Departure of Johnson Bank: A sign of things to come?

Wisconsin-based Johnson Bank is closing its branch in the Cayman Islands. The branch was opened in 1998 in order to facilitate the cash pooling and investment arrangements of commercial customers.

Johnson Bank explained the planned closure with a corporate restructuring as well as the effect of the Dodd-Frank Wall Street Reform and Consumer Protection Act on US banking laws.

“The branch is being closed due to changes in the Johnson Financial Group Inc corporate structure and changes in US banking law which now allows interest to be paid on commercial deposit accounts,” Johnson Bank senior vice president John Topczewski said in a letter to the Wisconsin Department of Financial Institutions and the Federal Reserve Bank of Chicago.

According to the letter the Cayman Islands office will close by 31 December, 2011. Earlier this year, Johnson Financial sold TransOcean Bank & Trust Ltd, another subsidiary in the Cayman Islands.

E

urodollar sweeps questioned

The closure raises questions over the future of other US bank subsidiaries in Cayman that maintain similar sweep and overnight investment arrangements for their US customers.

The sole purpose of Johnson Bank’s Cayman Islands branch, which holds a class B banking licence, was to facilitate overnight investments for large commercial customers through Eurodollar sweep accounts, a spokesperson for the bank confirmed in response to questions by the Caymanian Compass.

“The primary driver [for the branch closure] is the change in US law that now allows banks to directly pay interest on commercial demand deposit (checking) accounts – eliminating the need for investment vehicles of this type,” Johnson Bank said.

The purpose of Eurodollar sweep accounts is to pool the group wide cash reserves of a US customer in an offshore deposit account where the consolidated funds gain interest or can be invested into money market instruments and other investments.

Sweep accounts are a common cash management service that connects commercial depository accounts to an investment account. In this set-up, account balances exceeding a predefined balance are transferred automatically to the investment account for overnight investment, before depository account balances are readjusted to the required levels the following day. As a result, excess cash can earn interest rather than sit idle in non-interest bearing demand deposit accounts.

In practice

, sweep accounts are not only a convenient way to invest excess cash but they also offered a way around Regulation Q of the US Code of Federal Regulations, which prohibited the payment of interest on checking accounts, until it was repealed by Dodd-Frank in July of this year. Following the repeal of Regulation Q banks have the opportunity to offer interest on business checking accounts.

“We are not required to pay interest, but we may choose to do so for competitive reasons,” Johnson Bank said.

There has been some speculation that the ability to pay interest on business checking account balances may make sweep products less attractive and lead to simpler approaches to cash management. To the extent thatsweep arrangements are more complex and expensive, it may make sense for banks to simply pay interest on business checking account balances.

The fees associated with operating such a sweeping structure in the Cayman Islands may therefore also play a role in the viability of offshore sweep accounts, said Gonzalo Jalles, president of the Cayman Islands Bankers Association.

In CIBA’s opinion “it is imperative that the government does not increase fees any further and evaluates the possibility of reducing them back to previous levels as soon as possible, although that is not likely to happen any time soon given the budget constraints,” he said.

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eposit insurance

Another aspect of Dodd-Frank that could affect offshore account structures are changes to the federal deposit insurance scheme. Under new US regulations a balance of up to $250,000 in an interest bearing account is covered by FDIC insurance, whereas FDIC insurance is unlimited for non-interest bearing accounts. It is therefore likely

the regulatory change will diminish the attractiveness of non-insured interest-bearing accounts located offshore.

Pratt’s Corporate Treasury Management Manual estimates 44 per cent of all US sweep assets are deposits into offshore affiliates of US banks. Offshore investments are typically used by larger more sophisticated investors who feel more comfortable to manage the slightly higher risk compared to domestic money market instruments, but are also looking for a higher return.

In the Cayman Islands, 66 of the licensed 250 banks, or 26.4 per cent, are subsidiaries of US banks. More than 80 per cent of the more than US$1 trillion on deposit with banks in the Cayman Islands are interbank bookings between onshore banks and their Cayman Islands branches or subsidiaries, according to The Cayman Islands Monetary Authority.

However, Mr. Jalles said “none of the banks that have a physical presence in Cayman have this kind of business as a core to their operations” and therefore the local economic impact of Dodd-Frank would be limited to a small reduction in the level of fees collected by CIMA.

“Even if Dodd-Frank were to affect this business, I do not see a direct impact on the operations of the banks that provide lending and employment on the Island as these deposits are not used to provide local lending,” he said.

CIMA may face a small reduction in its licence fee intake and Cayman may drop a few positions in the international league tables for capital deposits because of fewer overnight deposits, but overall it would not be a significant issue for Cayman and might even have some positive implications, Mr. Galles said.

“In my personal opinion, we will continue to see regulation worldwide that will favour substance over form, and businesses that are purely registered or booked in Cayman with limited or no real operations on island will continue to be at risk. Cayman should continue to embrace this trend to ensure its continued 
future success.”

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