Seven years ago, the collapse of Lehman Brothers not only rocked the stability of the world’s financial system, it brought to the forefront the key question on the ability of banks to survive a financial crisis without government assistance. In response, Basel III, an international regulatory framework to address this, was developed.
While Basel III seems like it may primarily affect banks, corporates will also feel the impact. Treasurers need to understand how to leverage Basel III to their own advantage.
What Does Basel III mean for corporates?
Basel III aims to strengthen banks’ capital adequacy and their resilience to liquidity risks. These regulatory changes push banks to prioritize their core businesses against existing resources and to improve their performances by increasing operational efficiency. For banks with an extensive footprint, optimizing their balance sheet mix under Basel III at a local, regional, and global level has now become incredibly complex, akin to solving the hardest logic puzzle imaginable.
This probably explains why RBS announced plans to massively reduce its presence in Asia and why HSBC will slash costs by as much as $5 billion in the next two years. In the years to come, we can expect that it will be especially difficult for corporates to use a single bank to serve their global cash management needs. Corporates may be forced to use the services of regional or local banks in markets where these large banks plan to exit.
Under Basel III, banks are under more pressure to generate client returns that justify their capital investment or even consume no capital. Banks will evaluate more carefully which clients they want to work with and which business they want to bid for. Some corporates may be informed by banks that their pricing will be increased, their credit facilities will be reduced, or that their cash pools may need to be terminated.
Some corporates may also receive cash management proposals from banks in exchange for the continued credit support or to provide the commercial substance of liquidity overlay structures. Yet others may see banks asking for more fee-based business or a more diversified share of corporates’ bank wallets. Faced with these various banking agendas, corporates should start thinking about how to find the right balance between the use of bank credit facilities and the reciprocal awarding of cash or other businesses such as FX and investment.
Managing banking relationships in this new environment
Likewise, this may also be a perfect time for corporate treasurers to reevaluate their banking strategies and which banks they want to work with. They should consider managing their banks on a holistic basis because the trade-off now extends across the whole range of banking services rather than just between cash and credit facilities. Corporates that prefer using a more fact-based evaluation to select bank partners can consider the following:
Consolidating and analyzing company-wide exposures and positions. Doing this for the first time can be painful, but it helps set the reference points to conduct the analysis by bank, by product, by country, by currency, etc. Corporate treasurers can also assess whether there is a need to diversify certain concentration that draws their attention or creates a risk. Most importantly, corporates should establish a regular reporting protocol to monitor and manage changes.
Estimating the total bank wallet and the distribution. Bank wallet refers to the estimate of the total amount corporates pay to banks for the services they use. This typically includes transaction costs, commission/advisory fees, FX spreads, etc. After establishing the central view of group exposures and positions, corporates can calculate their bank wallet by applying various assumptions and following the same approach to analyze the share distribution by bank, by product, by region and so on.
Developing a balanced scorecard. To evaluate bank performances more objectively, corporates can consider using both quantitative and qualitative metrics. Examples of these metrics are:
- Quantitative metrics: Transaction volumes, transaction values, bank income estimate, bank wallet share, etc.
- Qualitative metrics: The quality of services, the consistency of service delivery, the transparency about bank capabilities, proactiveness, professionalism, etc.
Often we see corporates using a weighted average approach to design their balanced scorecard. They first define their preferred key performance metrics and then assign weights that reflect the importance of each measure. An overall weighted average score for each bank will be derived accordingly. This approach enables corporates to give concrete feedback to banks on the dimensions that need improvement.
To manage their banks more effectively, it is also crucial for corporates to share their management philosophy openly with their banks. For example, the company policy may require that their treasury department minimize FX hedging or its policy may also disallow deposits with banks in certain countries due to perceived high sovereign risk. By being transparent about such policies, corporates will be in a better position to manage the expectations and efforts of their banks to ensure a mutually beneficial working relationship.
Nikki Lin is director, treasury solutions team (Transaction Banking) at Standard Chartered Bank. In this role, she drives strategic client initiatives in Asia Pacific region.