NOTIONAL CASH POOLING:
AN ENDANGERED SPECIES?
A study on the impact of Basel III on notional cash pooling
Abstract
This study investigates the effect of the implementation of Basel III on the offering of notional cash pooling. Using a qualitative study, semi-structured interviews were conducted with several stakeholders to triangulate the data and gain a thorough understanding of the topic. It was found that banks are under increased pressure because of the implementation of Basel III and the ECB’s supervision. Consequently, banks are reconsidering their business model and several banking products will change or increase in price. In the case of notional cash pooling, the Liquidity Coverage Ratio (LCR) and the Leverage Ratio (LR) make it more difficult and expensive to net the cash pool positions. This makes it more expensive for banks to maintain the product, and costs of holding more capital and liquidity are most likely passed on to corporates. Furthermore, after the analysis it was found that corporate size and the degree of dependency play a mitigating role in the extent to which corporates are affected. Finally, the corporate view shows that although there are many market developments, the effects of Basel III do not play a major role yet at the corporates. Results of this study indicate that costs and control are two factors that drive the corporate liquidity management choices. Corporates use notional cash pooling as a means of minimizing transaction costs and to maintain control over group’s liquidity.
Key words: Basel III, liquidity management, cash management, notional cash pooling JEL classification: G21, G28, G32, G39
Author: F.A.C. Baum
Student ID number: 1887726
Date: 31/12/2014
Supervisor: dr. W. Westerman Co-assessor: prof. dr. L.J.R. Scholtens
MSc thesis International Financial Management
A study on the impact of Basel III on notional cash pooling 3
TABLE OF CONTENT
List of figures ... 5 List of abbreviations ... 5 Acknowledgements ... 5 1. | INTRODUCTION ... 6 2. | BASEL III ... 9 2.1 Background ... 92.2 Basel III liquidity requirements ... 10
2.2.1 Liquidity ... 10
2.2.2 Liquidity Coverage Ratio ... 12
2.2.3 Net Stable Funding Ratio ... 13
2.3 Impact of Basel III on banks... 13
2.4 Impact of Basel III on firms ... 15
2.4.1 Corporate liquidity management ... 16
2.4.2 Notional cash pooling ... 17
2.4.3 Impact of Basel III on notional cash pooling ... 19
2.4.4 Changes in corporate liquidity management ... 20
2.5 Conceptual framework ... 21
3. | METHODOLOGY ... 22
3.1 Research strategy ... 22
3.2 Research sample ... 22
3.3 Research execution ... 23
3.3.1 Orchard Finance Consultants ... 23
3.3.2 Data collection ... 23 3.3.3 Data analysis ... 24 3.4 Quality aspects ... 24 3.4.1 Construct validity ... 24 3.4.2 Internal validity ... 25 3.4.3 External validity ... 25 3.4.4 Reliability ... 25 4. | DESCRIPTIVE RESULTS ... 26
4.1 Impact of Basel III experienced by banks ... 26
4.1.1 General impact ... 26
4.1.2 Impact liquidity regulation ... 26
4.2 Impact of Basel III requirements on notional cash pooling ... 27
4.2.1 LCR ... 27
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4.2.3 Leverage Ratio ... 27
4.2.4 CRD IV and CRR ... 28
4.2.5 Expectations future of notional cash pooling ... 28
4.2.6 Alternatives for corporate’s liquidity management ... 29
4.3 Impact for corporates ... 30
4.3.1 Perception Basel III ... 30
4.3.2 Current practices ... 30
4.3.3 Adaptation to Basel III ... 31
5. | ANALYSIS ... 33
5.1 Additional factors ... 33
5.1.1 Supervisory authority... 33
5.1.2 Business model ... 33
5.1.3 The degree of dependency ... 34
5.1.4 Corporate size ... 34
5.1.5 Amount of control ... 35
5.1.6 Cost reduction potential ... 35
5.2 Adapted conceptual model ... 35
6. | DISCUSSION ... 38
6.1 Relation to literature ... 38
6.1.1 The role of regulation ... 38
6.1.2 The role of size and degree of dependency ... 39
6.1.3 Drivers in corporate liquidity management ... 40
7. | CONCLUSION & RECOMMENDATIONS ... 41
A study on the impact of Basel III on notional cash pooling 5
List of figures
Figure 1 Summary table Basel III ... 10
Figure 2 Components of cash management ... 16
Figure 3 Example benefit notional cash pooling... 18
Figure 4 Conceptual framework ... 21
Figure 5 Adapted conceptual model ... 36
List of abbreviations
BCBS Basel Committee on Banking Supervision CRD IV Capital Requirements Directive IV
CRR Capital Requirements Regulation
DNB De Nederlandsche Bank
ECB European Central Bank
LCR Liquidity Coverage Ratio
LR Leverage Ratio
NSFR Net Stable Funding Ratio OFC Orchard Finance Consultants
RWA Risk-weighted asset
Acknowledgements
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1. | INTRODUCTION
When the financial crisis hit in 2008, the banking sector came under severe stress, resulting in many banks receiving enormous public sector bailouts to avoid bankruptcy. Banks have always been of high importance as financial intermediaries because of their role as providers of liquidity insurance, monitoring services, and producers of information (Santos, 2001). The transformation service of creating liquidity is almost exclusively provided by banks, making it important to preserve the ability of banks to create liquidity (Diamond and Dybvig, 1986). Moreover, banks are institutional mechanisms to overcome information asymmetry problems (Crockett, 1996). When depositors pool their funds, the bank serves as an agent who is able to differentiate among different borrowers and price loans according to their relative riskiness (Diamond, 1984), thereby reducing adverse selection. Furthermore, the financial intermediary is better able to monitor and influence a borrower’s behavior after it is granted the loan, limiting moral hazard problems (Stiglitz and Weiss, 1981).
Because of these important functions, the Basel Committee on Banking Supervision (BCBS) developed new regulations to replace the current outdated Basel II regulations, which had replaced Basel I in 2004. These new regulations, known as Basel III, should help prevent future market failures by imposing larger and more high-quality capital reserves regulation on the banks. It aims to promote the resilience of the banking system and improve its ability to absorb shocks that arise from financial and economic stress (Basel, 2010a). The proposals are broken down into different pillars: capital reform, liquidity reform, and other elements relating to improvements to financial stability. Banks will experience pressure on their balance sheets as they have to respond by reducing loan assets, increasing eligible liquid assets, and increasing funding from equity, long-term debt and stable customer deposits, in order to improve their positions under the liquidity requirements (Allen et al., 2012). These developments imply that banks need to reconsider their activities and business lines to understand what must be done to comply to the regulations, and how to make their compliance as profitable as possible. This has consequences for the products that banks offer (Härle et al., 2010).
