Is Cash Really King?

Cash is the lifeblood of any company. If a corporate has access to cash, it can generally fund its working capital requirements. As the ultimate liquid asset, cash is on hand to make short-term investments and is easily transferrable into other asset classes and currencies.

Therefore, wherever a corporate treasurer is placing their company’s cash, their priority is to ensure that they are: (a) not locking it up in investments for too long; and (b) have the correct investment guidelines in terms of counterparty risk.

In response to the global credit crisis, corporates have been hoarding cash. Although the increase in merger and acquisition (M&A) activity has effectively reduced some cash stockpiles, hoarding continues to be an ongoing trend as the fear of another credit crisis persists. For example, a large US company recently told us: “We haven’t quite determined what to do with our cash, so you will see us building up balances of US$ X million every month for the foreseeable future.” This corporate clearly didn’t know the appropriate place for its excess cash.

The problem is exacerbated because the low interest rate environment challenges the perception of appropriate return. Although it is useful to have free cash for M&As and other activity, a corporate cannot hold it as cash if it wants to get an appropriate return. Since the crisis, only a few countries, such as Chile, India, and Brazil, as well as the eurozone, have started to raise interest rates – albeit very slowly – and most are still held at historically low levels. Therefore, from a client’s perspective, holding cash can be a drag on overall return.

Even though corporates are working hard to protect their cash, whether from inflation or erosion by other means, they could also lose value holding excess cash in certain countries that have restrictions on cash repatriation. For example, China is an emerging – or, as some would say, emerged – country, where many foreign companies are expanding due to a booming population and growing domestic consumer demand. However, those corporates accumulating cash in China are faced with a number of restrictions such as cash concentration techniques and capabilities. As a result, they may be sitting on cash piles but earning very little in return.

Basel III: Changing Banks’ View of Cash Balances

Historically, if a corporate client made a large cash deposit for an extended period of time, it intuitively thought that it would receive a favourable rate of return from its bank. Basel III, as it is currently written in the December 2010 draft, is going to challenge that assumption.

Under Basel III, a bank receiving long-term cash deposits will be required to collateralise those deposits by up to 75%, if it is a corporate reserve, and up to 100%, if it is another bank. Therefore, banks will be faced with the situation that long-term large cash deposits will incur a huge cost.

As a result, they will be more selective in the future in terms of accepting certain types of cash deposits. For example, deposits linked to the provision of transaction services will have a lower collateral requirement for working capital deposits. This will result in banks fighting over the same type of corporate activity because they won’t want only one-off deposits out of a client’s strategic cash pile – they will be eyeing the balances that are linked to underlying transactional activity.

Therefore, corporates with a reserve cash deposit will start to see banks pushing them to move their cash balances into cash equivalents, such as money market funds (MMFs).

The MMF environment, in turn, has not escaped regulatory reform. Examples of this are the amendments to Rule 2a-7, approved by the Securities and Exchange Commission (SEC) on 27 January 2010 to manage the quality, maturity and diversity of investments. To improve the quality of MMFs, the SEC amendments include:

  • Restricting Tier 2 assets to a lower percentage than before, giving the MMF powers to stop redemptions in a run.
  • Reducing the weighted average maturity (WAM) of an MMF from a maximum of 90 days to 60 days or less.
  • Prohibiting investing more than 5% in any one issuer, except for government securities and repurchase agreements.

As a result, MMF families will not be able to substantially differentiate themselves. In spite of these funds being considered commoditised in the past, now they are going to become even more so. In addition, it is likely that the reforms are going to put pressure on the fund families that are smaller and/or not bank-sponsored.

In the next three to four years – as banks feel the effect of Basel III – we will see increased pressure to move money off-balance sheet, but there will also be fewer fund families available to take that cash because the reforms to Rule 2a-7 may increase consolidation in the MMF environment.

This consolidation has already started to happen in the UK. Many small MMF providers have sold out to larger providers because new regulations make it uneconomical for them to carry on.

Unintended Consequences of Basel III for Customers

As with other regulations, there are good reasons for implementing Basel III. Effectively, regulators are trying to reduce the chances of another colossal financial crisis. For that reason, their emphasis on liquidity risk management within banks is absolutely pivotal.

However, from a banking perspective, the regulators have not proved that they understand the transaction services business. So a consortium of banks is drawing up plans to:

  1. Educate the regulators.
  2. Highlight the impact that some provisions will have on customers.

The objective is to show certain instances where Basel III will have an unintended consequence on customers. By highlighting some of these, the banking community can collectively help to steer the Basel III draft in a direction that avoids some of these pitfalls.

For example, as mentioned earlier, Basel III could potentially have a negative impact on clients, as it could result in fewer choices for their cash. If banks are pushing away money and there are fewer MMFs because of consolidation in the marketplace, then at a certain point those funds will reach capacity. Some corporations may then be forced to move into funds with non-stable net asset values. The end result is that in the future, there will be a limited number of ‘safe havens’ that offer value for customers’ cash.

In addition, the lack of options will drive down the rate of return. It is important that corporates are realistic about what return to expect on their cash when they hold it as a truly liquid instrument. They now know from experience that getting a higher than average rate of return increases risk. For example, many companies invested a substantial amount of money in Icelandic banks that were paying a high rate of interest – 8% in some cases – compared to most other banks that offered 1.5%.

Another well-worn phrase comes to mind: “There is no such thing as a free lunch.” The reason why it was possible to get above-average returns for cash when investing with an Icelandic bank was because they, in turn, were investing in high-risk credit default swaps (CDS). The moral of the story is clear: although cash is still vitally important, corporates have to expect a realistic rate of return.


For corporates, cash will be even more valuable in the future based on the lessons learned from the recent financial crisis and taking stock of evolving credit standards. Treasurers need to re-examine their cash deployment methods given the much-changed credit environment since 2008.

As a result of this new environment, treasurers will need to look further ahead than they are accustomed to doing and deal with a greater variety of investment instruments than before. With the introduction of Basel III, organisations may have fewer options from a credit perspective and should continue to review their cash position, so that they are able to weather stress events. They should look at enhancing their cash flow forecasting – an area upon which all companies could improve. They will also need to review their investment policies, processes and procedures.

While early regulatory reform looks punitive from a bank’s perspective, there is still time to shape the reform (specifically Basel III), or at least highlight adverse impacts on customers. This bodes well for customer-bank relations, since banks can become the ‘voice of the customer’ to regulators in the short-term.

The hope is that banks can work closely with regulators to illustrate the vital nature of cash within the treasury environment and demonstrate how the current provisions may alter buying behaviour in a way that was not intended.


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