Cash and liquidity: March Hares and Headlights

The other week we saw the Bank of Japan move to a tiering of negative interest rates against Japanese Yen (JNY) central bank deposits.

In Japan the fear of negative returns in Japanese Government Bonds (JGBs) is beginning to drive funds elsewhere, however finding the same level of asset quality on bond investments as they would have against JGB’s at a decent yield is a challenge – hence that movement hasn’t happened to the extent that it has in the past.

Meanwhile corporate long cash positions are at record highs in Japan. No sign of that cash (as yet) being released into the economy. There is a similar story happening in Europe.

As discussed in a previous blog, banks don’t hold excess reserves at central banks. They hold what they deem as necessary to support their internal liquidity stress models, and their regulatory liquidity ratios. Meanwhile, those short-term corporate cash deposits will have a detrimental influence on those very same ratios [they are a cost in balance sheet and RWA terms]. We therefore have something of a vicious circle; negative rates driven by low, to no value in the very short end, high demand for (truly) high quality liquid assets driving down yields in the longer end of notes issuance, and economies still struggling to recover due to a nervousness in investing, from a corporate perspective exacerbated by capital, liquidity and leverage ratio constraint in respect of the banks.

So what to do with this surplus cash that has no value? Here are a couple of ideas:

1) Retail and commercial banks could work with their corporate clients to devise strategies to gain value from releasing funds, or depositing with longer notice periods
For instance, although larger corporations in the UK are long cash, many of their smaller suppliers will be managing their businesses against overdraft facilities (a further drain on the banks scarce resource). Whilst there is a statutory requirement for firms to pay invoices within 60 days, this in many cases is not standard practise [in fact the opposite is more the norm]. The supplier may well consider a discount for early payment, which would be equivalent to a much higher rate of return than the large corporate would be likely receive for deposits with short notice periods.

2) Banks themselves could better analyse their intraday liquidity flows
How much do they really need to reserve to ensure they meet their obligations as they fall due in a crisis? Experience would suggest that, with appropriate analysis of data at the account level, which in turn would drive process change, banks could reduce their HQLA and cash reserves considerably, releasing some of these assets into the market and reducing the liquidity squeeze for HQLA. Moreover, this would be a welcome advance in terms of risk management and prudent management, in addition to the creation of savings and other benefits

Much of this analysis can be done quickly and with offline recent and historical data. Leaving cash on balance is now just a waste, and one that the banks and corporates can no longer afford.