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Related Expertise: Financial Institutions, Wealth Management, Wholesale Banking


TRIMMING THE SAILS


INSIGHTS FROM BCG’S TREASURY BENCHMARKING SURVEY 2018

December 13, 2018  By Gerold Grasshoff, Pascal Vogt, Robert Schäfer, Clemens
Elgeti, and Mireia Granzer



In nautical terms, trimming the sails means making adjustments that allow a boat
to get the most power from the wind. That’s precisely what treasury functions
need to do. After a tumultuous decade, market and regulatory pressures have
eased slightly. While treasuries may relish the chance to catch their breath,
they cannot become complacent. They must use this period to begin storm-proofing
their operating models and advance digitization. Markets are cyclical. In time,
another downturn will command round-the-clock attention. Business models are
also changing as banks respond to new competitors and new technologies.
Treasuries that take advantage of the relative stability now to improve
governance, enhance front-office visibility, shore up needed knowledge and
skills, and provide the right data and IT infrastructure will help their banks
ride the waves of disruption and become more competitive and more profitable.

Our 2018 Treasury Benchmarking Survey looks at how treasury organizations have
weathered the past two years and what it takes to trim the sails. A total of 44
banks across Europe and North America participated in our study, including 10
global systemically important banks (G-SIBs), 19 banks with balance sheets of
€200 billion or more, and 15 regional and midsize players with balance sheets of
less than €200 billion.




TREASURY HAS EVOLVED OVER THE PAST TEN YEARS

This 2018 benchmarking survey is the fifth in a biennial series spanning the
past ten years. That decade-long view provides a helpful vantage point from
which to observe how treasuries have responded to one of the most challenging
periods in banking history. For most, it has been a journey of significant and,
in some cases, profound change.


FOR MOST TREASURIES, THE PAST DECADE HAS BEEN A JOURNEY OF SIGNIFICANT AND, IN
SOME CASES, PROFOUND CHANGE.



Prior to 2008, for instance, many treasury functions were housed within capital
markets divisions and run like a trading business because liquidity at the time
was considered an ample resource with no set limits. The financial crisis
changed that. In the years that followed, many treasuries began moving out of
capital markets and taking on a greater strategic or steering role for managing
the balance sheet. With liquidity management crucial to bank viability,
treasuries began to systematically identify liquidity risk and establish better
day-to-day methods to measure, monitor, and manage it.

The past ten years also saw a new slate of banking regulations introduced.
Managing the increased regulatory volume kept bank treasuries consumed with
compliance activities, work that included implementing new coverage and funding
ratios, conducting stress testing, managing asset encumbrance, and building
appropriate liquidity buffers.

The macroeconomic environment presented its own challenges. For much of the
decade, a sluggish economic recovery diminished investor appetites and led to a
sustained period of low—and sometimes even negative—interest rates in most major
markets, pushing treasuries to reduce costs and improve how they manage the
banking-book position.

The resulting changes constitute significant improvements in overall treasury
maturity. Our survey found that 50% of respondents now rate their treasury
functions as having reached stage 3 in our four-stage assessment of treasury
maturity, with stage 1 being the least advanced and stage 4 being the most,
meaning they have achieved greater structural balance and visibility in managing
the bank’s treasury positions and their own profit and loss (P&L) contribution.
While that is encouraging, the remaining 50% indicated that they are still
somewhere between stages 2 and 3, and none have achieved stage 4. (See Exhibit
1.)





Survey trends suggest several priority areas for treasuries as they work to
improve management and oversight.

Governance for the banking book continues to centralize. In keeping with the
steering-oriented focus that has become predominant across banks, oversight of
all banking-book risks—including liquidity, foreign exchange, credit spread, and
interest rate risk—continues to shift to treasury. Treasuries are also becoming
the primary manager of the bank’s financial resources as they gain increased
responsibility for liquidity, funding, capital, and the balance sheet. With that
expanded financial-oversight role, the number of treasury units reporting
directly to the CFO has grown significantly. Our 2018 survey found that 75% of
treasurers now report to the CFO, compared with less than 20% ten years ago.
(The exceptions are those in treasuries that have historically played a
significant execution role.)

Execution activities increasingly fall under treasury’s purview. The majority
(80%) of survey respondents reported that treasury manages the bank’s money
market activity, up from 60% in 2014. In addition, where treasuries once
predominantly used money markets as a profit center, many now rely on them to
support liquidity management. This is because the implementation of regulatory
reforms such as the liquidity coverage ratio and leverage ratio—in addition to
the bank levies charged by some national regulatory authorities—has made money
market trading less profitable and liquidity management more important.

In keeping with this integration trend, 65% of repo desks now sit within
treasury and 50% of treasuries reported that they have a mandate to access
markets directly to execute interest rate risk hedge trades. This shift reflects
the fact that, for many treasuries, the majority of interest rate risk now comes
from the banking book. Also, market making in interest rate derivatives requires
scale, which means that smaller banks can no longer compete against larger banks
in this area.

Lines of defense continue to sharpen. Treasuries are working to improve how they
segregate oversight responsibilities, but practices vary by region.


TREASURIES ARE WORKING TO IMPROVE HOW THEY SEGREGATE OVERSIGHT RESPONSIBILITIES,
BUT PRACTICES VARY BY REGION.



In Europe, roughly 50% of treasurers said they run model development and stress
testing within the first line of defense, where treasury manages the risk, and
the other 50% include it in second-line functions. While no standard operating
model has yet emerged, our analyses suggest that European treasuries are
increasingly moving toward housing model development within the first-line
function.

In the US, by contrast, there is much greater uniformity: 90% of survey
respondents said they place interest and liquidity modeling in their first-line
defenses, while model validation sits within the second line. The
standardization is a result of regulatory pronouncements, such as the Federal
Reserve Board’s Supervisory Guidance on Model Risk Management (SR 11/7), that
advocate this type of risk
delineation.

Visibility gaps prevent treasuries from assessing the bank’s risk position.
While survey respondents have made improvements in the way they categorize and
view risk, with approximately two-thirds of treasuries reporting that they can
now split risk types, only 50% of survey participants said they have daily
insight into their entire banking-book position. Likewise, only a small number
of banks have real-time data feeds to oversee their loan portfolio and deposits.
Most treasury functions report that they need to use multiple systems to get
relevant information, and much of the analysis continues to rely on manual
labor.




TREASURY CONTRIBUTION CONTINUES TO AVERAGE 10% OF BANKWIDE NET INTEREST INCOME

Treasury P&L plays a crucial role in helping banks to maintain stable net
interest income (NII), but value generation varies depending on risk strategy,
risk appetite, and the makeup of the treasury function, such as whether it
manages the money market and repo desk.

While these factors can result in P&L variance, with some treasuries
contributing zero P&L to NII in 2018 and others as much as 30%, the average
contribution across all respondents continues to be 10%—similar to the average
reported in both our 2014 and 2016 benchmark surveys. (See Exhibit 2.) In terms
of composition, about 60% of the average treasury P&L comes from pure interest
rate mismatch and 25% comes from pure liquidity maturity transformation. The
remainder comes from the liquid asset buffer, a dedicated investment portfolio,
and other sources. Surprisingly, several survey participants still cannot
measure their treasury P&L or the P&L components that are reallocated to the
business units.





As we delved deeper, survey data revealed that next to structural liquidity and
interest rate maturity transformation, three factors play a particularly big
role in influencing treasury P&L strategy and performance.

Low rates prompt a search for growth. Roughly 60% of treasurers employ a
dedicated investment portfolio, which usually consists of bonds issued by
financial institutions, covered bonds, high-quality corporate bonds, and
sometimes even equity investments. The size of these portfolios has grown in
recent years as treasurers—especially those in Europe—seek to offset the impact
of the low-interest-rate environment. Some also lowered their liquidity buffer
risk appetites to support higher investment portfolio risk tolerances.

