Addressing the cash issue for charities
Charities are constantly being advised to balance the amount of risk they are taking with their assets in order to get a sufficient return to meet their objectives. This typically entails time spent reviewing various policies, and trustees will naturally try to diversify the charity’s income where possible. Cash and cash-flow are usually central to this.
A decade after the financial crisis, we are living in an extraordinary economic world. While the interest rate cycle appears to be turning in the US and UK, with rates increasing from almost 0%, they are highly unlikely to return to the near 6% rates seen before the crisis.
This has been a chronic time for savers with cash in the bank. Luckily, through depressed wages and a massive monetary boost from central governments, prices have remained relatively low during this period and inflation subdued. As demand picks up, uncertainty over Brexit has caused sterling to devalue and the days of easy money may be behind us. This benign economic period could be passing.
High levels of cash
During this time of uncertainty charities have been risk adverse and sitting on high levels of cash. This is a consequence of austerity and greater pressure on charities to provide public benefit in a transparent manner. Central and local government are increasingly funding contracts rather than grants and even Camelot recently announced that its distributions to good causes declined by £300 million in 2016 as sales of Lottery tickets decline.
Notwithstanding the economic backdrop, charities should have a robust reserves policy, outlining what funds are available to maintain their operations at times of financial stress. While the Charity Commission offers guidance on setting a reserves policy, there is not a simple answer. General guidance states that a charity should have reserves equivalent to a number of weeks or months of income, to allow time to develop new sources of income or to cut back on related expenditure.
While it doesn’t state that the reserve should he held in cash, having sufficient liquidity is vitally important. Kid’s Company has been in the spotlight recently as a charity failing due largely to financial mismanagement, but there are a surprising number of charities which have closed due to poor liquidity management. There are also an alarming number of charities which are sitting on large amounts of cash and not spending it charitably.
Rock and hard place
Charities are caught between a rock and a hard place when it comes to cash. They need sufficient amounts to cover their immediate needs, such as short-term grants, staff salaries and operational expenditure. They need to have liquid deposits in the event of an unforeseen drop of regular income or planned capital expenditure. Indeed, some may have large reserves restricted to a specific cause and the capital cannot be spent on general expenditure.
While inflation has been subdued in recent years, it is increasing in the UK. Core inflation is currently at 2.7%, compared to 1.5% 12 months and 10 years ago. Therefore, if a charity is holding cash in the bank and assuming the bank is paying interest on this of 0.5%, it is currently losing 2.2% of the value of its cash in real terms.
This is a very expensive price to pay for “security” or low risk. The longer the cash is held the more this effect is compounded, assuming underlying rates do not change dramatically, which is the current forecast.
With central bank rates at rock bottom, there is little incentive for banks to offer competitive interest rates on which they will lose money.
Memories are relatively short, but Northern Rock, RBS and Lloyds (following the takeover of the crippled Halifax Bank of Scotland) all had to be supported by the government. We narrowly avoided a run on the banks and unlike the Icelandic banks before them, UK banks were not allowed to fail. Counterparty risk, the concept of putting all your deposits into one bank which may fail, was very much in focus.
Spreading risk between banks
Spreading this risk between numerous banks is the prudent answer, taking advantage of the government guarantee offered to depositors under the Financial Services Compensation Scheme (FSCS), whereby the first £85,000 deposited with each bank or building society is covered should anything happen with the institution. Not all financial institutions in the UK are covered by the FSCS.
This sounds like a good idea, but in practice opening multiple bank accounts is a laborious process, especially if the identification of each trustee and executive needs to be verified for money laundering purposes. Charities are generally categorised as a business and anyone who has opened a business bank account recently will know the process is not straight forward and accounts are generally not free. Engaging with a bank can be difficult as branches are being closed and customers directed to a call centre or website.
The rates paid for cash deposits are currently anything between 0 – 1% and business rates are generally lower than those offered to personal customers. Higher rates are available, but you need to investigate why a bank is offering a rate significantly over the Bank of England’s base rate. Is the cash available at instant access? What is the capital strength of the bank?
Is the offer a “teaser” rate that is only available for a short period which reverts to a lower rate for longer? Does the rate come with strings attached, such as other products and services which the charity doesn’t need?
Alternative solutions available
There are managed cash funds available, which invest into the wholesale cash market, short dated bonds and other cash instruments. The rates on many of these funds after the management fee are not compelling, but they are an alternative solution. Furthermore, it is easy to confuse cash and short dated bonds. Not only do they behave in very different ways but, the two year UK Government bond yields 0.5% while the best two year bank account yields 1.5%.
The bond is more liquid but for that compromise, the charity with the fixed deposit is earning three times the return. In addition, if the amount per bank is £85,000 then the bank deposit is FSCS protected and the risk profile is very similar.
In practice, when faced with this cash burden for what appears to be very little gain, most charities suffer from inertia and opt to keep cash in their core bank on a low interest account. After all, there are many other pressing issues that charities are faced with and provided the bank is safe they can sleep at night. Most charities do not have the resources to have an active treasury management function in-house.
A charity which holds £100,000 cash in an account that pays an interest of 0.5% is potentially giving up on up to £1,000 a year by not shopping around. That is the expense of inertia and this is before the impact of inflation.
Opening up banking data
Thankfully, things are changing in the banking world. “Open Banking” is a general term that describes two pieces of regulation: the Competition and Market Authority’s “Open Banking remedy” and the European Payment Services Directive 2 (PSD2). Open Banking has the potential to disrupt the way that people interact with their finances and the relationship they have with financial services providers by opening up customers’ banking data through secure application programming interfaces (APIs).
PSD2, which came into force on 13 January 2018, aims to promote the development and use of innovative online and mobile payments, for example through Open Banking and making cross-border European payment services safer. The new rules aim to reduce the cost and complexity of payment processing across the European Union, and better protect consumers when they pay for goods and services online.
Greater use of technology is having an impact on the banking system and the way we bank. This is not just the use of apps or cashless payments, but useful software such as APIs. APIs allows different computer applications to talk to each other. This means that it is now very easy to move money between banks securely, quickly and cheaply.
The other advantage to savers is the greater choice of banks, with the introduction of challenger banks and financial companies that are embracing technology commonly known as fintechs.
Improving interest rates
It is now possible to open an account with an active cash management service that carries out one check on the charity and then searches for the best rates with banks that are covered by the FCSC. It manages this on an ongoing basis and can often improve the rate of interest by over 1% by embracing the new regulation and technology, moving money securely between banks as the rates change at a very low cost.
It is a well-known investment mantra that you have to take more risk to get a better return. However, regulation, technology and greater choice of banks mean that charity depositors can actually reduce risk and get a better return in a cost effective and time efficient manner.
It is accepted that the trust in banks has fallen, embracing technology takes time and education on Open Banking needs to improve. However, it is estimated that the top 5,000 charities in the UK hold cash deposits of £15.5 billion. If they could improve the returns on that cash by 1% then that releases £155 million of improved returns back to charities to spend on their beneficiaries. Charities psychology around cash needs to change.