Attracting and managing corporate deposits

Transcription

1 Financial Services Attracting and managing corporate deposits Authors Axel Miller, Partner Ugur Koyluoglu, Partner Roland Tan, Senior Manager

2 TRANSACTION BANKING: Attracting and managing corporate deposits A lasting effect of the financial crisis has been the disruption to the flow of wholesale funding that banks previously enjoyed. Securitisation markets are still nearly closed, and the cost of long-term, senior unsecured funding, while down from its crisis peak, is still well above pre-crisis levels. New liquidity regulations in particular, the Net Stable Funding Ratio (NSFR) requirement of Basel III will require banks to raise ~ 2.7 TN of additional long-term wholesale funding between now and 2018 or else reduce the gap between loans and deposits by a commensurate amount. Achieving this through additional wholesale debt would require issuance volumes 80-90% higher than the average between 2007 and Short of a retreat by global regulators from the NSFR, meeting this refinancing challenge will require a mixture of deposit raising, deleveraging and additional wholesale funding. As the cheapest and safest source of funding, deposits are in particularly high demand to fill this funding gap. Banks will need to improve their corporate deposit strategy as competition increases in this space. At the same time corporate cash holdings have reached unprecedented levels. Corporate cash holdings were estimated at approximately US$15.5 TN globally at the end of 2011, and are expected to grow at ~12% a year to US$24.6 TN by This enormous cash pile accumulated over the last three years as internally generated profits outstripped capital expenditures and dividends. Unsurprisingly, corporates have been unwilling to invest because of the uncertain macroeconomic conditions and tighter credit arising from bank deleveraging. As a result, corporate deposit balances have been increasing (see Exhibit 1). Corporate cash levels are likely to remain elevated in the medium term too, as interest rates remain low, macroeconomic conditions remain uncertain and banks continue to deleverage. However, corporate treasurers are likely to find innovative ways to invest this cash, by using dynamic discounting or direct lending. Dynamic discounting is a method of paying suppliers early with negotiated discounts, effectively investing existing cash into the supply chain. Methods like dynamic discounting will provide stiff competition for corporate deposits. 1 See Oliver Wyman report The State of European Bank Funding, November Economist Intelligence Unit. Copyright 2012 Oliver Wyman 2

3 Exhibit 1: Corporate deposit balances, selected regions BALANCE (US$ BN) 2,500 2,000 1,500 1, Eurozone US Japan UK Eurozone, Japan, and UK data is deposits outstanding from private non-financial corporations (including SME, excluding NBFI). US data is nonfinancial corporate deposits and cash, excludes foreign deposits in US accounts, but includes US deposits in foreign accounts In addition to these general observations, we are seeing different drivers shaping demand and supply in individual market s funding structures (see Exhibit 2). With these various funding pressures, banks are keen to get their hands on some of this corporate liquidity. However, all that glitters is not gold and not all cash is created equal. A distinction must be made between operational cash and excess cash because they have different stickiness and value and capturing them requires different strategies. Copyright 2012 Oliver Wyman 3

