Banking Treasury: Managing bank liquidity now and tomorrow

By Marc Bernert | 24 August 2016

Treasury is at the heart of change in the capital markets following the global financial crisis. Funding, liquidity management, and balance sheet optimisation have each been significantly impacted by the crisis and the wave of regulation that followed it.

Today, the primary focus of banks is cost and regulation.

Banks have started reorganising their resources to carefully navigate the complex regulatory environment. Group level treasuries are now vital to control the global balance sheet and manage resources centrally while unsecured funding has become the responsibility exclusively of the treasury. Now, decisions surrounding the allocation of collateral is often owned by a single desk for funding and margining business. In order to account for interrelationships, funding, capital, investment and banking book market risk is increasingly managed by a balance sheet management team rather than in siloes. Daily reporting of liquidity metrics, which were considered an impossibility in the past, are now a reality.

What will change for bank liquidity tomorrow?

To keep up with the fast pace of change in the capital markets, treasuries will need to adapt in order to remain profitable.

The continuing evolution of financial markets regulation

Regulations coming into force over the coming years include the NSFR, leverage ratio, MREL and TLAC. Beyond liquidity, banks are also dealing with structural reform, new regulation surrounding interest rates (IRRBB guidelines) and accounting standards, such as IFRS 9.

Further regulatory changes are envisioned, including shadow banking regulation and the introduction of an intraday liquidity buffer.

The necessity of enhanced balance sheet optimisation to restore margins

Once regulatory requirements are met, it is time to focus on optimisation.

No two banks have the same balance sheet and for this reason, regulation will have a different impact on each bank. Depending on funding sources and capital available, balance sheet binding constraints differ. For example, if a bank that is already running close to 100% LCR increases its lending faster than it takes in deposits, LCR becomes a binding constraint to activity.

Although most banks have already gone through strategic balance sheet optimisation exercises and ad-hoc optimisations, there is much more to gain from embedding balance sheet optimization in the daily processes of the bank.

As day-to-day optimisation is a complex task, it should focus on key areas of cost and on scarce resources allocation. In other words, it should focus on balance sheet binding constraints.

Optimisation requires a global view on costs and constraints. As such, it is typically monitored and achieved by central treasury desks. However, information can also be passed to business units for better day-to-day decision making.

Treasury Optimisation

To avoid running with a higher than necessary ratio and wasting scarce liquidity resources, banks should have a treasury division with the necessary tools to monitor binding constraints (e.g. LCR) and take remediation action when required.

The integration of balance sheet resources optimization into a day-to-day treasury process began with collateral and is extending to all treasury activities. Now, it also addresses the interrelations between liquidity and capital constraints. Questions such as, “If I need to increase HQLAs to address LCR deterioration, what is the best trade in terms of RWA, liquidity DV01, IR DV01, liquidity haircut and yield?”, are becoming increasingly important.

Transfer pricing: incentives for optimal use of balance sheet resources

Transfer pricing provides vital information to sales and business lines, enabling them to make decisions that will result in the optimal use of balance sheet resources.

Largely neglected in the past, liquidity pricing now requires new components to better account for banks’ costs and full transparency to business line decision makers.

Basis risk, resulting from different liquidity between funding instruments and currencies, has emerged as a key cost that needs to be passed to business lines.

Curve analytics and real-time curve calibration will become increasingly important in wholesale markets to ensure that real-time pricing is accurate.

In banking, costs are now driven by regulation over internal economic views. LCR/NSFR FTP components will help to contain the costs associated with regulation.

The emerging FVA-MVA transfer pricing components will adapt to regulation and drive a first round of -limited- convergence between banking and trading book practices.

The evolution of transfer pricing methodologies will require even more integration between FTP, risk and front office systems.

Adapting liquidity management to payment system evolutions

With the introduction of T2S in Europe, intraday liquidity regulation and the possible applications of blockchain technology, settlement systems are in the throes of a quiet revolution.

In light of these developments, payment processing is heading in the direction of real-time decision making using a wide quantity of data. This involves the combination of internal, bank-owned information with external sources, such as a settlement timestamp.

In addition, the settlement process is now identified as part of wider liquidity risk. As such, the settlement process must now be a concern shared by back-office, front-office and risk.

Cost and automation

New competition from fintechs is emerging, focusing on client-facing activities.

This could lead to a new landscape of financial services where banks differentiate themselves in some specific customer segments and by their ability to hold positions, originated internally or not, within their balance sheets.

Assuming regulators will extend scrutiny to all types of credit activities, the ability to run a balance sheet efficiently, mastering increasing complexities and further reducing associated costs, could become a key competitive advantage for banks.

How can technology help today and tomorrow?

Transforming bank treasury, focusing on cost, regulation and optimization, will require the right technology.

Concentrating the number of IT systems, centralizing data management and harnessing the power of a front-to-back-to-risk software enables optimization and allows for cost reduction.

Real-time data centralization and cleansing remains a challenge in most IT infrastructures, and require dedicated investment.

Bank treasury platforms capable of addressing the integration of internal and external data sources, seamlessly orchestrating bank processes with external matching and settlements utilities, will have a key role in the future of treasury.

Front-to-back-to-risk integrated platforms emerge as the clear winner in the context of bank replatforming initiatives, bringing both cost reduction and functional benefits. From a TCO perspective, having separate systems for capital markets trading activities and treasury no longer makes sense. Furthermore, high integration quality and wide functional coverage set the top technology vendors apart in this highly competitive market.

To leverage functional integration in the future, banks’ treasury systems will need to propose an optimisation layer, taking advantage of the centralisation of data and processes. This layer is responsible for guiding the day-to-day decisions of the treasury and steer business units through FTP incentives.

IT systems will need to be flexible and capable of evolving at a rapid pace. Treasuries will need the support of vendors who are committed to innovation and investment in order to address the ever-expanding quantity of regulations.

By Marc Bernert, Treasury Business Solution Supervisor, Murex.

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