A Sisyphean StruggleInsights from BCG’s Treasury Benchmarking Survey 2016

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November 2016

Gerold Grasshoff, Duncan Martin, Pascal Vogt, Carsten Wiegand, and Clemens Elgeti

A Sisyphean StruggleInsights from BCG’s Treasury Benchmarking Survey 2016

2 A Sisyphean Struggle

AT A GLANCE

BCG’s fourth Treasury Benchmarking Survey, based on interviews with 33 leading banks in Europe and North America, examines the major issues affecting bank treasury departments.

Margins Remain Under PressureMarket turbulence and the low-interest-rate environment require banks to redouble their efforts to stabilize net interest income. Treasuries must also improve front- and back-office efficiency to cut costs.

Treasurers Face an Uphill Regulatory BattleBanks must adapt their balance sheet structures in response to significant new regulatory requirements, necessitating complex changes to products, systems, and operating models.

Treasurers Embrace Centralized SteeringStrategic, coordinated steering is critical to improve incentives, performance, and oversight. Changes in traditional funds transfer pricing and modeling approaches that use advanced analytics can help treasuries improve steering, manage risks, and increase profitability.

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Slow growth, very low interest margins, and heightened regulatory demands require banks to reinforce their fundamentals.

In the two years since The Boston Consulting Group conducted its last Treasury Benchmarking Survey, banks have remained locked in a Sisyphean

struggle. Once an issue like liquidity coverage ratio (LCR) is dealt with, other challenges and new regulations appear. Low—and, in some cases, negative— interest rates are a major part of this struggle and have dominated the economic environment for banks. (See Time for Rebalancing: Insights from BCG’s Treasury Benchmarking Survey 2014, BCG Focus, December 2014.)

Our 2016 survey found that most banks are still in the stabilization phase. Slow growth, very low interest margins, and heightened regulatory demands require banks to reinforce their fundamentals, reduce noncore assets, and improve their capital allocation. Pressure is also on banks to refine their steering, IT, and analytics approaches to eke out basis points of margin, improve their operating efficiency, and enhance their insight-generating capabilities. Those changes can open up critical avenues for growth and support the development of new offerings and partnerships.

Our 2016 Treasury Benchmarking Survey analyzed how treasury departments are approaching these imperatives. A total of 33 leading banks across Europe and North America participated in our study.

Low Interest Rates and Subdued Interbank Lending PersistSince 2014, balance sheet composition in the Eurozone and North America has stabilized. Still, the economic environment remains challenging—especially when coupled with new uncertainty over the impact of the UK’s departure from the European Union on financial markets.

One challenge is that interest rates are low. Continued rate hike delays in major markets have prompted banks to take a number of measures to help P&L perfor-mance and generate additional yield and income. Banks are revisiting the asset allocation and investment strategy of their liquidity buffers and investment portfolios—in some cases downgrading credit quality to improve returns. Banks are also making adjustments to their hedging, derivatives, and money market oper-ations. On the customer front, some banks are passing negative interest rates on and introducing loan pricing floors to prevent variable lending rates from falling below zero. In addition, they are fine-tuning their funds transfer pricing (FTP), deposit modeling, and risk appetite frameworks in order to sharpen and align business unit incentives for asset and liability origination. Some banks are also

4 A Sisyphean Struggle

revisiting accounting designations, such as “held to maturity.” (See Exhibit 1.)

Interbank lending and borrowing remain low. (See Exhibit 2.) In Europe, interbank lending (in absolute numbers) has largely plateaued since hitting historical lows in 2012. Given lingering questions about Brexit, we expect that interbank lending in the Eurozone will remain cautious and that the European Central Bank will con-tinue to play an important funding role.

In the US, interbank lending has been on a steeper downward trend, with a compound annual decline of 23% since 2007. That has forced banks in the US to rely more heavily on deposit funding and secured short-term funding, such as repurchase agreements.

Governance Centralizes Steering-oriented governance models, in which treasury decisions inform activities within the business and not just interactions with financial markets, continue to dominate. The survey found that both global and regional banks (those with bal-ance sheets of greater or less than €500 billion, respectively) are embracing an expanded role for treasury and combining traditional liquidity management with broader banking-book management.

The steering-oriented approach is especially common in North America, where all treasurers in the survey report to the CFO.

MEASURES TAKEN IN RESPONSE TO LOW OR NEGATIVE INTEREST RATES

0

Seek additional yield/income

Adjust hedging, derivatives,and money market operations

Set loan pricing floors

Adjust deposit models

Pass negative rates to customers

Generate fee/ancillary income

Adjust FTP

Adjust “held to maturity” designations

Customer-relatedmeasures

Treasury P&L-relatedmeasures

Steering-relatedmeasures

Share of respondents (%)

10 20 30 40 50

824

024

5048

3329

17

17

14

10

2514

175

Global players Regional banks

Source: BCG Treasury Survey 2016.Note: n = 33; multiple answers allowed.

