Bolstering cash management in banks

The Economist once credited effective cash management, also known as transaction banking, as a key reason for Citigroup's survival during the global financial meltdown in 2008. Citi's global transaction services earned a lot of recognition for helping the bank manage its assets and liabilities more efficiently.

In Bangladesh, we have seen banks pay a high price for funding long-term assets through short-term borrowing, or by depending excessively on call money and short-term deposits to support medium or long-term loans. Even today, not all banks can claim to have the right focus on balance sheet management. Much of their time and resources are dedicated to managing loans or mobilising term deposits. Some face difficulties due to over-dependence on call money or excessive exposure to long-term project financing.

In Bangladesh and similar economies, loan losses are often blamed as the main risk factor. However, my experience as a treasury manager, spanning more than 15 years in multiple global banks at home and abroad, tells me that a major part of the problem lies in our failure to manage receivables and payables in a timely manner.

The balance sheet of a commercial bank is quite different from that of a typical company. Most of a bank's balance sheet comprises money deposited by customers (liabilities) and money lent to customers (assets). In addition to loans, banks also invest in various instruments, often to meet regulatory requirements.

Although these activities may seem straightforward, the reality is complex. A bank typically handles thousands of crores in deposits from numerous accounts, across multiple currencies. Each deposit and loan has different maturities, creating what is known as a maturity mismatch across time periods.

The aim of balance sheet management is to maximise returns while minimising risks linked to different portfolio combinations. Many banks also carry large off-balance-sheet exposures.

The North American financial meltdown showed how some global banks held trillions of dollars in derivative positions that did not appear on their balance sheets until their debtors exercised loan options. As a result, published balance sheets often understate a bank's actual risk exposure.

A bank's capital acts as a form of self-insurance, providing a buffer against unexpected losses and incentivising prudent risk-taking. Financing additional assets with capital raises the leverage ratio, while a shortage of capital can strain the economy by preventing banks from lending to creditworthy borrowers.

Measuring a bank's capital, however, can be tricky. Valuing liquid instruments such as treasury bonds is straightforward, but corporate and emerging market bonds are far less liquid.

During periods of financial strain, a bank's assets become harder to value. In such times, not only liquidity but also solvency determines asset value. The Asian financial crisis in the late 1990s showed how sudden fluctuations in exchange rates can expose banks to foreign exchange risks when they hold assets or liabilities in foreign currencies. These movements can affect a bank's earnings and capital.

Since commercial banks regularly handle foreign currencies, they are constantly exposed to foreign exchange risks arising from both trade and non-trade transactions. Any unhedged exposure, known as an open position, increases this risk. Banks mitigate such risks through hedging techniques while focusing more on tenor mismatch, maturity ladders, and alignment between deposit and loan maturities.

Many commercial banks in Bangladesh are now recognising the importance of distinguishing themselves through improved balance sheets and cash management. The sooner others follow suit, the better it will be for the entire industry.

The writer is a banker and economic analyst