How Are You Thinking About Cash in a Rising Interest Rate Environment?

Surveying the current interest rate regime and recent banking industry events, two areas of focus have made their way to the forefront of Treasury management. One concerns the relative performance disparities in professional money fund managers. The second is exposure to deposit-taking arms of banks traditionally considered less prone to deposit flight and insolvency. Each presents opportunities to optimize capital allocation and yield, while protecting the principal cash that powers daily investment activities.

In the wake of recent banking failures, institutions must be ready to rethink how they oversee their Treasury function. From implementing new tools to understand risk, exposure, and cash availability, to carefully evaluating service providers, everything must be on the table.

Cash management and yield performance

Treasurers of both large financial and non-financial institutions alike are often tasked with allocating their firm’s unencumbered cash reserves, whether it’s dry powder for non-levered funds or borrowed cash from prime brokers to maintain contractual margin. Market-neutral funding opportunities exist, particularly around quarter- and year-end that present attractive economics. Still, a majority of cash gets allocated to outright sovereign bills, notes, or bonds. Alternatively, institutions may choose to outsource active management to professional money fund managers who offer underlying same-day liquidity money market mutual funds.

The advantages of money managers are numerous. Cash liquidity can be made available within hours of trade execution; funds have specific access to facilities at the Federal Reserve for liquidity (Standing Repo Facility) and yield (Reverse Repo Facility); and funds have access to an array of counterparties for trading and repurchase agreements. The industry itself is homogenous in the sense that it offers similar products and services. The main differentiating factor is fund performance, which inevitably oscillates when interest rates become volatile.

When projections on the frequency, size, and pace of interest rates differ, some managers noticeably trail their peers. Managers can – and do – make wrong-way bets on rates and load up on longer-dated securities that drag down fund performance, even accounting for differences in expense ratios. When managers underperform, even a three- to eight-basis point variation on large pools of capital over a 6- or 12-month horizon can have a meaningful impact on firm-wide P&L.

Therefore, it’s important to have flexibility, optionality, and ease when allocating free cash to money fund managers in the event portfolio managers make decisions that adversely impact the fund’s yield. This manifests itself in the form of using technology and service providers that have direct access to all the major players in the money market fund (MMF) space. With the click of a button, organizations can pivot in and out of funds at a moment’s notice to optimize allocation.

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Exposing the exposure risk

It’s not uncommon to think of “medium-sized” and G-SIB banks as immune to deposit flight. This may be due to the aggregate size and diversification of their liability base. It could be the vast scope of regulatory bodies to which they report. Or it may be backstops the Federal Reserve and Treasury have provided when the economy and funding markets get turbulent. Whatever the reason, the contemporary notion is that the blueprint for running a larger bank makes the odds of failure and wiping of deposits near impossible.

Yet, that theory was put to rest as events unfolded throughout March 2023 and continue to the spillover. Sudden failures renewed depositor concerns from the height of the Global Financial Crisis. Within a handful of days, Silicon Valley Bank fell into FDIC receivership amidst a whirlwind of fleeing deposits under the backdrop of a re-priced bond portfolio in a higher interest rate environment. In the case of Signature Bank, the liquidity situation appeared more manageable. Nevertheless, authorities took pre-emptive action and took over the staggering bank.

Almost overnight, the calculus of keeping deposits at banks above the FDIC-insured $250K morphed. There are indeed still inherent exposure risks to keeping large cash deposits at reputable banking institutions. Even in the face of extraordinary measures of suspending the $250K cap and making whole depositors of all sizes, corporates and other depositor institutions cannot rely on salvation from regulators in every failure scenario. They also cannot expect immediate access to their funds even in the event the cap is eliminated again in the future.

If not in fully insured and regulated banks – or even in certain issues of USTs (think debt ceiling) – where is cash safe?

While it’s mostly impractical for a firm to maintain no balance at a bank processing their operating payments, keeping a majority of cash in non-prime MMFs is a strong alternative to placing concentrated exposure with banks that run the risk of going under at a moment’s notice. Government and repo MMFs are in the business of providing T-0 overnight liquidity and are able to send Standard Settlement Instructions (SSIs) soon after a redemption trade is placed. If an organization finds their main operating bank is facing troubles, they can easily amend SSIs to send redemption payments to other accounts.

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The future of cash management

Full control over the movement and allocation of cash is essential to Treasurers. Even if banks offer traditional “sweep” functionality where cash is automatically moved to a MMF each day to earn yield, organizations don’t have direct access to cash in the event the bank itself goes under.

Active cash management doesn’t have to be a cumbersome operational burden. Service and technology providers have plugged into the broader system to allow Treasurers to invest and redeem free cash in a matter of seconds. Treasurers need a centralized, robust, and speedy tool that presents a bird’s-eye view of all relevant data to optimize allocations based on internal risk tolerances and firm mandates. In the current rate environment, Treasurers can’t be complacent with money fund underperformance, concentrated exposure to banks, and stitching disparate MMF trading portals together to manage liquidity needs.

The future of cash management is one with a more skeptical eye and geared toward more effectively moving cash under expedited timelines.