Exhibit 1 | Low Interest Rates Force Banks to Adapt

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The study found that, in addition to classic steering functions like banking-book and liquidity management, global players are increasingly integrating execution activities, such as money market and swap or derivatives desks, into their group treasury departments to create a stronger link between steering and execution. New leverage ratio, LCR, and the fundamental review of the trading book (FRTB) rules are accelerating this integration. Respondents from larger banks stated that the asset and liability committee is playing a more central role and giving treasur-ers a seat at the table in banks’ strategic steering discussions.

In general, most treasury departments have been able to keep their head count rel-atively steady even while centralizing and coping with an increased regulatory load. The survey shows that in 2016 the number of treasury full-time equivalents (FTEs) as a percentage of total bank FTEs ranged from 0.06% to 1.17% for regional banks and from 0.10% to 0.37% for global players. That compares with 0.06% to 0.99% for regional banks and 0.01% to 0.37% for global players in 2014. Absolute numbers vary widely, however, with some regional banks having as few as 10 FTEs or as many as 138. Among global banks, the largest staffs had about 500 more FTEs than the smallest. (See Exhibit 3.)

Income Contribution and Stabilization DominatesNet interest income (NII) stabilization is a major task for all banks, regardless of size or location. Treasuries will need to manage overall NII more closely and steer the banking book effectively. Intriguingly, the survey found wide variance in

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015Eurozone interbank lending US interbank lending

0

50

100

150

200–80%

–54%

Index: cash-lending volume (2003 = 100)

100 100106

20

110102 101 103

128121

159

129121

96

70

103

6172

3944 40

4635

53

26

46

Sources: European Central Bank Euro Money Market Survey, September 2015; FRED money market survey.Note: Lending volume is indexed to the year 2003.

Exhibit 2 | Interbank Lending Continues to Decline

6 A Sisyphean Struggle

treasuries’ contributions to total NII, with some bank treasuries contributing 40% of total NII and others zero. Smaller banks tend to be on the higher end of the contri-bution range in general.

Liquidity maturity transformation (where banks lend over long-term horizons using funding from deposit accounts and other short-term liquidity sources) is an import-ant element of NII. In the period following the financial crisis, however, banks had to pull back on maturity transformation to curb their liquidity exposure. Looking ahead, banks may need to rethink that posture in light of current margin pressures. That will require changes in risk appetite and careful discussion with a variety of stakeholders, most particularly regulators.

Liquidity buffers, which usually carry a negative spread, also affect NII. Following the financial crisis, most banks established large buffers to meet stiffer regulatory requirements and protect against the risk of future funding freezes. Our 2016 sur-vey data found, however, that these buffers continue to grow. The average liquidity buffer size for global players rose by more than 1% in the past two years (from 17.4% of assets in 2014 to 18.8% in 2016). Regional banks saw theirs grow from 13.6% to 15.5%. (See Exhibit 4.)

For more than a third of participating banks, liquidity buffers now represent more than 20% of their balance sheets. Much of that growth is fueled by LCR require-ments and the results of internal stress scenarios. The low-interest-rate environ-ment—and the types of refinancing and tenors used—is helping to temper some of the cost of maintaining large buffers. As a result, banks have been more active in reducing their refinancing tenors over the past two years than they were during

0 100 200 300 400 500

Mainly regional banks

Mainly global players

600

600Number of treasury FTEs

Balance sheet size

Number of treasury FTEs

315

298

138

137

135

120

117

110

95 84 80 72 6047 44 42 40 37 34 30 28 22 22 20 12 10

Regional banks

Minimum:Average:Maximum:

117262600

1055

138

TREASURY HEAD COUNT VARIES WIDELYACROSS BUSINESS MODELS AND COMPLEXITY

HOWEVER, BALANCE SHEET SIZESEEMS A KEY DRIVER

High correlation mainly driven by global players;

regional banks have more inhomogeneous functions

in treasury

R² = 0.88

418

336

215

185

140

Global players

Source: BCG Treasury Survey 2016.Note: n = 32; FTE = full-time equivalent.

Exhibit 3 | Head Count Varies but Scales with the Balance Sheet

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2010 through 2014, the time frame that comprises the two periods covered in BCG’s prior treasury surveys.

More than 90% of the global players reported having some kind of NII optimization model in place. The same was true for only 60% of the regional banks. NII volatility (occasionally in combination with the economic value of equity [EVE]) remains the most common metric, used by 82% of global players and 78% of regional banks.

The new interest rate risk management in the banking book (IRRBB) regulation will force banks to manage interest rate risk using both fair value and earnings views. That will affect regional banks in particular given that half of those surveyed primarily rely on an earnings view and just over one-third (38%) primarily use pres-ent value. Global banks are more likely to use both methods already.

