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August 10, 2011

Cash Management: More Than Just Public Financial Management

Posted by Greg Horman

The overriding objective of cash management is to ensure that the government is able to fund its expenditure in a timely manner and meet its obligations as they fall due. Cost-effectiveness, risk reduction, and operational efficiency are also important. Cash management is a critical, albeit not so visible, dimension of effective public financial management, with important linkages to monetary policy implementation. More precisely, cash management encompasses two distinct but related activities: cash flow forecasting and cash balance management. The former is concerned with these questions: (i) Over a given time period (daily, weekly, monthly, and so on), what is the volume of the government’s aggregate cash inflows and outflows? (ii) At the end of each time period, what is the balance of cash at hand? The latter is concerned with this question: (iii) What actions does the government take to ensure that it has the “correct” amount of cash at hand at any point? This posting highlights some of the issues related to managing cash balances, which is not very well covered in the public financial management literature.

Changes in the daily cash balance of the treasury single account (TSA), domiciled at the central bank, are mirrored by changes in banking sector liquidity. Indeed, they may be the most significant autonomous influence on liquidity. The central bank takes these changes into account in its monetary policy operations. Effective cash management is characterized by agreement between the ministry of finance and the central bank on the flow of information from the ministry of finance to the central bank on the likely future size of the TSA. Ideally, this should be provided in real time, or at least before the start of each day. Insofar as the ministry of finance can manage its cash flows reasonably tightly around a target balance for the TSA, the government’s cash balance becomes largely neutral for monetary policy purposes.

Three broad models of cash balance management can be distilled from country practices. In the first, the central bank is the government’s de facto cash manager. In the second, the ministry of finance is an active cash manager. The third model embodies hybrid responsibility. Among the models, a key issue concerns the distinction between transactions to manage the government’s cash balance and the central bank’s liquidity management operations. Related to that are the nature of the target cash balance, the responsibility for managing any residual cash balance, and the instruments used for cash management operations.

The central bank may be the de facto cash manager. In this model, the government’s overall net cash flows are managed passively, through the central bank. A cash surplus is put on deposit at the central bank, while a deficit is covered by an overdraft or through operations conducted by the central bank. As a result, the government’s cash position vis-à-vis the central bank may be substantial. The central bank, therefore, becomes the effective cash manager. The central bank actively manages the forecast cash balance and any deviations from the forecast. It is the principal user, and possibly the coordinator, of cash flow forecasts. This situation applies whether the central bank has direct responsibility for cash management or operates as agent for the government. In practice in this model, cash management operations form part of the central bank’s liquidity management operations. This model is appropriate in those countries (particularly developing and emerging-market economies) where the ministry of finance lacks the technical capacity to accommodate the transaction flows and also manage the financial and operational risks that are associated with transactions with the market.

Alternatively, the ministry of finance may be an active cash manager. In this model, the ministry of finance, through the state treasury or (as is frequently the case in advanced-market economies) debt management office, manages the government’s overall net cash flows directly with the market, by investing a cash surplus or securing funds to cover a deficit. Consequently, there is a clear distinction between the government’s cash management operations and the central bank’s liquidity management operations. The ministry of finance decides its own modes of interaction with the market, including the choice of instruments and counterparties, and the timing and tenor of interventions. Its operations are generally characterized by the active use (to the extent that the state of market development allows) of a broad range of instruments, such as securities issuance, repo and reverse-repo transactions, purchases and sales of assets, foreign-exchange swaps, and credit lines with commercial banks, and the state treasury or debt management office is responsible for managing the market, credit, and liquidity risks associated with their use. The potential impact of government cash flows on monetary conditions is, depending on the expertise in cash management, offset within the banking sector and, thus, does not have to be taken into account in the central bank’s monetary policy decisions. Ideally, there is a low and stable target cash balance at the central bank. The state treasury or debt management office is the principal user, and possibly the coordinator, of cash flow forecasts. It is responsible for managing the forecast cash balance, as well as any residual balance arising from deviations from the forecast.