4 TRANSACTION BANKING: Attracting and managing corporate deposits Exhibit 2: Market-specific funding issues Market United States Europe Asia Other emerging markets (e.g. Turkey, Russia) Observations Since November 2010, the Federal Deposit Insurance Company ( FDIC ) has guaranteed all corporate deposits in non-interest-bearing transaction accounts As a result, cash in transaction accounts (as a proportion of total cash balances) increased from the long-term average of ~12% to ~15%* This guarantee expires 31 December 2012, after which the additional 3% might: Move out of the US banking system into non-banks (e.g. money market funds) and highly-rated foreign banks Reallocate from weaker US banks to more creditworthy US institutions The Dodd-Frank Act also had a large impact on the corporate deposit market, by repealing regulation Q, which prohibited the payment of interest on corporate demand deposit accounts There has not been much reaction so far to interest on demand deposit accounts, but as rates rise we expect this to change: Banks will be able to use this for the first time as a tool to attract deposits Deposit funding will become much more expensive, changing the economics of the business Ongoing deleveraging the IMF estimates a further 1.6 TN of balance sheet shrinkage reduces the demand for funding, however sovereign debt crisis continues to put pressure on bank balance sheets and keep bank wholesale funding costs elevated Need to comply with Basel III and other regulation (e.g. ring-fencing in the UK) has made corporate deposits a critical source of funding European banks deleveraging in Asia have created a significant US$ funding gap, particularly in trade finance Asian banks are taking advantage of this gap, but are constrained by US$ funding, despite being extremely well funded in their local currencies Better capitalised Asian banks have been raising US$ funding, but more through one-off efforts (e.g. US$ bond issuances) than systematic funding approaches Western-Asian partnerships to address this US$ funding gap have not been observed There is the potential for a game-changer if the shift to an alternative clearing currency (e.g. RMB) becomes a reality; a continued growth in cross-border trade settlement in RMB (which grew from almost 0% to 9% of China trade flows last year) could support a movement towards this Many of the high-growth emerging markets exhibit signs of a credit bubble, with increasing loan to deposit ratios This credit growth has increased the need for deposits to fund the expansion Regulation and restrictions on cross-border capital flows render domestic funding capabilities increasingly important * FDIC (as at end 2011) Copyright 2012 Oliver Wyman 4

5 Operational vs. excess cash Operational cash is the cash used by corporates for the day-to-day management of their business. It forms part of the working capital and is used for payments, managing inventory, sales, etc. Corporates keep this type of cash in demand deposit accounts or transaction accounts, which are usually managed by the transaction bank. Because it is difficult to change a payment mandate with a transaction bank, and because these accounts generally have a core positive balance with only minor fluctuations, operational cash is sticky and thus very valuable. It makes up ~12% of total corporate cash balances 3. Excess cash is cash held over and above what is required for daily operations. It could be held as a buffer or for future investments (e.g. capital expenditures, acquisitions) and it is less sticky than operational cash. Much of the increase in corporate cash balances observed today is excess cash. From a regulatory (e.g. Basel III) perspective excess cash is most attractive for banks as term deposits with long maturities. 3 Long-term average based on FDIC data. Banks will need to improve their corporate deposit strategy as competition increases in this space Copyright 2012 Oliver Wyman 5

6 TRANSACTION BANKING: Attracting and managing corporate deposits Attracting and managing liquidity The competition for corporate liquidity is rapidly heating up Attracting deposits will be vital for wholesale banks. In Europe and the UK, banks have already decreased the loan to deposit ratio in their corporate businesses since 2009 by 40 and 60 percentage points respectively (see Exhibit 3). These reductions are likely to continue as Basel III requirements on the LCR and NSFR come into effect. Wholesale businesses will need to attract corporate deposits or reduce lending if they don t have access to retail franchises. Banks intending to expand their liquidity gathering can follow two approaches: When seeking to capture corporate s excess cash, the bank s credit quality, product design and pricing are more important than transaction banking capabilities. For example, pure investment banks lack transaction banking capabilities but derive significant amounts of funding from corporates by offering competitive liability products such as structured notes Targeting greater amounts of operational cash will require a build out of transaction banking capabilities if the product suite is incomplete. Not only is this normally a multi-year endeavour with need for significant investment budget but it also requires specific skills and capabilities well-embedded with the broader corporate and wholesale banking strategy. Once successful, captured demand deposits through transaction banking services will be the most valuable deposits for the bank Copyright 2012 Oliver Wyman 6

7 The cornerstone of any effective corporate deposit capture strategy is a good understanding of corporate deposit behaviour, especially the differences between operational and excess cash by client segment. While a full behavioural analysis can be complex, there are many advantages to be gained from the investment and there are also pragmatic shortcuts that can be taken in the shortterm (see Exhibit 4). Understanding corporate deposit behaviour and economic characteristics can form the basis for pricing, incentivisation, product design and hedging of interest rate risk. Exhibit 3: CORPORATE loan TO deposit RATIO, Eurozone and UK RATIO 350% 300% 250% 200% 150% 100% 50% Eurozone 0% Jan.09 May.09 Sep.09 Jan.10 May.10 Sep.10 Jan.11 May.11 Sep.11 Jan.12 UK Copyright 2012 Oliver Wyman 7

