The requirement under Basel III for higher capital and to have an improved global liquidity framework is designed to reduce the probability and severity of banking crises in the future. Financial institutions around the world are expected to fulfill these requirements by January 1, 2013, which could prompt tighter liquidity in global banking systems.
As a result, banks must learn how to manage their clients’ cash payments more effectively, especially flows between various time zones, as this could potentially impact their Basel III liquidity ratios.
“Liquidity is going to be a scarce resource that needs to be managed more effectively,” declared Isabel Schmidt, New York-based head of product management for financial institutions cash clearing at Deutsche Bank to Asiamoney PLUS in a telephone interview on March 29. “A key element that Basel III introduces is liquidity ratios and that is in the medium-to-long-term going to have quite a significant impact on the way we do business.”
Historically, the time difference between the US and Asia, for example, presented liquidity challenges to financial institutions – when a US-based bank made payments to an Asian-based beneficiary bank, the latter bank was unable to process the transaction as Asia was not open for business yet.
These funds were deemed ‘idle funds’ as they sat in the current account, where returns could not be maximised, and were waiting to be paid out.
The difference in time zones has created a ‘liquidity drain’, which is anticipated to exacerbate with the emergence of Basel III unless properly managed, believes Deutsche Bank.
“In an environment of tightening liquidity, it is important to optimise liquidity by prioritising payments made into those particular markets which are operative and thereby ‘recycled’ and reapplied towards additional payments,” said Schmidt.
The extension of banks’ processing hours and the emergence of offshore US dollar clearing systems in various locations – where the client has a separate US dollar liquidity pool in Hong Kong, for example, and a separate pool of liquidity in New York for the rest of their payments – in the past few years has helped resolved this issue, but only partially said the bank.
“That addresses half the needs in terms of timeliness for the beneficiary, but that doesn’t really address what we believe is going to be the biggest issue, which is utilisation of liquidity in an efficient manner,” said Schmidt.
Deutsche Bank highlights that financial institutions need to prioritise payments between different time zones in order to maximise usage of their cash-at-hand and ensure that there is sufficient liquidity on their balance sheet to meet Basel III requirements.
“We are able to identify those particular transactions and prioritise them, moving them to the top of the queue so that they go to a beneficiary bank that is operating in a market that’s open for business,” said Schmidt. “The transactions that need to go to Europe or the US are being moved back to a later time of the day, with those beneficiary banks in Europe and the US still getting the funds in their business day which opens later than the Asian business day.”
As a result, this prevents ‘idle’ cash from accumulating in financial institutions’ current account and recycles much needed liquidity.
Despite increasing worries revolving around Basel III and its stringent requirements, Deutsche Bank believes this will not have an impact on the volume of trade payments.
“These new rules are not meant to curtail bonafide payments and trade,” declared Kiat-Seng Lim, a Singapore-based co-head of cash management for financial institutions Asia at Deutsche Bank to Asiamoney PLUS. “They are among a system of risk mitigation measures put in place to ensure banks globally have sufficient reserves to meet their obligations.”
Capital and liquidity rules for banks, known as Basel III, were enacted by international regulators in 2010 in a move to help protect the world’s economy after the worst worldwide financial crisis in decades following the collapse of the US subprime mortgage market. Basel III regulations, which need to be implemented by 2019, require banks to have capital levels.
The global liquidity framework is a new, quantitative framework for liquidity risk management which places greater emphasis on firms’ ability to assess liquidity risks and develop policies to tackle them. This also includes new liquidity reporting requirements based on contractual obligation, which extends both the frequency and detail firms need to report.