There may be hybrid solutions, however. In this model, the ministry of finance, through the state treasury or debt management office, manages the government’s overall net cash flows both directly with the market and via the central bank. This situation may manifest itself in two ways. From the perspective of the ministry of finance, the central bank may be an optional counterparty, in that the ministry of finance has the option to pass responsibility for any end-of-day cash surplus or deficit to the central bank. Alternatively, the central bank may be a required counterparty, in that the ministry of finance is obligated to maintain a high minimum target cash balance at the central bank. The ministry of finance and the central bank each decide their own modes of interaction with the market and are responsible for managing the associated risks. The two entities may agree, however, to use different interventions so as to avoid conflicts. The ministry of finance makes active use of a broad or narrow range of instruments, as the case may be, while the central bank takes account of any residual cash balance, which is likely to be minor, in its liquidity management operations.

Dynamic management of the government’s short-term cash position makes it possible for the timing of bond issuance to be largely independent of net cash flows arising as a result of a mismatch in the timing of receipts and payments. The benefit from being able to manage cash flexibly in this way is of particular value in handling economic shocks or unanticipated changes in the government’s cash position without needing to make sudden and unpredictable changes in the bond issuance program. Sound practice is to maintain a clear distinction between transactions undertaken for government cash and debt management purposes and operations undertaken for and monetary policy reasons so as to support the credibility of both functions in the financial markets. Regular cash management coordination meetings, at both the policy and the technical working level, between the ministry of finance and the central bank can be helpful.

In managing the cash balance, treasury bill issuance to the market is the most straightforward approach to offset the impact on the banking sector of net cash flows in and out of government. Net treasury bill issuance is higher (lower) in any week depending on whether inflows are expected to be lower (higher) than outflows in that week. Buy-backs of outstanding debt can also act as a rough-tuning cash management tool. Other approaches rely on a wider range of instruments, such as repos and the interbank market, to smooth more precisely the short-term changes in the balance of the TSA; the focus becomes the day, rather than the week.

The government and central bank must agree whether interest will be paid on the balance in the TSA. Sound practice is for the central bank to pay a market interest rate on a surplus. This improves transparency and avoids the implicit cross-subsidy associated with administered rates. It removes the incentive for the government to take economically inappropriate decisions in relation to its balances, such as placing funds in commercial banks with low credit ratings. It also reduces the risk that some part of the extra profit generated by the central bank because of not paying interest to the government would be lost through leakage to administrative or other expenses.

Similarly, the government must pay a market interest rate to the central bank on any overdraft balance or in conjunction with central bank-provided financing. Increasingly, the practice is to restrict, through legislation, access to financing from the central bank, with both a ceiling on the amount and a maximum tenor of the financing. Sound practice is to forbid access to central bank-provided financing entirely, or to allow it only in emergency situations in which funding operations with the market are not viable. In addition, sound practice prevents the government from extracting a cash dividend from the central bank when it is simultaneously running an overdraft. The dividend should be used in the first instance to reduce the overdraft, before it can be paid out to finance fiscal operations.

The government and the central bank must agree on the nature of the target for the cash balance. It may represent a minimum floor, in addition to any requirement not to go into overdraft. In this case, it acts as a precautionary buffer against unexpected cash shortfalls. On the other hand, the target may represent a positive, non-zero ceiling not be exceeded, in which case incentives are aligned if balances in excess of the target are unremunerated.


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Good, informative write up on the cash management. To me, the Tresuries/MOF in most developing countries are not epuipped to handle the cash management directly.

Untill the Treasury Cash Managment Unit is skilled, professionally managed; with required capacity of cash managment operations; it is better to draw upon the strength of the Central Bank for cash management. Treasury can negotiate with the Central Bank to pay interest (at the repo/bank rate) to the treasury on overnight and short term surpluses (to begin with. Hoewever, it will also cut both ways; the TSA in treasury should not get the overdrafts from the central bank for either (and pay interest at the bank rate).

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