As the European Central Bank (ECB) has introduced negative deposit rates for banks t in early June and pushed them down again this month, the topic appeared on the radar of many CFOs and board members. Although rates are still not negative for corporates, the CFO and the treasurer might have the following conversation:
CFO: Will banks pass negative interest rates on to corporates?
Treasurer: At the moment there is a lot of uncertainty in the market. Although the ECB has cut its deposit rate for banks from zero to -0.1% in June and again to -0.2% this month, banks have not yet imposed negative rates on their clients. However, if interest rates stay negative for 3, 6 or 12 more months, banks might pass them on in some way. They might still keep rates positive, but compensate the loss through other areas of the relationship, or they might charge a custody fee for short-term deposit.
CFO: How would negative interest rates impact our business?
Treasurer: In the low-interest environment over these past years, our company, like most other cash-rich organisations, followed a very conservative strategy. Our main goal was to protect our cash. In order to ensure liquidity, we took low risk in short-term investments, and in return, only gained very little yield.
If we are not willing to accept negative interest rates, we could either give up liquidity or security. If we invest money for a longer term, we sacrifice liquidity. If we swap cash to other currencies to get higher interest, we increase FX risk. The good news is we have a solid risk management strategy in place that provides with a framework to help us balance these decisions.
Looking at the bigger picture, the ECB has introduced negative rates to increase investment in the real economy. Think of it like this: In a negative yield environment capital would be eroded over-night because companies would have to pay for depositing money at a bank, so it would be worth reviewing where we might invest in our business.
CFO: How are we preparing for negative interest rates?
Treasurer: First, we will look at liquidity. We will try to reduce our bank facilities and improve the accuracy of cash forecasting. By knowing cash flows better, we will be able to reduce working capital and move to longer-term financing – without impacting liquidity and optimising interest. Additionally, we will be in better shape to support short-term and long-term investments in our business.
Second, we will analyse interest rate risk. We will do stress tests and scenario analysis to prepare for any unknowns, simulating:
- How would shifts in interest rates impact cash on hand?
- How would negative interest rates impact our cash forecast?
- How long would we be able to sustain negative interest rates?
- At which percentage do we have to change our investment strategy?
Third, our Cash flow at Risk (CFaR) tool will provide us with deeper insights into liquidity and risk. What CFaR offers beyond common stress testing capabilities is the ability to incorporate correlation assumptions across multiple simulations to establish mean, worst case and best case outcomes. Thus, we will be able to identify the core drivers in our risk profile and the correlations between interest rate risk and other risks. Knowing this, we will be able to adapt our hedging program accordingly.
Finally, we have to make sure our treasury technology supports negative interest rates
Whether or not interest rates go negative, we will leverage our technology to manage liquidity and risk together to provide a solid basis for the board’s decisions.