Rule Changes Create New Value Opportunity for Banks

By Steve Kinner
Senior Managing Director

Now that the Security and Exchange Commission’s (SEC) new rules on money market funds (MMFs) have been in effect for approximately six months, institutional money managers are looking at how to adjust their investment strategies. Many investors are looking for the exits, at least from prime funds. For most of these money managers, safety is the key.

According to the 2016 Association of Financial Professionals (AFP) Liquidity Survey, 98% of financial professionals say that safety of principal (68%) or liquidity (30%) is their organization’s most important short-term investment objective.

The focus on safety and liquidity over yield has been confirmed by the actions taken by money managers during the run up to the implementation of the SEC’s new MMF rules. Prime money fund assets have declined by a significant amount of $513 billion, or 58 percent, since the beginning of 2016, while government MMFs were up by $2.1 trillion, or 78 percent, over the same period.

Source: Crane Data, Money Fund Intelligence, Volume 12, Issue 1, January 2017.

Institutional investors have an array of options when it comes to managing their cash deposits, and once a strategy is institutionalized, it takes work to go back and evaluate new options. In fact, for many institutional investors, investment practices are written into policies, further increasing the difficulty for reevaluation. This structure often leads investors to live by the idiom, “If it’s not broken, don’t fix it.” However, the SEC rule change has effectively “broken” the investment policies for many institutional investors, triggering a reevaluation of investment practices. This opens a window of opportunity for banks.

Banks are a trusted resource for institutional depositors and have played a growing role in institutional investment strategies since the financial crisis, even before MMF rule changes. According to the AFP’s 2016 Institutional Cash Management survey, institutional money managers allocate 55 percent of short-term portfolios to bank deposits. For context, the same survey from 2007 showed just 27 percent of short-term institutional funds allocated to bank deposits.

Using deposit placement services, like ICS®, or the Insured Cash Sweep® service, (for demand deposit accounts, money market deposit accounts, or both) and CDARS® (for CDs), banks have the ability to offer institutional cash managers access to FDIC insurance on large deposits without having to lock up the deposits in collateral or repo sweeps. Eligible ICS funds are backed by the full faith and credit of the federal government just like government MMFs but don't have floating net asset values (so don't have that same risk of loss of principal to the customer) and are not subject to liquidity fees or MMF redemption gates.

For banks, ICS and CDARS can help cost-effectively attract and retain valuable relationships that help build franchise value with safety-conscious customers of all types. ICS and CDARS deposits tend to be large (with balances averaging $2.4 million per customer for ICS and $2.1 million per customer for CDARS), thereby helping to lower customer acquisition costs per deposit dollar generated. Banks can keep ICS and CDARS funds on balance sheet (and use them to fund loans) or sell the excess for fee income and bring the deposits back on balance sheet later (if a bank is liquid now and wants to build flexibility in for the future).

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