ttra acting and managing corporate · pdf filettra acting and managing corporate deposits. ......

Authors

Axel Miller, Partner

Ugur Koyluoglu, Partner

Roland Tan, Senior Manager

Financial Services

AttrActing And mAnAging corporAte deposits

TRANSACTION BANKING:

Attracting and managing corporate deposits

A lasting effect of the financial crisis has

been the disruption to the flow of wholesale

funding that banks previously enjoyed.

Securitisation markets are still nearly closed,

and the cost of long-term, senior unsecured

funding, while down from its crisis peak, is

still well above pre-crisis levels.

New liquidity regulations – in particular, the

Net Stable Funding Ratio (NSFR) requirement

of Basel III – will require banks to raise

~€2.7 TN of additional long-term wholesale

funding between now and 2018 or else

reduce the gap between loans and deposits

by a commensurate amount. Achieving this

through additional wholesale debt would

require issuance volumes 80-90% higher

than the average between 2007 and 20101.

Short of a retreat by global regulators from

the NSFR, meeting this refinancing challenge

will require a mixture of deposit raising,

deleveraging and additional wholesale

funding. As the cheapest and safest source

of funding, deposits are in particularly high

demand to fill this funding gap. Banks will

need to improve their corporate deposit

strategy as competition increases in

this space.

1 See Oliver Wyman report The State of European Bank Funding, November 2011.

At the same time corporate cash holdings

have reached unprecedented levels.

Corporate cash holdings were estimated

at approximately US$15.5 TN globally at

the end of 2011, and are expected to grow

at ~12% a year to US$24.6 TN by 20152.

This enormous cash pile accumulated over

the last three years as internally generated

profits outstripped capital expenditures

and dividends. Unsurprisingly, corporates

have been unwilling to invest because of the

uncertain macroeconomic conditions and

tighter credit arising from bank deleveraging.

As a result, corporate deposit balances have

been increasing (see Exhibit 1).

Corporate cash levels are likely to remain

elevated in the medium term too, as interest

rates remain low, macroeconomic conditions

remain uncertain and banks continue to

deleverage. However, corporate treasurers

are likely to find innovative ways to invest

this cash, by using dynamic discounting

or direct lending. Dynamic discounting is

a method of paying suppliers early with

negotiated discounts, effectively investing

existing cash into the supply chain. Methods

like dynamic discounting will provide stiff

competition for corporate deposits.

2 Economist Intelligence Unit.

Copyright © 2012 Oliver Wyman 2

In addition to these general observations, we

are seeing different drivers shaping demand

and supply in individual market’s funding

structures (see Exhibit 2).

With these various funding pressures,

banks are keen to get their hands on some

of this corporate liquidity. However, all

that glitters is not gold and not all cash is

created equal. A distinction must be made

between “operational” cash and “excess”

cash because they have different stickiness

and value and capturing them requires

different strategies.

ExHIBIT 1: CORPORATE DEPOSIT BAlANCES, SElECTED REgIONS†

500

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

0

2,500

2,000

1,500

1,000

BALANCE(US$ BN)

UK

Japan

US

Eurozone

† Eurozone, Japan, and UK data is deposits outstanding from private non-financial corporations (including SME, excluding

NBFI). US data is nonfinancial corporate deposits and cash, excludes foreign deposits in US accounts, but includes US deposits in

foreign accounts




ExHIBIT 2: MARKET-SPECIFIC FUNDINg ISSUES

MArket observAtions

United States • Since November 2010, the Federal Deposit Insurance Company (“FDIC”) has guaranteed all corporate deposits in non-interest-bearing transaction accounts

• As a result, cash in transaction accounts (as a proportion of total cash balances) increased from the long-term average of ~12% to ~15%*

• This guarantee expires 31 December 2012, after which the additional 3% might:

− Move out of the US banking system into non-banks (e.g. money market funds) and highly-rated foreign banks

− Reallocate from weaker US banks to more creditworthy US institutions

• The Dodd-Frank Act also had a large impact on the corporate deposit market, by repealing regulation Q, which prohibited the payment of interest on corporate demand deposit accounts

• There has not been much reaction so far to interest on demand deposit accounts, but as rates rise we expect this to change:

− Banks will be able to use this for the first time as a tool to attract deposits

− Deposit funding will become much more expensive, changing the economics of the business

Europe • Ongoing deleveraging – the IMF estimates a further €1.6 TN of balance sheet shrinkage – reduces the demand for funding, however sovereign debt crisis continues to put pressure on bank balance sheets and keep bank wholesale funding costs elevated

