Costly Post-Y2k Bank Burden: Vault Cash as Nonearning Asset

Much attention has been focused on increased demand for cash ahead of the New Year's weekend, but the real action for the banking system is expected to begin after the revelry.

The Federal Reserve's procedure for making more money accessible to cash-hungry consumers has proceeded in an orderly fashion over several months. But the reflow back into the Fed system is expected to be rapid, as banks seek to ship excess cash back as soon as possible so it can be converted into an earning asset.

"We will try to get rid of it as soon as possible," said John Adam Kanas, chairman and chief executive officer of North Fork Bancorp in Melville, N.Y. "It is costing us a fortune to keep the extra cash around."

The emphasis on speed is causing bankers, armored car companies, and Fed officials to consider the logistical challenges of transporting so much cash, especially since armored car companies already are operating at peak loads due to holiday demands.

The Fed currently has $262 billion available - if banks need it - in case of excessive cash withdrawals. In total, $589 billion of currency is in circulation, one-third of it domestically. Bankers were sitting on $72 billion of "vault cash" as of Dec. 15, according to the Federal Reserve. This total, which includes cash in branches and automated teller machines, counts toward a bank's reserve requirement of 10% on transactional account balances.

As much as $30 billion of this vault cash is a nonearning asset because it exceeds banks' minimum reserve requirements, observers said. Vault cash balances during the Christmas season typically total $45 billion to $50 billion, according to the Fed.

Ernst & Young officials say the industrywide opportunity cost associated with the year-2000 cash buildup easily will surpass $300 million through January, assuming that banks hold an average of $15 billion of excess cash for four months. This cost excludes labor and transportation.

"I think we are talking about some of the larger banks having in excess of $1 billion of extra cash," said Lawrence Forman, cash management analyst at Ernst & Young. The reflow of funds could easily and quickly become a "logistical nightmare," he added.

"Most major banks have a plan to start returning cash back to the Fed," said Ernst & Young partner Ed Herman. "How well they will be able to execute it remains to be seen, and that obviously will impact their profitability."

The $12 billion-asset North Fork is holding an extra $100 million to meet potential extra demand for cash. Mr. Kanas said lost earnings would amount to $600,000 a month. "Just imagine what a $100 billion bank is losing," he mused.

He said Wall Street has been briefed on how such cash considerations will affect North Fork's fourth-quarter income, but the analysts are not making "a big deal" out of it.

"There is some amount of lost earnings in this last quarter that the entire industry is sustaining as a result of having to keep this tremendous liquidity around," Mr. Kanas said.

How long the losses last may depend on the demand that actually materializes. "We certainly want to be convinced that there is no need for it," Mr. Kanas said. "We will probably want to watch the customer traffic for a few days."

Federal Reserve officials described the days leading up to New Year's weekend as a calm before the storm. No emergency shipments of cash have been made or are needed.

The Fed and the Federal Deposit Insurance Corp. have been taking the public's pulse with periodic surveys by the Gallup Organization. A November study showed a decline in the number of people who said they would take out cash for Y2K reasons.

As of Nov. 18, nine out of 10 U.S. bank customers deemed their banks ready for the calendar change. Only 5% said they were "very concerned," down from 11% in March.

Thirty-nine percent in the November survey said they would "definitely or probably" remove cash, compared with 62% in the March survey. Most said they would withdraw less than $500.

The Fed has taken an early and active role in planning for the distribution and return of large volumes of cash, said John Halverson, executive vice president of Patriot Courier Services Inc., a West Hampton Beach, N.Y., armored car service.

As early as 1997, the Fed began soliciting bids from banks and armored car companies to develop strategic inventory locations, or SILs, around the nation. The SILs are holding cash reserves to respond to sudden spikes in demand.

The Fed expects to spend $5 million to $6 million for developing and maintaining these facilities, said William Stone, first vice president at the Federal Reserve Bank of Philadelphia and the Fed's national cash product director.

He said reflows would be orderly. "We are pretty comfortable with the logistics of the cash coming back in," Mr. Stone said. "There won't be a long line of armored cars, but my expectation is that there will be more cash in those trucks than there might otherwise be."

He added: "There will be more specialized runs of cash coming back in, but because we will know about those we can plan adequately and keep staff on hand. We are prepared to work whatever hours it takes to handle this cash coming back in."

The Fed is recommending that banks not open shrink-wrapped packages of cash until necessary.

That would spare the need to repackage the currency for the return trip.

Ron Riffle, a director in Ernst & Young's national cash management consulting practice, said the year-2000 cash issue highlights the need for banks to regularly do more to reduce nonearning assets.

"This is going to be a big issue in 2000," Mr. Riffle said. "Banks have all this extra cash floating around."

As for the coming holiday weekend and the weeks that follow, Mr. Halverson of Patriot Courier said he is confident his company would be able to handle excess demand.

"It means I will have to pack the truck tighter," he said. "I think New Year's Day will be interesting."

Next: Regulators' preparations

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