A study on the impact of Basel III on notional cash pooling 7 To this point, the effects of Basel III remains a relatively scarcely research topic due to the novelty of the regulation and the fact that several of the new requirements are yet to be phased in. Most previous research has focused on macro-economic effects of Basel III (Angelini et al., 2011; Allen et al., 2012) or on effects on specific aspects such as lending rates and interest margins (King, 2013; Sutorova and Teply, 2013; Dietrich et al., 2014). No academic research has been conducted to investigate how banks react to Basel III and what consequences this has for a specific product such as notional cash pooling. This study closes this gap by identifying important factors that play a role in the current market developments regarding the offering of notional cash pooling.
The aim of this study is to investigate the impact of the implementation of Basel III on the offering of notional cash pooling and consequently, how corporates are affected. To do so, the relevant requirements and how banks react to these must be identified. It must be investigated how these specifically affect notional cash pooling and how the product will be adapted in return, and what consequences this has for corporate’s liquidity management. Because this research is of exploratory nature, a qualitative research approach is adopted. Data was collected through semi-structured interviews with a research sample consisting of banks, corporates, accountants and lawyers, all headquartered in the UK and the Netherlands. These are the only two European countries where notional cash pooling is allowed. The position of notional cash pooling is under more pressure in the Netherlands, because the new regulations differ more from the current regulations than in the UK. Therefore, the following research questions are formulated:
- How will Basel III influence the offering of notional cash pooling among banks headquartered in the Netherlands?
- What will happen to notional cash pooling practices among Dutch corporates when Basel III is implemented?
8 major role yet at the corporates. Results indicated that cost and control are two factors that drive the corporate liquidity management choices.
A study on the impact of Basel III on notional cash pooling 9
2. | BASEL III
2.1 Background
In 1974, after a turbulent period in the financial markets, the central governors of the G101 countries established the Basel Committee on Banking Supervision2 (BCBS) to enhance financial stability by improving the quality and knowhow of banking supervision worldwide (Basel, 2013a). This resulted in the issuance of the first Basel accord in 1988 (‘Basel I’) establishing an 8 percent capital requirement for internationally active banks from the G10 (Santos, 2001). In June 1999, the BCBS issued a proposal for a new capital adequacy framework to replace the outdated Basel I accord. Basel II was released in June 2004 and consisted of three pillars: 1) expanded minimum capital requirements, 2) supervisory review of an institution’s capital adequacy and internal assessment process, and 3) the effective use of disclosure in order to strengthen market discipline and encourage sound banking practices (Basel, 2013a).
Even before Lehman Brothers collapsed in September 2008, it was clear that the Basel II framework needed to be strengthened because the banking sector had built up too much leverage and inadequate liquidity buffers, along with poor governance and risk management. The results were mispricing of credit, liquidity risk, and excessive credit growth. Consequently, the banking sector came under severe stress causing banks to receive enormous public sector bailouts to avoid bankruptcy. The banking system was not able to absorb the losses and could not cope with the large off-balance sheet exposures that were built up (Keefe and Pfeiderer, 2012). Moreover, the economic and financial crisis became so severe due to a procyclical deleveraging process and the interconnectedness of systemic institutions. When the crisis was at its peak, there was no confidence in the solvency and liquidity of banks, which quickly spread to the rest of the financial system and the real economy resulting in a huge contraction in liquidity and the availability of credit (Basel, 2010a).
In response, new regulations in the form of Basel III were issued. These should help prevent future market failures by introducing larger and more high-quality capital reserves. Basel III aims at promoting the resilience of the banking system and improving its ability to absorb shocks arising from financial and economic stress and to reduce the risk of shocks spreading from the financial sector to the real economy (Basel, 2010a; 2010b). Because banks are the most important intermediators between savers and investors and provide critical services, a strong and resilient banking system is the foundation for sustainable economic growth. Consumers, firms, and governments rely on banks to conduct their daily business at both domestic and international level. Therefore, both micro and macro prudential fundamental reforms to the international regulatory framework were introduced, to help the resilience of individual banks and to address system-wide risks and the procyclical effects in the
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Belgium, Canada, France, Germany, Italy, Japan, Netherlands, Sweden, Switzerland, United Kingdom, United States. 2
The BCBS currently consists of senior representatives of bank supervisory authorities and central banks from: Argentina, Australia, Belgium, Brazil, Canada, China, France, Germany, Hong Kong SAR, India, Indonesia, Italy, Japan, Korea,
10 financial sector. Basel III came in to force starting in 2013 and ending in 2019 (for a schematic overview, see Appendix A) (Basel, 2010a).
2.2 Basel III liquidity requirements
Basel III builds on the three pillars that were established in Basel II. It focuses on the quality and quantity of the regulatory base and the risk coverage of the framework. Additionally, a leverage ratio is developed to make sure banks do not build up excessive leverage again and to discourage risk taking. Lastly, to contain the systemic risks and reduce procyclicality, macro prudential elements are introduced. Basel III introduces additional internationally harmonized global liquidity standards as strong capital requirements alone are not sufficient to create and maintain a stable banking sector. The structure of Basel III is depicted in Figure 1.
Figure 1 Summary table Basel III
Source: BIS
The newly introduced liquidity requirements are expected to be of major impact for both banks and corporates. These ratios are expected to have a direct effect on notional cash pooling, as explained later. More details will be explained below. For an outline of the other requirements, see Appendix B.
2.2.1 Liquidity
A study on the impact of Basel III on notional cash pooling 11 real economy by creating liquidity on-balance sheet and risk transformation (King, 2013). Because banks finance long-term assets with short-term liabilities, liquidity management is an everyday aspect of banking to ensure that banks can meet deposit withdrawals without liquidating illiquid loans (Kowalik, 2013). Because of their role as liquidity providers, most banks’ funds are traditionally associated with comparably short-term deposits from third parties. This allows depositors to optimize their consumption preferences, but it makes the bank vulnerable to liquidity risk and the risk of bank runs (Diamond and Dybvig, 1983). Liquidity risk can be explained as the risk that the bank, although being solvent, either does not have enough financial resources to meet its obligations or cannot acquire these funds at reasonable cost (Vento and La Ganga, 2009). This can occur when the depositors collectively try to withdraw more funds than available (Diamond and Dybvig, 1983). Banks have an advantage over other commercial institutions in managing liquidity risk because of their access to deposit insurance, government guarantees and central bank liquidity (King, 2013). Banks own liquidity and their role of providing liquidity are interconnected: by holding more liquid assets, banks decrease their liquidity risk but reduce their ability to provide liquidity to the market. Banks can hold more liquidity than needed in the form of a liquidity buffer, which helps to meet liquidity needs in times of increased liquidity pressures. However, this lowers the amount of liquidity available to the market in normal times (Van der Vossen and Van Ness, 2010). To require such a liquidity buffer is one prominent approach towards regulating liquidity in the financial system. A liquidity buffer may reduce the risk of system crises in four ways. First, it makes banks less vulnerable to runs because investors’ confidence in the bank is increased. Secondly, it decreases the bank’s reliance on asset sales as a way to obtain liquidity, or withdrawing the financing they provide to other financial institutions (liquidity hoarding). Thirdly, it provides for some extra time to find a solution in case of a liquidity stress event. Lastly, it reduces dependence, and thus the moral hazard problem, on central banks to provide liquidity in times of stress (Kowalik, 2013).