8 Exhibit 4: Corporate deposit CHARACTERISATION Deposit characterisation normally uses three types of analyses: 1. Balance behaviour BALANCE STEP 1: Fit a trend line to the data to capture the underlying growth rate STEP 2: Measure variation from this trend Volatile deposits Core deposit STEP 3: Define a core level of deposits that will not be breached with a high degree of confidence (e.g. 3 standard deviations) TIME In this analysis, deposit balances are segmented into the following segments: Volatile: balances that fluctuate randomly Rate-sensitive: balances that fluctuate when rate or index spreads change Core: balances that remain under virtually all market conditions A regression-based approach is typically used to estimate the fraction of balances that are core 2. Average life # ACCOUNTS Average Life TIME To value deposits, a behavioural term needs to be assigned to the core balance A quantitative analysis of account mortality is performed on account-level data to derive the average life of each deposit in the portfolio The outputs should be supplemented by a comparison to peer benchmarks (for sense-checking ) 3. Rate sensitivity 30 CHANGE IN RATE PAID (BP) y = x R 2 = CHANGE IN 3M LIBOR (BP) Another component of deposit valuation is the determination of the effective frequency at which they reprice Relevant for administered rate products (not so for fixed rate/non-interestbearing) Also regression-based seeks to establish the relationship between the bank s discretionary pricing and the market rate A full characterisation exercise is a valuable but data-intensive project. In addition, the models need to be adjusted to capture the differences between the in-sample period and later periods. Some pragmatic shortcuts may be applied e.g. using Basel III parameters for estimating core balances and using benchmarks for average life. However, these shortcuts are not the long-term solution as incorrect valuations of deposits could lead to poor decisions. Modelled parameters sometimes conflict with Basel III parameters. For example, many banks will characterise operational corporate deposits more valuable than Basel III implies. In these instances, the Basel III parameters should be used if they are more conservative, otherwise it will result in a subsidy for the business because the true regulatory cost has not been allocated. Copyright 2012 Oliver Wyman 8

9 Corporate deposit STRATEgy Traditionally, corporate deposit strategies were often little more than pricing grids for deposits. Attempting to grow corporate deposits based on such an approach bears significant risk of a spiralling price war and economically unsustainable models. Many banks lack the building blocks of an effective deposit-gathering business. That is, a clear strategy, a distinct market proposition, targeted and innovative products, pricing schemes aligned to the value of the deposits, specific sales models, sales support and marketing and a clear focus in corporate sales steering and incentive systems. There are broadly four distinct approaches for attracting corporate deposits, depending on the two main factors of transaction banking capability and counterparty credit risk. Banks should build on their relative strengths along these two dimensions when determining their overall approach to corporate deposit-gathering. Banks with strong transaction banking capabilities and good ratings are structurally advantaged and will have more options available to them. Corporate cash holdings were estimated at approximately US$ 15.5 TN globally at the end of 2011, and are expected to grow at ~12% a year to US$ 24.6 TN by 2015 Copyright 2012 Oliver Wyman 9

10 TRANSACTION BANKING: Attracting and managing corporate deposits Exhibit 5: Approaches for attracting corporate deposits Bank rating AA or better Bank rating below AA No or weak transaction banking CAPABILITY Leverage creditworthiness to target excess cash as term deposits from corporates Build on product capabilities in combination with outstanding sales approach In particular, target US corporates as the FDIC guarantee will soon run out these companies will be looking to diversify their cash holdings Structurally disadvantaged attracting large corporate deposits will be difficult To mitigate weaknesses, leverage lending relationships to bring in deposits Lead with innovative liability products that offer competitive returns or have attractive characteristics such as enhancing the bank s own rating Examples include CPPI/VPPI products, structured notes, 35-day call deposits, deposits acting as derivative collateral, and combined lending-deposit products May help bring in corporate deposits, but is not a panacea for bank credit rating and transaction bank capabilities Strong transaction banking capability Use full product suite spanning liability management (from short to long-term) and payments and cash management or custody Actively promote term deposit product and seamlessly integrate it into the broader PCM/ custody offering Integrate management of asset and liability side to win transaction banking business by using credit provision Lead with credit to win transaction banking mandates requires strong data and stringent steering to manage overall relationship profitability Will require a combination of lending, transaction banking and deposit product innovation managed in an integrated fashion Focus on core markets and home market customer segments with clear market proposition The deposit strategy for each of the four clusters will have six dimensions: Market proposition and positioning This is based on a clear understanding of the target customer segments, the bank s overall positioning within these segments, its strengths and weaknesses compared to its peers and the behavioural characteristics of these segments in terms of usage of deposit products. A me too approach which only differentiates by price is not a sustainable proposition because other factors such as flexibility and security will be as important if not more so to corporates. Some examples of differentiated propositions and positioning are: Copyright 2012 Oliver Wyman 10

