There has always been a clear distinction between cash and checks. But as a result of banks' recent efforts to reduce reserve requirements and of proposed changes in the Federal Reserve's Regulation D, the differences are beginning to blur.
I foresee a day when checks are assigned one- and two-day float and cash is assigned two-, three-, and four-day float. No longer will we say "as good as cash."
In the 1950s, commercial customers were given immediate credit on both cash and check deposits. Covering items in the process of collection was seen as a cost of doing business. One day, some bright person came to realize that, though float is a fact of life in the banking business, certain customers were taking advantage of it, drawing out funds before they were collected. We all came to realize that some valued customers with large balances were really not very profitable and kept very little "money" in the bank.
Associating float with a customer, or allocating float to a customer, became the way to do business. It was easy to explain: "We make money by lending out money. If we can't invest your money, then your money has no value to us, and we can't invest the checks you deposit until the various banks your deposited checks are drawn on wire money to our Federal Reserve account. It just takes a couple of days. It's not really a big deal."
Everyone came to understand the difference between ledger and collected balances. We told our customers, "Don't worry, cash is cash. There is no float on cash, and you can withdraw cash the same day. Cash is king."
Well, cash may be king, but from a float manager's perspective it is looking more and more like checks, at least as it relates to our ability to invest and use the funds.
Today, many large financial institutions meet their reserve requirements with vault cash. Not because cash balances have grown but because required reserves have declined.
Reserve requirements for demand deposits are much greater than for time deposits (10% versus 0%). Many larger banks classify high-balance demand accounts as time accounts until six checks (transfers) pay against the account. This process of reclassifying demand accounts as time accounts occurs monthly and has dramatically reduced required reserves.
Before reclassification, about $40 billion was maintained in the Federal Reserve banks as reserve balances. That total has dwindled to less than $10 billion, primarily because not all banks have chosen to reclassify accounts.
Reserve requirements can be met with a combination of vault cash and money in reserve accounts. As required reserves are reduced through account reclassification, many banks find themselves with excess cash. Efforts to reduce cash levels have helped, but these banks remain overreserved.
Proposed changes in Regulation D would allow for the payment of interest on reserve balances. It is important to note that the Federal Reserve is not proposing to pay interest on all reserves -- just what are held in the reserve banks.
Reduction of reserve requirements brought on by reclassification, coupled with the costs of cash resulting from the proposed Regulation D changes, will forever change the way we view vault cash.
In the past, vault cash was a cost of doing business. High cash levels meant higher risk of loss from a robbery, higher insurance rates, and less wiggle room in the reserve account. But the speed with which cash deposits were credited to Federal Reserve accounts in no way affected banks' levels of investable funds. Such is not the case today.
Most armored-car deposits made by large corporate customers go into banks that more than meet their reserve requirements with vault cash. Unfortunately, many of these banks do not yet understand the ramifications of continuing to assign immediate credit to these deposits.
Deposits taken and credited on a Monday are often not verified until Wednesday and not shipped to the Federal Reserve until Thursday. To a float manager, this looks like a sterile asset. We've given credit before receiving credit. Not a good way to make money.
Looked at on the margin, that new money-center customer you took away from your crosstown competitor may be a whole lot less profitable than you think. It may maintain $250,000 in balances, but if that money sits as an increase in vault cash, what have you gained?
The institution that lost the account may end up more profitable. This will only get worse with the proposed changes in Regulation D. Once we are paid interest on our reserve balances, every dollar in our vaults will have an associated opportunity cost.
So what should we do? We need to do what we did years ago with checks: look for ways to expedite the "collection" of cash and allocate the cost of carrying a sterile asset to the customers responsible, who must be educated as to why this issue has arisen.
We need to allocate float to our customers to offset our carrying costs. We need to look for ways to minimize cash levels by reducing the time that deposited money stays in our vaults. We need to develop product offerings that will assist us in our handling of cash. And we need to work with the Federal Reserve to obtain product offerings that will make it easier to deposit cash into reserve accounts.
We all need to better understand these issues and to understand the impact they will have on banks and on customers.