Regulatory Compliance Remains Focused on LCR Today, treasurers face a more demanding regulatory environment. Several rules that were in the proposal stage when our 2014 survey was released have now come into force, and several others are due to be finalized over the next two years. Rules in five domains dominate the agenda: liquidity, bail-in-able debt, separation, IRRBB, and FRTB.

Survey participants were focused on the technical implementation of LCR two

Bank

1

Bank

32

Bank

31

Bank

30

Bank

29

Bank

28

Bank

27

Bank

26

Bank

25

Bank

24

Bank

23

Bank

22

Bank

21

Bank

20

Bank

19

Bank

18

Bank

17

Bank

16

Bank

15

Bank

14

Bank

13

Bank

12

Bank

11

Bank

10

Bank

9

Bank

8

Bank

7

Bank

6

Bank

5

Bank

4

Bank

3

Bank

2

0

5

10

15

20

2525

23 23 22.5 2221 21

20.3 20 20 20 20 2019

18 17.516 16

15 15 15 1513.9

13 13 13

10.710 10 10 10

9.0

Minimum:Average:Maximum:

201411.1%17.4%25.0%

9.7%13.6%23.0%

Minimum:Average:Maximum:

20169.0%

18.8%25.0%

10.0%15.5%23.0%

SIZE OF THE LIQUIDITY BUFFER IN RELATION TO THE BALANCE SHEET

Global players Regional banks

Source: BCG Treasury Survey 2016.

Exhibit 4 | Liquidity Buffers Have Grown by Roughly 2% Since 2014

8 A Sisyphean Struggle

years ago, and now they are concerned about applying LCR as a steering metric in practice. Global players must ensure regulatory compliance across all their oper-ating regions. As a result, they rely more heavily on local liquidity ratios than do regional players, which favor group-wide liquidity gap profiles and associated limits. Net stable funding ratio (NSFR) use remains low at present, but uptake will likely increase dramatically once rules concerning the ratio are finalized and take effect as expected in 2018.

In response to new regulations addressing total loss absorbing capacity (TLAC) for global systemically important banks and minimum requirements for own funds and eligible liabilities (MREL), global banks are revisiting their funding structures to en-sure sufficient resources in the event of a bail-in. This is a greater concern for global players than regional ones, with 42% of global players issuing TLAC/MREL-eligible instruments compared with 29% of their regional counterparts. Some banks are also deleveraging in order to reduce their funding and capital needs. Others are simply waiting for the final announcement of the MREL rules, with about a third of partici-pants believing that TLAC/MREL will have little impact on their balance sheet com-position (either because the rules do not apply or because their funding structures are already in line with the requirements). Canadian domestically important banks are not yet affected, pending the finalization of their bail-in regime.

Europe has different regulations on bank separation that involve separating higher- risk activities such as investment banking from customer-related activities like retail banking. These have not had a major effect on funding and liquidity management, although 25% of global players and 10% of regional banks reported that they have reorganized their processes and governance structures to manage liquidity centrally and to create separate liquidity buffers.

IRRBB, published in its final form in April 2016, requires banks to take the Basel Capital Framework’s Pillar 2 treatment into account when forming economic capi-tal calculations. Banks must also develop specific shock and stress scenarios. They must enhance disclosure—for example, reporting the effect of shock and stress scenarios on the EVE and on NII. The regulation will become effective in 2018, which makes it a high priority for banks.

In light of the more heavily regulated environment, banks should review their trea-sury and trading operating models and revisit how they transfer risks from the banking book to the trading book.

Enhanced FTP Is NeededIn the current economic environment, adequate steering instruments are crucial because they ensure that limited capital, funding, and liquidity resources are opti-mally deployed. For treasurers, the FTP methodology is the central steering tool. Treasurers cite the inclusion of negative interest rates, LCR and NSFR costs, im-provements in liquidity buffer cost calculation, and enhanced behavioral modeling of loans and deposits as the most significant changes to FTP over the last two years.

To succeed in the present environment, banks may need to adopt a more client-

In light of the more heavily regulated

environment, banks should review their

treasury and trading operating models.

The Boston Consulting Group 9

centric approach to FTP and take a wider portfolio view. One prerequisite for such an approach is high granularity in the FTP model to ensure that costs can be allocated at a client level, ideally as part of the pricing process (that is, ex ante). One example of this is the refinement of the calculation and allocation of liquid asset buffer costs—these have more commonly been allocated at the profit cen-ter level, instead of a more granular desk or individual-ticket level. Survey data found that this remains the current practice for 75% of global players and 57% of regional banks.

Too Many Systems, Too Little DataThe 2014 survey found that many banks use multiple front- and back-office systems, largely as a result of acquisitions. This has not changed. While a varied architecture mitigates overreliance on any one vendor, it also dramatically increases IT com-plexity. Updating and maintaining multiple systems and databases increases costs and operational risk.

