22 JanIntraday Liquidity. The Intraday Measurement Requirement.

With new rules coming into effect on Jan 1 2015, this is the second in a series of posts on how banks and FI’s might adapt. Humble

Those that can measure may well find that they are surprised by the results. The sheer volume of credit taken will see the regulators require that they increase their buffer. In this case, transparency will, at least initially, be a case of “be careful what you wish for.” The buffer will have to go up until the bank can demonstrate that it is genuinely using significantly less credit. That simply cannot be done over night.

How high is up? One Tier 1 Investment Bank, which managed, with great difficulty, to do the necessary measuring of credit taking at least periodically, found that on the basis of actually knowing how much credit they were taking, the regulator asked them to raise their intraday liquidity buffer from $9B to $15B. The result was a ⅔ increase and an immediate increase in costs of some $90 million.

If a particular bank finds that it is unable to properly measure credit taken intraday, then it will be open to a subjective interpretation from the regulator. That is likely to be a conservative one; an increase in the size of their liquidity buffers is an almost certain consequence. If a 2/3rds increase is the benchmark for a bank where there is insight into the intraday credit taken, it is difficult to imagine any outcome other than a larger increase to allow for the uncertainties.

Agent banks will suffer the same fate. They will need to find a method to pass the costs incurred on to the clients. Some form of value based charged will be needed. Today the Nostro model is heavily biased towards ticket fees and interest charges. Recovering the liquidity costs in that model is a challenge and one where there is a huge potential first mover disadvantage. In the Transaction Services business, the expectation is that each year there is: “The same for less or more for the same.” If a Nostro tells a client that transaction charges are going up, the most likely reaction, even if it is only a knee-jerk one, is that the client will issue an RFP to find an alternative supplier. Some competitors may not yet have understood the changes and, based on old assumptions, may put in an offer which is very much optically cheaper than what the incumbent Nostro has offered. The likely result is that the affected bank moves its Nostro, believing it has dodged a bullet. That relief will only be temporary.

The unfortunate consequences of a state guarantee

When all the banks were setting up the CLS ecosystem, one of the important roles was as a Nostro provider. In the initial 7 currencies, each of the initial 39 members had to have bank in each currency to make their payment. So no surprise that in Switzerland, the banks looked to UBS and Credit Suisse as principal providers. Both banks had worked out that ensuring there was cash on hand to serve clients, meant going into the repo market and had costs. So, quite rightly and independently, both had worked out that this needed to be charged for. The state bank of Zurich, Zuercher Kantonalbank (“ZKB”), was also a settlement member. At a meeting of the German shareholders, the ZKB rep asked us about liquidity for these payments and charging. “Zo, do you know how you vil measure ze liquidity usage?” “Yes, of course, “ we replied. “Vil you charge for it?” ”Yes”. This of course suggested that they could not measure and would not charge for it. They confirmed this. Their only customer was Bayerische Landesbank, a German state bank. So here was one market participant, with a state guarantee, not obeying the rules of physics effectively subsidising another state guaranteed bank.

This sort of disruption may also add systemic risk to the payments systems; one would expect that the major banks offering Nostro services work this problem out faster than others, so there is a risk of business moving to smaller banks. This does happen; in Switzerland, in the last decade, both the cantonal banks and the regional banks under the Raiffeisen label, have aggressively pursued mortgage business; offering lower prices and higher loan-to-value deals. Now their balance sheets are overweight mortgage exposure, whilst the majors have largely stuck to their guns on lending standards.

The requirement imposed on payments systems participants should not be a major burden; they should be able to meet the reporting requirement using the same data they use today to control throughput between their own systems and the external payments systems.

On the securities side of the house, development will also be needed. When looking at the depot, if an FI is long both securities and cash, then life is easy; cash or securities can be moved at will. The trickier situation is when the FI finds itself long securities and short cash. Is it possible to move any of the securities at all? This requires transparency from the custodian. Actually, the kind of calculations that are typical in a CCP or at a clearing broker, who will show clients their excess margin. This does not have a direct impact on cash management, but it helps manage the cash, because securities that are not needed as collateral can be moved to generate cash or support overdrafts elsewhere.

Lessons Learned: Measuring actual intraday usage is not a trivial task. It should though be addressed immediately, because if not an FI will be subject to the worst possible outcome; it will likely see the regulator ask it to increase its liquidity buffer and with it, its costs, without having any means to manage those the causes and the costs down over time.

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