King Cash is dead? Long live.........what?

I was rather surprised the other day when, in a meeting with a major European bank, the representative across the table sucked their teeth and rather turned their nose up when it was suggested we might give them cash as collateral; they preferred high quality securities such as US Treasuries and UK Gilts.

For those not familair with the terms, collateral is the assets one puts up as protection (a guarnatee is you like) against failing to meet one's future obligation. In this case derivative contracts that will not complete for sometime and hence there is a risk one will go bust or otherwise not be able to pay as promised. As it is a guarantee putting up cash has long been very acceptable, if not preferred.

As a young man when I started working in financial services in the City of London cash was always  far preferrable to anything else, it's value was known, it was flexible and readily usable. When I was crunching through credit applications I was required to major on the cashflow analysis, ensuring that no matter what they claimed their profits to be, they were generating enough cash to meet their bills and pay for the loan that we would be granting.

When I worked with smaller companies, cash was esssential for paying wages, for supplies, etc.

It was just simple.........Cash was King!

The banker's reaction above is a measure of how things have changed. This may be the unintentional result of well-intentioned regulation, but it feels wrong. The explanation given was that if cash is pledged as collateral in goes on the Bank's balance sheet. This then triggers a need for the Bank to provide/put aside capital to protect the cash, capital that would othewise be earning for the Bank.

We were also advised that an additional factor is the existence of negative interest rates at some of the entities where the collateral is then placed, ie it costs the depositor to leave money there!!!!

In contrast providing a high quality security as collateral does not appear on the Bank's balance sheet and is not subject to interest when lodged with a clearing house. It misses both "costs".

Of course cash on the balance sheet can, if of significant value, negatively affect other ratios and measures of the Bank's performance too.

So giving cash as collateral costs the bank more to handle; costs the bank either has to swallow or pass on to its clients, neither of which is appealling in a highly competitive world. Of course as the client there are reasons why we may well prefer to provide cash, so I can see some interesting discussion coming down the line.

I really wonder if creating the situation where a bank shies away from cash is what was intended and/or creates less risk? I suspect not.

 For me it was a reminder or maybe a wake-up call about how much things have and are still changing and the need to question and test assumptions and general widsoms.