Participants also struggle with data availability. For example, more than half of all respondents said that when performing their intraday collateral management (that is, ensuring that sufficient collateral is available to cover obligations), getting need-ed data quickly and efficiently is their biggest challenge.

Behavioral Modeling Is Well Established but Other Simulations LagTreasury models that approximate behavioral cash flows of nondeterministic assets and liabilities, such as mortgages with prepayment options or assets whose cash flow is variable, are widely used by global players, but less so by regional banks. Every global bank in the survey stated that it uses behavioral models to oversee loans with optionalities, but that was true for only 71% of regional banks.

All global players and 79% of regional banks also use behavioral models for non-maturing deposits. The sophistication of these models varies significantly, however. Whereas most banks use total deposit balances for deposit modeling, fewer use individual customer balances or transaction level information, which provide a more accurate analytical base. Also, few track the reasons for balance changes (such as shifts from deposits to investment funds).

Deposit modeling is typically a two-step process. In the first step, banks identify homogeneous clusters—for example, products, client types, or account balance ranges. Then, in the second step, they develop interest rate and liquidity models using a variety of targets and constraints—minimizing margins or volatility, for example, or maximizing returns. Our survey found that while many banks put con-siderable effort into the second step, most have yet to employ big data or advanced analytics to refine their segmentation analyses. As a result, many banks are relying on less-than-precise modeling groups.

Advanced analytics can also help banks perform better and develop more- integrated balance sheet, profitability, and regulatory ratio simulations. While some banks are

Advanced analytics can help banks perform better and develop more- integrated balance sheet, profitability, and regulatory ratio simulations.

10 A Sisyphean Struggle

starting to use such integrated simulations, overall adoption remains low. Barriers include inadequate data quality and availability and the difficulty of determining the appropriate level of granularity for the input parameters, such as profit center, business unit, or bank level.

Taking ActionSince the 2014 Treasury Survey, the regulatory and operating environment has grown more complex. Treasurers can sometimes feel their role is a Sisyphean task: as soon as they address one issue, other, more challenging ones appear. To help treasurers anticipate issues more nimbly, we recommend the following steps:

• Revisit the operating model to ensure adequate governance, functional design, and head count.

• Review and optimize the operating model from the perspective of the IRRBB and FRTB regimes.

• Optimize the balance sheet structure and management with respect to LCR/NSFR and TLAC/MREL.

• Use FTP to set the right incentives and support a shift from product to client profitability in the business lines.

• Streamline the IT platform to reduce system cost, complexity, and associated risk by trimming the number of interfaces and integrating core processes.

• Enhance modeling skills to adopt ex-ante simulations for overall balance sheet optimization.

• Proactively investigate ideas and technologies (such as digital funding plat-forms) that can help treasurers support growth.

High-performing treasuries can play a pivotal role in helping banks return to growth—or at least minimize the suffering caused by the ongoing low-interest-rate environment. By managing steering tasks in conjunction with overall bank eco-nomics, treasurers can provide crucial insight, stability, and governance as well as economic impact.

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About the AuthorsGerold Grasshoff is a senior partner and managing director in the Frankfurt office of The Boston Consulting Group and the global head of risk management and regulation. You may contact him by e-mail at grasshoff.gerold@bcg.com.

Duncan Martin is a senior partner and managing director in the firm’s London office and a colead-er of the risk team for North America. You may contact him by e-mail at duncan.martin@bcg.com.

Pascal Vogt is an associate director in BCG’s Cologne office and the global topic leader for trea-sury. You may contact him by e-mail at vogt.pascal@bcg.com.

Carsten Wiegand is a principal in the firm’s Frankfurt office and a treasury topic expert. You may contact him by e-mail at wiegand.carsten@bcg.com.

Clemens Elgeti is a consultant in BCG’s New York office and a treasury topic expert. You may con-tact him by e-mail at elgeti.clemens@bcg.com.

AcknowledgmentsThis report and the underlying BCG Treasury Benchmarking Survey would not have been possible without the cooperation of the banks, as well as the support of the firm’s Financial Institutions practice. The authors would especially like to thank Michael Widowitz and Benedikt Ruprecht, as well as all the participating treasurers.

The authors would also like to thank Marie Glenn for her editorial direction, as well as other mem-bers of the editorial and production teams, including Katherine Andrews, Gary Callahan, Philip Crawford, Catherine Cuddihee, Kim Friedman, Abby Garland, and Sara Strassenreiter.

For Further ContactIf you would like to discuss this report, please contact one of the authors.

To find the latest BCG content and register to receive e-alerts on this topic or others, please visit bcgperspectives.com.

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© The Boston Consulting Group, Inc. 2016. All rights reserved.11/16

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