By Ryan Miles, Senior Investment Adviser | Managing Director

Best Practices for Evaluating Banking Relationships

Governmental entities are responsible for a significant amount of public funds, making the selection and evaluation of banking relationships a critical aspect of sound financial operations. The choice of a banking partner impacts not only the safety and accessibility of governmental dollars, but also the operational efficiency and overall fiscal responsibility. Below are the best practices for evaluating banking relationships, with a focus on earnings credits, fraud prevention tools, zero balance or sweep accounts, necessary collateral coverage, and cash flow considerations.

1. Earnings Credits: Maximizing Value from Deposits

Municipalities typically maintain large balances in their accounts. Evaluating the earnings credit rate (ECR) offered by a bank is crucial as it determines the value entities receive for these balances. The ECR is applied to offset banking fees, so a higher rate can significantly reduce out-of-pocket costs.

With the Federal Open Market Committee (FOMC) lowering their benchmark rate by 100 basis points since September, now is an important time to evaluate your entity’s ECR as it may have adjusted downward in-line with the FOMC rate decisions.

When evaluating your entity’s ECR, be sure to:

• Compare ECRs among different banks to identify competitive offerings.
• Understand how the ECR is calculated and whether it adjusts with market interest rates.
• Ensure that the rate aligns with your entity’s cash flow needs and deposit balances to maximize benefits.

Additionally, consider negotiating ECRs during contract renewals or consolidating accounts to leverage higher balances for better terms.

2. Fraud Prevention Tools: Protecting Public Funds

The increasing sophistication of financial fraud makes robust fraud prevention tools an essential component of your municipality’s banking relationship. Banks offer a host of fraud prevention solutions such as:

• Positive Pay: Reconciles checks issued against those presented for payment to ensure the amounts match
• ACH Debit Blocking & Filtering: Protects accounts from unauthorized electronic withdrawals
• Multi-Factor Authentication (MFA): Strengthens access controls for online banking platforms

Governmental entities should also regularly update their internal controls and ensure bank-provided tools integrate seamlessly with existing processes. Evaluating a bank’s record in fraud prevention and responsiveness to incidents is equally important.

3. Zero Balance Accounts (ZBA) and Sweep Accounts: Enhancing Cash Flow Efficiency

Zero balance accounts (ZBAs) and sweep accounts are valuable tools for optimizing cash flow management, particularly during periods of elevated short-term interest rates.

• ZBAs consolidate funds by maintaining zero balances in subsidiary accounts, automatically sweeping funds to or from a master account, as needed. This function streamlines funds transfers and helps ensure the liquidity needed for day-to-day operations.
• Sweep Accounts automatically move excess funds into investment vehicles like statutorily allowed money market accounts to earn better returns, while still maintaining full liquidity.

Municipalities should evaluate whether these account types align with their cash flow patterns and liquidity requirements. It’s also important to make sure banks are fully transparent with regard to account fees and investment returns so you can make well-informed decisions.

4. Necessary Collateral Coverage: Safeguarding Deposited Funds

Public fund deposits at banks often exceed FDIC insurance limits, necessitating collateralization to protect uninsured dollars. To maintain compliance with both regulatory and policy-based collateral requirements, be sure to:

• Confirm your bank(s) fully complies with state and local laws regarding collateralization of public deposits.
• Evaluate the types of collateral offered (e.g., governmental securities) and their market values.
• Monitor collateral coverage regularly to evaluate its sufficiency relative to impacted deposits.

Make sure your bank(s) provide regular reports on pledged collateral and require third-party custodians and proper documentation for all collateral to avoid conflicts of interest.

5. Cash Flow Consideration: Tailoring Services to Needs

A comprehensive understanding of cash flow patterns is vital for governmental entities to evaluate banking services effectively. Seasonal revenue inflows, such as property taxes, and consistent outflows, like payroll, should shape your banking needs. As you consider various relationship options, remember to:

• Analyze historical cash flow data to identify trends.
• Evaluate whether banks offer customizable solutions for your entity’s unique requirements.
• Seek banks that can provide advanced cash flow analysis tools or consulting which can help streamline liquidity management and financial planning.

Evaluating banking relationships is not a one-time task but a dynamic process which requires municipalities to balance safety, cost efficiency, and service quality. By focusing on the key areas discussed above, municipalities can establish strong, mutually beneficial banking partnerships. Add in regular performance reviews and open communication, and you’ll go a long way toward making sure your banking services and expenses evolve in concert with your municipality’s unique financial needs.

Ehlers can assist your entity in reviewing and maximizing your banking relationship. If you’re interested in learning more, reach out to your Ehlers advisor to schedule some time to discuss.

Required Disclosures: Please Read

Ehlers is the joint marketing name of the following affiliated businesses (collectively, the “Affiliates”): Ehlers & Associates, Inc. (“EA”), a municipal advisor registered with the Municipal Securities Rulemaking Board (“MSRB”) and the Securities and Exchange Commission (“SEC”); Ehlers Investment Partners, LLC (“EIP”), an investment adviser registered with the SEC; and Bond Trust Services Corporation (“BTS”), holder of a limited banking charter issued by the State of Minnesota.

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