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Banks Tweak Products with Basel III in Mind.

Byline: Susan Kelly

Banks are preparing for the new capital requirements that will start to take effect in the United States at the start of next year by making improvements in their earnings credit rate products, and additional changes in banks' cash management products are expected down the road.

Basel III's liquidity coverage ratio considers banks' ability to hold onto deposits for a period of 30 days in times of stress and requires banks to hold more capital against deposits deemed likely to be withdrawn. One way to qualify deposits for lighter reserve requirements is to show that the deposits are linked to the corporate customers' operations, such as accounts used to make payroll or handle accounts payable.

"Those deposits that don't qualify as operating deposits will have very low value," said Dave Robertson, a partner at consultancy Treasury Strategies. "The nice thing about earnings credit is it clearly ties the balance to the services."

Earnings credit rate (ECR) products give corporates implied interest on deposits that they can use to offset cash management fees.

Despite forecasts that the discontinuation of unlimited Federal Deposit Insurance Corp. coverage for bank deposits at the end of 2012 would send a lot of corporate money elsewhere, companies continue to keep a large portion of their short-term cash in bank deposits. The Association for Financial Professionals' 2014 Liquidity Survey showed companies had 52% of their short-term portfolios in bank deposits, up from 50% in 2013. And three-quarters of the more than 700 finance executives surveyed said their companies realized earnings credit rates on their bank deposits.

As the new capital requirements get closer, banks are making ECR products more attractive by broadening the time frame and the fees that ECR can be used to offset.

ECR products usually work on a monthly use-it-or-lose-it basis; a month's implied interest can be applied against that month's fees, and any implied interest that's not used in that month goes away.

According to the AFP survey, some banks now calculate ECR on a quarterly, instead of a monthly, basis, and some are allowing companies to use ECR to pay not only cash management fees, but other bank charges, such as custody or escrow fees.

"We see that banks have stepped up and recognized that this is a major driver for decision making, and they've responded accordingly, either by offering termed-out earnings credit or they've allowed non-traditional uses of earnings credit," said Tom Hunt, director of treasury services at AFP.

Robertson, pictured at left, said the more exciting change is the expansion of ECR programs outside the United States.

"We are seeing the largest banks allowing companies to use ECR on U.S. dollar balances around the world," he said. "So a client with offshore U.S. dollars in Hong Kong, they can offset Asian bank expenses. It's a toe in the water of extending ECR outside the U.S.

"The second phase would be a non-U.S. regional bank saying, 'I'm going to roll out an earnings credit product,'" Robertson added, but said he hadn't yet seen that. ECR has traditionally been a U.S. product because banks in other countries didn't face Reg Q's prohibition on paying interest on business accounts.

ECR products are a "win-win" for both banks and their corporate customers, Robertson said. "In today's environment, balances aren't really worth much to a corporate treasurer because rates are so low, but they're worth a lot to banks - banks value them.

"A corporate might get an ECR of 12 basis points or 20 basis points, which is well above what they could do at the margin overnight anywhere else," he said. "And the bank gets stable balances that are very attractive to it." While the level of interest banks pay on ECR deposits is higher than what they pay in the overnight market, banks prefer to pay ECR on companies' deposits "because it's more stable and it's more valuable from a liquidity perspective," Robertson said.

"ECR is king, and non-ECR balances are going to have to be put into restructured deposit products as part of Basel III," he added.

Many banks are currently working to develop products that align with the new capital requirements, Robertson said. He noted that in addition to operating balances, ECR values deposits that "are guaranteed not to leave for 30 days."

Banks currently offer short-term certificates of deposit (CDs), but Robertson noted that for purposes of the liquidity coverage ratio, a 45-day CD "would offer value over the first 14, 15 days," he said. "After that, it would be a non-stable source of funding."

So banks are looking at callable CDs that would require customers to give the bank 31 days notice before withdrawing the money, he said. "It's perpetually a stable source of funding."

One bank is piloting such a product, he said. "And I would say of our bank client base, probably 20% are doing some sort of development work to roll them out and another 40% are doing more conceptual design around these solutions."

Robertson predicted banks would start rolling out the products this fall or next spring. "It's just a matter of how quickly they can bring them to market.

"In the long run, you're going to see products like [money market deposit accounts] have a very low rate because they really are not attractive funding for a bank, and things like 30-day CDs become really unattractive," he said. "Banks will only offer those as an accommodation to their clients. These callable CDs will have an attractive rate because they allow the banks to offset loans and other longer-term assets."

Peter Gilchrist, a managing director at consultancy Novantas, predicted banks will ramp up their efforts around ECR as interest rates head higher and make other short-term products more attractive places for treasuries to invest corporate cash.

"As you start to see rates rise, you'll see banks become more competitive on the ECR front," he said.

Gilchrist, pictured at right, also expects that banks will eventually promote interest-bearing business accounts, a product made possible by the repeal of Reg Q in 2011. And paying interest means the money in the account is more likely to be classified as operational funds for the purpose of calculating reserve requirements, he said.

Interest-bearing business accounts haven't yet taken off, he said.

"There's a set of believers that say it's going to happen, as there will be more value placed on deposits and [banks] will be willing to pay interest on them," Gilchrist said. "The naysayers are saying in an environment where so much of a bank's profitability is under attack from regulatory and compliance burdens and we're looking at profit numbers that are quite depressed, banks will hesitate as much as possible to offer new products.

"I think you've got banks in both camps, but larger institutions have those interest-rate accounts on the shelf, ready to roll out," he said. "It's just a prisoner's dilemma of waiting to see who moves first."
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Author:Kelly, Susan
Publication:Treasury & Risk
Date:Sep 1, 2014
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