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2.2.2 Liquidity Coverage Ratio
The LCR builds on traditional coverage ratio methods used internally by banks. It should enable the bank to survive 30 days in case of liquidity stress. By that time, management and supervisors of the bank should have taken action to resolve the problems. The LCR requires that at minimum, the stock of high-quality liquid assets (HQLA) should be equal to net cash outflows, which can be defined as follows:
𝑳𝑪𝑹 = 𝑺𝒕𝒐𝒄𝒌 𝒐𝒇 𝒉𝒊𝒈𝒉 𝒒𝒖𝒂𝒍𝒊𝒕𝒚 𝒍𝒊𝒒𝒖𝒊𝒅 𝒂𝒔𝒔𝒆𝒕𝒔
𝑻𝒐𝒕𝒂𝒍 𝒏𝒆𝒕 𝒄𝒂𝒔𝒉 𝒐𝒖𝒕𝒍𝒐𝒘𝒔 𝒐𝒗𝒆𝒓 𝒕𝒉𝒆 𝒏𝒆𝒙𝒕 𝟑𝟎 𝒄𝒂𝒍𝒆𝒏𝒅𝒂𝒓 𝒅𝒂𝒚𝒔 ≥ 𝟏𝟎𝟎 %
This ensures that global banks have sufficient liquid resources to offset the net cash outflows it could experience under an acute short-term stress situation, based on the events experienced in the recent financial crisis. The stress test should be viewed as a minimum supervisory requirement for banks (Basel, 2010b; 2013b).
Stock of HQLA
Assets should be liquid in markets during a period of stress in order to qualify as HQLA, meaning they should be easily and immediately converted into cash without loss of value (Basel, 2013b). Shortly, HQLA are a combination of very high and high quality liquid assets that need to be immediately available to the bank. Very high liquid assets (Level 1) consist of cash, central bank reserves and debt securities that are issued or guaranteed by highly rated public authorities. These can be included unlimited. High quality assets (Level 2) comprise highly rated non-financial corporate and covered bonds and securities. Having a slightly lower quality, these can only be included partially in HQLA (Basel, 2013b; Bonner and Jongen, 2013).
Total net cash outflows
A study on the impact of Basel III on notional cash pooling 13 The LCR should be reported at least monthly, with the ability to report weekly or daily when required. It will be implemented starting in January 2015, with the minimum requirement set at 60% and rising in equal steps to 100% in January 2019 (Basel, 2013b).
2.2.3 Net Stable Funding Ratio
The NSFR complements the LCR by stimulating a more stable, medium and long-term funding of the assets and activities of banks. The standard ensures that long term assets are funded with at least a minimum amount of stable liabilities in relation to their liquidity risk profiles. Stable funding is the portion of the types and amounts of equity and liability financing that are expected to be reliable sources of funds over a one-year horizon under conditions of stress. The NSFR can be defined as follows (Basel, 2010b):
𝑵𝑺𝑭𝑹 = 𝑨𝒗𝒂𝒊𝒍𝒂𝒃𝒍𝒆 𝒂𝒎𝒐𝒖𝒏𝒕 𝒐𝒇 𝒔𝒕𝒂𝒃𝒍𝒆 𝒇𝒖𝒏𝒅𝒊𝒏𝒈
𝑹𝒆𝒒𝒖𝒊𝒓𝒆𝒅 𝒂𝒎𝒐𝒖𝒏𝒕 𝒐𝒇 𝒔𝒕𝒂𝒃𝒍𝒆 𝒇𝒖𝒏𝒅𝒊𝒏𝒈 > 𝟏𝟎𝟎 %
Available stable funding
The following are included in available stable funding (ASF): capital, preferred stock and liabilities with a maturity of more than one year, and the portion of non-maturity deposits and wholesale funding with maturity of less than one year but that are expected to stay with the bank in case of a stress event.
Required stable funding
Supervisors require and measure the required stable funding (RSF) on the basis of the liquidity risk profiles of the institution’s assets, off-balance sheet exposures and other activities. It is calculated as the sum of the value of the asset multiplied by a specific RSF factor which is assigned to the asset.
The NSFR should be reported at least quarterly. It will move to an ongoing minimum standard of 100 percent by 1 January 2018. Both standards will be monitored during the implementation period in order to be reviewed if necessary (Basel, 2010b).
2.3 Impact of Basel III on banks
14 2011; King, 2013). Lastly, liquidity regulation mainly affects economic activity through increasing costs of bank intermediation. This is because banks increase lending rates to compensate the cost of holding more capital and liquidity, leading to lower investment and lower output because of imperfect substitutability between bank financing and market financing (Angelini et al., 2011).
Banks around the world are moving towards the implementation of Basel III. In Europe, Basel III will be primarily implemented through regulation in the form of CRD IV and CRR (Keefe and Pfeiderer, 2012). Härle et al. (2010) estimate that by 2019, the European banking sector will need about €1.1 trillion of additional so-called Tier 1 capital, €1.3 trillion of short-term liquidity (because of the LCR), and about €2.3 trillion of long-term funding (in reaction to the NSFR). The latter are related: as banks rebuild their long-term funding this will lower their short-term liquidity needs.
A study on the impact of Basel III on notional cash pooling 15 Complying with the new standards of Basel III thus has a significant impact on bank performance that will in turn affect other sectors as banks need to manage these changes. Banks could do this by cutting costs, adjusting prices, and considering many of their activities and business lines, to understand what must be done to comply, and how to make their compliance as profitable as possible (Härle et al., 2010). Banks are forced to hold more capital on their balance sheets to cover credit and operational risks to comply with the higher capital and liquidity requirements under Basel III. This capital cannot be used for other purposes, resulting in a decrease of liquidity in the system. Moreover, costs could increase, causing a drop in profitability. This may be an incentive for banks to scale back activities that are most vulnerable to liquidity risks in periods of economic stress, and pass higher costs on to their corporate customers. This means that Basel III also presses corporates to strengthen their cash and liquidity management (Van Alphen et al., 2012).
