Treasury management in a higher interest rate environment

Jason Macdonald discusses a relatively higher interest rate setting and how that impacts corporate treasury functions managing deposits.

Looking back in time

For almost 15 years, from the financial crisis of 2008 through to 2022, UK interest rates averaged just over 1%. As a result, many corporate treasury and banking professionals have never known anything other than ultra-low rates.

However, if we look back before the financial crisis, we can see that rates were higher and more volatile in the 1970s and 1980s as the government tried to counter inflation and soaring house prices.

Following the UK’s withdrawal from the European Exchange Rate Mechanism in 1992, when rates were ramped up to protect the pound, they were gradually reduced over the next 12 months. There was then relative stability from the mid-1990s to 2008, with the average base rate at 5.5% – a level we almost reached again recently.

Then, in 2008, the world changed, and the base rate fell to 0.25%. As the pressures of the financial crisis eased, it rose from 0.25% to 0.75%, but then the impact of the Covid-19 pandemic led to the rate falling again – this time to a historic low of 0.1%.

Since 2021, inflation has come back to haunt the UK economy and rates have steadily risen from that low to the current level. The consensus view is that rates are expected to gradually come down in small increments from summer 2024, but they will still remain considerably higher than has been the case since 2008.

Average Bank of England base rate between 2008-2023

Impact of Basel III on cash deposits

Although interest rates are now close to where they were before the financial crisis, we are in a very different world from a deposits perspective.

Balancing yield, security and liquidity has always been fundamental to corporate treasury management, but this equation is heavily influenced by the prevailing interest rate environment and banks’ attitudes to, and regulations around, client deposits.

For decades before 2008, companies could keep a ‘buffer’ level of cash in a current account and use, for example, savings accounts, notice accounts, fixed-term deposits and techniques such as laddering (using differing maturities of fixed-term deposits) to achieve a higher yield on deposits while managing the average maturity profile.

Before the financial crisis, one company’s £100 deposit was in effect the same as any other company’s £100 deposit in respect to its value to a bank and, therefore, the yield available to the company.

However, the capital adequacy requirements introduced under the Basel III regulations in response to the financial crisis mean that the value of cash deposits to a bank now reflect the underlying nature of that cash. This is due to the need for the bank to keep a certain amount of capital aside in case of a stress situation that might result in a cash outflow.

In simple terms, the more likely a deposit is to be withdrawn, the more capital a bank must hold. For example, a standalone deposit from the proceeds of a business divestment can be withdrawn relatively quickly and easily, compared to, say, cash resulting from a company’s day-to-day operations.

Focusing on broader banking relationships

The Basel III requirements mean that banks have increasingly shied away from taking on standalone deposits and focussed instead on the overall cash management relationship with their clients.

Typically, day-to-day operational payments that businesses make to suppliers and receive from customers are a key driver of the value of deposits to a bank because they can’t just be switched off suddenly, so the capital adequacy requirement for the bank is lower.

As a result, most banks are now more focused on establishing a broader relationship with their clients than simply taking deposits. The nature of the relationship between client and bank, and the resulting capital costs to the bank, inevitably impact the pricing they provide to clients for deposits.

Following a panel discussion we’re hosting at the 2024 Association of Corporate Treasurers (ACT) Cash Management Conference, we will be hearing from corporate treasurers about their experiences in navigating the dynamics of yield, security and liquidity in a higher interest rate environment.

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