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The past decade of record low interest rates looks to be coming to an end. Following 7 years close to zero, the Federal Funds Rate rose to 2.4% between December 2015 and April 2019, before the coronavirus pandemic brought it back towards zero. Now though, with the Fed hawkish around the risk of inflation, the Fed has increased the rate by 0.25% and has signalled 6 additional quarter-point increases in 2022.
What’s different this time?
While the Federal Funds Rate rose to 2.4% before the coronavirus pandemic, it took over 3 years to reach that level and only peaked for less than 6 months. Now, it is expected that those levels could be reached much quicker. The Fed’s dot-plot of FOMC members’ target interest rates (Figure 1) indicate 6 additional quarter-point increases in 2022, taking the rate to 2.0%. JPMorgan’s forecast, in a February research note, went further, predicting that the Fed would increase the Federal Funds Rate by 0.25% at every meeting until March 2023. This would represent 9 rate hikes, taking the rate to 2.5% within 12 months.
Figure 1: Federal Reserve Rate Target Dot Plot – March 2022
This speed of incline presents a much greater challenge for banks and credit unions as it often takes time to implement operational adjustments to offset some of the cost. Also, banks need to be agile throughout the rate rises in case the Fed does change course. This is particularly the case in armored transport scheduling changes, which can be a good lever for both hard cash savings and residual reductions due to greater cash utilization.
Furthermore, banks and credit unions’ cash management and holdings across their network, particularly for ATMs, are very different post-pandemic. Throughout the pandemic many banks reported that their forecasting software or processes weren’t robust enough for the demand changes being experienced. Lockdowns and stimulus created an environment of significant demand volatility which non-dynamic solutions couldn’t react to.
Figure 2: Demand Volatility by Weekday Pre-Pandemic to Pandemic
Through this volatile period of demand, financial institutions rightly prioritized availability, increasing load amounts or max-filling ATMs. While this ensured cash was able to get into the customer’s hands, residuals greatly increased. This is difficult to unwind and taper, and the lasting trends of the pandemic have compounded these difficulties.
The significant increase in average transaction values demanded by customers from ATMs (Figure 3) and the requirement of a more branch like experience can further increase unutilized cash. In response to the branch experience, more financial institutions have implemented multiple denominations at the ATM. However, the impact of not implementing these multi-denomination strategies efficiently can be disastrous to residuals. CMS Analytics has found that optimizing sub-optimally managed single-denomination ATMs can yield a 25% reduction in residuals, but for sub-optimal multi-denomination networks this residual reduction can be as high as 60%.
Figure 3: Average Transaction Value at ATM – 2018 – 2021
An Action Plan for Residual Management
Given these pernicious trends, banks and credit unions need an action plan to bring their residuals in line before interest hikes start to hit. All too often banks try and ‘target’ a residual level. This should not be the case. Optimized residuals should be an output of effective cash management, not a metric to work towards.
CMS Analytics recommends reassessing the following three areas of your cash management to optimize and increase utilization, to then manage residuals organically:
Ensuring that your forecasting is robust is vital. As mentioned, many forecasting solutions faltered through the pandemic. However, financial institutions can’t expect the turbulent periods to be over. As the cost of cash increases, a dynamic solution is necessary to ensure holding costs and delivery costs are balanced and that you can adapt when changes do occur. This ensures that you stay cost optimal, while improving availability and reducing residuals.
A sub-optimal multi-denomination strategy can be the greatest driver of residual value. With an effective strategy, cassettes, pre-sets and dispense algorithms are considered and optimized simultaneously. This can be a competitive advantage for customer availability but also means that cassettes empty evenly, reducing the impact of high denomination residuals.
In the current environment, armored transport budgets can be the greatest source of cost reduction through optimized rescheduling. This rescheduling can also help to reduce residuals by influencing utilization. Optimized rescheduling should always be data-driven. It should consider all aspects of your cash operations and then simulate possible schedules on a site-by-site basis. Availability should never be compromised. The impact rescheduling can have is significant; financial institutions can typically reduce schedules by 20% and reduce residuals by 25%. If combined with optimizations, forecasting and denominational strategy, these results can be even greater.
Need help with your action plan?
CMS Analytics works with banks and credit unions to optimize cash operations to increase efficiency and reduce costs. Get in touch to find out more or take a look at some of our helpful guides: