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FD Report: Safe and sound – the importance of spreading your banking risk

Bank risk

The last few years have shaken many FDs’ faith in their key suppliers. While
the downturn has threatened those relationships, no other supplier has come
under more scrutiny than their banks. For many companies, it’s been a stark
awakening: your bank can go down ­ and you can down with it.

It’s an issue the banks themselves acknowledge and have been at pains to
highlight the efforts they have made to strengthen their balance sheets.
Measures that were once only of interest to corporate treasurers are now at the
forefront of clients’ minds when choosing their banks. But the fact remains that
banking services haven’t improved and despite the imprecations of Gordon Brown
and others, rate cuts haven’t been passed on to corporate borrowers.

“Everyone has had to review their risk management,” says Keith Strachan,
director in the corporate treasury consulting practice at Deloitte. “Whether
it’s placing funds or relying on banks operationally, the last few years have
really changed that. The idea that a bank could go under was simply not in their
thinking. Now it is and it’s real and you’re not prepared to gamble your
company’s existence on a bank’s survival.”

While the banks retrench and set about recuperating, we are seeing a
recalibration of the way in which large corporates deal with their banking
arrangements, what they expect and how they mitigate the risks inherent in the
current banking model. Changes are afoot and adapting to the new model of
banking is one of the top challenges facing FDs today.

Spread the risk
That means spreading the risk. Ensuring a prudent spread of banks was previously
considered the exclusive preserve of multinationals. But more businesses are now
weighing up their options as the banks rebalance their portfolios. “In general,
corporates are refocusing business on those who are lending them money,” says
Strachan. “And in some cases where refinancing is necessary, some banks have
pulled out. We’ve seen some overseas banks pulling out and that has caused the
corporate to review the sort of business it gives to that bank.”

Further evidence, then, that the traditional model has changed. Now it’s
banks that are forced to look at how they access capital. And balance is key.
“Some corporates might have two global banks to help them with the global cash
management structure and they’re questioning whether having one or two banks to
do their disbursements makes them too reliant on a small number of banks,” says
Strachan. “What if it gets into difficulty? That means they’ll have to put in
place a back-up bank.”

Further down the food chain, the landscape is slightly different. Smaller and
mid-market firms are a long way from being in a position to operate
independently of banks’ systems, so those relationships remain fixed. But for
many, the coming 12 months will see such a reappraising of priorities.

“There has been a significant change in the dynamic,” says Donald Stewart,
partner at Faegre and in his spare time, chairman of the Quoted Companies
Alliance (QCA). “People are now aware of counterparty risk and FDs realise
having your money in the bank is no longer just ‘money in the bank’.”

Stewart believes the mid-market now includes many businesses that are looking
beyond traditional sources of bank finance. “People who are trying to raise
finance for everyday corporate activity are having to go further afield and be
more creative or daring in their choice of banks than they were before,” he
says, “because the few banks that are lending are foreign ­ Svenksa, for
example. Anecdotally, the banks that are seen as a safe bet are Scandinavian and
to a lesser extent, Spanish, because the traditional high street banks simply
are not lending.”

QCA members, AIM-listed in the main, are suffering more than most, according
to Stewart. “The reality is that the big banks have effectively closed their
doors. So we’re seeing banks coming in to fill the gap that are smaller and more
entrepreneurial. They’re trying to create a business out of that opportunity and
that can be a bonus for mid-market firms.”

Proof of this is the number of businesses looking to access lending from
foreign banks. However, it’s not a free-for-all. Some industry experts believe
relying on the network of foreign banks for business-critical operations is a
risk too far.

And there is a new development that could change the dynamic of the blue-chip
bank relationship. Ensuring banking systems are integrated and secure is the
leading challenge for FDs and treasurers. Any business with international
dealings will be well aware of the difficulties of managing the different
payment stations.

International payment and treasury services are a great source of revenue for
banks, so the chances are that any international relationship bank will offer a
range of payment management solutions. And the chances are they will run these
services via Swift.

Put simply, Swift (Society of Worldwide Interbank Financial
Telecommunication) is a messaging service used by banks. In essence it is an
email system. The difference is that it is the most secure email system in the
world and the standard means by which banks send mandates to each other.

Until now, it has been used solely by international banks making payments on
clients’ behalf. However, Swift is now being offered as a direct consumer
service. “There is opportunity for larger corporates ­ where the cost benefits
work ­ to access Swift services,” says Strachan. “It enables businesses to deal
directly with a wider variety of banks because they are able to send them
messages directly. Previously, to do that you needed a lot of bank systems which
meant a lot of interfaces with your own systems. But if you’ve got Swift you can
send messages to lots of banks.”

So far, Cisco, Intel, Vodafone, Tesco have all joined the party and are in
the process of building their own international payments system. Malcolm Cooper
is group tax and treasury director at National Grid: “We are looking at the
possibility of implementing Score [standardised corporate environment],” he
says. “There is an alternative system, but Score is the preferred option. The
benefits for us will be simplifying our payments systems, infrastructure and
processes. In terms of risks we need to make sure we understand and address the
security issues. The banks that provide existing payments systems are fairly
relaxed ­ I think they see this as inevitable.”

Creating a standard
The biggest issue is a lack of a standard format. There are currently too many
platforms, so establishing global standards is key. Some multinationals are
reporting in scores of formats, so we’re at year zero for standardising that.
Only the very largest companies need think about this now, but as Cooper says,
Swift will ultimately be the standard form of payments processing and
transaction guarantees across the world.

Some banks, including HSBC, are committed to rolling it out and they want
customers to join. Michael Cannon, HSBC’s head of payment cash management in
Europe, told a recent conference the focus had changed from cost-cutting to
liquidity management. With credit markets being so tight, managing what cash you
have is even more important.

Banks are aware of big corporates’ need to find and pool their cash in order
to pay down debt and reduce the need for expensive borrowing. And that means
dealing in marginal currencies, which means a global system is necessary.

The question this poses is whether widespread adoption of Swift will mean a
fundamental shift away from process to value-added services for the big banks.
And the question also remains: are they prepared for that?

Forex provision
As some FDs look beyond banks for ancillary services, Louis Pearce, head of
sales at Caxton FX outlines some quick wins for FDs entering the murky world of
foreign exchange.

1 Beware commission-based models
Most FX brokerages pay traders low salaries topped up with attractive
commission. That would encourage traders to attract as many customers as
possible to make as many trades as possible.

Great for the broker, not so much for the client. After all, it is in the
trader’s interest to get clients trading, even when the rates might not be
favourable, or the timing poor. So, always find out the broker’s renumeration
policy. The heavier the commission offered to traders, the more likely it is
that the client will receive pressure to trade unnecessarily. A commission-free
model, where the trader is paid a competitive flat rate, is more favourable.

2 Know who you’re dealing with
The growth in the number of foreign exchange brokers has brought more choice. It
has also multiplied the number of unregulated brokers offering their services.
Put simply, the barrier to entry for the FX market is so low that it often
requires little more than a fancy website. Many will be perfectly reputable and
professional outfits.

However, these companies are engaged in high risk strategies predicated on
minute movements in very volatile markets. The result? Greater risk of
bankruptcy or business interruption. So, verification becomes all important.

3 Demand guarantees
There are a lot of FX companies making huge profits every month, but not all can
guarantee their clients’ funds are protected should the broker go out of
business. So FDs should demand guarantees that their funds will be safe with
their broker, preferably to a level mandated by the FSA. The most reputable
brokers, rather than holding their clients money on account (and thereby
exposing it to loss), hold funds in a separate, ring-fenced account (akin to
escrow). So any problems the broker encounters won’t affect clients’ money.
Given the volatility of the global currency markets that is surely worth
something.

4 Get your timing right
To achieve the best possible return on your currency dealings, timing is
crucial. Not just at the time you buy, but in terms of when you alert your
broker to future needs. The more time you allow, the better the outcome.

For clients that buy on an ‘as-and-when’ basis it can be quite tricky.
Remember, at the time of getting in touch, they’re looking for the best rate
they can get. If you’re buying euros and you need them in two minutes’ time,
then there’s not much they can do, other than quote you a rate of exchange – and
anyone can do that. So, allow a little bit of time.

The key message here is: businesses willing to engage with their broker in a
timely fashion will increase their chances of achieving the best possible rate
of return.

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