2.4 Impact of Basel III on firms
16
Source: adapted from Van Alphen et al. (2012) p. 55
2.4.1 Corporate liquidity management
Corporate liquidity management involves the management of day-to-day cash deficits and surpluses. Corporate liquidity is a short-term characteristic that measures the firm’s ability to pay its obligations on time, whereas corporate solvency measures the ability to cover long term debt obligations (Gryglewicz, 2011). Companies can use liquidity management effectively to search for ‘hidden’ cash (Hoogendijk, 2014) and seek to maximize return on surplus cash and minimize the cost of financing cash deficits, while at the same time minimizing interest, currency and other financial risks. This means that the liquidity of the firm must be managed efficiently by making sure that cash is available in the right place, in the required currency and at the right time (Reinoud and Russo, 2012). Corporate liquidity is driven by several factors: information asymmetry between managers and capital markets makes liquidity valuable because firms will not have to access capital markets to raise funds when costs of external capital is high. This is called the precautionary motive for liquidity. Liquid firms incur less transaction costs as they raise funds less frequently. It provides firms with financial flexibility and strategic benefits. Moreover, contrasting to credit lines, cash is unconditional liquidity available in all circumstances whereas credit products are more risky and relatively illiquid. However, holding cash can create an agency problem: management or the controlling shareholders may hoard cash in order to use it for their own private benefit. This managerial discretion can be reduced by using bank financing as the bank monitors the firm (Lins et al., 2010).
Optimizing liquidity management helps to increase financial performance and supporting shareholder value. Furthermore, making liquidity available is strategically important to the survival of the firm, as a company’s cash flow is never stable from time to time (Cooper, 2004; Van Alphen et al., 2012). Liquidity management is challenging because of differing excess and deficit cash positions across multiple entities, regulatory environments, and currencies (TAG, 2012). Liquidity and solvency risks are closely related to cash flow uncertainty as short-term shocks to cash flows, together with the
A study on the impact of Basel III on notional cash pooling 17 availability of cash reserves, affect corporate liquidity. On the other hand, uncertainty about future profitability and leverage generates solvency concerns, which means that a firm can become illiquid after a negative short-term cash flow or it can be insolvent if the expected rate of cash flows decreases, both causing financial distress (Gryglewicz, 2011). For medium to long term cash mismatches, a firm can best combine adjusting capital structure via intercompany and third party lending. For the short-term, cash pooling is a good tool to offset deficit positions for some entities with the surplus positions of others (TAG, 2012). Liquidity management can be broken down into two main activities: cash balances management and (short term) investment management and funding. Firstly, balances management involves identifying which balances the company maintains with which banks, on which accounts and in which currency. This position is subsequently compared with the company’s expected cash flow position based on cash-flow forecasts. Based on this, balances can be moved using cash pooling techniques after which matching can take place between surpluses and deficits. Alternatively, short-term investment and funding involves the forecasting of future liquidity positions, collecting information about the development of interest rates and executing investment and funding transactions (Van Alphen et al., 2012). After the financial crisis, the ongoing liquidity squeeze highlighted the criticality of liquidity management, triggering treasurers of global firms to make better use of internal liquidity resources.
2.4.2 Notional cash pooling
One liquidity management technique that is beginning to attract attention in the current light of Basel III is notional cash pooling, as it is expected that this product will come under pressure (Brace, 2013). Cash pooling is a common practice to ensure that corporate group’s liquidity is visible, readily available and earning an adequate return. The main goal is to get full control of cash balances and to offset debit and credit balances of all accounts in the pool. Its main advantage is that it achieves an optimized interest income or expense as interest is charged or credited on the resulting net balance, reducing overall financing costs (Reinoud and Russo, 2012; Van Alphen et al., 2012). Two types of cash pooling are most frequently used by corporates: physical cash concentration and notional cash pooling (OFC, 2012).
Physical cash concentration
18 should be kept in mind are the cut-off times for transactions, the actual costs of these transactions and the administrative burden of an intercompany loan administration (TAG, 2012). Moreover, the internal interest rates should be in line with the market interest rates (at arm’s length pricing) (Van Alphen et al., 2012).
Notional cash pooling
With notional cash pooling, there is no actual movement of funds, but the balances are virtually booked for interest calculation (see Figure 3). It allows the firm to benefit from one global liquidity position, while subsidiaries remain autonomous in their day-to-day cash management (see Appendix C.2 for a schematic overview).
Figure 3 Example benefit notional cash pooling
Source: simplified example from Van Alphen et al., (2012) p. 313
Notional cash pooling consists of balance compensation and interest compensation. However, balance compensation is not allowed in many countries (except in the Netherlands and the UK); therefore interest compensation is more common. In notional pooling, the bank offers the company the benefit to offset the balances without physically combining them. Therefore, the bank has to ensure that the offset can also be achieved in its solvency reporting to the central bank. This means that the bank must be able to achieve a ‘100% right of set-off’ from the company, meaning that the bank can claim the value of the debit balance from any other account when the company with this debit position goes bankrupt. If the bank can only partially offset, there are solvency costs associated for the bank. (Van Alphen et al., 2012). The benefit generated by pooling consists of a reduction in external financing costs and the more favorable interest income that can be obtained as a result of economies of scale (Reinoud and Russo, 2012).
A study on the impact of Basel III on notional cash pooling 19 interest on the net balance is calculated under an interest enhancement structure. Better interest conditions can be negotiated, and no cross-guarantees or mirror accounts are required (OFC, 2012).
Notional cash pooling can be offered with all accounts in one single country or with accounts spread across multiple countries The latter is very rare as it requires credit facilities to cover all participating accounts, balance compensation capabilities across multiple countries, and the required pledges and securities are documented in local legislation. In case of default, this results in extremely complex legal situations. Moreover, notional pooling can be offered in different currencies: cross-currency notional pooling. In this case, interest results are affected by daily movements of foreign exchange rates and varying interest rates on different currencies (Van Alphen et al., 2012). Other aspects that should be borne in mind are the security rights incorporated in notional cash pooling documentation:
- Right of pledge: Banks require that each group company grants a first ranking right of pledge on the credit balances of the sub-accounts as security for the payment of all obligations of any other group company.
- Joint and several liability: Each group company is liable for the secured liabilities. This right is often subordinated to all rights of the bank.
- Right of set-off. Under this right, the bank may offset any credit amounts from the sub-accounts against debit amounts of the sub-accounts.
- Parent guarantee: The parent company (the master account holder) unconditionally and irrevocably guarantees to the bank the payment by other group companies of the secured liabilities and agrees to pay those liabilities to the bank on requests. (Van Horzen, 2012).
