Cash Management: the In-house Bank – Part 2

Cash pooling interest optimisation solutions are commonly offered by banks in most geographical regions. Subject to the bank’s technical capabilities and to local tax and related regulations, two forms of cash pooling are generally available: notional pooling and zero-balancing.

Notional pooling involves the calculation of notional amounts of debit and credit interest on a group of physical bank accounts. The interest amounts are then netted together to calculate one amount that is then debited or credited centrally. In zero-balancing, debit and credit account balances are physically swept into a ‘header’ account; a single amount of debit or credit interest is calculated and applied to the header account balance.

In-house banking (IHB) technology plays an important role in managing both kinds of cash pooling. With notional pooling, the critical role is the reproduction of the bank’s interest calculations, and its allocation – in debits and credits – to the accounts of pool members. The IHB acts as a check and control on the bank’s operations, helping to detect and eliminate error.

IHBs play a major role in support of zero-balancing. Firstly, they can calculate and check – and even drive – the calculation and execution of the zero-balancing account sweeps. They can also accommodate leaving any required target or peg balances in swept accounts. Subsequently, the IHB will update internal accounts with reconstructions of each subsidiary’s pre-sweep positions, so that it can calculate and apply debit and credit interest accurately across the entire pool. Finally, the IHB can set up and execute the reverse sweeps, enabling the pool’s component accounts to be accurately reconstructed at the start of the next business day. In this case, the IHB technology has either managed the cash pooling sweeping process itself, or has validated it; and it has performed the required interest allocations among pool members.

In both cases, IHB technology enables the organisation to validate and enjoy the benefits of interest optimisation through cash pooling, and to allocate debit or credit interest accurately.

Inter-company Lending

An alternative approach to using IHB accounts for inter-company financing transactions is the use of inter-company loans. This method may be mandated in some cases by the dictates of regulation or policy.

This approach is less flexible than the use of IHB accounts; but may be facilitated by automated features, such as the generation of the mirrored side of a transaction: the IHB simply defines the loan issued to the subsidiary as a transaction, and the treasury management system (TMS) automatically creates the mirrored transaction and applies any transaction fee.

This use of automation is efficient, and eliminates the potential sources of error in a manual process. Its workflow logically and naturally extends to back-to-back transactions: in the case of a loan, the central treasury draws down from an external facility, and then allocates the proceeds to subsidiaries via a series of automated and mirrored internal transactions. The TMS controls this process, and will automatically generate the cross-referenced strings of transactions, which can be subsequently researched and reported. Such solutions have the additional merit of high audit quality. The IHB may, if permitted by treasury policy, take a spread on the internal allocation of borrowed funds.

The in-house TMS bank will automatically issue confirmations to the internal counterparties of the loan, and will automate subsequent interest management and rollover/maturity operations.

Inter-company Deposit Taking

Similarly, IHBs can replace commercial banks in taking deposits from subsidiaries. These funds naturally form the basis for the subsequent financing of inter-company lending transactions. The IHB may receive compensation for their operations by taking a spread on the interest credited to subsidiaries’ IHB accounts compared with their cost of internal or external borrowing.

As with inter-company lending, the IHB will confirm its deposit transactions with all internal and external counterparties. It will additionally perform the subsequent interest and principal management operations. The TMS will allocate, generate and link external deposits placed with the IHB’s transactions with subsidiaries from both parties’ perspectives – namely deposits taken and placed.

Inter-company FX and Commodity Dealing

Among the IHB’s primary functions is to receive and act on subsidiaries’ requests for executing foreign exchange (FX) and commodity hedging transactions. Requests to the IHB for cover are communicated to the centre via the web. Receipt should be automatically acknowledged by the TMS, in line with best practice.

Several areas of added value can be achieved by an IHB in this area, especially with strong technology support. The TMS can consolidate similar requests for cover, allowing dealing to plan and time market operations to optimise intra-day pricing. Consolidating amounts into ‘round lots’ of a suitable size commands the tightest market quotations, and the IHB’s expert dealers will be accordingly equipped to seek the best results for the enterprise in their market operations.

As with other types of dealing, the TMS will generate and manage confirmation and settlement of the external and internal transactions – providing a secure, transparent platform for hedging operations.

Other Deal Types

These same principles extend to all other types of in-house bank dealing in any permitted instrument, including trade finance letters of credit (L/Cs) and guarantees, internal allocation of the proceeds from capital markets issuances via term internal loans, and the transaction of all kinds of derivative – especially interest rate swaps. The TMS will organise settlement of internal transactions through the IHB and across its network of accounts, achieving a cost- effective and low risk result compared with external settlements.

Treasury Accounting

An IHB can assume the central functions of treasury accounting for its clients, the finance subsidiaries. This service can extend to the generation and export of accounting journals, and the preparation of accounting reports such as the subsidiaries’ balance sheet, profit and loss (P/L) and trial balance reports by the TMS. It can provide substantial added value by centralising a demanding technical treasury and finance function; for example as part of a shared services centre’s (SSC) operations. The provision of timely and accurate treasury accounting is achieved through the application of concentrated expertise and specialist technology.

Payments Management

All TMSs include the facility to export payments to banks, using bank workstations, file transfer and SWIFT messaging, or a combination of these. At the level of the IHB organisation, this function tends to overlap with the organisation’s management of payments on behalf of (POBO) and commercial bulk payments, through a payments hub or payments factory.

As a general rule, treasury is concerned with low volumes of high value transactions, and finance departments with high volumes of low-value commercial bulk payments. Treasury simply requires summary information about payment outflows, for cash positioning and forecasting purposes. On the other hand, in many organisations a payments factory must function efficiently with very large volumes of payments, and deal with cyclical volume peaks. In this area, the IHB bridges the disciplines of treasury and finance.

If a company needs a high volume payments factory solution, many TMS solutions are simply not designed to accommodate this. In outline, their database management process will not have been designed to manage high volume effectively, and performance may degrade geometrically as volume increases. Such requirements demand properly scalable solutions; and if such usage is projected for a TMS, it is imperative that effective volume testing and benchmarking form central parts of the system evaluation and selection process. One size does not fit all in this case.

Not all IHBs have bulk payments management as a central feature of their terms of reference; but those that do should make this requirement influences their technology selection project.

Conclusion

The deployment of IHBs continues to grow in corporate treasury around the world. Organisations are looking to benefit from the centralisation of resource and expertise that can be gained from an IHB. Additionally, they are seeking the costing and pricing advantages that be gained by concentrating cash management, hedging and other treasury operations in-house.

These developments minimise the needs for external dealing, enabling internal sources of cash to be detected and put to work, reducing demands for expensive external liquidity, and hence optimising interest income/expense performance. In-house banks support efficient cash pooling, and provide the means for radically reducing bank fees and overhead. The use of effective TMS technology – selected according to the specific business requirements of a particular IHB – is central to securing the many business benefits offered by a well-implemented IHB.

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