Cash Management

5 Keys for Managing Bank Risk

Diversifying financial institutions is vital right now, but so are developing a continuity plan and preserving capital.
Vincent RyanMarch 22, 2023
5 Keys for Managing Bank Risk
Photo: SWinxy, CC BY-SA 4.0 via Wikimedia

Why would a startup or any company make the unwise decision to park millions of dollars in one bank?

To deepen an existing banking relationship by consolidating banking services; to give one bank the company’s cash management, foreign exchange, and capital markets services in hopes of being charged lower fees; or making the incorrect assumption that the bank or banks are a totally safe place for a company’s operating accounts and its excess cash.

Bank fees are now far down the list of priorities: A Gartner survey last week found that in the wake of the Silicon Valley Bank and Signature Bank failures, only 9% of CFOs plan to benchmark existing bank services and associated fees. 

Most CFOs are instead thinking about counterparty risk, a subject that faded after most of the regulation from the financial crisis had played out. Now that it has returned, finance chiefs could use a refresher on how to mitigate the potential risk that a bank will default on its contractual obligations.

1. Spread Out. Treasury Secretary Janet Yellen on Tuesday vowed to safeguard deposits at smaller banks, but this is not time to sit back and relax. CFOs need to diversify their financial institutions if they haven’t already. A lull, however brief, gives finance teams time to be choosier with their banking partners.

As a small business, I don’t think there’s a ton of service or benefit in big-bank relationships. — Jay Jung, Embarc Advisors

Zack Ellison, a former credit trader and founder of Applied Real Intelligence, recommends businesses have three banks, at least two of which are “systemically important” banks, like JP Morgan Chase, Bank of America, or Citi. ‘The likelihood they won’t honor their commitments is much lower,” Ellison said. But it’s OK to add a smaller or regional bank that the CFO or CEO has known for years into the mix, he added. Just be sure to have a backup plan.

Jay Jung, the founder of Embarc Advisors, a capital markets advisory, said, “As a small business, I don’t think there’s a ton of service or benefit in big bank relationships.” Jung recommends organizations have two bank accounts and one money market account. “If you raise a $100 million round,” he said, “you can ACH some of that to the asset management account and have the money managed.”

The vital requirement is that new bank accounts integrate well with your financial systems, Jung said. A company should be able to move money quickly with ACH. Then, “you can start building a banking relationship with your banker; I think that’s also very important,” Jung said.

2. Plan. Every business needs a continuity and disaster recovery plan, said Ellison. In light of the current funding and balance sheet issues with commercial banks, companies should update their continuity plans with a focus on liquidity and cash management. What happens if the company’s primary bank goes into receivership? What events (rating downgrade, stock price plummet, credit default swap price) should trigger finance to pull some or all deposits from a bank? Where will the company get money to pay suppliers and employees during a banking crisis? How will the business operate if it is prevented from accessing its cash?

Instead of digging into Call Reports, CFOs can tap services that rate the financial health of U.S. banks. Among them are DepositAccounts, which uses the Texas Ratio to gauge bank credit risk, and Bauer Financial. The rating agencies evaluate financial institutions but, in the past, have tended to leave credit ratings where they are until a crisis actually occurs.

3. Be transparent. Have a communication strategy. If the company’s bank fails, the CFO needs to be open with the board of directors, investors, and other stakeholders, said John Pennett, a partner in the technology and life sciences group at EisnerAmper. “Tell people what’s going on, what your exposure is, and what you’ve done about it. And tell them what you’re going to do next week,” Pennett said.

This is the time for the CFO to buckle down and find good solutions. — John Pennett, EisnerAmper

4. Be super capital-efficient. Banks and the capital markets are tightening up, and deals are harder to close. CFOs of younger firms not well-capitalized need to understand and analyze costs and “strip down things” as much as possible, Pennett said. Efficiency and prioritization decisions must be made. “We see companies that have two or three projects going on and they [are putting] a couple on the shelf and just working on their best program,” he said. 

Amid turmoil like the last 10 days, companies must think “capital preservation” and have or develop a long-term capital strategy. “This is the time for the CFO to buckle down and find good solutions,” Pennett added.

5. Pay attention to the FDIC insurance limit. For now, deposits may be relatively safe in U.S. banks. But as fiduciaries, CFOs shouldn’t gamble. Many businesses ignored the $250,000 Federal Deposit Insurance Company limit prior to the latest bank failures. “It’s actually a disclosure in your audited financial statements,” Pennett pointed out.

Besides adding bank relationships, companies can get deposits guaranteed through deposit brokerage services. They spread out deposits at multiple banks to keep all the accounts under the FDIC-insured cap. The best-known service is called CDARS – Certificate of Deposit Account Registry Service. It’s offered by IntraFi (formerly Promontory). 

Fintech Mercury Vault introduced a product on March 13 that uses a sweep network of bigger banks like Capital One to provide deposit insurance up to $5 million. The service spreads a customer’s deposits among as many as 20 different banks without requiring the customer to open and manage separate bank accounts.

Ironically, some fintechs and cryptocurrency firms came under fire from federal regulators last summer for misstating that their own customers’ accounts were FDIC-insured.