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Shifting sands: Cash Management

In these straitened times, effective cash management has rapidly become the priority for both banks and their customers, but this return to so-called back-to-basics banking is anything but basic. This guide charts the changing cash management landscape and how banks can navigate it in order to come out on top when the global economic downturn subsides. Writer Charlie Corbett
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Shifting sands: Cash Management
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Charlie Corbett, Economics Editor, The Banker

The Banker's Financial Intelligence Guide to cash management is published at a time when banks and corporations are under more pressure than ever to generate revenue, reduce costs and mitigate risks. As the initial panic of the financial crisis abates and the prospect of a lengthy economic downturn increasingly becomes a grim reality, bankers and their customers are focusing their attention on internal processes. The importance of managing cash efficiently is paramount in these straitened times and businesses across the world are looking towards their banks to help them to navigate the stormy financial seas that lie ahead. For the banks, the future is equally uncertain. Those banks that have survived the crisis intact, albeit some of them via huge state-backed cash injections, will need to adapt to a financial landscape that has altered irrevocably. As the dust of the financial crisis clears and banks can once again focus on growth, rather than mere survival, the landscape that emerges will present challenges and opportunities in equal measure.

It is not only the financial crisis that is reshaping the banking industry, but technology and globalisation. When it comes to cash management, the traditional suite of domestic payments processing products will no longer satisfy the needs of a customer base that is increasingly looking beyond its own borders to do business, and demands ever-more complex products and services. The financial crisis has only speeded up a more general focus by banks on their cash management businesses and shown, with crystal clarity, how important such steady, reliable revenue streams will be in the future. The downturn has also catapulted counterparty risk to the top of corporations' worry lists.

The latest survey from JPMorgan Asset Management on global cash management emphasises this point. Out of the 314 corporate treasurers surveyed, the vast majority of respondents had either increased their number of banking relationships or kept them the same. This reversed a trend that had, until 2007, seen companies reducing the number of banks they did business with.

Technical revolution

It is hardly surprising that banks want to diversify their bank exposure, given the high profile collapses of late 2008 and the government-backed bail-outs in the US and Europe. Client attitudes are changing, not only due to the crisis, but due to technology. The internet has revolutionised the way that companies and consumers interact with their banks. According to JPMorgan's survey, the proportion of respondents that used online portals for cash management leapfrogged from 47% in 2007 to 73% in 2008.

A recent study for IBM's Institute for Business Value identified a series of ways in which banks' relationships with their clients will change in the next five to 10 years. The study claims that the internet has altered the balance of power between companies and their banks, liberating clients from traditional practices. They will, according to the survey, demand more advocacy, more personal security and, above all, more control in their banking relationships. The universal bank model, so vaunted by so many for so long, is coming under increasing pressure. According to the report, industry specialists and non-banks will begin to compete with banks by offering tailored products and services to targeted groups.

On top of this, banks are beginning to realise that they cannot be all things to all people. Cash management is an increasingly expensive business and many banks simply cannot afford to keep up to date with the latest technology and in line with the latest regulations. Most likely, they will look outside their own institutions to provide transaction services to clients, either through a stand-alone technology company or through buying the necessary technology from a bigger rival bank, a process known as 'white labelling'. According to the IBM survey: "All this will take place in an atmosphere of significant economic and geopolitical uncertainty, intense regulatory scrutiny and compliance requirements, merger and acquisition activity, risk exposure and technological change."

Understand your client

Cash management might be back in fashion with banks, but that does not mean the road ahead is any less challenging. One solution put forward to help banks cope with the technological and financial demands of the new cash management landscape is service-oriented architecture (SOA). In the drive to better understand customers' increasingly complex needs, SOA could be a tool that can revolutionise the way banks and clients interact. The technology allows banks to integrate and develop their software and makes for a more flexible way of working and the ability to build new capabilities. In relation to clients, SOA means banks can share their back-office processing directly with customers so that companies can check the status of payments and balances in real time, and at little or no cost to the bank.

This is all part of an industry-wide attempt to understand the needs of clients better. Going forward, clients will want to play a far more active role in their cash management. Technology has allowed customers more control over their finances, but the economic downturn has awakened them to the need to monitor their risk exposure and counterparty situation ever more closely.

Concerns about managing cash positions, 2008

Concerns about managing cash positions, 2008

Liquidity risk

A tumultuous year in financial markets has fundamentally altered clients' attitudes towards the banks that finance them. The direct impact of the credit crunch was the collapse in funding. The JPMorgan survey shows that liquidity was the single largest concern treasurers had about managing their cash positions. Looking ahead, that concern will evolve into one of liquidity risk. The ability to trade out of an asset with speed and without a loss has become an imperative among treasurers and banks alike. The root cause at the heart of the financial crisis was the inability of banks to trade out of their positions in complex debt derivatives that had previously proved to be highly liquid assets. Once the market in collateralised debt obligations collapsed, it was only a matter of time before the mainstream debt markets ground to a shuddering halt. No one wants to make the same mistake again.

