Our business at Bank Performance Strategies is to revitalize retail-time deposits, and with the abundance of liquidity in recent years, we've faced some headwinds in the demand for our services. Now, just as we are experiencing tapering of quantitative easing and new industry headlines trumpet the value of deposits, the SEC may be handing the deposit industry a fresh opportunity to secure more low-cost, short-term deposits. While this isn't great news for our work in retail-time deposits, we recognize that for many of our banking clients a new flood of liquidity could present a vital resource given the growing concerns over eventually rising interest rates.
There are some early indications that the tide may be shifting in the abundance of liquidity. It doesn't take a great deal of imagination to picture a very different environment where banks will be competing to attract and retain depositors, or risk the prospect of having to purchase funds at a higher rate.
Into this environment comes the SEC's proposed rule change for money market funds. The two proposed changes will either force MMFs to transact at a floating net asset value, and/or would create requirements for funds to create "gates" or impose a liquidity fee if a fund's liquidity level falls below a certain threshold.
According to a 2013 Liquidity Survey conducted by the Association for Financial Professionals, 65% of organizations would be less willing to invest in MMFs if they were forced to transact at a floating NAV. Fifty-six percent would be less willing to use MMFs with the potential of liquidity fees or temporary gates.
Banks, meanwhile, are well positioned to respond to the new demand from investors looking for a combination of liquidity, safety of principal, earnings and simplicity. The intrinsic core competency within commercial banking is the provision of trusted commitments of liquidity. In light of new rules exposing that the MMF industry lacks that same explicit liquidity, banks will have an opportunity to deliver upon their intrinsic competitive advantage.
Given the restrained competition among banks for new funds at this time and the low return on MMFs, it's likely that any effort to attract these funds can be relatively cost-efficient. This opportunity however is not destiny. Only those who create and execute a plan are likely to seize the advantage of bringing new funds into the bank prior to the onset of materially rising rates.
Traditionally, banks use repurchase sweep agreements to offer institutional investors liquidity and protection on large deposits. However, these programs could become burdensome for banks given an influx of institutional deposits. Repo sweeps come with requirements that may reduce the value of jumbo deposits for banks, as they are generally collateralized with low-yielding securities like Treasuries and agency notes.
Over the last few years, there have been developments in reciprocal money market deposit placement services that have improved banks' abilities to meet institutional investors' needs while also increasing the value of jumbo deposits to banks. Reciprocal money market deposit placement services allow banks to offer daily liquidity and Federal Deposit Insurance Corp. insurance without requiring banks to inventory low-yielding collateral to support repurchase sweeps.
While it may always be possible to acquire the raw material of banking (deposits) as they become scarcer, it is typically a lot easier, and less costly, to acquire them when they are in abundance, such as now. As we begin to move from abundance to scarcity, it is likely that maintaining these deposits will be less costly than competing for new deposits. After all, the best time to buy drought insurance is in the midst of a flood.
The fact is the most well-informed analysts aren't sure what to expect as the Federal Reserve continues its tapering this year. It's unclear whether rates will gradually return to typical levels, or whether they will spike quickly as pent-up rate demand motivates customers to flock to those places offering above-market rates. But given this uncertainty, it's probably better to be the bank working to retain customers than one trying to lure them back after signs of a drought cycle begin.