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Interest rates: not as low as you think

By : Robin Angus

August 22, 2014 02:24 PM

Interest rates are near zero in the US, but it’s a different story if you look at other countries around the world.

 

In the UK and Europe rates are just as low—the European Central Bank has even taken the unprecedented step to take its deposit rate into negative territory. The effects on cash management of this low rate environment have been relatively straight forward to deal with. Consistency has been banks’ ally—the Fed funds rate has been near enough zero for six years and despite all the talk there are no signs of it moving higher just yet.

 

Look further afield, however, and it’s a different picture. Brazil has been hiking rates consistently for months and the base rate now stands at 11 percent. Any bank with operations in Brazil and the US would clearly have to think about how it approaches things in each country. India’s rate is 8 percent, Indonesia’s 7.5 percent.

 

Turkey is a great case. Faced with a collapsing lira back in January, the Turkish central bank hiked its overnight lending rate to 12 percent from 7.75 percent. It also increased the overnight borrowing rate to 8 percent from 3.5 percent.

 

How does a bank factor a rise like that into its cash management strategy? Probably with great difficulty. Suddenly the equation is turned on its head—borrowing from each other overnight to ease short-term liquidity issues is vastly more expensive. In turn, the relative cost of armored cars and transporting cash drops significantly.

 

Moreover, it costs a lot more to hold the cash in the bank. Vault cash earns no interest and must be financed by interest-bearing liabilities, while there are also security and insurance costs to bear. But consumer demand for cash still needs to be met. Therefore being able to reduce vault cash holdings to the most efficient level required to meet total demand becomes a lot more important.

 

Cash management teams in currently low interest economies would be wise to consider this in how they will deal with a future where “virtually free” cash is no longer available. Are their cash management processes and systems capable of adapting to the new realities as they emerge and mitigating the impact of interest rate rises? Two of the Bank of England Monetary Policy Committee members voted to triple the cost of cash last month. It only takes three more to agree with them and it is the new reality for banks in the UK.