Intraday Liquidity. A new charging model?

With new rules coming into effect on Jan 1 2015, this is the thirteenth in a series of posts on how banks and FI’s might adapt. The previous posts are available on the 3CAdvisory website, click here.

In the transaction banking business, intraday liquidity is not something that has traditionally been charged for explicitly or even that has generally been taken into account in pricing and charged for implicitly. Timed critical payments, such as those to CLS and to CCPs are a notable exception; they are often charged for either on a “pay for what you use” basis or, in the case of committed lines, on the size of the line.

In some cases, the providers of CLS third party services have moved away from the traditional ticket fee-based model in that business. Historically, the norm, as in the payments business, was to charge per trade. However, as credit and liquidity became an issue after the Lehman collapse, some providers chose to pass on some of the liquidity cost based on the net settlement balances that the CLS third party ended up with. This is actually a sensible model, as it accurately reflects the costs incurred by the provider in making the service available. On the prime brokerage side of FX, the business model has always been to charge based on value.

Now, if we assume that the liquidity buffer costs are both pushed down into the business and are painful, the transaction businesses will need to pass these on. The next decision is: “explicit” or “implicit”? The latter would imply a rise in ticket prices for payments to compensate for the extra costs, possibly even with a charge, or with a higher charge than today, for credits to reflect the cost of all the processing needed to process them.

The implicit route has a couple of pitfalls:

a.Clients will make a like-for-like comparison to other providers and will simply conclude that Bank A’s ticket fee is higher than Bank B’s.

b.They may overlook, or ignore, the fact that the price includes the liquidity charge.

The alternative approach to applying a charge is to apply an explicit one, a specific charge based on the actual overdraft or on some average over a period. This is, in fact, the basis that many providers of CLS Nostro services use in charging the settlement members for the timed payments associated with making payments to CLS to cover shorts. So this would really be a derivative type of pricing and an approach that the larger Nostros are already equipped to measure and bill for.

With either approach, there are several dangers associated with the way clients might react. In either case, the introduction of new or higher charges is quite likely to prompt the FI client to “RFP the market”, that is, to issue a request for proposal so they can see if it is cheaper elsewhere. If there is an explicit charge, the FI might try to go cold turkey and switch to a just-in-time approach. However, this can only be done with the right infrastructure in place.

Many an hour might be spent on philosophising over which is the better approach. There is no one right answer. I would recommend as a first step that the Nostro reduce intraday overdraft facilities and also look at the payments patterns of the largest users of those facilities. Are credits from their counterparts always coming in late? That will drive the dialogue with the client and might set the scene for introducing charges once the Nostro can clearly demonstrate that it has its own shop in order.

Lessons Learned: In the long run, I would counsel the use of an explicit charge that is related to value and not to volume.

A personal request: Finally. I have ventured into self-publishing. The not so creatively titled, but practical guide: “Cash & Liquidity Management: Mastering the Challenges of New Regulations and a Changing Marketplace” is now available in print and on Kindle. All the bits form the Blog are there, together with a lot of detail on current challenges. Many of those challenges will take effect on Jan 1 2015. Time to be well informed! As too is the book on more general operations issues.

Book #1: The Bankers’ Plumber’s Handbook

How to do Operations in an Investment Bank, or Not! Includes all the Blog Posts, with the benefit of context and detailed explanations of the issues. True stories about where things go wrong in the world of banking. Available in hard copy only.

Book #2: Cash & Liquidity Management

An up to date view of the latest issues and how BCBS guidance that comes into force from Jan 1 2015 will affect this area of banking. Kindle and hard copy.


Hard Copy via Create Space: Click here

Amazon UK: Click here

Amazon US: Click Here

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