Megatrends in US Dollar Deposits
“There is a Chinese curse which says: ‘May he live in interesting times’. Like it or not, we live in interesting times. They are times of danger and uncertainty; but they are also the most creative of any time in the history of mankind.” Robert F Kennedy in his Day of Affirmation Speech in South Africa, 1966
It is remarkable to note how relevant this quote is to global financial markets over the last couple of years. For banks, the volatile market conditions have resulted in major challenges for certain players and provided significant business opportunities for others. Ratings of a significant number of large banks have been either downgraded or placed on review for downgrade. The elite club of countries with a AAA sovereign rating has become smaller too.
Prior to the global financial crisis, corporations pushed the risk-return spectrum in search of higher yields. The global financial crisis followed by the ongoing eurozone debt crisis has resulted in severe market gyrations. Corporate treasurers are now defining corporate investment policies and/or investment guidelines in the treasury policies. Corporates with existing investment policies are reviewing their relative priorities of the three critical objectives for short-term investments:
Counterparty risk management is now paramount. Credit ratings published by the main credit rating agencies (CRAs) enable investors to assess the credit standing of counterparties. In some cases, this is supplemented by internal risk evaluation. Infrastructure to support risk management of bank counterparty exposures and country ratings have been put in place. That being said, treasurers recognise the operational risk of utopian investment policies, with reporting requirements which may not be economically feasible to implement with their legacy systems and processes. There is an increasing convergence between financial institutions and large corporates for implementing stress-testing practices and liquidity contingency planning.
With the key corporate imperatives of capital preservation, risk management and access to liquidity and funding, treasurers are seeking safe harbour in traditional, risk-free investments with well-capitalised banks. Vanilla investment products such as term-deposits with highly-rated banks have increased in weight and these are skewed towards the short end of the yield curve.
Much has been written about the amassing of cash on corporate balance sheets in the US. Corporate cash on US balance sheets is today at all-time record highs. According to US Federal Reserve data, since 2009 the cash holdings of US non-financial corporations has risen 56% to US$2.23 trillion, as of end-2011; domestic deposits in Federal Deposit Insurance Corp (FDIC)-insured banks increased by US$882bn in 2011. While certificate of deposit (CD) balances decreased by US$157bn in 2011, chequeing, savings and money market balances increased by over US$1 trillion.1
There are different explanations for these record cash-levels. Corporate treasurers continue to be risk averse, hence most treasuries have increased their short-term cash holdings in (FDIC-insured deposits, in spite of unprecedented low interest rates on US dollar deposits. The extension of unlimited federal deposit insurance for non-interest bearing demand deposit accounts until 31 December 2012 has contributed to this growth. Money market funds (MMFs) have been traditional short-term investment alternatives providing overnight liquidity and same-day value of redeemable funds. However, there is heightened awareness of the risk profile of this instrument, particularly after the Reserve Primary Fund (RPF) ‘broke the buck’ during the financial crisis in 2008.
The record deposits are a challenge for US banks. Some have even resorted to imposing fees on their institutional customers for placement of large deposits. This bold step was taken as holding cash was incurring cost to the banks due to the fees paid to FDIC to insure deposits.
The world is now increasingly looking towards Asia, which is at the cusp of experiencing significant collective economic growth and development. According to the World Trade Organisation (WTO), Asia led all regions with the strongest annual growth in merchandise trade exports in volume (i.e. real) terms of 6.6% in 2011. India was the top contributor with the fastest export growth of 16.1%. This was followed by China with the export growth of 9.3%. Countries with the fastest growing merchandise import volumes in 2011 were again China and India.
As a result, businesses are adjusting their strategies to reflect this accelerating shift in the regional pattern of both domestic demand and world trade, which will intensify going forward.
The majority of global trade is denominated in US dollar, resulting in an increase in US dollar trade financing. Hence trade is impacted whenever there is a scarcity of dollars. Many European lenders, which have historically been big providers of trade finance in Asia, are now fixing their balance sheets and divesting assets in Asia by scaling back their dollar-loan books. There is a distinct pullback in trade finance, project finance and syndicated loans.
The retreat by European banks has created a gap of US$390bn in lending in Asia.2 This has created significant financing opportunities for Asian banks, but created a further demand for US dollar funds in Asia. Well-capitalised Asian banks with strong liquidity positions have stepped in to fill the gap. The market share of Asian banks in export bills for Singapore-originated trade activities increased from 36% before the crisis to 55% in Q411. Similarly Asian banks’ market share of trust receipts increased from 55% to 64% over the same period.3
Large Asian banks are able to exploit this trade financing gap and grow marketshare, but smaller banks may not be able to do so. A constraint that a number of the smaller banks face is counterparty limits and their high, existing US dollar loan-to-deposit ratios. While eurozone banks, which have specialised in structured trade finance with specialist lending lines in shipping and aviation in Asia, have cut back on lending, the smaller Asian banks do not yet have the expertise in such areas or have limited credit appetite to such industries.
