When looking at an organisation’s balance sheet it’s important to consider the purpose of each pool of capital. Certain pools require greater levels of liquidity than others. Since 2008 there have been few options outside of traditional bank accounts or long-term investment portfolios, meaning that ‘reserve’ cash has been unloved. Reserve cash is funds that will be drawn down at some point in the future. As they have no immediate requirement they will differ from operating cash and working capital which needs to be more liquid and readily available.
Balance sheet structure
Source: HSBC Global Private Banking
Since 2022 both inflation and interest rates have increased significantly in the UK and most other major developed markets. In the UK, inflation (CPI) is now running at 10.4 per cent (as at February 2023) and interest rates 4.25 per cent meaning that careful management of reserve cash is important (rates correct at 5 April 2023). However as result of increased rates, cash management options that have not been appealing, or even available, since the Financial Crisis may now look attractive. We believe that considering these can help you maximise the return of the reserves part of your balance sheet. To support Charity and Education organisation to capitalise on this, we have put together a ‘3 pool approach’ to outline potential solutions.
The first pool is made up of cash held in current and deposit accounts. Cash will be held on the deposit-taking bank’s balance sheet. How to long to fix funds for will depend on how readily available you need them to be. It will be important to consider counterparty risk and why some institutions may be paying a higher interest rate than others.
Liquidity funds invest into short-dated money market securities and focus on preservation of capital. They are off-balance sheet, which means that are not subject to a bank’s counterparty risk. They enable organisations to spread risk across c 50 underlying securities. This reduces counterparty risk, which is important following the recent volatility we’ve seen in the banking sector. Liquidity funds can be redeemed on a daily basis and the yield is usually slightly below base rate.
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