Liquidity buffers continue to grow. In 2010, liquidity buffers accounted for
approximately 10% of the average cash balance sheet; 2018 survey data found that
they now constitute 19%. The growth is due in part to regulatory requirements
that mandate certain liquidity coverage ratios and in part to the fact that
sustained low market rates have presented relatively few attractive investment
alternatives. Growing buffer sizes create opportunity cost: instead of
increasing their core credit business, banks are holding a greater number of
high-quality liquid assets (HQLAs), which can come with a negative carry
(meaning that holding costs exceed income earned).

Funding tenors have also grown over the past decade, increasing from an average
of 6 to 12 months in 2008 to an average of 18 to 24 months in 2018, which has
added to buffer costs. Lowering those costs requires treasuries to have granular
cash flow data and tools to forecast cash movements more accurately, along with
transparency about the true value of highly liquid assets and tools to support
investment decisions in the most valuable HQLAs.


TREASURIES NEED TO MOVE FROM THE RISK AVERSION MINDSET THAT DOMINATED MUCH OF
THE PAST DECADE TO A VALUE MINDSET THAT WILL MAKE THEM MORE RESILIENT.



Forecasting intraday liquidity remains difficult. While treasurers are focused
on improving the steering and pricing of intraday liquidity, many said that
forecasting working-capital demand continues to be challenging. There is wide
variation in the amount of working capital that banks are holding against
intraday outflows: amounts range from 0.8% to 13.5% of cash balance sheets.
While reporting of the intraday liquidity position according to the Basel
Committee on Banking Supervision’s standard 239 has improved internal
risk-reporting practices, treasuries must continue to strengthen their cash
management forecasting capabilities. As they look ahead, about half of
respondents said that they expect to see new intraday products such as intraday
swaps, deposits, and money market products become available as the enabling
technologies mature.




IT’S TIME TO OPTIMIZE THE TREASURY OPERATING MODEL

With global markets largely stabilized, banks now have breathing room to focus
on improving the maturity of their treasury operating models. In doing so,
treasuries need to move from the risk aversion mindset that dominated much of
the past decade, when bank survival was at stake, to a value mindset that will
allow them to become more resilient. (See “Enhancing the Strategic Potential of
Treasury,” BCG article, August 2017.)

Here’s what it will take to trim the sails.

Establish a clear mandate. Treasuries have always played a prudential role to
protect the bank and stabilize NII. To maximize value generation and risk
management, treasurers must have full transparency and oversight into all
banking-book risks and P&L drivers. That’s true regardless of whether the
treasury mandate emphasizes resource allocation or optimization, whether
treasury is a profit center or not, and whether treasury simply executes asset
liability committee (ALCO) decisions or has the freedom to optimize. Creating
that structure and steering it effectively require that treasury has leadership
consensus to govern in this way, the knowledge and skills to do it well, the
ability to examine the treasury position on both an economic and an accrual
basis, and clearer delineation between risk types and between treasury and the
risk department.

Close the expertise gap. Survey data found that large banks had a median of 35
FTEs for every €100 billion on their cash balance sheet, regional banks a median
of 43 FTEs, and GSIBs (which typically have better economies of scale) a median
of 24 FTEs. Regardless of bank size, however, survey data found that treasury
FTEs are divided fairly evenly across steering and execution functions. Looking
ahead, staffing composition will need to become more nuanced.


LOOKING AHEAD, STAFFING COMPOSITION WILL NEED TO BECOME MORE NUANCED.



The growing complexity of balance sheet and bank operations will require
treasury to acquire specialized subject matter expertise. Risk management, agile
development, process, and application design skills will become especially
important along with data scientists and business “translators” who can work
closely with treasury and IT to explain needs and priorities. Meeting these
needs will require treasuries to inventory their existing skill base, identify
crucial gaps, and incorporate hiring and development planning into their change
management processes.

Acquire visibility across the banking book. Some treasurers view the banking
book primarily through an accrual lens, while others favor a full economic or
fair-value view. But maximizing value generation and risk management will
require treasurers to manage the banking book from both angles because the
accrual view looks at fixed periods and is the basis for NII and other
comprehensive income (OCI) steering while the economic view factors market rate
movements and economic sensitivities (such as interest rate and credit spread
movements) into the steering decisions.