Another contributor to the tight US dollar liquidity in Asia is central banks (particularly in China and India) raising domestic interest rates due to inflationary pressures. Hence, corporates in Asia prefer US dollar financing to local currency financing to benefit from all-time low US dollar borrowing rates vis-a-vis the relatively higher financing rates in local currencies.
The high entropy in global financial markets has presented a window of opportunity to nimble Asian banks to expand the geographic footprint of their customer franchise. Asian banks are relatively safe from the contagion in Europe. They are in much healthier shape, with strong balance sheets and high credit ratings.
The resulting ‘flight-to-safety’ of capital for Asian banks with the highest credit ratings, has resulted in the remarkable growth of US dollar deposits with such banks. The more savvy Asian banks have successfully established new deposit relationships with US and European financial institutions and multinational corporations.
The stronger Asian banks have diversified funding strategies for US dollar covering US commercial paper, euro commercial paper and medium-term note (MTN) programmes, which are relatively cheaper funding sources than corporate deposits. The success of Asian banks in the competitive US dollar deposits markets is not only due to the safety proposition and attractive yields, but also a function of deposit innovations and packaged solutions.
Deposits are subject to local regulations, which vary across Asia. Certain Asian countries do not allow credit interest on savings accounts, while some others have a cap on the maximum credit interest that can be paid on such accounts. Regulated interest rates and minimum tenor requirements are applicable to term deposits in some countries. Deposit restrictions differ between local currency and foreign currency accounts too. Foreign exchange controls are applicable in a number of Asian countries and may be different for resident and non-resident accounts.
The major regional financial centres of Singapore and Hong Kong, which generally do not have any currency or capital controls or deposit restrictions, have become the primary magnets for institutional deposit flows from the West.
A range of local yield enhancement options are available for surplus liquidity. Traditional term deposits continue to be the preferred investment products for corporates. Liquid funds are parked by customers in current accounts, and savings accounts (CASA), which may be interest-bearing. Tiered credit interest structures with credit interest typically on floating basis, and linked to an internal or external benchmark rate are also popular.
Loyalty-based pricing solutions are offered to reward clients to increase stickiness of funds with the bank. New deposit innovations provide preferential credit interest to clients on their core/stable CASA balances with the bank. For transaction clients, banks offer relationship-based pricing by bundling preferential product pricing with customers’ deposits (CASA balances and/or term deposits) with the bank. Automated two-way sweeps between CASA and term deposits are selectively available in certain markets. Liquidity management solutions such as interest optimisation enable corporates to enhance yield, based on balances with the bank across multiple geographies in Asia.
The more aggressive Asian banks have set up dedicated deposit desks to service and market deposits to their rapidly increasing base of global deposit clients. These desks seamlessly manage clients across multiple continents. The desk dealers can even book transactions via Reuters/Bloomberg platforms, with accompanying SWIFT confirmation.
These desks enable banks to develop strong deposit relationships with their clients, by providing a one-stop, end-to-end solution for their investment requirements. The desk acquires strong deposit insights across different client segments and industry verticals.
Deposit desks are key in developing effective deposit pricing frameworks for banks, to perform the tough balancing act of setting deposit rates to increase deposit balances as well as to grow margins and profits. A crucial component of the solution is determining the price elasticity of demand for deposits. This statistically measures the correlation between deposit rate changes and deposit-balance fluctuations. Deposit desks determine patterns in price sensitivity by tracking and analysing movements in rates and resultant customers’ balance movements over time. Such patterns form the basis for segment-based pricing structures. These deposit pricing structures are based on a combination of factors, customer segment (size or industry vertical), depth of relationship and cross-sell, geographic region, access to market information, nature of competitors, etc.
New regulations, such as the Basel III liquidity standards, will have a significant impact on banks’ assessment of the value and pricing of customer liquidity, once these standards take effect. Basel III standards include pre-defined run-off factors for different categories of deposits, which reduce deposit profitability if these increase the liquidity requirements of the bank.
As an illustration, call accounts are generally assessed to have more rapid run-off rates under Basel III liquidity standards, so these will be less attractive to banks. Banks will aim for transaction business of deposit customers to improve deposit profitability. Moreover deposit and banking restrictions in certain Asian countries will gradually get relaxed, enabling newer products.
At times of risk aversion, US dollar liquidity gets tighter. The ability of a global bank to run a successful trade business is contingent on their access to US dollar funding. The high demand for US dollar liquidity in a number of Asian markets is resulting in challenges both for banks and clients. Nevertheless Asian banks have been quietly winning new deposit business from major multinationals, which are diversifying their banking partners.
Corporate treasurers’ focus on liquidity and capital preservation is encouraging the movement of cash buffers from the West to stronger banks and safer countries in the East. Asian banks’ customer insights into deposit pricing and products have contributed to significant US dollar inflows. Winning such US dollar deposits has been the key to Asian banks’ successes in increasing their franchise in the rapidly growing trade markets in Asia.
1Market Rates Insight.
2Estimate from The Bank of International Settlements.
3Monetary Authority of Singapore.