I've written this article for smaller banks, building societies, and corporates. It’s a topic I haven’t explored before, but it warrants consideration: the relationship you have with your banking counterparts. It’s an area where you can add significant value, not in outright profit but in cost savings by getting fair value. After all, giving up a basis point has the same effect on the P&L as paying a fee, but because it often goes unnoticed, it is frequently overlooked. The inspiration for this piece comes from my experience working with large banks in wholesale markets and later with smaller firms.
There is a marked contrast in how large banks interact with each other compared to how smaller firms are treated. When big banks deal with one another, they treat each other as professional counterparties. Consequently, pricing, execution, and the negotiation of legal agreements occur on a level playing field. Both sides understand the intricacies of the game. However, the dynamics are very different when you work for a smaller firm.
From the outset, you need to be clear that you are a customer of the bank, which immediately creates a conflict of interest. You want the best price, good execution, and fair documentation, but your counterparty views you as an opportunity to make money.
Smaller businesses face additional challenges. Dealing with multiple counterparties is difficult because they often lack the resources for thorough due diligence and relationship maintenance. This frequently means relying on one or two main banks for most services. Your banking relationships may have been in place for many years, and it may be time for a review. Let’s consider some important issues.
Firstly, it’s easy to assume that all banks have the same credit standing and rating, but they don’t. Your main banking relationship likely involves taking credit exposure through unsecured deposits with the counterparty or their operational ability to perform. Therefore, it’s important to be aware of the counterparty’s credit standing and have alternatives should it deteriorate. This main counterparty will also handle payments on your behalf. While you usually expect your main bank to perform this task consistently, it’s wise to have a backup bank for payments to settle intraday commitments.
Credit risk and payments are not the only considerations. You may also need to hold surplus liquidity with the counterparty, making credit risk important again. Additionally, the bank should offer you a fair price for cash deposits, and you can reference this against market rates. Once you are locked into a banking relationship, competitiveness can decline. Hence, dealing with more than one financial institution is advisable.
For longer-dated investments, such as bonds, competitive pricing remains crucial. A bank may excel in cash management but fall short in handling longer-dated products. If you regularly buy bonds, ensure your bank can consistently execute trades at fair market prices. Comparing several counterparties side by side helps gauge their performance. For regular transactions, consider using a broker to secure the best execution.
Now, let’s consider derivatives. Managing interest rate exposure through swaps requires a capable bank. Given the complexity of derivatives, you need a master agreement and familiarity with margining. Legal counsel should evaluate any agreements to avoid less favourable terms and conditions, as many aspects are negotiable. Ensure you have the skills to independently calculate and manage margin payments.
Typically, you may have only one or two counterparties for derivatives, which can create issues. Price competitiveness is critical, as these deals are often long-term. If your counterparty knows you are reliant on them, there is little incentive for competitive pricing. Additionally, your business model may require continuous hedging, necessitating ongoing transactions. Therefore, having at least one other counterparty ready to trade is prudent if, for whatever reason, your normal go-to is not able to trade.
Apart from payments, cash management, long-term investments, and derivatives, other factors also matter. Your relationship with banks isn’t solely about pricing and execution. Your bank must understand your business. For example, if you’re a building society, do they comprehend the issues around using derivatives for hedging? The way banks interact with you, whether through a central point of access or specialist salespeople, is significant, does it work for you? For complex transactions like derivatives, trust is key and if you rely on your bank for advice or expertise to help you manage risk, ensure you independently assess anything that is suggested.
To make sure you are getting the best value and service from your banking relationships, regularly review and evaluate what you are getting. Appraising your relationship with your bank(s) should be an annual exercise. This assessment can be both quantitative and qualitative. Quantitative measures include calculating how much you pay the bank in bid-offer spreads for transactions. This is not an exact science but more an approximation or estimate of the value of your business. For instance, if you regularly place overnight deposits and they take four or five basis points each time, it’s straightforward to calculate the value you give up over the year. Likewise, applying bid-offer spreads in bond markets and using mid-prices as fair value estimates helps you understand transaction costs. For derivatives, a simple basis point value for the swaps you transact over the year multiplied by a spread from mid-price provides a value estimate.
Subjective measures include the bank’s ability to offer quick and efficient service, understand your business, and provision of a range and depth of products and hedging solutions. Personal relationships also count. Once you’ve established quantitative and qualitative measures, you can build a scorecard, (see below), to assess bank counterparties’ performance, identifying areas for improvement or the need for new banking partners.
As evident from this article, managing bank relationships is largely in your hands. There is an inherent conflict of interest, as banks profit from your business. Your counterparties’ credit risk and long-term strategy are crucial to their ability to meet your needs. Some banks excel in specific areas, and you may need several counterparts for a comprehensive and continual suite of treasury products, from overnight deposits to fixed income and derivatives. Even for simple businesses, having at least two banks ensures operational resilience. Medium-sized financial institutions or corporates may require relationships with two to five banks to meet their treasury needs.
Keeping a regular scorecard of bank performance is helpful. A few basis points on longer-dated transactions can be costly if overcharged. Therefore, regularly reviewing and managing these relationships ensures you get the best value and service from your banking partners.
Example Scorecard
You can easily build a scorecard like this to evaluate your banking relationships. Simply add in your specific products and tailor the criteria to your requirements. This example combines both quantitative measures, such as cash deposits and bond investments, and qualitative measures, including operational performance, legal flexibility, and business understanding. By using this comprehensive approach, you can gain a complete view of the value and service offered by your banking partners, identify strengths, and address any areas needing improvement.
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