Treasurers will also need to establish clearer distinctions between risk types
and separate liquidity risk from interest rate risk and credit risk. In
addition, they must improve their ability to steer nonlinear risk (especially
optional financial components such as mortgage prepayments) so that they can
adjust positions on the basis of a more complete assessment of risks and value
drivers.

Leading treasury functions intent on improving their P&L contribution will need
to acquire the analytics, data integration, and predictive-modeling capabilities
to enable a comprehensive view of the entire banking book.

Integrate key data and systems. Survey data found that treasuries that
historically had a strong market execution focus tend to use front-office
systems that support daily economic-position management and those with an
accrual focus tend to use asset liability management (ALM) systems for daily
position management and front-office systems for trade capturing. Even
treasuries that take a blended view still struggle with fragmentation. Many use
a front-office system for daily economic-position management and an ALM for
periodic (weekly or monthly) modeling and sensitivity analysis.

Yet each of these setups brings challenges. While front-office systems are great
at tracking market movements, they typically lack the analytics and processing
power to support the complex simulations, sensitivity analysis, and periodic
steering that treasurers increasingly need. Likewise, while ALM systems offer
more-robust computing power, they generally lack the needed front-office
functionality.


JOCKEYING BETWEEN DIFFERENT TYPES OF DATA SYSTEMS CAN INTRODUCE ERROR AND
REQUIRES SIGNIFICANT MANUAL INTERVENTION.



Jockeying between these two systems is not ideal either because that requires
treasury teams to continually upload daily position management data and then
rigorously reconcile the information—efforts that can introduce error and
require significant manual intervention. In addition, many treasuries suffer
from rigid IT and noninteroperable software. Basic functionality like cash flow
or valuation management often has to be replicated in different systems to
compensate for these gaps, creating huge data reconciliation challenges and
increasing operational risks.

To address these issues, treasuries must commit to creating a modern, flexible
IT environment, capable of supporting application programming interface
(API)–enabled microservices such as valuations or cash flow generation.

Embrace digitization. Treasuries are not immune to the digital transformation
sweeping the broader banking sector, but many have been slow to embrace it
because they’ve been besieged by more-pressing issues over the past several
years. Now, bank treasury departments have the opportunity to make up for lost
time.

Technologies like artificial intelligence (AI), machine learning, blockchain,
robotics, and data capture techniques (such as optical character recognition
[OCR] and voice and speech recognition [VSR]) have the potential to help
treasury departments optimize their activities. Process automation can help
alleviate excessive manual effort, putting many day-to-day tasks on a competent
autopilot. Basic automation is a first step that could deliver significant
efficiency gains, reducing operating costs by 20% to 30% over the next three to
five years.

Overall performance—in terms of deeper risk management insights and better
decision making—could outweigh efficiency gains by a factor of five to ten and
raise the average treasury NII contribution by 10% to 15%. Although the
application of distributed-ledger technology for treasuries is in its early
stages, treasuries can still make big strides in advancing their digital
maturity by applying machine learning to analytical and forecasting tasks. Many
treasuries have implemented data capture techniques to improve their collateral
optimization and repo-trading processes. Those that have not should prioritize
the development and deployment of those solutions to inform their activities.




RIDING THE SEAS OF CHANGE

Treasury departments must ensure that their operating models are nimble enough
to sustain a stable P&L performance and resilient enough to withstand potential
disruptions as new competitors and new technologies enter the arena. Working
harder and faster won’t be enough. Treasuries need to work smarter as well.
Future-proofing the treasury function will require new skills, tools, and
capabilities as well as a strong, modern, and flexible IT foundation. Treasuries
that take advantage of the current calm in the market to lay that groundwork
will help ensure smoother sailing for their institutions in the long term.





AUTHORS

Gerold Grasshoff

Managing Director & Senior Partner

Frankfurt


Pascal Vogt

Partner & Director

Cologne


Robert Schäfer

Managing Director & Partner

Frankfurt


Clemens Elgeti

Associate Director, Treasury & Risk

Hamburg


Mireia Granzer

Principal

Frankfurt




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