Wallet Size: How Well Do You Know Your Bank?

At most companies, the amount of services purchased from banks are often equal to or greater than the treasury’s staff budget. However, Lynn sees few companies accurately budgeting this expense because forecasting lending, deposit levels or service usage is difficult or even unknown. While he acknowledges some treasurers may argue this fact, it maybe because they are unaware of what they are actually paying for.

“I think if you asked a corporate treasurer the simple question, ‘How much did you pay each of your banking partners last year on a global basis?’, the treasurer would be hard-pressed to come up with a complete answer,” said Lynn. “Then, if you asked the treasurer what services they paid the bank for, there would be a lot more head-scratching.”

Lynn, who began his career in the banking industry, but has also worked on the corporate side, believes that banks generally have a better idea of what their corporate clients paid, and the services they provided, than corporate clients.

The reason for this discrepancy, Lynn explained, is simple: “Recent regulations – Basel III, Dodd Frank, Patriot Act, etc. – have created more requirements for banks to really know more about whom they do business with on a risk-adjusted basis. When you don’t do that, you see what happens where the U.S. banking system almost imploded – financial institutions failed, multiple banks needed to be rescued by the US Government, or paid a billion-plus in fines for tax evasion, money laundering, etc.”

What’s more, Lynn thinks banks are more aware of what corporate clients cost, or what they make from a client, if for no other reason than bankers’ bonuses depend on it. Banks have a goal to earn a positive net interest margin from their customers, and their customers are the ones with the negative interest margins. Banks are also extremely interested in fee-based business as fees usually boost the ROE (return on equity) without significantly affecting the denominator, i.e. equity.

Considerations for Corporate Treasurers

Given a bank’s preference for fees, Lynn argued that interest expense is only a part of the answer to the question, “What did you pay your bank last year?” Corporate treasurers must consider cash management services, foreign exchange services, fiduciary services, short-term and long-term investments, and a plethora of other services. So banks have multiple means by which they can earn money from their corporate clients, and Lynn doesn’t think corporates have a good way to measure many of those means, especially when they use non-US banks or services performed outside the US.

Moreover, most large corporates deal with many – perhaps too many – banks, which can cause problems when they try to determine which of those banking partners are the “good” ones. “If you have 10 banks and you give them each 10% of your business, what’s that really worth?” Lynn asked. “Let’s say you have more banks (20) and you give them each 5% of your business. What is that 5% or 10% of your total wallet worth? Is that enough to make those banks responsive to your future needs?”

One of Lynn’s clients, an executive director of a Fortune 500 company, is concerned about the financial stability of a Chinese bank partner and is thinking a lot about the size and allocation of the company’s wallet. But where does a company put tens of millions of dollars if not in a bank? “They’ve got to keep it in the bank, or multiple banks,” he said. “But even if they keep it in US banks, there is risk, and if I keep it in foreign banks, there’s even more risk, i.e. legal or country risk. Also, funds kept in non-USD expose the company to other risks, i.e. market risks.

So a company looking at wallet size should consider whom they give it to as well (i.e. counterparty risk). Which is worse – the risk that you spend your banking dollars unwisely or that the wallet will “fall out of your pocket,” Lynn joked. Both are bad.

Cash Reserves at Record Levels

Today, Fortune 500 companies have more cash on the balance sheet than they’ve had in the last decade. According to the latest AFP Corporate Cash Indicators™ (AFP CCI), a quarterly metric tracking changes in US corporate cash balances calculated by the Association for Financial Professionals (AFP) and underwritten by State Street Global Advisors, 48% of reporting organisations expanded cash balances in 2013.

These companies have substantial risk simply by having that money in a bank. Lynn noted that Citibank, Royal Bank of Scotland, HSBC, Banco Santander and Zions Bank all recently failed stress tests by the US Federal Reserve. “What does that mean for all those customers who have their money in there?” he asked.
It is completely unrealistic for large corporates to try and spread their money into numerous banks just so the individual deposits fall under the US$250,000 limit for insurance established by the Federal Deposit Insurance Corporation (FDIC). Additionally, spreading the money around causes other problems. “The more banks you use, there are administrative costs,” said Lynn. “It comes down to what a corporation expects from its banking partners.”

Better Banking Relationships

Lynn added that, years ago, a number of big oil companies kept large deposits in their banks simply because they would get responses from them. “If I keep US$100 million in my bank, you’d better answer my phone calls,” he said. “Because I can take that US$100 million and send it to another bank. We have found, based on our latest surveys that the majority of corporations use five to 10 banks. They have choices. Banks really interested in relationships need to consider this fact to prevent corporations from playing a game of moving money around.”

Corporates not only need to determine how much they give each of their banks, but more importantly, what they expect to get in return from a price/performance perspective. How many banks should you use, how much do you deposit into them, and what made you choose these particular banks? These are all questions corporate treasurers need to answer, Lynn said.

“I think wallet size is certainly an issue,” he said. “But you have to come back to ‘value at risk.’ I don’t know too many corporates who can measure bank performance very well. It’s one of those ‘Holy Grails’ like cash forecasting. How do you measure bank performance? What is it you want from your bank?”

Lynn cited the results of a CFO.com survey last year that looked at what corporates expect from their banks. “They want a relationship,” he said. “The problem is, most banks focus on transactional versus relational banking. Everybody wants to make deals, but you saw what happened in the last couple of years; banks ran into problems. They turned around and said, ‘You know that US$100 million revolver? You never used it. So… we’re going to make it US$50 million instead.’ That response was not true ‘relationship banking.’”

Next Steps

While Lynn noted that great minds may differ on getting more bang for your banking buck, a corporation with many needs could start looking at its wallet by initiating the following actions:

  1. Ensure your banking relationships are aligned with your business needs on a look-forward basis. “Too many” banks are not in anyone’s best interest: your banks will not earn enough from you and you will be disappointed in the level of service received/not receive.
  2. Talk with your banks on a periodic, say quarterly basis. Set price/performance goals and discuss variances (One-time? Ongoing?) for all services including lending, investing, operational and risk-oriented ones. Remember fee-based services are more desirable to banks than those based solely on assets or liabilities and even the banks have problems understanding which services their non-US offices offer.
  3. Do your homework on market prices. Do not expect “champagne” (i.e. custom) service for “beer” prices, but do consider whether you need all that champagne. Remember, electrons are cheaper than paper so seek to substitute lower-priced, off-the-shelf electronic services for paper-based or customized ones.
  4. Ask for/inquire about volume discounts. Often banks can offer services at lower unit costs than the in-house equivalent. If you can offer your bank more services, you may find they can afford to offer you better prices – a win-win for every one.
  5. Your bank is your friend (or could be). Banks are not interested in picking your pocket; they are profit-making instructions just like yours. They want a clear understanding of what it takes for them to earn a market return (price) as much as you want them to meet your needs (performance). To make this happen takes clear communication between you and your bank relationship team. Just make sure you know who that is.

 

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