Managing cash like an institutional investor

1. What is the risk for the global banking system?

After the Silicon Valley Bank collapse and Credit Suisse takeover by UBS, the last few weeks have shown that the impact of higher interest rates, and more broadly, tighter access to liquidity and capital, will be felt across the entire industry.

Market expectations are that major institutions (ie key market players) will not be as heavily impacted:

• Major institutions are subject to more regulatory scrutiny and partake in yearly stress test exercises conducted by central banks
• Larger banks tend to be more structured and benefit from better risk management and controls
• They tend to have more exposure to retail clients, whose liquidity needs are less correlated to the financial markets and whose deposits are more often insured by market authorities

Governments and market authorities have evidenced that they are monitoring the overall situation and have stepped up to minimise any spill-over effects. This effort includes the creation of specialised programmes designed to provide liquidity to institutions and lessen market turmoil. In the case of Credit Suisse, the $3.25bn takeover by UBS has been supported with additional liquidity from the Swiss National Bank and the Swiss Government.

The biggest risk to the global banking system is one of trust. The fate of SVB and Credit Suisse is largely the result of failed risk management which was amplified by the challenging rates market environment. That said, whilst the interest rate increases of the past 12 months mean the value of the certain bonds that banks may sell to meet customer demands for withdrawals has fallen quite severely, most banks are well capitalised with ample liquidity, making it very unlikely for them to rely upon the firesale of these types bonds to meet customer demands.

In fact, well managed banks are always focussed on effectively balancing the risks of their assets and liabilities. When they fail to do so, the consequences are a loss of trust in the bank leading to large withdrawals and a 'liquidity' crunch. This is what happened at Credit Suisse lately. There were large deposit outflows following the loss of confidence of some of its major institutional shareholders.

Fortunately, since the 2008 Global Financial Crisis, banking regulators have enforced strict rules that banks must comply with in order to reduce the liquidity risk.

2. Y TREE’s approach to cash management: Investing like an institutional investor

At the heart of our approach is a strong belief in the power of diversification and robust risk management, which includes counterparty risk. That is why we recommend that our clients invest their cash in Money Market Funds, like most institutional investors do, rather than holding material cash deposits with banks. A cash deposit is attached to a bank’s balance sheet.

This means, in the event of insolvency, any depositor will be in the creditor list of the bank and the likelihood of getting their money back (above the £85k that may be compensated by FSCS per eligible person, per UK-authorised bank) will depend on the outcome of the liquidation process. 

A Money Market Fund is an investment and so it is segregated from a bank’s (or custodian’s) balance sheet. The regulations in the UK and Europe require it to be identifiable and so fully recoverable in the event of an institution’s insolvency. Most Money Market Funds also invest across a large number of instruments and issuers.

For example, a Money Market Fund may be diversified in over 200 holdings across short-term loans (sometimes known as 'commercial papers'), time deposits and short-term treasuries issued by banks, corporates and government entities globally. Most managers of these funds also adhere to a strict selection criteria with regards to the issuers credit quality and solvency quality.