11 Some banks in the US have established global advisory teams for corporate deposit clients to provide advice and guidance related to tax, regulations, deposit products, financing, JVs, etc. These teams are particularly useful for serving middle market companies that are unfamiliar with global finance, liquidity requirements, banking and payments Other banks have focused on developing tools to provide clients with better reporting, analysis and monitoring of cash forecasts and working capital management flows, or better integration with FX tools (e.g. electronic FX platforms) Products In most cases deposit products have been structurally similar across competitors, leaving little room for differentiation. Only recently have banks started to develop more innovative products. Some examples of recent innovations include: 32 or 35-day call deposits to optimise LCR and NSFR treatment Use of deposits as collateral for derivative exposures Combined lending-deposit products Term accounts with growth linked to an index but with full capital protection RMB trade settlement accounts that permit offshore RMB deposits Zero balance accounts with auto-sweeping Pricing Pricing will continue to be one of the most important buying criteria. However, we believe that deposit pricing must become more sophisticated, differentiated and focused on specific client segments or behavioural characteristics. Pricing flexibility and repricing are important drivers of performance: Key question is what to do when interest rates go up partial repricing with a lag would maximise the earnings (though with the risk of customer switching if a bank lags behind its peers) Nevertheless, liabilities will probably reprice faster than assets, leading to pressure on overall wholesale banking profitability in a period when rates rise. When all assets are later repriced at higher rates, this pressure will diminish and the bank will earn more as a result of larger margins for demand deposits Pricing should be fixed as a percentage of the prevailing rate rather than as a spread this will allow for more income to be captured as rates go up (although it introduces interest rate risk that will need to be managed) Copyright 2012 Oliver Wyman 11

12 TRANSACTION BANKING: Attracting and managing corporate deposits Sales model Relationship managers are usually neither focused nor incentivised to go after deposits (except for one-off deposit-gathering initiatives). Furthermore, banks often lack appropriate consideration of deposit products in an asset-focused sales model. As a result, the sales support, CRM, account planning, sales processes and tools do not properly support either the identification of client demand for deposit products or the corresponding sales process. In addition to building out the respective processes and tools, soft credits for deposit income could be a way to encourage relationship managers to focus more on deposit-gathering. Training To sell transaction banking, including deposit products, relationship managers will need to understand the working capital management cycles of their clients and be able to have an advisory discussion on the topic. Currently, while relationship managers are generally extensively trained on the credit process and understand the credit needs of their client, the same cannot be said for corporate deposits and working capital management. Organisation Many organisational units and functions are involved in providing deposit products for bank funding, such as corporate and commercial banking, transaction banking, capital markets and treasury and finance. In addition many banks have a fragmented organisation structure for the deposit product suite itself. For example, some have sight deposits and term deposits sitting in different organisational units, with all the resulting incentive and steering issues that come with that separation. While a developed Funds Transfer Pricing (FTP) structure and policy are the basis for managing liquidity provision and usage across the bank, we believe that a close coordination or even organisational integration of the deposit product suite is required for a targeted build out of a corporate deposit business. Copyright 2012 Oliver Wyman 12

13 Conclusion The competition for corporate liquidity is rapidly heating up. Differentiation, whether in the form of strong transaction banking capabilities or tailored deposit products, is imperative to stand out from the mass of highly similar offerings. With bank funding costs rising and likely to stay high for the foreseeable future, the benefits of capturing more deposits will exceed the cost of designing and implementing a corporate deposits-gathering strategy. Copyright 2012 Oliver Wyman 13

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