a company uses to connect with its banks.

SWIFT, which provides secure messaging for banks around the world, began making its services available to corporates in 2006. In 2008, it introduced Alliance Lite, a web-based version that targeted smaller companies. Most recently, SWIFT has started teaming up with software providers, including some treasury management system vendors, to build its connectivity into cloud-based products. Meanwhile, ERP provider SAP is rolling out a Financial Services Network (FSN), which uses the cloud to link companies to their banks.

“We’ve been seeing the trend moving more and more toward centralized bank communications,” said e5’s Ryan, adding that SWIFT’s offerings aimed at smaller companies mean that SWIFT connectivity is no longer limited to the biggest companies.

“It certainly streamlines the process when you can work with one entity like SWIFT or SAP’s FSN to do your connections to the bank and then be able to streamline with single formats,” Ryan added. He noted, though, that content is still not harmonized.

Once a company communicates with its banks through a network like SWIFT, setting up a connection with a new bank becomes easier, he said. “In today’s world, with risk mitigation, the desire is plug and play.”

“If a company wants to change banks now, the level of effort involved in doing that is so much smaller than it would have been 20 years ago, [given] common connectivity, common standards,” said e5’s Scioli. “But I feel the corporates are still largely constrained by things like credit relationships, the ability to borrow when they need to, geographic considerations. I don’t think we’ve seen that sea change occur yet.”

“There’s no question corporates are increasing their use of SWIFT,” said Bank of America’s Newman. “It’s on a double-digit basis.” He cited the secure communication that SWIFT provides for corporates and noted that interfacing with their banks using just one protocol reduces companies’ technology costs.

Treasury Alliance Group’s Webster said SWIFT is a great tool for companies that have four or five banks and operate in various parts of the world, because it allows them to get daily balances and transaction information at the same time it lowers the cost of communicating with their banks.

But while SWIFT makes it easier for a company to bring on a new bank, the company still has to establish a relationship with a bank before making the move, he said. Webster doesn’t see SWIFT causing corporates to switch banks more frequently. In fact, he argues, the tighter communication that SWIFT is facilitating between banks and their corporate customers is making the relationships stickier.

“I’m getting daily balance reporting, and it’s becoming best practice to look at all transactions on a daily basis and reconcile all my accounts on a daily basis,” Webster said. If the company decides to switch banks, “I’ve got to test all that; all my processes and procedures have to change. If there’s not a reason to do it, I’m going to avoid it.”

Newman also argued that the adoption of SWIFT wasn’t encouraging companies to change banks. “I think it’s facilitating a lot of great things for clients, but we have not seen switching as something that’s resulted from the adoption of SWIFT,” he said. “There’s so much more to a bank relationship than simply the messaging part of it.”




Getting a Handle on Banking Relationships

As banks prepare for stricter capital requirements that could dampen their interest in extending credit, it behooves corporate treasuries to get a better handle on their relationships with their banks. Some treasuries are turning to risk-adjusted return on capital, or RAROC, models to assess the return their banks are realizing on their business.

“We’ve helped our corporate clients develop their own RAROC models,” said Mark Webster, at partner at consultancy Treasury Alliance Group. RAROC models measure the return on an investment or business relationship while taking into account the amount of risk involved.

“Ten years ago, the companies that were at the leading edge of this were just taking a look at revenue,” Webster said. “Now some of them are beginning to move to using an actual RAROC model to say, ‘What are the banks getting from us?’”

When a company obtains a credit line from a group of banks, each of the banks hopes to win cash management business or other work from the company. When bankers visit corporate clients, they often tell treasurers the bank isn’t earning enough, and they ask for more of the company’s business, Webster said. This is where a company’s RAROC calculations come in handy.

“What we’re finding as a best practice for corporate treasurers is to track the relationship and be able to say to the banker, ‘Gee, you’re one of five banks in our credit group and you’re getting 25% of our business,’” he said.

If the bank disagrees with the company’s estimate, the company can ask the bank for more information. Using RAROC calculations gives treasuries “a wonderful tool to have a discussion with the bank and try to improve transparency,” Webster said.

“It’s expensive for the corporate to move bank accounts, and it’s expensive for banks to lose the relationship,” he added. “They want to keep the relationship.” The question is: “How do they maximize it for both sides?”

Laurens Tijdhof, a partner at European consulting company Zanders Treasury & Finance Solutions, talks about wallet-adjusted return on capital, or WAROC, a RAROC calculation that takes into account the portion of the company’s credit line that each bank provides.

A WAROC calculation isn’t “an exact science,” Tijdhof said, because companies have to estimate some numbers. “It’s very difficult to make an exact calculation like the bank does,” he said. But, he added, “even based on these assumptions, you get quite good insight on whether your bank makes money on you or not.

“It really supports the decision-making for making the right balance between a corporate and a bank,” he added.

A recent article by Tijdhof and a colleague, Pieter Sermeus, argued that companies which use WAROC to assess their banks should also take into account factors that can’t be included in the WAROC calculation, such as insights that a bank provides on the company’s business or specific services it offers that the company needs.

Tijdhof also pointed to the risk management aspect of monitoring, given the likelihood the new capital requirements will cause banks to be more selective about the companies to which they extend credit.

If a bank is losing money on a corporate client, “they will probably step out and withdraw the credit,” he said. “It’s in the interest of the corporate to make sure the relationship works for both.”




Harmonizing Bank Messages

Using a common conduit like SWIFT to communicate with banks can help treasuries eliminate a lot of the expense and IT effort involved in linking to each bank separately. The banking industry has been moving toward even greater efficiency by implementing ISO 20022, an XML messaging standard, for the various kinds of communications that flow between banks and their corporate customers.

“We’re seeing more and more banks offering these types of standard ISO messages,” said Jaime Ryan, co-founder and managing principal of e5 Solutions Group, adding that standardized messages “definitely help with the automated integration with the banks.”

But standardized messaging formats are only half the battle, since there can still be differences in the content within messages from bank to bank. Now banks, vendors, and corporates are working to harmonize content.

One content issue involves the types of codes that can populate certain fields, said Blaise Scioli, director of treasury services at e5. Sometimes not all banks accept all the different types, he said. “Harmonization takes fields like that and says, ‘We’ll use these four, but only these four.’”

Harmonization also sets up rules for repeating, he said, such as allowing companies to define multiple signers for an account, and it looks at how to deal with free-form information.

SWIFT organized Common Global Implementation (CGI) groups to focus on different standards. The Global Rapid eBAM Adoption Team has been working on electronic bank account management (eBAM) messages, and its harmonization proposals for eBAM messages are currently open for comment.

More recently, CGI set up a task force to consider whether it should make an effort to harmonize CAMT cash management messages. “The question is, to what extent is this practical, would there be a groundswell of support for it,” Scioli said. “We spent a lot of time on the task force talking about scope.”


Read the September Special Report on Bank Relationships & Borrowing.

Banks Tweak Products with Basel III in Mind
Opportunity Knocks on the Future of ISO 20022
Health Check

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