• Need to comply with Basel III and other regulation (e.g. ring-fencing in the UK) has made corporate deposits a critical source of funding

Asia • European banks deleveraging in Asia have created a significant US$ funding gap, particularly in trade finance

• Asian banks are taking advantage of this gap, but are constrained by US$ funding, despite being extremely well funded in their local currencies

• Better capitalised Asian banks have been raising US$ funding, but more through one-off efforts (e.g. US$ bond issuances) than systematic funding approaches

• Western-Asian partnerships to address this US$ funding gap have not been observed

− There is the potential for a game-changer if the shift to an alternative clearing currency (e.g. RMB) becomes a reality; a continued growth in cross-border trade settlement in RMB (which grew from almost 0% to 9% of China trade flows last year) could support a movement towards this

Other emerging markets (e.g. Turkey, Russia)

• Many of the high-growth emerging markets exhibit signs of a credit bubble, with increasing loan to deposit ratios

• This credit growth has increased the need for deposits to fund the expansion

• Regulation and restrictions on cross-border capital flows render domestic funding capabilities increasingly important

* FDIC (as at end 2011)


OPERATIONAl vS. ExCESS CASH

Operational cash is the cash used by

corporates for the day-to-day management

of their business. It forms part of the working

capital and is used for payments, managing

inventory, sales, etc. Corporates keep this

type of cash in demand deposit accounts

or transaction accounts, which are usually

managed by the transaction bank. Because

it is difficult to change a payment mandate

with a transaction bank, and because these

accounts generally have a core positive

balance with only minor fluctuations,

operational cash is “sticky” and thus very

valuable. It makes up ~12% of total corporate

cash balances3.

3 long-term average based on FDIC data.

Excess cash is cash held over and above

what is required for daily operations. It could

be held as a buffer or for future investments

(e.g. capital expenditures, acquisitions) and

it is less sticky than operational cash. Much

of the increase in corporate cash balances

observed today is excess cash. From a

regulatory (e.g. Basel III) perspective excess

cash is most attractive for banks as term

deposits with long maturities.

“Banks will need to improve their corporate

deposit strategy as competition increases in

this space”




ATTRACTINg AND MANAgINg lIQUIDITy

Attracting deposits will be vital for wholesale

banks. In Europe and the UK, banks have

already decreased the loan to deposit ratio

in their corporate businesses since 2009 by

40 and 60 percentage points respectively

(see Exhibit 3). These reductions are likely

to continue as Basel III requirements on the

lCR and NSFR come into effect. Wholesale

businesses will need to attract corporate

deposits or reduce lending if they don’t have

access to retail franchises.

Banks intending to expand their liquidity

gathering can follow two approaches:

• When seeking to capture corporate’s

excess cash, the bank’s credit quality,

product design and pricing are more

important than transaction banking

capabilities. For example, pure

investment banks lack transaction

banking capabilities but derive significant

amounts of funding from corporates by

offering competitive liability products

such as structured notes

• Targeting greater amounts of operational

cash will require a build out of transaction

banking capabilities if the product

suite is incomplete. Not only is this

normally a multi-year endeavour with

need for significant investment budget

but it also requires specific skills and

capabilities well-embedded with the

broader corporate and wholesale banking

strategy. Once successful, captured

demand deposits through transaction

banking services will be the most valuable

deposits for the bank

“The competition for corporate liquidity is rapidly heating up”


ExHIBIT 3: CORPORATE lOAN TO DEPOSIT RATIO, EUROzONE AND UK

Jan.09 May.09 Sep.09 Jan.10 May.10 Sep.10 Jan.11 May.11 Sep.11 Jan.12

0%

350%

300%

250%

200%

150%

50%

100%

RATIO

UK

Eurozone

The cornerstone of any effective corporate

deposit capture strategy is a good

understanding of corporate deposit

behaviour, especially the differences

between operational and excess cash by

client segment. While a full behavioural

analysis can be complex, there are

many advantages to be gained from the

investment and there are also pragmatic

shortcuts that can be taken in the short-

term (see Exhibit 4). Understanding

corporate deposit behaviour and economic

characteristics can form the basis for

pricing, incentivisation, product design and

hedging of interest rate risk.


