Treasury banking

Treasury banking

and the best interest of the tax payer

Treasury banking for government bodies has been a much-debated topic ever since the idea was launched some 12 years ago. In many cases the spotlight has been shone – by both proponents and adversaries of the concept – on the relationship between public sector clients and commercial banks. Recent events, including the 2008 crisis, the euro crisis and the debate on government spending, suggest that a review of the relationship between public-sector treasury management and commercial banks, would be in the tax payer’s interest.

Banking is literally a marginal business; it is about investing other people’s money in a range of different instruments. Key to the success is minimizing the liquidity required to satisfy the daily cash demands of depositors; the more client deposits are pooled the more likely it is that settlement among clients can be done electronically.

For more than 30 years corporate treasurers have striven to cut banking costs in a similar way by running an in-house bank. Techniques and labels may have evolved, but the underlying principles remain: 1) cutting out margin, spreads and fees by netting positions before trading outside the group and 2) centralizing liquidity with the objective to reuse an increasing permanent core in cash balances as a free source of funding. No one questions the economic sense of in-house banking. The savings potentials are too obvious with the logical consequence that a specialized banking and software industry emerged to satisfy the demand.

Some 15 years ago Mr Zalm, then Dutch minister of Finance, roused the banking industry by introducing treasury banking for government bodies and local government with the objective of reducing the EMU debt position of the Netherlands. Treasury banking is very similar to in-house banking provided you see municipalities and government bodies as subsidiaries. According to the Dutch Central Bureau of Statistics (CBS), lower government bodies, universities and schools together amassed over EUR 20 billion in liquidity on their balance sheet. For 2009 this represents some 3.6% of GDP and could reduce EMU debt well below 60%

The debate about public-sector treasury banking rages on

The original plan was resisted fiercely by bankers and lower government bodies on three accounts: firstly, calculated benefit would be awash with only additional cost, leading to value destruction, secondly, it would be unfair competition to commercial banks and thirdly, it would constitute collateral damage due to seeping of treasury expertise.

“However irrespective of how you slice and dice the evidence and arguments, treasury banking most certainly has an intrinsic benefit.”

Prior to implementation in 2004 the plan was scaled down to be mandatory for central government bodies and optional for education. Furthermore, local governments were excluded, with drastic impact on the funds under consideration. The debate about treasury banking is still not settled. As recently as last year a review of treasury banking by Rebel Finance (no relation to the author), in preparation of a review debate in the Dutch parliament, spent over 100 pages trying to prove that the impact of treasury banking is slightly negative and at most neutral.

Of course the government is required to take a wider macro-economic view on the topic and should look at more aspects than a corporate treasury evaluating its in-house bank. An argument often used against treasury banking is that there is ‘lost tax income due to lower banking profits.’ This implicitly acknowledges that commercial funding of government is viable business. And if true, one also should include distribution of ‘after tax profits’ in the cost benefit analysis. Another somewhat related element left out of the analysis is the potential impact of a debt reduction with EUR 20 billion currently managed by lower government on the cost of fund of the state.

The DSTA versus commercial banks

Is the Dutch State Treasury Agency (DSTA) a less fair competitor than any well rated commercial bank? The government’s cost of funding is indeed lower and therefore could work at lending prices beyond the reach of most commercial banks. But if the DSTA should apply ‘arm’s length conditions’ just like the income revenue tries to impose on corporate treasuries for their in-house bank operations, it will keep the margin for the tax payer instead of commercial banks. In fact this line of thinking raises the issue of fair distribution of benefits not the nature or extent of the benefits; treasury banking by the DSTA either is a way of funding (or if you will; subsidizing) lower government efficiently or income for the central government including coverage of cost.

From discussions with clients we understand that commercial banks do try to raise transaction fees when clients adopt treasury banking. Such attempts could indicate that banks cross-subsidize cash management with interest income. Such package deals from commercial banks then need to be assessed in perspective of the overall wallet size to be distributed between commercial banks and DSTA.

Then there is the argument of seepage of treasury knowledge away from local government. FIDO – even though often viewed as a straight jacket – was successfully used by lower government to be exempt from mandatory treasury banking. But did this exemption prevent the local governments being hurt by the Landsbanki debacle? The province of Noord-Holland at one point even claimed that the ministry refused to accept a deposit on legal grounds days before Landsbanki collapsed! And do we know how exposed local governments are in their quest for higher returns to FIDO-compliant, ‘risk free’ Greek and Portuguese bonds?

Supporters needed for public sector treasury banking

Last but not least, one should also incorporate the capital and liquidity unlocked by banks for funding other commercial sectors if they do not service governments any longer. Some expert bankers might then need to look for alternative employers, but this might be an opportunity for the DSTA to take on a bank-style product and account management capabilities.

The debate about treasury banking is still not conclusively settled. However irrespective of how you slice and dice the evidence and arguments, treasury banking most certainly has an intrinsic benefit. However in the interest of the tax payer, clients and the wider economy, treasury banking deserves more vocal proponents.

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Basel III     cash management     corporate finance     corporates     credit risk     cure     financial institutions     financing     hedge accounting     modelling and valuation     processes and systems     public sector     risk management     SAP     strategy and organization     SWIFT     treasury     treasury management     valuation desk     WACC