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The Costly To and Fro of Cash Flow
BY KAREN EPPER HOFFMAN
As interest rates rise and greater operating efficiencies become paramount, more banks are turning their attention to driving greater efficiency in how they manage their cash at branches, ATMs and even their vaults.
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SYNOPSIS | With higher interest rates boosting the "cost" of cash, more banks are making an effort to keep closer tabs on where they are keeping their cash. Once unconcerned with keeping residual cash reserves high, bankers are now mindful of the fact that every dollar that sits unused in a branch or ATM is a lost interest-bearing opportunity. They are embracing stricter currency controls - often through arrangements with core banking service providers, ATM makers or other third parties. Ultimately, managing the flow of cash may become even more important as the infrastructure that supports paper payments, and perhaps even cash usage itself, begins to decline.
Spurred by 14 consecutive federal funds rate inc-reases in 19 months and mounting pressures to improve operating efficiencies, banks have been paying more attention to the management of their greatest physical asset: cash.
In the normal course of operations, financial institutions take their customers' funds and invest them for higher returns, in loans or securities. At the same time, however, they need to have cash available for customers when they want it. How much cash to retain and how to make it available are issues that financial institutions deal with on a daily basis.
Such calculations grow more complex in environments such as the current one, when the Federal Reserve's inclination is to raise interest rates. The Fed's recent series of interest rate hikes has essentially raised the cost of managing cash - moving it to and fro from a bank's vaults to ATMs and branches and to the Federal Reserve - potentially costing in the tens of millions of dollars per year for the average regional bank, according to Bob Blacketer, director of the cash and logistics practice for Dallas-based Carreker Corp.
"Whenever interest rates rise, banks become more interested in optimizing their physical cash flow because they can't earn money on idle cash balances," says Richard Crone, founder of Crone Consulting of San Carlos, Calif.
And, with new Federal Reserve changes coming within the next couple of years on storing reserve cash, the cost of managing cash could rise even more (see "Fed Readies Rules on 'Cross-Shipping' Cash")
Banks are responding to this challenge by adopting new technologies and systems aimed at minimizing unneeded cash reserves, in hopes that they will save operating costs and earn interest from what have been underused funds.
But even with the most effective systems in place, institutions have a difficult balancing act. Demand for cash, even at a single site, fluctuates widely based on seasonal changes, holidays, paydays or even unforeseen natural events. The onslaught of Hurricane Katrina in August 2005, for example, produced a great surge in cash demand by people fleeing the affected areas.
Also, bank employees who order cash for their individual branches can be more concerned with keeping consumers happy (and not running out of popular denominations) than with an enterprise-wide objective of minimizing cash reserves. Bank executives and solutions providers alike stress that managing cash requires careful and flexible planning and must include efforts to get buy-in from staff in the field.
Interest Rate Bind
Notwithstanding the well-documented rise of electronic payments, banks continue to accept, hold and disperse currency, although some experts think that demand for cash will fall in future years (see "A Murky Future for Cash"). In today's economy, however, customers at the branch or ATM still need to be able to access their account balances and withdraw cash.
Banks pay close attention to the plethora of costs involved in this activity. Managing cash levels at ATMs, branches and vaults involves balancing and reconciling funds, coordinating and scheduling replenishments, transporting and securing cash as it moves to and from various vaults maintained by the bank itself or a third party and also moving cash back and forth to the Federal Reserve.
Banks must weigh transportation costs (made more expensive in recent years by rising fuel prices) against the demands of customers, the lost opportunity costs of money not invested and the "cost" of currency as defined by Federal Reserve-set funds rates. Making the task even more complex are geographic differences or seasonal and event-driven changes that can greatly affect the demand for cash at seemingly similar locations.
For many years, the desire not to run out of cash has caused banks to keep reserves high. Some banks typically maintain as much as 40% more cash at their ATMs than what's needed, and possibly more at branches, even though many experts consider a cash excess of 15% to 20% to be sufficient. As interest rates have risen in the past year and a half, the cost of keeping so much cash inactive has become a greater burden.
"Any dollar that is not being used to service the customers is a lost opportunity for the bank," says Douglas Ceto, executive vice president of Ceto and Associates, an Atlanta firm that consults with banks about increasing revenues. Since banks cannot reasonably charge customers a fee for accessing their cash, Ceto says, the only way to cut losses is to look for efficiencies in how they manage their delivery and movement of cash.
The saturated state of the U.S. ATM market, which has forced most banks and ATM deployers to run their networks at breakeven or even a loss, has also encouraged banks to drive down excess cash as a way to lower those costs, says John Clatworthy, vice president of sales and marketing for Cash Connect, a Newark, Del., division of WSFS Financial Corp. that provides vault cash services for ATMs.
Carreker's Blacketer says that this kind of "cash management" as a means of reducing operating expenses can translate quickly and directly to a bank's bottom line. He recalls working with one Midwestern bank that had about 2,000 ATMs and 1,200 branches and was spending more than $150 million per year on managing its cash. "It's not a cheap proposition," Blacketer says.
In Blacketer's view, most of the top 50 U.S. banks have "optimized" the way they manage cash management, but "there's still a lot of scrambling going around."
Solutions Providers Respond
To achieve that optimization, banks have turned to technology. Wells Fargo & Co., for example, has been using a few different automated systems, at its retail branches and in its vaults, designed to keep cash reserves low, according to Mitch Christensen, executive vice president of payment strategies.
The Carreker system the bank uses in its branches has a neural network, which can detect the changing patterns in cash access over time and thereby more accurately predict how much cash is needed at each location. "We've invested a lot of time and money in keeping the utilization of that non-earning asset as low as possible," Christensen says.