Banks will also have to manage their clients' foreign exchange risk more effectively. In the past 12 months, currencies across the world have been see-sawing against one another - a situation that causes banks bad dreams and corporate treasurers nightmares. Foreign exchange risk was mentioned as an important concern by 43% of those surveyed by JPMorgan, up from just 6% citing it as a concern in 2007. Advances in technology, combined with globalisation, mean that even the smallest businesses need to make transactions in all manner of currencies. Increasingly, the demands of smaller customers are becoming the same as those of bigger customers. This will mean that the smaller, more domestic-focused banks will be forced to offer the same kind of products and services as the larger international outfits. Given the cost of establishing an effective cash management division within a smaller or more medium-sized bank, the future lies in outsourcing the service to a stand-alone provider or white labelling products from a rival bank.

Regulatory burdens

On top of the need to keep up with technological advances, banks are faced with complying with a mountain of new regulation that will have a profound impact on how they do business in the future. Arguably the most important initiative to affect banks during the past two years is the Single European Payments Area (Sepa), which was launched amid much fanfare in January 2008. The initiative is explored in more detail in this guide's following article, but in very broad terms its implications are enormous. A single, harmonised payments area in Europe will be of huge benefit to banks' customers, but not necessarily to banks. Aside from the cost of converting outdated legacy systems so that they are in tune with banks across the rest of Europe, banks will lose valuable income from cross-border fees and charges.

Sepa direct debit is due to be rolled out across Europe in November and, again, will herald a new age in banking harmonisation. The reality, however, is somewhat different. Despite being launched more than 18 months ago, Sepa's impact has so far been negligible. Few banks have had the time, money or inclination to put in place the systems needed to make the dream a reality. Add to this a distinct lack of demand from bank clients for Sepa and it seems highly unlikely that a truly harmonised European payments area will be established any time soon. For one thing, no one has yet to establish a deadline for compliance, and few have any idea which European institution is responsible for setting such a deadline.

Payments progress

A more pressing concern for banks at the moment is the Payments Services Directive (PSD). Again, explored in more detail in the following article, the PSD will fundamentally alter the banking landscape in Europe. Unlike Sepa, however, the PSD has a strict deadline and will pass into law in November. It aims to create a new regulatory framework for payments services in the EU, harmonising the legal environment for all electronic payments instruments for all providers. Not only will this cut yet more cross-border revenues for banks, but it will also allow for separate payments institutions outside the traditional bank framework. This will add an extra layer of competition, in an already cut-throat market, as smaller unique payments technology providers seek to grab market share. For those banks that take seriously their cash management operations, the future is clear. They will be operating in an environment of increased competition, higher technology spending, falling revenues and plunging margins. The only way to survive in such a market is to operate on such a large scale that it makes the investment worthwhile. Smaller and medium-sized operators will be forced to outsource their payments and cash management functions either to larger banks or specialist providers.

Concerns in the treasury department, 2008

Concerns in the treasury department, 2008

The future

Those banks that fail to adapt to the altered cash management landscape will undoubtedly usher in a future of unhappy customers, loss of business and unwanted attention from regulators. Ultimately, those banks that pay sufficient attention to what their clients want will succeed. Currently, clients' most pressing need is survival. Cash needs to be managed in a way that does not present undue risk, but is also effective. The biggest concern for corporate treasurers during an economic downturn such as this is liquidity. The desire to mitigate liquidity risk is reflected by the fact that so many are expanding the number of bank relationships. Not only this, but clients want more transparency. The ability to track payments and communicate effectively with their banking partners will put clients' minds at rest and alleviate some of the renewed concerns about counterparty risk. Whereas once upon a time, fear of a supplier going bust was an overriding concern for companies, now they need to be reassured that their bank will remain solvent.

Most banks have moved on from the panic phase of the financial crisis and are just beginning to focus, not only on survival, but on how they grow in the future. It is clear that the cash management divisions of banks have taken on a renewed significance during the economic downturn. The interest-bearing products that for so long generated mega-profits are, for now, sitting on the top shelf gathering dust. For those banks that make the necessary investment, cash management has the potential to provide steady revenues in all market environments. But for those banks that lack the commitment and financial muscle, the shifting sands of the cash management landscape are likely to swallow them.

What is SOA?

Service-oriented architecture (SOA) is a style of developing and integrating software. It involves breaking an application down into common, repeatable 'services' that can be used by other applications, both internal and external, in an organisation, independently of the applications and computing platforms on which the business and its partners rely. Using this approach, enterprises can assemble and reassemble these open, standards-based services to extend and improve integration among existing applications, support collaboration, build new capabilities and drive innovation at every point in the value chain.

Source: IBM Institute for Business Value

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