How Banks Can Leverage the Recent Changes to Money Funds

Deposit Marketing

Last week, the Securities and Exchange Commission announced changes to money market fund (MMF) regulation in an attempt to lower the risk to investors.  During the financial crisis, the combination of credit and liquidity shocks caused several money market funds to “break the buck” or trade below their par value due to losses. One notable one close to home, The Reserve Fund, caused many community banks problems.


MMF are mutual funds that are targeted as short term investment alternatives and are targeted at corporations and asset managers. Up to this point, they have a fixed share price at $1 and the yield would change to reflect any problems with valuation. Under normal times, the values of short term instruments don’t change much, so usually problems in commercial paper extensions or issues have been taken care of by reducing the yield. However, when credit fails, such as was the case with Lehman Brothers, and the fund sponsor does not have the inclination or the wherewithal to make investors whole for their loss, then the fund “breaks the buck” or trades less than $1 per share. The issue is compounded when the fund is rumored to trade below $1 then everyone wants out, potentially spreading the losses over a smaller investor pool. Since no one wants to get stuck with disproportional losses, liquidity seizes quickly and presents a systemic problem.


The new rules require that all money market mutual funds trade on a floating rate net asset value (NAV) so the price could change from day to day. While credit losses could impact share prices, so can quickly rising interest rates. By allowing a floating NAV, investors take an immediate mark-to-market hit which doesn’t necessarily mean they have to sell, so this helps liquidity of the whole market. In addition, the SEC will allow penalties so that early withdrawals are discouraged.


Aside from the surface changes to MMFs that will impact some banks as investors (only a few banks are investors in MMF), this also impacts banks that utilize sweeps to move money off balance sheet into money market funds. However, offsetting these negative aspects, the new rules could create cheaper deposits for banks.


This final rule goes into effect in the next 60 days and will phase in over what is expected to be two years. As such, banks that want to take advantage of this should email or alert their corporate customers of the change letting them know that bank deposits are a suitable alternative. MMFs are now a less attractive place to park money than they used to be. According to the recent 2014 Association of Financial Professionals (AFP) Survey that we posted last week, 27% of the respondents said they would not invest in top rated (called “Prime Funds”) MMF funds altogether if they were to operate with a floating NAV. Having a floating NAV creates potential impact to earnings which is uncertainty. Corporations, like banks, are not big fans of earnings uncertainty so a bank interest bearing deposit looks pretty good by comparison.


The size of the prime money market world is about $930B in size, so if 27% withdrawal takes place, it means about $250B is up for grabs by banks. The AFP didn’t ask anything about fees, so we think the combination of a floating NAV and new potential fees result in an even higher percentage.


While your bank may not need deposits now, this opportunity is hard to pass up given then prime money market funds are only paying about 1 to 4bp.


Stay tuned and get your chief deposit officer (or whoever) signed up because we will be testing some marketing pieces and will provide them for free to banks that are interested.