Banking capacity for clients in uncertain times

28 May 2020 - How COVID-19 is prompting managers to diversify from money market funds, treasuries and traditional banks on cash balances.

A range of pressures since the onset of COVID-19 are predicted to compel fund managers to diversify away from treasuries, money market funds and traditional banks towards ultra-liquid banks for holding unencumbered cash balances.

The current low interest environment has affected banks’ capacity to hold non-operational cash on their balance sheet, treasuries experienced a drop into negative rates in March and money market funds recently received an injection from the Federal Reserve via the ‘Money Market Mutual Fund Liquidity Facility’ to guard against illiquidity caused by COVID-19 related redemptions.

Therefore, managers are looking for additional solutions as a safe haven to help diversify their cash holdings. We are expecting this trend of increased demand to continue in the near future for the following reasons:

Lack of options

The Liquidity Coverage Ratio (LCR) introduced as part of Basel III reforms has helped to reduce the liquidity risk of some banks through restricting maturity transformation options for non-operational cash. However, the combination of extremely low interest rates at present and the inability to engage in maturity transformation due to LCR constraints, has dramatically reduced the appetite of most banks for non-operational cash.

Before the Global Financial Crisis in 2008, banks could have loaned out these balances and received an uplift in yield; however, while the LCR has reduced overall liquidity risk, it has combined with deteriorating economics to lead banks that traditionally provide services to the asset management industry to scrutinize this customer base.

Much like treasuries, it looks likely that some banks may go negative on US$ interest rates for fund clients in the near future; in fact some have already started to do so.

In addition, the liquidity risk from money market funds recently led to a cash injection from central banks: the largest came from the Federal Reserve’s backstop to help funds meet redemption requests, a total of US$ 51bn to the US’s US$ 3.8trn money market sector.

Capacity for our clients in uncertain times

The Citco Banks - operating in the Netherlands, Ireland, Luxembourg, Canada, Curacao, the Bahamas and Cayman Islands – are highly regulated, risk averse transactional banks. Our long-term strategy has been to operate with superior levels of liquidity and capital adequacy, which is a multiple of those employed by traditional banks on average.

While there is no one definitive destination for holding cash, we are clearly finding that managers are seeking to diversify their cash holdings in addition to banks, money market funds and treasuries.

In turn, we continue to provide our clients with capacity, diversification and certainty from both a cash and credit perspective in these uncertain times.

By James O’Friel, Business Development, Citco Bank Nederland N.V.