December 26, 2011

Historically, many banks treated "collateral management" as an afterthought, a perfunctory back-office function that could simply be tracked in a spreadsheet.

That approach may have worked when the global markets weren't so interconnected, and even then, when they were awash in liquidity. But with the ubiquitous spread of derivatives and securitized asset pools, collateral management has become a complex process with interrelated functions involving multiple parties. And as the last financial crisis showed, unexpected problems with one counterparty can create a domino effect that causes the credit markets to seize up overnight.

There's great opportunity here for the banks that can get this key function right, because the reality is much of the $16 trillion or more in collateral held by financial institutions globally can be managed far more efficiently. Against the headwinds of weak loan demand and tougher regulation, better collateral management could not only help banks reduce costs, but could help boost their chances of weathering future market upheaval. Collateral management could even become a profit center for banks and infrastructure providers, as smaller institutions look to outsource this task to third parties that can help them optimize their own holdings and reduce their technology and personnel costs.

Accenture and Clearstream recently studied the collateral management practices at some of the world's largest banks. As part of our research, we conducted interviews with more than 30 executives at 16 global banks that collectively manage nearly 20 percent of banking assets worldwide. Our conclusion: Banks collectively could save billions each year by better managing their collateral.

The benefits don't end there. Banks that better manage their collateral not only save money but become more competitive in the marketplace. Improved collateral management helps banks lower their financing costs, and frees up liquidity that could be put to other uses. By offering cross-asset class collateral and netting, banks are able to provide better pricing and do more business with their counterparties and provide additional services and products for their clients.

The Regulatory Wild Card

Granted, making estimates such as these also means predicting the future of regulation. While that's an inexact science, it's clear the efforts to reduce systemic risk will affect how banks manage their collateral. Recent regulatory reforms will likely require banks to hold more collateral from trading partners with whom they've had a history of disputes in the past, and could crimp the ability of banks to re-use collateral that's already committed to another counterparty.

Regulatory restrictions such as this could render inter-bank lending less attractive and make liquidity more critical. Regulators also are demanding banks hold more equity capital, which is the most expensive source of capital. To reduce their capital needs, banks will have to mitigate their credit and counterparty risk exposures through collateralization.

Having a better handle on their collateral would enable banks to move these funds efficiently, and in the process, boost liquidity and their return on capital. Accenture estimates banks could save roughly $5.5 billion by reforming their internal processes, which historically have kept collateral in separate silos -- either by geography, asset class, business unit, or by department (repos, treasury, securities).

To be sure, banks can still allow each unit to maintain their own collateral pools. But what banks need is the ability to capture more information on every asset in their various collateral pools. While some banks once revalued collateral on a weekly or even monthly basis, today's bankers need the ability to determine the value of their collateral daily -- and in some cases intra-day. This requires banks to have detailed information on every asset, as well as an internal transfer pricing framework that measures the liquidity and funding costs and, thus, aids in cross-product netting.

This approach carries more benefits than bankers might think. For one, having a "holistic" view of their worldwide collateral -- and in real time -- would enable them to identify at any point what assets exist and to measure them by asset class, geography, currency, or legal entity. Having a holistic view also tells banks which assets are available, which are encumbered -- and whether substitution is possible. That helps banks avoid being over-collateralized and, in turn, enables them to put those excess funds to more-profitable uses. Even more important, though, better collateral management can help banks maximize liquidity and even help lower the cost and duration of their funding by qualifying them for cheaper unsecured debt. Much of this can be done today with automated collateral management systems, which enable banks to trade at higher volumes without overwhelming their back-office staffs.

Perhaps surprisingly, banks have been slow to come around. So far, only a third of the banks Accenture surveyed said they had reduced internal inefficiencies in their collateral management over the past three years, and roughly a quarter said they've reduced external costs. In our view, though, the benefits of a collateral program are clear. What's more, better collateral management would also help banks lessen the fallout from any future crises.

Bob Gach is a global managing director in Accenture's financial services group; Owen Jelf is managing director, Accenture Core Trading and Settlement Services.