Melville, N.Y.-based North Fork Bancorp has been using a service from VECTORsgi (now part of Metavante Corp.) for nearly three years to help predict day-to-day cash needs for the $16 billion-asset bank's 375 branches, according to assistant vice president Jim Boyle. By using this predictive system, Boyle says his bank has been able to reduce excess cash reserves from as much as 30% to about 15% to 20%. This change freed up an estimated $50 million over the three years, which the bank has invested in interest-earning accounts.
Efforts such as Wells Fargo's and North Fork's are not new to the industry. Banks first began to recognize the benefits of minimizing their excess reserves about a dozen years ago, when the Federal Reserve began allowing banks to move or "sweep" cash in transaction deposit accounts into money market deposit accounts, which have lower reserve requirements. This accounting change gave banks the incentive to reduce excess currency in their vaults, ATMs and branches, and put it to work earning interest.
"Cash managers at banks began keying into this in the mid-1990s, when reserve accounts came down," says Mark Mullinix, executive vice president and cash product manager for the Federal Reserve System in Los Angeles. Bo Holmgreen, president and CEO of Transoft International Inc. recalls that when his Cary, N.C.-based company began providing software for managing cash in the early 1990s, it did virtually all its business with banks overseas. There was little demand in the U.S. Then came the sweeps reform. "Until then," says Holmgreen, "there was no drive for efficiency. In bankers' minds, cash was free."
Circle of Hand-offs
How much cash is enough but not too much?
When interest rates are low and currency worth less, it makes sense for banks to keep more cash on hand at their ATMs, branches and vaults. What they may have lost in interest is offset by fewer potential transportation runs, according to Holmgreen. However, as interest rates have risen in recent years, the downside of keeping too much of currency "inactive" becomes more costly than other factors in the system.
"It's an area that has drawn more interest over time," says Michael Scarlett, senior vice president for franchise cash operations at Wachovia Corp., Charlotte, N.C. Today, Scarlett says, Wachovia is "paying a lot closer attention to money center operations and to the money in vaults." Using Transoft's software, Wachovia aims to maintain a 10% cash reserve. Holmgreen estimates Wachovia saves as much as $19 million per year using currency management.
But reducing cash reserves is not as easy as just investing in software. Vendors and bankers emphasize that tracking the movement of currency is much more difficult than following credit cards or checks. Cash payments, for example, aren't always recorded, as are check and card payments. "One of the most interesting things about cash is how it moves around... it's a giant circle of hand-offs," says Wells Fargo's Christensen.
And predicting the bank's place in feeding cash (and receiving cash) in those "hand-offs" is getting more complicated too. The popularity of receiving cash-back at retail points of sale has over time taken a significant bite out of consumer ATM usage for cash withdrawal, Christensen says. This further complicates the forecast of how much money banks and deployers need to stock machines.
Moving the Dial
Perhaps one of the most overlooked, but critical keys to developing an efficient currency management program within a bank is what Ceto calls "the human factor" - engaging the necessary support from the employees in the field who are ordering the cash for their individual locations.
"When you have a branch manager or head teller ordering cash for their branch, many of them use their gut to determine how much cash they should be carrying," Ceto says. "And their number one concern is never to run out of cash. So they tend to order more cash than they need out of that fear."
This is a recognized problem in the industry. When Wells Fargo implemented its currency management systems in branches more than 10 years ago, Christensen recalls, the employees initially tried to over-compensate, for fear the system would drive down cash reserves too much. Senior managers quickly recognized, he says, "that the head teller is not rewarded for keeping excess cash down."
Blacketer, whose company, Carreker, makes the currency management system used in Wells Fargo branches, says that many banks responded initially to this problem by just sending an e-mail to branch managers and head tellers asking them to reduce residual cash. But, since they weren't rewarding this new behavior, "it wasn't effective medium- to long-term."
Scarlett of Wachovia agrees that initially "it was a challenge changing mindsets and thought processes" among branch personnel. Wachovia started small, he says, with pilots aimed at demonstrating the systems to the people in the field. "We were keeping it out in front of folks and letting them understand the impact to the bottom line," Scarlett says. "Communication is really vital to get the commitment to move the dial."
Sometimes, it's not just branch employees that must be "sold" on tighter currency management. Aaron Strong, controller of Cashmere Valley Bank, a $697 million-asset bank based in Cashmere, Wash., says the pressure to keep an over-abundance of cash stocked at the branches and ATMs was felt by even the bank's most senior managers, who live in the same neighborhoods as their customers.
"The cost of failure is high, since we're small enough that people know us," says Strong. For example, if one of the bank's customers had a bad experience with insufficient cash availability, Strong says, "our president might bump into that person and hear about it at the country club."
When Cashmere Valley Bank started using the Ceto Cash Calculator in May 2005, Strong says the bank "brought in all of the cash managers and we showed them how we can lower cash reserves and still not run out of money." Strong says that his bank, like many other banks that are new to introducing cash controls, succeeded by reducing residual cash levels gradually. Their goal was to drive it down a few extra percentage points every few weeks, rather than all at once.
Boyle of North Fork Bank says he sends a memo to each branch every month telling the employees how much surplus cash they carried. He also offers specific recommendations to branches about how to "recycle" the branch cash that comes in - rather than sending cash to the vaults and then ordering the same amount back again.
While banks' approaches to gaining and maintaining greater efficiencies in managing their cash may vary - both in their technology and their execution - this is certain to be an issue that rates higher on bankers' agendas for the foreseeable future.
Questions or comments about this article? Post them at the Banking Strategies blog.
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