Managing Liquidity - Olaf Ransome

Why is this an important topic?

Complexity and cost. As we add new forms of payment, like Stablecoins or e-money, our day-to-day operational life gets harder, because we have to manage more buckets or accounts, often without extra resources, and even if we had the luxury of extra resource, that makes it harder to ensure we have the right amount of money, in the right currency, in the right bucket at the right time.

At any moment in time, our liquidity is fragmented and in wholesale markets there is no widespread Star-Trek-like ability to do instantly beam liquidity from one place to the other.

Let’s assume that we have to play the hand we are dealt and manage that complexity. How can we help ourselves and make things as easy as possible? There are two ingredients which together are the equivalent of the “spring clean”; simplify and de-risk.

The recipe

The number of places we have money aka accounts aka Nostro aka correspondent banking accounts (I’ll use Nostro) is something which tends to grow like weeds in the garden. We need to constantly prune. Here’s my basic recipe.

1. Only one. One account per entity per currency. That is a good rule. A decent estimate is that operating a Nostro costs about $30k per year. That’s the cost of monitoring, reconciling, even if not much happens, dealing with the due diligence. There will be exceptions, but manage them. I’d suggest scheduling a check every six month to review the current list. And, I would also suggest an iron-fisted policy that every external account needs the approval of both your Ops and Treasury heads. I have been in FS for over 35 years; tales of sudden discoveries of unknown accounts and balances. Now there may be an argument for having two accounts in one currency if you think one might kick you out. It happens, It’s called de-risking and you suddenly find you are PNG, persona-non-grata. If you decide to have two, manage them and share the fees around.
   
   
2. Same for all. If you have multiple legal entities, and they have a lot of inter-company activity, even if that is all sub to parent, then having all of them use the same provider is a plus. Why? Credit and speed. If a payment needs to move outside the bank, then in most cases intra-day credit is a factor. Banks make a payment assuming you will receive funds and be flat by the end of the day. If there is any credit, then it is not limitless. If you are making payments between your various entities and moving money between banks, then you are using up that limit. And, concentrating business gives you some bargaining power over fees and other terms.
   
   
3. You don’t got to move it. The chorus to this is: “net, net, net”. If you have many, or even just a few payments, flowing between you and a counterpart, then you need to be netting. If you could but don’t then you have two risks: one is simply the impact on the intraday credit that your Nostro gives you. The second is that if you simply always pay gross, then you are taking more counterpart risk than you need to. You owe Party A 100 and they owe you 80. If you pay that 100, you are at risk for all of the 80, so until you know the funds have been credited, you are using 80 out of your total credit appetire for Party A. Once you net, you can do more business If you net the 100 vs. 80, you are owe 20; which has no impact on your credit limit for Part A.

Special ingredients

1. Payment control. If you can’t net, for example, payment and receipt are in separate currencies, then another technique you might use is to control when you send payment instructions to your Nostro, i.e when the SWIFT instruction goes out the back door of your systems via SWIFT. This is sometimes referred to as “throttling”. It is useful in a couple of situations: i) you are worried about being paid, as you might have been in March 2023 when Credit Suisse was imploding, ii) You know your counterpart pays late and you don’t want to pay too quickly, or iii) You want to manage credit exposure tightly. You might make your first payment, but not the second unless you get paid.
   
   
2. Intraday reconciliation. Checking your internal ledger vs. the outside statement, but during the day instead of at the end. This sounds hard, maybe even a luxury or something unnecessary. Indeed, there is no obligation to do it. There is a lot of upside; today you spend the resources to reconcile, but only after the end of the day. Yes you spot issues, but none of that helps you in real-time. And you certainly can’t easily control payments if you are not reconciling in near real-time.
   
   
3. Revenue opportunity. The sooner you know where you stand the sooner you could use your long balances to trade in intraday liquidity markets, These are coming in wholesale. Idle cash has an opportunity cost! 
   
   

And there is one more thing. If you are a bank, you have to keep liquidity buffers generally, as well as buffers for intraday liquidity. These are super expensive. There are two key drivers of thses costs: i) the use of intraday credit and ii) the aggregate value of payments or movements. Cut the amount of money moving, minimise the number of Nostros, keep all entities banking in the same space will help you. If you can add intraday reconciliation and payment control, then you create a revenue opportunity.

In conclusion

Managing Liquidity aka cash management is like having a big, beautiful garden with a lovely lawn; it all needs maintenance and that takes discipline. Schedule the maintenance, check where you are and keep pulling up the weeds.

Thanks for reading. Please do let me know what you think of these notes. Feedback via the comments would be great.

Please feel free to get in contact via LiquidityFinder here.

Author

Olaf Ransome is a liquidity and financial services expert. He is the founder of 3C Advisory  You can message Olaf directly here.