Union Bank of California is revamping its cash custody operations to avoid incurring substantial fees when a new Federal Reserve Board rule on short-term cash deposits takes effect July of next year.
The San Francisco bank, which distributes cash to many West Coast financial companies, is preparing to enroll in the Fed's custodial inventory program, which will enable it to make virtual cash deposits without moving the bills to the Fed's vaults.
Union Bank, which is majority owned by Mitsubishi UFJ Financial Group Inc., is also adjusting its cash-sorting machines to improve its ability to spot damaged and counterfeit notes.
The Fed wants to handle less cash. In March, it announced recalculation policies designed to encourage banks to handle more of their own cash.
Jane LiVigni, a senior vice president and manager of cash services for Union Bank, said the rule also discourages cross-shipping - depositing money with the Fed and then withdrawing it quickly, sometimes the next day, to earn interest on cash that would otherwise be collecting dust in their vaults.
Union Bank has estimated that the Fed's fees for cross-shipping would drive up costs at each of its vaults that cross-ship by 10% to 20%, unless the bank changes its practices, Ms. LiVigni said.
"This is the challenge for banks that are cross-shippers, and we all know who we are," she said. "There's quite a few of us."
The Fed has said the new rule likely would affect about 150 to 225 financial companies.
The agency has long accepted banks' cash, in large part because it can then sort through the notes, replace worn and damaged ones, and search for counterfeits. However, the amount of cash in circulation has increased steadily over the years, and the percentage of fit bills has increased even faster.
As a result, the Fed is handing more cash and replacing less of it. In the March announcement, the Fed said it wanted to "reduce depository institutions' overuse" of its currency-processing services.
Though the Fed will continue to accept old and worn-out notes, beginning in July of next year banks will pay a fee for depositing more than 875 bundles of undamaged $10 and $20 bills a quarter. Each bundle contains 1,000 notes. The fee for depositing additional bundles will be about $5 each.
To avoid these fees, banks can participate in the custodial inventory program the Fed introduced last month. The program lets banks "deposit" cash virtually with the Fed and have the amount credited on the Fed's book, though the notes never leave the bank's vault.
Union Bank plans to begin doing so in October. The Fed's rules "make a huge difference in our organization and how we process cash," Ms. LiVigni said. "What we did in the past may not be good enough for the future."
As a result, the bank expects to have much more cash on hand, and in January it hired a specialist to help update its procedures.
Union Bank uses high-speed cash-sorting machines from De La Rue PLC, the British company that prints most of the world's cash, to weed out worn and counterfeit bills. De La Rue does not print U.S. dollars, but its high-speed sorters can determine which bills meet the Fed's standard for fitness.
K. Paul Blond, the director of cash processing solutions for De La Rue's cash systems business, said being able to spot the notes that should not be sent to the Fed will help Union Bank keep costs down.
The bank "could be potentially paying out, if they don't change their ways, $1 million to $1.5 million in fees" each year, Mr. Blond said. "All of a sudden, you're starting to have real business drivers for managing your cash more effectively."
The sorters can also be configured to evaluate notes' fitness using criteria set by individual banks.
Ms. LiVigni said what's good enough for the Fed may not be good enough for her bank's customers. "Financial institutions on the West Coast, within themselves, have different levels of fitness they will agree to."
Bob Meara, a senior analyst for the Boston market research firm Celent LLC, said that banks will be "slow to act" on the new rules. He predicted that several will have to pay the Fed's fees for several months before getting their cash-handing operations under control.
Other banking companies may ask their armored couriers to provide the service of sorting fit and unfit currency, he said; still others will choose not to act and to incur the fees.
The Fed's standards for bill fitness are still unclear, and that many financial companies are not ready to invest in sorely needed cash-handling systems, Mr. Meara said. "Most banks have pretty dated equipment" and will need to make investments to handle their cash in-house.
Union Bank, which is already improving its operations, is "well ahead of the ball game," he said.