Both physical and notional pooling structures can be used separately or combined in a hybrid solution. The latter means that an overlay structure is set up with one of the banks, concentrating all the funds from various local cash pools and accounts held at different banks and/or locations to one central location (Cooper, 2004; Van Alphen et al., 2012). In recent years, the use of notional cash pooling has increased enormously. It is currently a frequently used structure for concentrating balances and maximizing interest income (Hoogendijk, 2014).
2.4.3 Impact of Basel III on notional cash pooling
20 banks have a right of set-off for risk mitigation purposes. However, this is time-consuming and it requires the banks to have legal and fiscal knowledge in order to acquire this right. Regulations have to allow for compensation in the case of bankruptcy, guarantees need to be signed, and the company has to demonstrate that netting has taken place (Hoogendijk, 2014). If banks need to set aside additional capital for risk management purposes to cover the debit positions in the pool, notional cash pooling structures from most banks may be significantly reduced. Moreover, in most countries, banks rely on cross-guarantees to be allowed to offset credit and debit cash balances. The regulator usually assesses the reliability of this guarantee in order to allow the bank to offer notional pooling. When the guarantees are offered on a cross-border basis, this is more complicated as each regulator is primarily concerned with financial stability in its own jurisdiction (GTnews Guide, 2014). Moreover, as Basel III is implemented in Europe through CRD IV and CRR, it is important to learn which laws govern the rights and obligations of the parties to the cash pooling agreement, the transactions performed, and when and how the rights, obligations and transactions are affected. It is possible that Basel III also affects the legal aspects of cash pooling products (De Man, 2012).
There are some different scenarios when it comes to notional cash pooling:
- Banks could stop offering notional cash pooling on a cross-border basis or at all,
- Notional cash pooling could increase in price, due to additional costs associated with compliance to Basel III,
- Banks could offer a similar product, for example using mirror accounts with physical movement of cash,
- Banks could become stricter when it comes to allowing companies or entities into a notional pool on the basis of the solvency of the company (GTnews Guide, 2014; Hoogendijk, 2014).
2.4.4 Changes in corporate liquidity management
A study on the impact of Basel III on notional cash pooling 21 flows between two or more parties, thereby reducing transactions costs, administrative workload, foreign exchange costs and thus overall costs. Moreover, it improves cash flow and cash flow forecasting, liquidity forecasting and the centralization of liquidity in foreign currencies, thereby reducing foreign exchange exposure (Van Alphen et al., 2012). Fourthly, corporates could reconsider their bank account structure. By simplifying the structure and using fewer bank accounts, cash flows in the remaining bank accounts are easier to manage, saving costs as well. Finally, corporates could facilitate processes in-house. For example, payment factories and in-house banks can enhance process efficiencies while simplifying the firm’s bank account structure (Rebel, 2007).
2.5 Conceptual framework
Based on the previous sections, a conceptual framework can be developed that forms the basis of this research. It follows the line of reasoning and helps structuring the ideas. Because it is an exploratory research, this framework emerged after an extensive literature review. Subsequently, it forms the basis of the data collection, as it is used to create an interview guide (see Appendix E).
Figure 4 Conceptual framework
(Note: grey box outside the scope of this study)
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3. | METHODOLOGY
3.1 Research strategy
The aim of this study is twofold. First, to investigate how banks are affected by the imposed requirements of Basel III and the impact on banking products, and specifically, on notional cash pooling. Second, this study aims to investigate the corporate perspective on Basel III and notional cash pooling. As this is a new topic that is just beginning to attract attention (Brace, 2013), qualitative research is best to study the subject in-depth and is well-suited for exploratory research. Because of the lack of prior research on the effects of Basel III on notional pooling and the difficulty to gain access to the required information, this study is best classified as exploratory. A qualitative approach allows for deeper understanding of the context within which decisions and actions take place. In this study, this is especially important because it will improve understanding of the implications of Basel III in the real-life setting of the bank, and extend the body of knowledge on the effects that Basel III will have on banks and corporates. Furthermore, in order to gain a fuller picture of the changes in the market that are caused by the implementation of Basel III, I combine the banking view with a legal-, accounting-, and a corporate perspective. This allows for data triangulation by looking at the same topic from different angles which improves the quality of the research (Myers, 2009). The research involves multiple units of analysis, mainly because of the ‘replication logic’ (Eisenhardt, 1989; Yin, 2014), implying that analyzing multiple units yields more robust and generalizable evidence. One major drawback is that it is more difficult to generalize the findings to a larger population. However, even in qualitative research, this problem can be dealt with by generalizing to theory (Eisenhardt, 1989; Myers, 2009).
According to Myers (2009), researchers should be aware of the different philosophical assumptions underlying qualitative research. In this study I adopted a positivist approach, which is dominant in most business research. This assumes that reality is objectively given and can be described by measurable properties, independently of the researcher. This also applicable to this research, because of the attempt to objectively describe what will happen to notional cash pooling by formulating expectations after the data analysis.
3.2 Research sample
A study on the impact of Basel III on notional cash pooling 23 banks, who were contacted by telephone and e-mail to invite them to participate in the research. Because of the sensitivity and actuality of the research, some did not want to participate, resulting in a sample of 2 large banks and 2 smaller banks. Moreover, to gain insights from different and more objective angles, two lawyers and an accountant were included in the sample. To be able to capture the corporate perspective on the topic, two treasurers of international companies headquartered in the Netherlands and with many entities across the world were invited to participate in the research. Because most of the information discussed during the research is regarded as confidential and sensitive, the names of the participants are not disclosed. The participants were informed beforehand that the information would be treated confidentially and anonymously. The final research sample accounts for 9 participants that all deal with the topic of Basel III and notional cash pooling. An overview of the research sample can be found in Appendix D.
3.3 Research execution
3.3.1 Orchard Finance Consultants
This study was conducted in the context of working at Orchard Finance Consultants (OFC). OFC is a leading independent advisory firm in Finance, Treasury and Financial Control, located in the Netherlands. From September until December 2014, I worked at the office fulltime. This allowed me to gain broader knowledge about Basel III and notional cash pooling in the practical field. Using contacts of OFC, it was slightly easier to engage the participants in the research as there was already a level of mutual goodwill. Appointments with the participants were made with help of my colleagues, and in all cases, one or two colleagues joined the interviews. This helped in reviewing the interview reports, and discussing ambiguities afterwards, which also is a form of data triangulation. For OFC, the topic is highly relevant as the outcomes contain important market information that can be used in future advisory projects. For me, it helped facilitating the execution of this research.
3.3.2 Data collection
24 understanding and avoided misinterpretations that could harm the quality of the data. The notes were translated into English and reviewed by OFC to ensure nothing was missed.