ExHIBIT 4: CORPORATE DEPOSIT CHARACTERISATION

Deposit characterisation normally uses three types of analyses:

1. bAlAnce behAviour BALANCE

Core deposit

Volatiledeposits

TIME

STEP 1: Fit a trend line to the data to capture the underlying growth rate

STEP 2: Measure variation from this trend

STEP 3: Define a “core” level of deposits that will not be breached with a high degree of confidence (e.g. 3 standard deviations)

• In this analysis, deposit balances are segmented into the following segments:

− volatile: balances that fluctuate randomly

− Rate-sensitive: balances that fluctuate when rate or index spreads change

− Core: balances that remain under virtually all market conditions

• A regression-based approach is typically used to estimate the fraction of balances that are core

2. AverAge life

Average Life

# ACCOUNTS

TIME

• To value deposits, a behavioural term needs to be assigned to the core balance

• A quantitative analysis of account mortality is performed on account-level data to derive the average life of each deposit in the portfolio

• The outputs should be supplemented by a comparison to peer benchmarks (for “sense-checking”)

3. rAte sensitivity 30

20

10

-10

-20

-30

-40

-50

-60

-70

0

-60 -50 -40 -30 -20 -10 10 200 30

CHANGE IN RATE PAID (BP)

CHANGE IN 3M LIBOR (BP)

y = 0.7506x - 0.4393R2 = 0.4564

• Another component of deposit valuation is the determination of the effective frequency at which they reprice

• Relevant for administered rate products (not so for fixed rate/non-interest-bearing)

• Also regression-based – seeks to establish the relationship between the bank’s discretionary pricing and the market rate

A full characterisation exercise is a valuable but data-intensive project. In addition, the models need to be adjusted to capture the differences between the in-sample period and later periods. Some pragmatic shortcuts may be applied – e.g. using Basel III parameters for estimating core balances and using benchmarks for average life. However, these shortcuts are not the long-term solution as incorrect valuations of deposits could lead to poor decisions.

Modelled parameters sometimes conflict with Basel III parameters. For example, many banks will characterise operational corporate deposits more valuable than Basel III implies. In these instances, the Basel III parameters should be used if they are more conservative, otherwise it will result in a subsidy for the business because the true regulatory cost has not been allocated.


CORPORATE DEPOSIT STRATEgy

Traditionally, corporate deposit strategies

were often little more than pricing grids for

deposits. Attempting to grow corporate

deposits based on such an approach bears

significant risk of a spiralling price war and

economically unsustainable models. Many

banks lack the building blocks of an effective

deposit-gathering business. That is, a clear

strategy, a distinct market proposition,

targeted and innovative products, pricing

schemes aligned to the value of the deposits,

specific sales models, sales support and

marketing and a clear focus in corporate

sales’ steering and incentive systems.

There are broadly four distinct approaches

for attracting corporate deposits, depending

on the two main factors of transaction

banking capability and counterparty credit

risk. Banks should build on their relative

strengths along these two dimensions

when determining their overall approach

to corporate deposit-gathering. Banks with

strong transaction banking capabilities and

good ratings are structurally advantaged and

will have more options available to them.

“Corporate cash holdings were estimated at approximately US$ 15.5 TN globally at

the end of 2011, and are expected to grow at ~12% a year to US$ 24.6 TN by 2015”




The deposit strategy for each of the four

clusters will have six dimensions:

MARKET PROPOSITION AND POSITIONINg

This is based on a clear understanding of the

target customer segments, the bank’s overall

positioning within these segments, its

strengths and weaknesses compared to its

peers and the behavioural characteristics of

these segments in terms of usage of deposit

products. A “me too” approach which only

differentiates by price is not a sustainable

proposition because other factors such as

flexibility and security will be as important

if not more so to corporates. Some

examples of differentiated propositions and

positioning are:

ExHIBIT 5: APPROACHES FOR ATTRACTINg CORPORATE DEPOSITS

no or weAk trAnsAction bAnking cAPAbility strong trAnsAction bAnking cAPAbility

bA

nk

rA

tin

g A

A

or

be

tte

r

• leverage creditworthiness to target excess cash as term deposits from corporates

• Build on product capabilities in combination with outstanding sales approach

• In particular, target US corporates as the FDIC guarantee will soon run out – these companies will be looking to diversify their cash holdings

• Use full product suite spanning liability management (from short to long-term) and payments and cash management or custody

• Actively promote term deposit product and seamlessly integrate it into the broader PCM/custody offering

• Integrate management of asset and liability side to win transaction banking business by using credit provision

bA

nk

rA

tin

g b

elo

w A

A

• Structurally disadvantaged – attracting large corporate deposits will be difficult

• To mitigate weaknesses, leverage lending relationships to bring in deposits

• lead with innovative liability products that offer competitive returns or have attractive characteristics such as enhancing the bank’s own rating

