How Corporate Treasurers Use Money Market Funds, And How Banks Can Respond

This Month In Commercial Banking

Hundreds of billions of dollars are migrating from banks to money market funds. That makes it critically important for bankers to refresh their understanding of how corporate treasurers use these funds and the regulations associated with them. It’s also essential for bankers to understand what they can do, and perhaps should do, to respond.   

Money market funds are mutual funds that invest in short-term, low-risk debt securities such as Treasury bills, commercial paper and certificates of deposit. These funds are typically considered very safe and stable investments, and they are often used by corporations as a way to earn higher yields while maintaining a high level of liquidity. The SEC defines three types of institutional MMFs: prime, municipal and government. Corporate treasurers can choose to invest in MMFs directly or through a daily sweep mechanism. A corporate treasurer’s decision to shift money from bank accounts to money market funds is based on several considerations:

  • Cash management. Money market funds can be used to manage short-term cash holdings, allowing corporate treasury departments to earn interest on their cash balances while maintaining liquidity.  
  • Higher interest rates.  Since late 2022, money market funds have offered significantly higher interest yields compared with rates available through earnings credit rates on commercial bank accounts and money market deposit accounts.  
  • Transaction costs. The time and costs associated with shifting money between bank accounts and money market funds need to be offset by materially higher yields.    
  • Risk diversification. Investing in a money market fund can help diversify a corporate treasury department’s cash holdings, thereby reducing the risk of relying on a single financial institution. 

Investors can withdraw their money from money market funds on demand, meaning they can sell their shares at any time and receive cash in return. But it also means that during times of market stress or uncertainty, a rush of investors may want to sell their shares at once, which can put pressure on the fund’s ability to maintain its net asset value (NAV) per share. 

To address this concern, the Securities and Exchange Commission (SEC) implemented new rules in 2016 that allow money market funds to impose liquidity fees and redemption gates in certain circumstances. A liquidity fee is a charge that can be assessed when an investor tries to sell their shares, thereby intending to discourage large-scale withdrawals during times of stress. A redemption gate is a temporary suspension of withdrawals from the fund, which can be implemented if the fund’s liquidity falls below a certain level. 

The new fees and gates rules apply primarily to institutional prime and municipal funds. Government money market funds may voluntarily adopt them only if they have been previously disclosed to investors. Here are some important guidelines that corporate treasurers need to keep in mind:  

  • If a fund’s weekly liquid assets fall below 10% the fund must impose a 1% to 2% fee on redemptions. The fund’s Board of Directors can waive the fees if they believe the fees would not be in the fund’s best interest.  
  • If a fund’s weekly liquid assets fall below 30% of total assets, the fund may impose a fee of up to 2% on redemptions or temporarily suspend redemptions.   
  • A fund may impose a gate—that is, suspend redemptions—for up to 10 business days in a 90-day period. 

How Banks Can Mitigate Deposit Outflows

Additional effort is required when a company shifts its cash deposits from the bank where it maintains its transactional accounts. In this case, it needs to keep an accurate cash forecast and adopt weekly or daily cash positioning to maintain the needed balances in both the transactional accounts and the money market fund account. To reduce the incentive for corporates to move their money out of their bank, commercial bankers are well advised to complement their inherent advantages associated with holding the client’s transaction accounts with these steps:  

  1. Interest rates. Banks can raise rates associated with ECR and interest-bearing accounts. The reduction in the rate differential will reduce a company’s incentive to move the funds.
  2. Bank money market fund. Banks can offer their own money market funds. This approach still moves money off the bank’s balance sheet, but it produces some fee revenue while maintaining the relationship with the customer.
  3. Insured cash sweeps. Banks can participate in insured cash sweep programs to attract deposits and place customer funds in a diversified risk portfolio. 

With interest rates high and likely to go higher still, the outflows from bank deposits to money market funds are not likely to abate or reverse any time soon. Now’s the time, therefore, for commercial banks to better understand the uses and regulations of money market funds and how to seek advantage in today’s dynamic environment.

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