3.3.3 Data analysis
Using semi-structured interviews, the acquired data is very extensive in terms of breadth and depth. Because the interviews were conducted using an interview guide, all interview reports follow a similar sequence. This enables comparison of the data. The data analysis follows a similar approach as Eisenhardt (1989). This involves two steps: first analyzing within-case data, followed by searching for cross-case patterns. In this study, every single interview was analyzed separately to generate insight in how each party reacts to Basel III. This way, I could discover unique patterns and striking observations, and become familiarized with every interviewee’s story which improves comparison. After this stage, I was able to provide a general overview on the topics discussed and to explain the behavior of banks in reaction to Basel III and the consequences for notional pooling and corporate liquidity management. Secondly, I compared the interview reports to search for patterns, similarities and differences. This increases the probability that the analysis captures the novel findings that exist in the data. One tactic that I used is selecting categories, and then to look for within-group similarities together with intergroup differences (Eisenhardt, 1989). This is slightly comparable to the coding approach of Ryan and Bernard (2000), who suggest that the researcher can first identify the basic units of analysis within the text, and subsequently can induce themes from the text itself and from literature. By formulating such categories, I observed additional factors that play a role as most interviewees brought these up independently. Moreover, to ensure a high-quality analysis, all evidence should be shown, including rival interpretations, focusing on the most significant aspects, and using own knowledge (Yin, 2014). Finally, a model can be constructed that involves identifying how the themes, concepts, beliefs, and behaviors are linked to each other (Ryan and Bernard, 2000).
3.4 Quality aspects
Several aspects are commonly used to establish the quality of any research: construct validity, internal validity, external validity, and reliability. Concerning these, I follow the approach of Yin (2014).
3.4.1 Construct validity
A study on the impact of Basel III on notional cash pooling 25
3.4.2 Internal validity
Internal validity concerns whether the inferences made in the study are correct and is usually addressed during the data analysis phase. Internal validity can be assured by pattern matching, which is comparing emerging patterns in the data analysis to expected patterns from literature. After the literature review, a predicted pattern was defined in the conceptual model. I compared the outcome of every interview with this pattern by highlighting key words in the reports. This way, I had an overview of relevant key words for every report. These key words were later grouped into categories after comparing the reports. Some of these categories could be matched with the conceptual model, and it shows that the outcomes of the study actually follow this pattern, which helps to improve the study’s internal validity. Moreover, by addressing major rival explanations that arise during the data analysis, internal validity is also improved. This is done by including the additional categories that were not expected beforehand, and linking these to literature afterwards.
3.4.3 External validity
External validity addresses the extent to which a study’s findings are generalizable beyond this specific case study. On the one hand, this problem is partly tackled by using replication logic through conducting multiple interviews with several different stakeholders. This also enables data triangulation which helps to construct a holistic view of the impact of Basel III on banks and corporates. On the other hand, because of the small sample size, it is hard to generalize the findings of this research. However, this research can provide some preliminary predictions about what will happen after the implementation of Basel III, and future research could build upon this.
3.4.4 Reliability
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4. | DESCRIPTIVE RESULTS
This chapter presents the results of the interviews, following the structure of the conceptual model and the interview guides. Due to the confidentiality of the research, separate quotations will not be shown but rather a holistic story will be provided.
4.1 Impact of Basel III experienced by banks
4.1.1 General impact
Although Basel III is on top of everyone’s mind, the interviewees state that there are still many uncertainties regarding the developments in the regulation. There are several effects visible at the banks. First, banks feel the increased pressure of the implementation of Basel III, and are constantly reviewing how to interpret the regulation and how to deal with the changes efficiently. This concerns two matters: business model and compliance. The banks explain that they are revisiting the impact on their customers, products, pricing and how it affects their businesses and profitability. In order to comply, banks have increased their liquid assets, increased the duration of wholesale funding contracts, and improved the quality and quantity of the capital base. Secondly, the banks experience an increased workload due to the increased pressure from the supervisor. In most cases, special project teams are installed focusing completely on the implementation of Basel III. Thirdly, the banks have shifted towards a more ratio-driven focus when attracting new funding and creating new products. For many banks, costs have increased and the process of determining how to charge their corporate clients is still ongoing.
4.1.2 Impact liquidity regulation
A study on the impact of Basel III on notional cash pooling 27
4.2 Impact of Basel III requirements on notional cash pooling
As expected, all interviewees stated that Basel III will have little impact on physical pooling. Notional pooling on the other hand, is under pressure. Because it is an exceptional product in Europe, banks find it difficult to determine what the exact effects of Basel III are as it is not clearly specified in the regulations how to treat notional cash pooling as there is uncertainty about how the Leverage Ratio (LR) and the LCR will develop. Therefore, the banks all stated that they are still finding their way around the interpretation and implementation of the regulations.
4.2.1 LCR
The LCR is a ratio that covers liquidity risk and therefore involves the debit positions in the notional cash pool and is designed to protect the bank from bank runs. For example, before Basel III, a credit balance of +10 was sufficient to cover a debit balance of -10 in the notional cash pool since the net position of the accounts is zero. However, the LCR regards the debit balance as a fund that can ‘run-off’ in case of a stress scenario, thereby creating a risk for the bank which requires a liquidity buffer to be held for this position. However, this is regarded as paradoxical because in reality, the credit balance covers this risk. Thus, although in the notional cash pool there are credit positions versus debit positions, every single bank account could ‘run-off’ with their cash, creating a real risk for the bank. That is why under the LCR, the credit positions do not simply cover the debit positions in a pool, and netting is thus basically no longer allowed.
4.2.2 NSFR
Contrasting the expectations (e.g. Hoogendijk, 2014), the NSFR will most likely be of little impact on notional cash pooling. This is mainly because cash pooling is regarded as a short-term instrument. Both credit and the debit positions in cash pools have a short maturity profile and are therefore not affected by in the NSFR. Moreover, the NSFR will come into effect later than the other ratios in Basel III, and is therefore a less urgent topic for banks. It is expected that the NSFR will be in line with the LCR in terms of stringency.
4.2.3 Leverage Ratio
28 requirements. It was noted that the LR aims to shrink the banks’ balances. However, a cash pool is not aimed at increasing the bank’s balance sheet, and therefore netting of these positions should actually be no problem. However, the Delegated Act on the Leverage Ratio (European Commission, 2014) revealed that no exceptions would be made for virtual netting, and therefore the banks report all positions separately. Another issue with the LR is the current ongoing debate in the Netherlands whether the ratio will be set at 4% (e.g. “the Dijsselbloem norm”) or 3%, and whether this would apply to the entire EU or just the Netherlands. Setting the LR at 4% would put Dutch banks at a competitive disadvantage compared to other European banks.
