Basel III: Collateral Damage or Emerging Opportunity?

by Karin Flinspach, Managing Director, Head of Cash Products, Transaction Banking, Standard Chartered

One of the biggest challenges facing corporate treasurers and CFOs today is identifying and overcoming the impact of regulatory change. This is the case with Basel III, a series of reforms designed to strengthen the regulation, supervision and management of risk in the banking sector. However, as banks globally implement Basel III, the far-reaching implications for corporate users of banks’ services are becoming increasingly apparent.

Corporate treasurers are accustomed to managing regulatory change; the difference with Basel III, however, is that while treasurers have no specific compliance obligations, the solutions and pricing offered by their banks are changing as banks adapt their operating models to achieve compliance. 

Changing value of deposits 

One of the most immediate implications of Basel III for corporations is that different sources of liquidity no longer have the same value to a bank. Under the Liquidity Coverage Ratio (LCR), banks need to demonstrate their ability to weather a period of 30 days of stress, so unless deposits can be shown to be linked to day-to-day business activities, deposits need to have a tenor of above 30 days to be attractive to the bank. Furthermore, a deposit received from a non-financial corporation has more value to a bank than a deposit received from a financial institution, which is considered to have a higher run-off rate. This has considerable implications for corporate treasurers for whom short-term deposits are often the mainstay of cash investment policy, particularly when combined with the impact of low or negative interest rates in many markets.

However, a new generation of innovative deposit solutions is emerging to reflect the new regulatory environment. These include new instruments such as notice deposits, including LCR-friendly 31-day plus ‘evergreen’ deposits. In addition, banks and their corporate customers are taking a wider view of their relationships. For example, some banks are linking interest on deposits to the volume of flows across accounts, reflecting the use of balances for day-to-day, operational activities. Some are also netting notional interest against bank fees for certain customers. To maximise the benefit of these new solutions, corporates may need to consider consolidating their banking partners to a small group of core banks only. Higher operational activity is likely to lead to better overall pricing across deposits and transactions.

Bank deposits aside, some treasurers are also considering instruments such as commercial paper, tri-party repos and other capital market instruments; however, treasurers and CFOs need to be clear that treasury policy reflects the company’s risk appetite and be confident that they have the skills, transaction management and reporting capabilities within their departments to make such investments.

Looking across the enterprise

It is not only cash investment strategies that are impacted by banks’ need to comply with the LCR, but also liquidity management. Cash pooling is widely used by treasurers to offset funding needs in one part of the business with surplus cash in the other. The effect is to  minimise borrowing costs and maximise cash available for investment. Cash pooling can be physical (known as cash concentration), where cash balances are swept (usually daily) from pool accounts into a header account, or notional, where the bank takes into account the overall position of a group of accounts without physically transferring funds between them. There has been speculation for some time about the viability of notional pooling under Basel III. While there is no definitive position, it is certain is that banks will need to offer notional pooling more selectively. Notional pooling is rarely a profitable offering for banks, as they are earning a return only on the net position of the cash pool. Under Basel III, these solutions become even less attractive as banks may be required to hold capital/ liquidity buffers against gross positions; however, there continues to be development in this area.

With fewer banks offering notional pooling in the future, and to fewer clients, treasurers who use notional pooling should be considering their alternatives, such as physical pooling. In the past, many corporations preferred notional pools over physical pools for at least some of their cash for various reasons. For some, cash concentration is not feasible in the markets in which they operate; for others that have a more decentralised business or treasury organisation, it can be difficult to concentrate cash owned by different entities. However, as more companies centralise and rationalise their financial and operational risk management at a group level, the business case for cash concentration may be easier for many treasurers than it has been in the past. 

There are other considerations for treasurers, although these may be less significant. For example, intraday overdrafts, which many banks offer on a complimentary basis to institutional clients, are typically required to support cash concentration structures.  Under Basel III, however, banks may need to keep aside sufficient liquidity buffers to cover potential intraday flows. This is likely to impact or limit how intraday overdrafts are offered in the future.  

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The multiple facets of regulation

While managing the impact of Basel III is one issue that treasurers and CFOs need to consider, there are other key regulations emerging that impact banks, treasurers and CFOs and their financial strategies. The UK bank levy, for example, is currently applied to UK banks’ total global deposits. By 2021, the levy will only be imposed on deposits booked in the UK but across all banks, including US headquartered banks. Conversely, UK banks’ deposits outside of the UK will not be taxed, which will impact on deposit pricing. Similarly, new tax regulations such as Base Erosion and Profit Shifting (BEPS) are being introduced to tackle tax avoidance by multinational corporations. Companies with complex intercompany lending arrangements will have to review and adjust transfer pricing arrangements involved in intercompany transactions, which will impact liquidity management strategies.

Leveraging banking relationships

As regulatory developments force banks to adjust their product offering and revenue models, treasurers and CFOs should be taking the opportunity to re-assess their cash management banking relationships and route their working capital flows through a smaller group of core banks. This will ensure effective service and access to products, and optimise pricing based on overall bank relationships across markets. By fostering the most productive and strategic core banking partnerships, treasurers and CFOs can leverage regulatory change as a catalyst to enhance their cash and treasury management strategy, and deliver greater value to the organisation.