Liquidity costs come home to roost. Near 100% increases in transaction costs

Banks do not always get it right, in fact “hardly ever” may seem more apt. This week’s post tells the story of how the cost of liquidity when properly allocated and charged can dwarf the existing ticket charges we are all familiar with in transaction banking.

Banks have to keep liquidity buffers. They are always expensive and banks need big buffers. 100 to 150 bps is a broad cost and for major banks the buffers can and do run to three digit billions, yes B not M! These costs are central Treasury ones; at the top of the organisation. Down at the bottom, transaction services businesses, the GTB’s, GSS’s and TSS’s of the world, have mostly charged ticket fees for their services, with CLS related timed payments being the exception and being charged on value.
Cost allocation in banks is certainly more art than science. In recent months, I have heard from friend in FX oops and in transaction services business how their Treasurybis now specifically allocating liquidity costs to them. Large dollops of it too. For the transaction folks, clients’ peak intraday overdrafts seem to be the key. For FX, it is the gross payments. Costs like the brown matter, roll downhill.
How to pass costs on to clients? This is a very tricky question; there could be significant first mover disadvantage. The FX business would simply be priced out of the market if it said to clients that it would widen the spreads unless they net or use CLS; to date I have not seen clearly distinct pricing in FX based on settlement method, although I have heard of some cases where a distinction has been made for cleared vs. In-cleared derivatives.
The transaction businesses are similarly challenged; attempts to push ticket prices up are not likely to be easily swallowed by clients and big increases would be almost a sure fire bet to result in the client RFI’ing or RFP’ing. And, it is another sure bet that in a given market there will be other provides that have not correctly calculated and allocated these costs.
If the full costs of liquidity are passed on, the effect can be huge. In one case I have heard of costs going up by nearly 100% and nearly 400% in the space of a couple of years.
Lessons Learned: Inside banks, the cost allocation process is now running its proper course. Many activities will suddenly appear unprofitable. In FX, gross settlement ought to be seen as something to eliminate and there should be a drive to net anything that cannot be out thought CLS.
In the transaction businesses, life could get tricky. If the service providers add the costs to the ticket price, the only way to keep costs down is to do fewer trades. For those buying services, I would that if confronted price increases, they should ask about the drivers and try to have the supplier break out any liquidity costs in a way that makes them variable. For example, Third Parties using CLS services might seek to have those charges linked to their funding position and not to volume per se.

Previous Posts: Are available on the 3C Advisory website, click here.


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