4.2.4 CRD IV and CRR
Another issue that was highlighted by some interviewees is the change in regulation due to the implementation of Basel III in the form of CRD IV and CRR. For UK banks, this is of little impact as these do not differ much from the financial regulation in the UK, meaning that UK notional cash pooling practices are already in line with regulation in terms of documentation and offsetting. However, for the Netherlands this is of more impact as CRD IV and CRR replace the current act on financial supervision. One aspect that affects notional pooling is the topic of single- versus multi-entity counterparties. Under the previous regulation, the bank was able to net the credit and debit balances and report these on a consolidated basis when the parties in the notional cash pool provided a pledge to the bank, and no cross-guarantees were required by the regulator. This was possible in the name of the same counterparty, the same customer group, and across affiliated entities. In CRD IV, netting will only be eligible when in the name of the same counterparty. This means that if the bank still wants to make use of credit risk mitigation across counterparties to reduce their RWAs (e.g. the right of set-off), they need to refer to other possibilities offered and make sure that the new constructions satisfy the applicable eligibility conditions (DNB flag note, 2013). This means that the concept of mutuality needs to be in place which can be created if all entities give cross-guarantees for all debit positions in the cash pool. In the UK, the concept of mutuality was already in place and thus, this regulation is of less impact. However, this is from a legal perspective, for the bank’s reporting under the LR, the gross positions must still be reported.
4.2.5 Expectations future of notional cash pooling
A study on the impact of Basel III on notional cash pooling 29 will most likely be more defensive and will assess the corporate’s risk profile more critically. This includes assessing the corporate’s core activities, credit rating, whether the cash pooling structure is used for the correct objective, and whether the corporate is in a healthy financial position. Possibly, a 100% offset may no longer be possible in the future, as this involves too much risk for the bank.
Some banks indicated to have approached their largest customers already to stimulate them to reduce the largest peaks in the debit and credit positions, because these impact the bank’s reporting ratios significantly. Other banks already installed gross limits on these positions for the same objective. In some contracts disclaimers are included stating that although notional cash pooling is still possible at this moment, there may be alterations in the future price, or it may even cease to exist.
4.2.6 Alternatives for corporate’s liquidity management
As it is expected that notional cash pooling increases in price in the coming years, all interviewees stated that corporates must be aware of the developments in the market and must reconsider possible alternatives. There are several possibilities. Firstly, all interviewees noticed that a physical cash pooling structure such as zero-balancing is most likely the best alternative. However, it is noted that it should also be feasible for the corporate to implement this structure, since this involves a completely different structure than notional cash pooling, including an additional intercompany loan administration and additional working capital needs at the local entities. Additionally, it involves a cultural change.
Secondly, all banks noticed that one possible alternative in the future for notional pooling may be Nordic pooling, a structure that originates from the Nordic countries. This is a hybrid combination of physical and notional pooling using virtual transaction accounts. The ‘virtual’ property is primarily from a legal perspective. In reality, the accounts can be used as any regular transaction account. The transactions on the sub-accounts are mirrored to the top account, usually a private legal entity with limited liability such as “Treasury Ltd.” (see Appendix C.3 for a schematic overview). The balances on the sub-accounts are purely intra-group liabilities between the sub-accounts and the master account (Särnesten Schlegel, 2013). This way, subsidiaries remain in control of their cash and pooling cross-border is still possible. However, all interviewed banks indicated that such a structure is something that is not actively developed yet, but is kept in mind. Another interviewee is somewhat skeptical towards it because experience shows that other products from the Nordic region have not successfully set foot in the rest of Europe either.
30 Finally, some other alternatives were indicated by some interviewees. These included using a third, independent party for the notional cash pool. This party does not need to comply with the Basel III requirements and thus can provide similar services as notional cash pooling. Another option is netting of internal payments within the corporate to lower costs.
4.3 Impact for corporates
4.3.1 Perception Basel III
Interestingly, the perception of the corporates regarding Basel III appears to be completely different from the banks’ view. In contrast to the banks, the topic of Basel III does not play a role at the interviewed corporates. The overall opinion is that banks often use Basel III as a ‘threat’ or as an excuse to cover other problems. For some years, the corporates have heard different rumors about possible changes in the market. However, so far, the interviewees have not yet noticed any concrete changes in their cash pooling structure or in the pricing of cash management products. Other products, such as interest derivatives have increased in price. However, the corporates experience reluctance from the banks to actively discuss the ongoing changes in the market. Banks stated that the developments may take a while to actually take place, and that there are still too many question marks regarding Basel III to give concrete answers. Therefore, the interviewees are rather skeptical about the pace and the impact that Basel III will have and therefore, they will not set Basel III high on the agenda unless the pressure from banks increases. Finally, because of the small size of the treasury teams and the high workload, Basel III is not high on the corporates’ agendas, and the corporates prefer to wait and see for what happens.
4.3.2 Current practices
Both corporate interviewees explained that corporate liquidity is managed by means of several credit facilities that provide for enough strategic opportunities, which are determined by means of forecasting and policies. On the operational level, the corporates have to ensure that there is enough working capital at the local entities. For Western countries, liquidity management is usually centralized at the holding. By doing so, liquidity management concerns mainly the ‘logistics of cash’, i.e. ensuring that enough cash is available at the right place and the right time. In other regions it is more difficult to centralize liquidity management and to maintain control of cash because of bureaucracy, culture, and regulations. In these cases, liquidity management is more locally organized with local banks. For these countries, often other additional tactics are used to manage liquidity such as dividend payments, procurement, equity injections, and payment terms.
A study on the impact of Basel III on notional cash pooling 31 respondents strive to include as many local entities in their cash pooling structures as possible. However, whether this is possible also depends on local regulations. The current cash pooling structures are working sufficiently, and do not require a lot of management attention. The banks calculate the interest costs, and the corporate can subsequently decide which margins it applies for the local entities.
Characteristics that triggered the corporates to choose for these structures were based on historical structures, whether it is possible or not to set up a local cash pooling structure, the benefits it provides, providing the local entities with enough control over their cash, and because it does not require any intercompany positions.
Indicated advantages of notional cash pooling are the reduction of the amount of transactions, the savings on interest costs, the possibility to increase control over countries with a high-risk profile with a non-resident account in the notional cash pool, and the ability for local entities to maintain control over their liquidity. The biggest drawbacks of notional cash pooling that were indicated are counterparty risk and balance sheet lengthening. In order to manage these risks, the corporate can acquire a right of set-off to reduce counterparty risk and to manage liquidity risk. Legally, in order to be able to acquire this right, there must be the intention to manually set the balance to zero periodically, and not only in case of default. Furthermore, offsetting is a concept used for accounting and reporting purposes driven by IAS 32. This accounting standard requires the corporate to show that it has the intention and that it is technically possible to settle the balances, in order to be able to report the net position in its financial statement as a result of the legally enforceable right of set-off.
