07 MarIntraday Liquidity Management: the billion dollar challenge

This week’s post is about intraday liquidity and its costs. At somewhere between 100 and 150 bps,  $1 billion in liquidity equates to costs of $10 million. At that price, this is a topic worth mastering.

This is about right here, right now, so the only Blockchain angle is in possible solutions. The next post will focus on those. First, we will focus on understanding the problem.

For banks, the Intraday Liquidity Buffer is there to make sure that they can operate everyday and pay what they owe. Lately the rules for the size of the buffer have become tighter and its cost has been rising. Even for a second tier IB its activity may easily require some $10 billion in reserves just for the intraday needs.

Banks are under pressure to cut costs. First because profits are increasingly hard to come by and second, because their costs are too high. The costs of the Liquidity Buffer are a major contributor to operating costs. Using the typical across the board cuts approach, a bank would need to save 50 onshore heads or 200 offshore ones to achieve the same savings they could find by optimising their buffer by $1 billion.

The main driver of this change is BCBS 248, “Monitoring Tools for intraday liquidity management“. This is essentially the guidance from a key committee at the central bankers’ bank, the Bank for International Settlements. This is the basis for the local rules acted by individual countries.

Some countries already have rules in place, others do not, so there are already lessons learned and to be shared. A few observations from several different conversations with clients and potential ones:

Who is where? The Brits are out in front on this topic. UK banks have already implemented programmes and the topic is part of the on-going dialogue with the PRA, the UK regulator. In other countries, such as South Africa, regulators have indicated they will adopt the guidelines, but are not yet enforcing them. Elsewhere, for example in Northern Europe, there seems to be some combination of local rules not yet being set, timelines not being set out and banks yet to start preparing.

What do banks have to do? Understanding BCBS 248 is akin to reading an exam paper properly. It is a two part challenge. There are very clear reporting requirements. The second part is that banks have to meet the Operational Principals. Two of the six principals will require new operational processes and tools to support them:

  1. Principal Nr. 2 is the requirement to show how you monitor intraday
  2. Principal Nr. 5 is the ability to control payments outflow.

From experience, I know these get overlooked; this is like failing to turn the exam paper over. Project people read “reporting requirements”, see that it is a monthly reporting requirement and often look no further, ignoring the principals .

What does good look like? Banks have started to source intraday messages from their Nostros. These are the MT900, 910 and MT942 messages, on top of which for securities businesses MT548 status messages and MT566 ones will be required. Those messages are being used to provide a picture of actual intraday balances and to identify the peaks as dictated by the reporting requirements.

What does great look like? The best solution I have seen has three key attributes:

  1. Actual vs. Expected: It links the “actual” events documented by the SWIFT messages to the expected ones, the transactions and cash flows which were booked internally.
  1. Peaks vs. causes: It allows the bank to identify both the moment of peak usage by bank account and to then break that down by the expected cash flows and their sources. Those with a formal accountancy training will see a similarity here to the “Sources and Uses of Funds” statement.
  1. Precise cost allocation: Costs are then allocated to trades and then to trading books and businesses.

Lessons Learned: In those jurisdictions where banks do not yet have to do this, I would use a simple analogy from student times and term papers. Leaving this to the last minute and pulling an all nighter has little chance of success. Start now. And, if you can, ask the Brits how they did it.

For those who have started or are live, some initial observations:

  1. Cost allocations must be accurate: In most banks, there is a a maze of inter and intra-company bookings. Users of liquidity are those who sell a currency, make a money market deposit or buy securities. The cost allocation has to correctly work its way back through those bookings, specifically allowing for what was settled gross vs. net. If that is not done properly, individual desks will start to do trades that are rational for avoiding internal costs but totally irrational for the bank.
  2. Gross payments are the enemy: Payments drive the use of intraday overdrafts with your Nostros and the peak of those overdrafts governs the size of the buffer.

Careful analysis of peak overdrafts will be worth every minute you spend on it. Let us suppose that over 64 business days in a quarter you can always keep your max intraday overdraft in EUR to exactly 100 million each day. So your average is 100 and the 95% confidence level is 100. Now if on one day in the quarter your OD goes to 500 million. That drives your 95% level to 337 million, an increase of 227 million, which would cost you some $2 million per year more. If you had a single day when that OD went to 1 billion, your 95% level is now $600 million, which brings $5 million in costs.

  1. Inter-company payments are the devil incarnate: Big banks have lots of entities and lots of cash movements between those many left hands of the firm. Banks only have left hands. If money is moving between those many left hands in the real world,like death & taxes, for sure it is costing you fees and those movements will be driving up your overdrafts.

Now, banks can only be as efficient as the market infrastructure allows, but if you believe your bank has done all it can to be efficient, then I have a used Swiss Navy aircraft carrier I can sell you.

The market does though need a new piece of infrastructure. CLS Bank does a fabulous job delivering a net funding solution for the cash flows associated with a sizeable share of the world’s FX trades. The market now needs the next stage in evolution to support net funding for all the cash flows that do not go into CLS and are unlikely to go into it anytime soon. “CLS for the rest” as it were.

Good news. Things are happening and there is considerable momentum amongst leading participants, with CLS leading the charge. In next week’s post, some thoughts on what that potential piece of infrastructure needs to do in order to really our industry.

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