− Examples include CPPI/vPPI products, structured notes, 35-day call deposits, deposits acting as derivative collateral, and combined lending-deposit products

− May help bring in corporate deposits, but is not a panacea for bank credit rating and transaction bank capabilities

• lead with credit to win transaction banking mandates – requires strong data and stringent steering to manage overall relationship profitability

• Will require a combination of lending, transaction banking and deposit product innovation managed in an integrated fashion

• Focus on core markets and home market customer segments with clear market proposition


• Some banks in the US have established

global advisory teams for corporate

deposit clients to provide advice and

guidance related to tax, regulations,

deposit products, financing, Jvs, etc.

These teams are particularly useful for

serving middle market companies that are

unfamiliar with global finance, liquidity

requirements, banking and payments

• Other banks have focused on developing

tools to provide clients with better

reporting, analysis and monitoring

of cash forecasts and working capital

management flows, or better integration

with Fx tools (e.g. electronic Fx platforms)

PRODUCTS

In most cases deposit products have been

structurally similar across competitors,

leaving little room for differentiation. Only

recently have banks started to develop more

innovative products. Some examples of

recent innovations include:

• 32 or 35-day call deposits to optimise lCR

and NSFR treatment

• Use of deposits as collateral for

derivative exposures

• Combined lending-deposit products

• Term accounts with growth linked to an

index but with full capital protection

• RMB trade settlement accounts that

permit offshore RMB deposits

• zero balance accounts with auto-sweeping

PRICINg

Pricing will continue to be one of the most

important buying criteria. However, we

believe that deposit pricing must become

more sophisticated, differentiated and

focused on specific client segments

or behavioural characteristics. Pricing

flexibility and repricing are important drivers

of performance:

• Key question is what to do when interest

rates go up – partial repricing with a lag

would maximise the earnings (though

with the risk of customer switching if a

bank lags behind its peers)

• Nevertheless, liabilities will probably

reprice faster than assets, leading to

pressure on overall wholesale banking

profitability in a period when rates rise.

When all assets are later repriced at

higher rates, this pressure will diminish

and the bank will earn more as a result of

larger margins for demand deposits

• Pricing should be fixed as a percentage

of the prevailing rate rather than as a

spread – this will allow for more income

to be captured as rates go up (although it

introduces interest rate risk that will need

to be managed)




SAlES MODEl

Relationship managers are usually neither

focused nor incentivised to go after deposits

(except for one-off deposit-gathering

initiatives). Furthermore, banks often

lack appropriate consideration of deposit

products in an asset-focused sales model.

As a result, the sales support, CRM, account

planning, sales processes and tools do not

properly support either the identification of

client demand for deposit products or the

corresponding sales process. In addition to

building out the respective processes and

tools, soft credits for deposit income could

be a way to encourage relationship managers

to focus more on deposit-gathering.

TRAININg

To sell transaction banking, including

deposit products, relationship managers

will need to understand the working capital

management cycles of their clients and be

able to have an advisory discussion on the

topic. Currently, while relationship managers

are generally extensively trained on the

credit process and understand the credit

needs of their client, the same cannot be

said for corporate deposits and working

capital management.

ORgANISATION

Many organisational units and functions

are involved in providing deposit products

for bank funding, such as corporate and

commercial banking, transaction banking,

capital markets and treasury and finance.

In addition many banks have a fragmented

organisation structure for the deposit

product suite itself. For example, some

have sight deposits and term deposits

sitting in different organisational units,

with all the resulting incentive and steering

issues that come with that separation.

While a developed Funds Transfer Pricing

(FTP) structure and policy are the basis

for managing liquidity provision and

usage across the bank, we believe that a

close coordination or even organisational

integration of the deposit product suite

is required for a targeted build out of a

corporate deposit business.


CONClUSION

The competition for corporate liquidity is rapidly heating up.

Differentiation, whether in the form of strong transaction banking

capabilities or tailored deposit products, is imperative to stand out

from the mass of highly similar offerings. With bank funding costs

rising and likely to stay high for the foreseeable future, the benefits

of capturing more deposits will exceed the cost of designing and

implementing a corporate deposits-gathering strategy.


Oliver Wyman is a global leader in management consulting that combines deep industry knowledge with specialised expertise in strategy, operations, risk management, organisational transformation, and leadership development.

For more information please contact the marketing department by email at [email protected] or by phone at one of the following locations:

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Copyright © 2012 Oliver Wyman

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