Basel III: Changing the Game for Banks and Treasurers Alike

As a consequence of the financial turmoil in 2008, Basel III adds new requirements for the composition and quality of capital to financial institutions. Thinking of Basel III as a regulation for banks only may leave you unprepared for the effect it can have on corporate treasury.

Anticipating capital restrictions, banks have already increased interest rates on loans and decreased returns on short-term deposits. And for companies with lower credit ratings, the bad news on interest rates gets even worse as banks are taking a closer look when it comes to financing. In the longer term, corporates will see their banks change their corporate service offerings to increase the stability of their deposits. For example, they could provide let´s say 31 or more days, or call deposits. Furthermore, financial institutions could launch incentive programs to drive more transaction business. Last, banks might look at their relationships with corporates more holistically in order to cross-finance their services. Focusing on the most profitable relationships could lead to a point where banks start cherry-picking clients, which would put even more pressure on lower-performing companies.

Understanding the change in bank relationships, treasurers should consider the following:

  1. Redesign your bank portfolio
    No matter they are working with a few, global bank partners or a large number of local banks, treasurers should review their portfolio and re-evaluate counterparty risks and bank costs. As the sweet spot of banks is likely to shift to transactional banking, a great partner today is not necessarily a good partner tomorrow. In the future, it will be important for corporate treasurers to understand the changes in their bank partners’ financial strategy and the impact on the relationship. Banks have put a lot of effort into KYC (Know Your Customer) initiatives, and now it is about time that corporations start with KYB (Know Your Bank).
  2. Rethink your mix of financing
    As less credit will be available, treasurers should think about leaning more towards alternatives such as issuing corporate bonds or investing in private equity. In general, financing strategies might shift, in-house banking and supply chain financing becoming even more popular.
  3. Reconsider mix of deposit instruments
    With decreasing interest rates for overnight deposits, alternative instruments such as money market funds, which are also attractive instruments for spreading counterparty risk, should be considered. Treasurers should also watch out for incentives banks might offer to actually leave money in their operating accounts rather than frantically race for a slightly higher yield elsewhere. Moreover, at the top of the treasurers’ minds should be to become better in planning cash flows as longer term investments not only offer more variety, but also increased returns.
  4. Review credit facilities
    As banks will have to hold more capital for credit facilities, corporates should be carefully considering which bank facilities they really need and try to reduce unnecessary headroom – overall and with the individual bank partner. Advanced cash management techniques such as cash pooling or netting, can help manage facilities more closely.
  5. Reduce working capital
    Treasurers should have an overview of their cash on hand, but many finance professionals still struggle with cash visibility. With Basel III in place companies will pay higher fees, particularly for short-term funding. Therefore, accurate cash flow forecasting will pay off even more as it helps to optimise working capital and brings more clarity in funding. And the better a company knows their short-term and long-term cash flows, the better it will be able to align their finance strategy with their business needs.

As we have seen already, Basel III´s impact on bank relationships is considerable. However, the regulation also has the potential to consolidate the banking and corporate business landscape. On the one hand, some banks might not be able to fulfil the stricter requirements or lose part of their corporate clients as they consolidate their bank portfolios. On the other hand, companies, particularly those with lower credit ratings, will be hit most from the less favourable rates and fees, and might even end up not finding banks willing to lend them money at all. To prevent this, it is important that each understands the financial strategy of the other – both today and in the future.