Intraday Liquidity. Just in Time Payments.

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

There is one further twist that the response to these regulatory changes might take. If an FI were indeed able to successfully integrate rap-time intra-day data back into its own systems, there is another step it might consider under the label of “optimisation”. It could take the view that it neither wants to rely on an intraday overdraft nor carry the costs of the liquidity buffer that using it implies. Rather like a very stringent housekeeper, such as the mythical Swabian housewife that Germany’s Chancellor Merkel loves to talk about, an FI could decide only to make a payment when it has funds on its account. It could do this by coupling its payment release mechanism to the news of incoming funds, in the form of the MT910s and MT548s that we have discussed above. This is a recognised approached for payment systems; BRGS, the balance reactive gross system.

As a theoretical exercise, this is quite brilliant, and indeed, I know of one large FI that has done just this. It has made specific arrangements for its CCP- and CLS-related commitments, paying a fee to receive committed lines. All other “regular” payments are queued until funds come in. This means that their internal payments system has to be constantly checking the running balance and then making choices on which payment to release. There is high potential for a disconnection between what this FI calculates as its running balance, which drives the release of its payments, and its actual running balance with the Nostro. Feedback on debits will arrive faster than feedback on credits, simply because the former is based on when the Nostro internally debits the account, whereas the feedback on the latter, the credits, is after the Nostro has done the internal processing based on a receipt in the real world. Securities-related transactions might also have a lag between when a trade is settled and when the accompanying funds movement is made in the underlying cash account.

The firm I mentioned is quite proud of its success; however, I would offer a few words of wisdom on this. In past days at Goldman Sachs, there was an often-used phrase, “Don’t confuse a bull market with brains.” I would offer a variation on that theme: “Don’t confuse immediate results with long-term success”.

The strategy has delivered results simply because there is a distinct first mover advantage. At the extreme, if everybody followed the same strategy, gridlock would ensue in a Mexican standoff. There is some risk that counterparts will work out the game being played and potentially pay this FI later; in days past in New York, it used to be a well-practised art in Operations to deliver government bonds only just ahead of the deadline, so that turnaround was unlikely. But in the end, folks do work out what is going on. Another risk is the issue of the huge amount of operational risk inherent in this construction. If anything goes awry in the feedback process, the payments will not be released. The firm’s own processing systems must be constantly up, checking balances, releasing payments and ensuring that nothing gets stuck in the sanctions filter. A failsafe process might be added which, say, might release all remaining payments 30 minutes before cut-off.

Lessons Learned: Be careful what you wish for and be very careful claiming victory. The first applies to the regulators; they have imposed all these new measures and will need to be aware of and manage the consequences.  Some controls are in place; if this practice was widespread in GBP payments then the UK banks would struggle to meet targets around volume and value of payments that need to be complete by certain times.

The FI’s that take this approach are optimising for their own needs. This approach simply cannot work on a widespread basis. Beyond that narrow focus, all the FI’s need to work together to solve the wider issues.

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!

UK: For the print version and Kindle users: Click Here

US: For the print version and Kindle users: Click Here

Hot on its heels is a book on wider operational matters: The Bankers’ Plumber’s Handbook. Coming soon.

Thanks for your support and thanks to the numerous contributors.


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