- Stephanie Wolf
- Head of Global Financial Institutions and Canada Transaction Services, Bank of America Merrill Lynch
by Stephanie Wolf, Head of Global Financial Institutions and Canada Transaction Services, Bank of America Merrill Lynch
Regulatory change is leading to a significant shift in the relationship between banks and their clients. While the changing environment is likely to result in higher costs for certain services and client groups, corporate and financial institution clients are placing more value than ever on the quality of their banking relationships.
It’s no secret that banks are moving into a more complex regulatory environment. The impact of regulatory change is becoming clearer, and banks’ customers are learning about these changes and how they are likely to impact banks and their clients. But with the cost of holding deposits and providing lending services likely to rise, corporate and financial institution customers are increasingly asking, “What does this mean for me?”.
When customers ask this question, they are typically asking about the impact on the availability or cost of their banking services – whether that means the interest rate paid on deposits or the fee that a bank charges for loan services.
The answer is “It depends”. For organisations such as investment managers, hedge funds and private equity companies, the impact of regulatory change on credit facilities and deposits is expected to be significant. For traditional corporate clients, on the other hand, it is likely to be business as usual. Meanwhile, banks and other non-bank financial institutions (NBFIs), such as insurance companies, will fall somewhere in the middle.
Counting the costs
It’s widely understood that new regulations such as Basel III may affect these prices – but why? For banks providing basic services such as deposits and lending facilities, regulatory changes which require banks to hold more capital or high-quality liquid assets have a fundamental impact on the banks’ ability to offer these services in the first place.
The prices charged by banks often take into account the benefit that banks may derive from providing a particular service. For example, if banks have the use of customer money for two days while a cheque is being cleared, and can benefit from access to that money, it will impact the price that the bank charges its customers to clear a cheque.
Similarly, it should come as no surprise that banks make money in the treasury management business by having the use of their customers’ money while executing a transaction on their behalf. For this reason, the value of deposits and the steady annuity stream in treasury management has historically supplemented other businesses where banks may not get as high a return.
Commercial lending arrangements, for example, are not always profitable on a standalone basis, but they can be justified as part of a wider banking relationship if other bank services are part of the relationship. For the last decade, banks therefore looked to deepen client relationships in order to make up for the capital costs related to loans.
This balance may have worked well in the past, but the wave of new regulation is changing the mathematics underpinning this rationale. If regulatory changes mean that banks can no longer make full use of customers’ deposits, the value that the bank gains from treasury management services may decrease. Deposits that the bank would have been able to use in the past – such as a deposit for a non-regulated hedge fund – may no longer have the same kind of value for the bank.
Implications for banks
For banks, a reduction in the value of customer deposits may prompt a reassessment of how such services are priced – leading to one of two outcomes. First, banks may decide to reduce value given for deposits, but also to charge more for other services which have traditionally been supplemented by treasury services. Or, second, banks may discontinue the provision of certain services which are no longer deemed to be profitable.[[[PAGE]]]
Many banks are highly reluctant to charge for deposits, although some have already made it clear that this option is on the table. While many clients are unlikely to see this type of outcome – unless, for example, they hold Swiss francs or overnight euro deposits, which currently have a negative deposit rate – there is a growing understanding that certain services are likely to cost more than they have in the past.
Companies are aware that this is the case and many are now focused on gaining a clearer understanding of what the costs will be for budgeting purposes. Much as a company may have an annual budget for pencils, for example, as part of its cost of doing business, more companies are now regarding banking charges as another cost of doing business.
An increase in pricing is one option available to banks as they seek to cover their own growing costs – but another option is to discontinue providing certain services. This is a very real possibility in some cases, and across the market banks are re-evaluating what businesses they want to be in, in a way that has not been seen for many years. Some major global banks have recently announced that they are moving out of particular product areas, or, indeed, out of certain countries or regions. Others may decide to stop serving certain types of client.
These decisions will, of course, affect the balance of supply and demand in the market. If the supply of certain services decreases, there will be opportunities for other providers to step into the role. The regulatory pressures that banks are facing could, therefore, open up opportunities for non-bank financial service providers, which are subject to different regulations, to provide additional services in some of these areas. We have already seen such providers taking their first steps into areas such as lending.
Going forward, some key considerations will be whether these providers are able to fulfil this type of role from a capital, fraud protection and systems point of view – and at what point these providers will still have to tap into a traditional bank in order to effect transactions.
Shifting dynamics
This is an evolving situation – and as such, the dynamics affecting banks’ charging strategies are continuing to develop.
One interesting consideration is that regulation starts to become more complex once a bank’s asset size exceeds $50bn. A number of smaller banks are currently approaching that threshold, to the extent that a rise in interest rates – or indeed the result of normal business growth – could propel them over the $50bn mark. At this point, they would see their cost of regulatory compliance growing.
With this in mind, such banks are keeping a very close eye on the cost of providing services to clients. Anecdotally, some banks have begun to ask prospective clients for the exact amount of their daily in- and outflows before pricing services for those clients, so that they can do so with a full understanding of the high quality liquid assets that they will be required to hold.
When and if interest rates do begin to rise, the mathematics regarding pricing will of course change again. A rise in interest rate results in a greater difference between a bank’s cost of funds and the amount that it pays clients in interest – or between a bank’s cost of funds and the amount that the bank makes on a loan. As such, there might be less of an argument for charging customers for deposits if interest rates were to rise.
Strengthening relationships
The world is changing, and banks, and their clients, have to adapt accordingly. The good news is that forward-thinking banks are not only adapting to the new market conditions, but are also taking on a more consultative role and bringing clients along with them.
It’s becoming clear that price is no longer seen as the definitive consideration for organisations when choosing a bank. The strength of the overall relationship is becoming a much greater priority as companies and FI clients recognise the value that banks can provide through advisory services. As corporate treasuries become more connected with other departments within the organisation, banks are working to provide more integrated services across different areas within a client’s operation.
As they gain greater clarity over the costs of working with multiple banks in the new regulatory environment, treasurers are likely to consolidate bank providers and focus on developing a smaller number of strong relationships with core banks. The fewer bank relationships a company maintains, the more important those individual relationship will be – to both the customer and the bank.
The importance of this topic will only grow in the coming year. The world is changing, and the dynamics of bank relationships are shifting accordingly – but by working together more closely than ever before, banks and their customers can navigate these changes successfully.
