Transaction banks adjust to a new normal

In the past year there have been fears of a cliff, a collapse and a hard landing. Fortunately, disaster has been averted, and the US fiscal cliff, a collapse of the euro and a hard landing in China no longer frame the macro issues facing transaction bankers. 

Weak economic growth in developed markets – which translates into fewer transactions and less cash to manage – continues to be a concern, and the ramifications of regulation are also taking shape. These issues have lingered in the years since the financial crisis, but now there is a mood of acceptance that this is the new normal in which transaction banks have to operate. 

The low-interest-rate environment also persists, which has repercussions for transaction banks and treasurers alike. As interest margins have been squeezed, banks have turned their attentions to fee-based income as lending no longer brings in the same revenue. And for treasurers, the low rates mean there have been limited options in their search for yield. Debt is relatively cheap and many treasurers have opted to keep excess cash on their balance sheets.

Corporates have been stockpiling cash in recent years, and uncertainty about the economic environment is often cited as the reason. According to estimates from Moody’s Investors Service, non-financial corporates in the US had $1450bn of cash on their balance sheets at the end of 2012, which was an increase of 10% from the year before. 

By the first quarter of 2013, however, it seemed that sentiment had improved and a survey by the Association of Financial Professionals showed that business confidence in the US had gained momentum and the pace of accumulating cash had slowed down. 

At a global level, consultancy firm Oliver Wyman estimates that corporate cash holdings are expected to grow at about 12% a year to $24,600bn by 2015. In its report ‘Attracting and Managing Corporate Deposits’, Oliver Wyman notes the importance of these cash holdings because of their relationship to regulation. 

Regulation Q

There is one regulation in particular – Regulation Q – whose impact has not yet been fully appreciated because of the current low interest rate environment. In 2011, the US's Dodd-Frank Wall Street Reform and Consumer Protection Act repealed Regulation Q, a remnant of the Glass-Steagall Act of 1933, which had prohibited interest payments on corporate current accounts. With the repeal now in force, transaction banks are able to pay interest on demand deposit accounts and treasurers no longer have to sweep cash out of the current account to earn interest. The change has the potential to change the dynamics of pricing for transaction banks and their clients.

While interest rates remain low the impact will not be noticeable, but there are signs that the era of cheap money could be coming to an end. There are hints that the Federal Reserve will start to withdraw its monetary stimulus of $85bn a month. In May 2013, Federal Reserve chairman Ben Bernanke indicated that there could be a tapering of the asset purchasing programme. When asked in Congress when the Fed would scale back on the quantitative easing, Mr Bernanke said: “In the next few meetings, we could take a step down in our pace of purchase.”

The vagueness of the comment is typical for a central banker, but it shows that the topic – when quantitative easing will be reversed – is on the agenda and is a major concern to the markets. What Mr Bernanke actually had in mind is the subject of speculation but, if interest rates do start to rise, it will have implications for transaction bankers and treasurers.

Cash questions

With higher rates and the repeal of Regulation Q, treasurers will have more options of what to do with their excess cash. The need for transaction banks to attract corporate deposits will become more significant as they prepare for the deadline for the liquidity requirements of Basel III.

The liquidity coverage ratio requires banks to have enough liquid assets, ie, those that can be converted into cash easily, to cover a loss of funding in a 30-day period. Deposit accounts with terms longer than this address this need and provide banks with a stable source of funding that counts favourably under the Basel III liquidity requirements.

The liquidity coverage ratio will be introduced in 2015, starting at 60% of the requirements and will be raised incrementally each year to reach the full 100% by January 2019. By then, the interest rate environment could be quite different, and it remains to be seen how banks will change their pricing structure to attract the cash deposits of their clients.

Cross-border considerations 

The liquidity coverage ratio is just one element of Basel III that banks have to contend with and the other parts of the regulation are equally complex. For global transaction banks with operations across numerous markets, the regulations are a minefield of complexities and local peculiarities. The capital requirements alone involve national differences in the interpretation of the rules, as well as differing timetables for their implementation. This has led to concerns that the regulations have created an unfair playing field.

For example, in Switzerland there is a harsher treatment of Basel III capital requirements and banks that are deemed systemically important also have a ‘Swiss finish’ to comply with, which means that the capital adequacy ratios for some Swiss banks could be at 19% compared with the 9.5% requirement under Basel III. In other markets, such as the Philippines, where the regulator has pushed ahead with the deadline for the new capital requirements, local banks have complained that it puts them at a disadvantage to their neighbours and will impact their return on equity in the near term.

The flip side of this argument, however, is that early implementation inspires confidence and banks that are well capitalised will be highly regarded, which is especially important since counterparty risk continues to be a major consideration for transaction banks.

Pricing structures

While global transaction banks have to stay on top of the complexities of the regulations in all the jurisdictions where they have a presence, other regulations can impact banks that have not expanded internationally. Banks have found themselves indirectly affected by regulation because one leg of a transaction, or part of the client relationship, overlaps with regulation that has originated in another country.

This is the case with some US rules and regulations, which have long-reaching impact. Dodd-Frank Section 1073 is one such example, which lays out new standards for international remittances. Although the regulation was created in the US, it has a wider impact for providers of international wire transfers. Now the correspondent banks in the remittance network have to give a breakdown of the fees and charges in sending a payment.

Assessing the cost of a payment with any degree of accuracy has been a challenge for many banks. With regulations such as this, which call for banks to be transparent about their charges, it may spur banks to reconsider the pricing structure of their products and services and how they earn revenue from their clients.

Tech challenge

The cost burden of complying with this wave of regulation continues to be a concern for transaction banks. Another issue that also remains is the need for continuous investment in technology and the ability to build scale.

While transaction banks have the complexities of regulation to deal with, they are also grappling with the increasing complexity of their technology and IT platforms. And developing sophisticated products is expected by treasurers, but the emphasis is not just on products but the ability of transaction bankers to create solutions for their clients that fulfil their needs. Client centricity is a common theme in the industry and banks are working how to combine cash management with other business lines – such as trade finance – which were previously treated in silos, into a solution for a particular client.

Such changes are pushing transaction banks to continue to innovate. Technology, particularly for global transaction banks, requires massive investments and a commitment to continue to do so. This is a challenge, especially when the cost burden of regulatory compliance lingers, and the external economic environment remains uncertain. These challenges, however, have continued for a number of years and create a backdrop of the new normal for transaction bankers.