The State of Cash Management in Today's Banking Environment


The aftermath of 2007 led to extreme risk aversion and excessive cash hoarding by financial institutions (FIs) over the past decade. But today’s economic, interest rate and regulatory environment is much more cheery, so FIs must get back to aggressively managing cash assets by reallocating reserves, optimizing cash holdings and boosting lending.

The Great Recession Pushed Banks to an Overabundance of Caution

Depository institutions, such as banks and credit unions, typically decide cash inventory levels based on reserve requirements, customer demand, insurance limits, and anticipated spikes in cash withdrawal. But in the aftermath of 2007, chastened by other’s mistakes and chastised through regulatory backlash, banks and credit unions (FIs) became extremely risk averse and raised their cash limit presets to inefficiently high levels.

From 2008 to 2010, over 300 banks failed due to insolvency or being too illiquid. The panic surrounding the failure of key FIs - such as Lehman Brothers, Washington Mutual and Wachovia - led to liquidity concerns. This caused regulators to force FIs to liquidate their assets at huge losses or raise large levels of capital, so securities tanked across the globe, leaving FIs unable to cover their debt obligations and, ultimately, causing many of them to fail.

Disciplined by that bitter pill of 2007 and stringent regulations, the needle at banks’ and credit unions’ risk management departments swung heavily to the side of extreme caution. Moreover, when the post-2007 world economy was in shambles and interest rates were at all-time lows, FIs had few profitable investment opportunities – so cash holdings mounted.

Where, earlier, a large focus of management was to optimize any and all non-earning assets, such as cash (“make sure your branch never has more cash sitting around than there is demand for, make sure you always think of putting our capital to work!”), post-2007 risk aversion led management to forgo nimble demand-based cash management for the safety and comfort of larger-than-necessary cash holdings - the very antithesis of a financial institution’s raison d’etre.

The Fallout - Managing Cash to High Preset Limits

As a result, among other safety measures, banks and credit unions raised their cash levels. But that’s not the real issue. The main problem this risk aversion spawned was that it made management at most FI branches comfortable with, and trained, to keeping cash levels at those high preset limits. Here’s why:

Historically, cash limits were set as ceilings - cash holding levels that the branch must NOT exceed - in its pursuit of maximizing the deployment of capital for profit, in addition to insurance limitations. Prior to the Great Recession, bank managers leveraged their freedom to optimize cash liquidity so they could maximize profits through healthy risk taking and investments in loans, bonds, stocks, etc. But after the financial crisis of 2007, financial managers had a collective shift in mindset - from optimized risk-taking for profit to conservative risk aversion for safety.

So, instead of aggressively deploying capital and making sure cash does not reach or exceed preset limits, some FIs now make sure cash holdings are at or near prescribed upper bounds set by rules and restrictions – they’re managing cash to the limit when they really should be managing it down to usage. Moreover, this overly risk averse mindset is simply not compatible with a bank’s fundamental business model of optimizing its assets through deposits-vs-investments arbitrage.

While this conservative mindset served its purpose back then, it now threatens to sink staid FIs relative to more nimble competitors who see opportunity in a fundamentally improving economic and regulatory climate, and a rising interest rate environment that favors the financial sector.

Economic Data Solidly Point to Growth and Capital Investment

Now, things look a lot better, with steady GDP growth and U.S. unemployment at 4.4% - the lowest in a decade, amidst a rebounding jobs market with early signs of wage growth that should spur spending and consumption. Additionally, Trump’s planned infrastructure spending, regulatory reform and tax cuts should fortify economic growth and further drive lending opportunities for FIs.

Now is the time to return focus to non-earning assets and deploying the financial institution’s capital in this new environment of low unemployment, rising rates and, hopefully, a less restrictive banking industry.

It’s Time to Bring Back the Moxie

So, in a rising economic and interest rate environment, managers need to get back to their old hustle, re-focus on profits and optimizing cash liquidity, and then some… because technology has raised the bar for everyone. Where, earlier, bank managers could rely on their years of experience to manage cash reserves, today’s cool tools take optimization to levels not seen before, and offer early adopters nimbleness, greater access to cash when needed and a solid competitive advantage. 

The Solution – Optimize Cash Liquidity, Operate Well-Below Cash Limits

Although no one’s denying the practical value of cash limits, it is time managers at FIs recognize that limits are merely upper bounds for cash control, not mandates for cash holding levels, and understand that sophisticated cash optimization is the need of the hour in today’s fast-paced and hyper-competitive financial world. To win, managers must leverage technology-enabled, statistically-driven cash management solutions that accurately model a bank’s or credit union’s realistic cash needs, within risk parameters, and deploy every penny of excess cash into safe yet profit-oriented banking.