Corporate treasurers and cash managers face a rapidly evolving set of new regulatory challenges arising from Basel III and money market fund reform, according to Fitch Ratings. Basel III's leverage, liquidity coverage and net stable funds ratios will transform the relationship between corporate treasury departments and their banks by changing the characteristics of some of their most popular transactions.

USA problems
At the end of last year, U.S. corporate treasurers were forced to adapt to the expiration of unlimited FDIC deposit insurance (i.e. TAG program). This increased the challenge of managing bank counterparty risk while safely deploying excess cash. Money market reform also remains on the horizon, which could further limit access to a perceived safer and more flexible cash management alternative. Banks are already striving to comply with Basel III's more stringent liquidity rules, even though full implementation is a few years off.

Also Basel Committee guidance asks for a phase-in of the liquidity coverage ratio (LCR) between 2015 and 2018, but this would still need to be implemented into regulations in Europe and the U.S. before taking full effect. Already banks are steering internal liquidity management around LCR guidance, adding to treasurers' growing list of regulatory challenges.

Banks' greater focus on pricing for risk means that they are less likely to offer lending lines as a "loss leader" to build cash management and deposit relationships with corporate clients. Under Basel III's leverage and liquidity requirements, this strategy becomes less attractive even for large, highly rated companies.

Leverage ratio
The leverage ratio (which is similar to the one already applied in the U.S. but new to European banks) requires banks to set aside capital even against lowest risk assets. In addition, the liquidity ratios will make corporate cash deposits a less attractive and more expensive form of funding for banks. Under the net stable funding ratio (NSFR), long-term corporate loans and other long-term assets will need to be matched by long-term funding, and under the liquidity coverage ratio (LCR), banks will have to hold high quality liquid assets (e.g. Treasuries) against a portion of these deposits. The LCR requires that a bank hold a prescribed amount of high-quality (but typically lower-yielding) assets to mitigate the risk that less "sticky" types of short-term funding could run off during a stress event. For now, U.S. regulators are focusing their efforts on the LCR and are expected to address the NSFR at a later date.

The LCR calculation assumes a run-off rate of 40% (reduced from 75% in January) for short-term, unsecured wholesale deposits from larger, nonfinancial entities. This is changing the economics and incentives for bank funding away from short-term, wholesale sources to longer-term funding and liabilities that receive more favourable treatment under the LCR calculation, such as retail deposits. The LCR also assumes that a certain portion of unfunded commitments will be drawn in a stress scenario, adding further pressure on the costs of committed liquidity and credit facilities.

(Source: FitchRatings)

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In other words, deposits at banks are going to earn less and less, and banks may even refuse deposits.