4.3.3 Adaptation to Basel III
A study on the impact of Basel III on notional cash pooling 33
5. | ANALYSIS
Whereas the previous chapter elaborated on the topics of the initial conceptual model, this chapter shows that additional factors play a role in the impact of Basel III on notional cash pooling. These emerged when comparing and searching for patterns across the data. Six factors and their relevance are presented, after which the conceptual model can be complemented.
5.1 Additional factors
5.1.1 Supervisory authority
In November 2014, the formal banking supervision for 120 large banks in Europe was transferred from the local authorities to the ECB in Frankfurt. The aim is to ensure consistency in financial stability across the European Union. During the interviews, many respondents noted that this will be of significant impact on the banks’ implementation of Basel III. For instance, there is a considerable difference between the ECB and the DNB. It was noted that the ECB focuses more on hard data and therefore makes a lot of ad hoc data requests, whereas the DNB focused more on soft data. Moreover, as the ECB needs to supervise a large number of banks, the supervision will be more stringent and less personal. For Dutch banks the peer comparison has changed considerably given the small Dutch market with only a couple of large players, which has turned into a much larger European market, which may result in more distant monitoring. Previously, it was common practice for banks to build a relationship with the supervisor, and issues were discussed fairly informal. Now, some interviewees fear that the contact will be less personal. Lastly, it was noted that the ECB will increasingly receive more authority and imply more rules and interpretations of Basel III because of the ‘implied power principle’. Thus, the more stringent supervisory authority will be of large impact on the banks’ implementation of Basel III. There is less room for interpretation and the banks primarily have to focus on complying with the required ratios when conducting business, resulting in a less intuitive approach that is more ratio-driven.
5.1.2 Business model
34 different, and different products will be developed. Another possible consequence is that banks will focus more on other side businesses, such as consultancy. Therefore, the implementation of Basel III not only has a direct impact on the change of banking products, it also affects the banks’ business model which may lead to different products and pricing.
5.1.3 The degree of dependency
Some of the interviewees called notional cash pooling an ‘anchor’ product as it facilitates other products and thereby, creates a relationship of dependencies between the bank and the corporate. It was stated that because of the changes in the banks’ products, banks will more critically review their customers and become more selective about which corporates they want to retain and which they prefer to lose because of the earned margins. Banks depend more on certain corporates than on others in terms of product portfolio and revenues, and must constantly consider risks and returns. Some banks expect to become more selective towards which corporates they will offer notional pooling, and prefer to offer it to corporates that use more of the bank’s services. This can be beneficial for corporates with well-established relationships with the banks, but disadvantageous for others. If the corporate has a more extensive product portfolio at the bank, banks will base pricing decisions on the profits of the total wallet, as the increase in costs is compensated by other earnings.
From the corporate’s perspective, this is also an important factor. Both corporates stated that in case the bank increases the costs of notional pooling, this triggers a revaluation of their banking relationships to see if other banks can deliver better services, as the corporates are less dependent on a specific bank. Thus, although the change in the banks’ product portfolio and pricing model may lead to an increased price or a decrease in the offering of notional cash pooling, this effect can be mitigated by the degree of dependency between the bank and the corporate. In turn, a change in the offering of cash pooling products triggers the corporate to review their banking group.
5.1.4 Corporate size
A study on the impact of Basel III on notional cash pooling 35
5.1.5 Amount of control
An important driver for the corporate choice for a notional pooling structure is the amount of control. The corporates include the bank accounts of local entities in the cash pool where possible, to centralize liquidity management as much as possible. On the one hand, one important goal of cash pooling is to increase insight and visibility in corporate liquidity. On the other hand, the choice for a notional cash pooling structure is made consciously because it provides the local entity with enough control over their cash, because it is not physically swept to the master account but remains on the local accounts. Finally, as one interviewee noted, the current changes in the market are a good opportunity to centralize the treasury operations to a greater extent to gain more control. From a corporate liquidity management perspective, the amount of control is an important characteristic when choosing for a notional pooling structure and is thus an important consideration when the offering of cash pooling products changes.
5.1.6 Cost reduction potential
Another factor that was indicated by both corporates that drives the choice for a particular cash pooling structure is the ability to save costs. The corporates want to optimize their cash position, and thereby saving on interest costs and the amount of transactions required for the netting of cash positions, which decreases transaction costs. Therefore, in case the offering of notional cash pooling increases in price, the first thing that the corporates would do is to make a business case and consider whether the costs are still outweighed by the benefits of maintaining the notional cash pool structure.
5.2 Adapted conceptual model
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Figure 5 Adapted conceptual model
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6. | DISCUSSION
6.1 Relation to literature
The implementation of Basel III and the practical implications for banks and corporates appears to be an extremely ‘hot topic’ among banks and other involved parties as it is an ongoing process with many developments. However, so far it has received little attention in the academic world. Most previous research has focused on macro-economic effects of Basel III (Angelini et al., 2011; Allen et al., 2012) or on effects on factors such as lending rates and interest margins (King, 2013; Sutorova and Teply, 2013; Dietrich et al., 2014). To the best of my knowledge, no previous research has been conducted to investigate how banks will react to Basel III and what consequences this has for a specific product such as notional cash pooling. This study closes this gap by identifying important factors that play a role in the current market developments regarding notional pooling.
6.1.1 The role of regulation
The conceptual model shows how Basel III regulations work their way through the market and how eventually, products and corporates are affected. Basel III was implemented to create a more resilient banking system, as the absence of stability or disruptions in the financial sector can have a major impact on the economy (Crockett, 1996). Basel III liquidity regulation aims to protect banks against liquidity shocks. This is in line with the systemic risk argument that explains that asymmetric information can force an otherwise healthy bank into bankruptcy if depositors panic and withdraw their funds out of fear that other depositors will do it first, which can trigger contagion runs (Santos, 2001). Moreover, moral hazard needs to be dealt with by influencing bank behavior through regulation. If there would be no regulation in place, banks would be able to take excessive risks with market disciplines being unable to prevent this (Crocket, 1996). This study shows that because of the regulations, risky products needed to be changed. Since notional cash pooling involves liquidity risk for the banks, this is restricted by disallowing credit positions to serve as collateral for debit positions.
Central banks play a crucial role both in normal times and in times of financial crisis (Bindseil and Lamoot, 2011). The role of banking supervision is to ensure the safety and soundness of individual banking institutions (Vento and La Ganga, 2009). This study showed the large influential role of the supervisor. However, it is questionable whether this will have the desired effect. Barth et al. (2013) show that strengthening official supervisory power is positively associated with bank efficiency only in countries with independent supervisory authorities. The interviewed banks show a consistent view as they experience much pressure on complying with the ratios which increases the costs of doing business.
