Liquidity Management Solutions: Targeting Financial Institution Treasury
Regardless of the type of company, effective liquidity management is a core responsibility of its treasury group. Within a financial institution’s treasury, it is critical. Core revenue generating functions of banks – capital markets, lending, payments, etc. – depend on sufficient levels of liquidity to operate. Furthermore, as the financial world has become increasingly global, if a bank had insufficient liquidity to fund a time-sensitive continuous linked settlement (CLS) payment or to finance lending activities, the ripple effects would be felt across the globe and the reputation of the institution would be seriously, if not irreparably, damaged. With these critical responsibilities, the ability of a financial institution’s treasury group to minimise idle balances and identify all cash flows is essential to its success.
Beyond the relationship between liquidity and the revenue generating functions of a financial institution are the costs resulting from inefficient management of it. Manual processes require excess staff, are prone to error and limit treasury’s ability to focus on optimising liquidity and other strategic responsibilities. In addition, much of the information required for the liquidity management process exists across multiple and/or disparate systems, in batch form and typically not available in real-time. This results in the inability to quickly identify the lowest cost of funds, resulting in increased interest costs, and the need for treasury to maintain a liquidity ‘cushion’ to ensure liquidity levels do not drop too low.
Effective liquidity management requires three-steps where treasury identifies, manages and optimises liquidity. These steps are interdependent, each requiring the successful implementation of the other two to optimally manage liquidity.
Identifying liquidity is the foundation from which the entire liquidity management process depends. It involves understanding the balances and positions of the institution on an enterprise-wide level. This requires the ability to access and gather information across the institution’s many lines of business, currencies, accounts and, often, multiple systems. Identifying liquidity is primarily a function of data gathering, and does not include the actual movement or usage of funds.
Managing liquidity within a bank’s corporate treasury involves using the identified liquidity to support the bank’s revenue generating activities. This may include consolidating funds, managing the release of funds to maximise their use, and tasks that ‘free up’ lower-costing funds for lending or investment purposes to maximise their value to the institution.
Optimising liquidity is an ongoing process with a focus on maximising the value of the institution’s funds. As the strategic aspect of liquidity management, optimising liquidity balances requires a strong and detailed understanding of the financial institution’s liquidity positions across all currencies, accounts, business lines and counterparties. With this information, the bank’s treasury is able to map the strategic aspects of the institution into the liquidity management process.
The biggest challenge in the liquidity management process is the limited time and resources available to treasury. Although treasury groups are staffed with very capable personnel, a large amount of their time is spent on the task-based function of identifying liquidity instead of on the strategic elements necessary to optimise balances. This results in the entire liquidity management process being less efficient and affects the institution’s bottom line.
Perhaps the biggest trend in financial institution liquidity management is the need for and centralisation of enterprise-wide liquidity management functions within the organisation. As financial institutions have expanded into new markets and/or acquired other industry players, having multiple systems and personnel involved in the liquidity management process has become the norm. This frequently results in mission-critical information being stored in multiple, non-integrated systems, a reliance on excess personnel, and a lack of quality in the information on-hand. This often results in spending too much time gathering liquidity information at the expense of being more strategic.
Centralising liquidity management functionality isn’t enough if the information is stale. To most effectively manage liquidity requires real-time, intraday liquidity information. As the speed of transactions accelerates, so does the need for accurate and timely information. Being able to identify and mobilise funds (if necessary), in a real-time, intraday environment, enables a financial institution to prepare for and respond to market events as they occur.
Directly related to centralisation and the need for real-time information is the ever-changing regulatory environment. As regulations change, the demands placed on bank treasury groups increase. For example, with the introduction of TARGET 2 and the single euro payments area (SEPA) in Europe, the movement of funds is quicker, and the emphasis on real-time liquidity information has increased. Furthermore, financial institutions face an increased level of scrutiny on the intraday monitoring and stress-testing surrounding their level of control for liquidity information. Some believe that new regulations will be instated by regulating authorities, requiring financial institutions to increase their level of awareness about intraday liquidity. A move such as this will likely cause many financial institutions to turn to technology that can provide them with the intraday information required by regulators. As a senior treasury employee from a global financial institution said: “Although we did not anticipate the current economic environment when we adopted a liquidity management solution several years ago, our solution positions us well for increased regulatory scrutiny. We have discussed our processes and intraday capabilities with regulators and believe we are well positioned in the event of potential changes.”
Liquidity management solutions have gained attention in recent years as gains in technology enable solutions to meet the complex needs of financial institution treasury groups. Manual, time-consuming tasks can now be automated as a result of high-volume processing engines and bolt-on solutions that reduce the need for costly replacements of legacy systems. These solutions support treasury in automating balance and position information enterprise-wide, in real-time. Several offer a range of additional functionality, assisting treasury in such areas as payment flow control, collateral management, cash forecasting and predictive analytics.
Despite these gains in technology, however, and the significant benefits and savings recognised by financial institutions that have adopted solutions, a relatively small number of solutions have been deployed. Unlike more established areas of financial services technology, the liquidity management technology space is still relatively new, and is rapidly developing. This results in an undefined market, along with significant differences among the features and functionality offered by each vendor’s solution.
Benefits of these solutions are many and the differences offered by each are significant. A senior treasury employee at a Tier 1 global financial institution described their vendor’s solution as “invaluable” to their liquidity management process. This assisted them in improving enterprise-wide, intraday predicted liquidity positions from a variance of US$100 to US$300m to a range of US$10 to US$20m. Additional benefits to the organisation included reduced staffing costs, improved client servicing to both internal and external clients, reduced interest costs and a shift from a task-focused to a strategically focused treasury. As these and other benefits of liquidity management solutions become more well-known throughout the industry, the number of vendors and the functionality offered will likely increase even more.
To date, European financial institutions have shown the highest adoption rates thus far, accounting for more than 50% of the deployed solutions. Banks operating in the region have operations spanning multiple countries and currencies, and are required to maintain relationships with multiple regional and central banks. This creates a need to efficiently manage liquidity positions across many channels, resulting in excessive staffing and an often inefficient information gathering process.
Other regions, such as Asia-Pacific, are similar to Europe in that multiple countries and currencies exist. However, the banking markets are not quite as established as their European counterparts and the emphasis on dedicated liquidity management systems is not as pressing. Financial institutions in these regions are instead focusing their attention on updating antiquated core systems and cash management platforms to more advanced capabilities. Some liquidity management functionality may be included in the adoption, but institutions in these regions are not yet adopting dedicated liquidity management solutions as more urgent needs exist.
Liquidity management solutions offer an exciting and promising new opportunity for financial institution treasury groups to utilise technology and increase control and efficiency in managing liquidity. At this stage in the evolutionary process of the liquidity management space, however, wide variances in the capabilities of each solution exist. Because of this, when selecting a solution, financial institutions should place the greatest emphasis on finding the one with the features and functions best fitting the needs of the organisation.
Similar to the corporate treasury workstation space, liquidity management solutions for financial institution treasury groups are an arena in which costs should be of less importance than fit. Significant differences exist between each vendor solution, making it difficult to make cost and benefit comparisons. Additionally, and perhaps more importantly, the risks and costs of inefficient liquidity management are so significant that it is imperative that a financial institution select the solution best aligned with its needs.