In-house banking: not just for big business

An in-house bank (IHB) is a structure within a corporate treasury organisation, providing various services which are traditionally performed by commercial banks. Until quite recently, IHBs were seen as the preserve of the largest corporations. This was based on the general opinion that substantial investment in technology and infrastructure was needed to create and sustain an internal banking operation that could provide the required scope and quality of services and therefore deliver effective and valuable results.

Contemporary technology has now brought scalable in-house banking solutions within the budget range of many more companies.

Who qualifies for an IHB?

Today’s efficient corporate treasury technology means that even organisations with an annual turnover of less than €1bn can now enjoy some – or all – of the benefits of running an IHB, provided that their treasury requirements reflect the appropriate levels of financial risk exposure and complexity.

Modern tools have radically reduced the costs and effort needed to set up an IHB, so more and more medium-sized organisations can join the multinationals and operate one in line with their functional business requirements – and their budgets.

As the financial threshold for justifying an IHB project has fallen, a growing number of treasuries globally are taking the opportunity to improve the quality and scope of their service provision to the parent organisation.

What goes on within an IHB?

Companies investigating the potential value of an IHB need to look carefully at which of their treasury processes would truly benefit from being operated in-house. Some common examples include:

• Companies which operate multiple subsidiaries can benefit from centrally controlled internal finance to provide low-cost, readily available liquidity managed by the IHB to fund their commercial operations, through inter-company loans and cash transfers to IHB accounts.
• Inefficient cash management results in poor visibility and hence utilisation of cash resources. An IHB enables the company to manage and control cash centrally, so that this critical resource can be accurately measured, and moved to where it is needed through enhanced cash positioning, forecasting and mobilisation.
• Additionally, an IHB can administer complex cash pooling arrangements, enabling organisations to concentrate cash, fund shortages externally, optimise interest performance and reduce external debt.
• Many organisations need to provide trade finance through guarantees and letters of credit (LoC) to facilitate subsidiaries’ commercial operations. The IHB functions as a central expert provider of trade finance to the group.
• Companies which have a complex pattern of internal transactions, resulting in high volumes of payables and receivables within the company, can benefit from a multilateral netting operation run by the IHB. Essentially, the netting process collects internal invoices, nets them together for each subsidiary and generates a single net settlement transaction per subsidiary (where legally possible). This eliminates most related external FX and payment transactions, cutting costs and eliminating operational risks.
• Organisations with significant exposures in multiple currencies can use the IHB to manage the risk centrally, and to execute the hedges required by treasury policy centrally and efficiently. The IHB might initiate hedge execution itself, or it might act on hedging requests identified by subsidiaries, according to policy. The IHB may include expert market resources, operating centrally for the benefit of the whole company.

Scaling an IHB

It is quite likely that smaller companies are not exposed to the full range of challenges outlined above. Today’s scalable solutions enable such companies just to implement those IHB components, which provide the most useful returns based on the actual challenges being experienced, so they can selectively target the most beneficial IHB functions to implement, and keep costs under control.

Of course not every company needs an IHB. If an organization has only a few subsidiaries and bank accounts, and limited FX exposure, an IHB is unlikely to be justified. However, if financial transaction volumes and risks are found to be growing, IHB investment may well be justified, to secure and formalise aspects of treasury, enhance control, reduce risks and secure profits and revenues. Ultimately it’s the level of the underlying risk that can justify an IHB investment.

Setting up an IHB

Companies setting up a new IHB operation are, inevitably, confronted with the need to comply with a formidable mass of relevant legislation. The details of regulation vary from country to country. In Germany, for example, there is a specific set of regulations relating to IHBs known as the ‘Konzernprivileg’. These are designed to make matters more straightforward – and thus more cost effective – for qualifying IHBs.

IHBs may be established in Germany with or without a banking licence, as is the case in other jurisdictions. IHBs established without formal bank licencing are exempt from many of the onerous reporting and compliance obligations which are imposed on commercial banks; but their operations are tightly constrained, so that they may only conduct banking business with their parent and with the group’s subsidiaries and affiliates. These are not onerous restrictions for most corporates, which are focused on efficiency and control priorities within their organisation.

Corporations which are permitted and able to do so will identify IHB locations, which will allow them the highest levels of flexibility in their operations. They can then maximise IHB benefits relating to cash utilisation, funding and tax efficiency.

Organisations which operate in Organisation for Economic Co-operation and Development (OECD) member countries are subject to a range of transfer pricing regulations. These are designed under the ‘arm’s length’ principle, which aims to ensure a fair tax treatment of profits that arise from transactions between related parties. For an IHB, this means in practice that inter-company borrowings – for example – must be transacted at rates which reflect the current external market. IHB operations need to be transparent, so that both sides of an inter-company transaction are clearly reflected.

The efficiency and scalability of today’s IHB implementations mean that it is straightforward and cost- effective to roll out additional IHB functionality when the need has been established through the growth and diversification of the business, and therefore of the related financial flow management requirements. Thus, for example, a smaller enterprise might initially implement a multilateral invoice netting solution to provide a more streamlined solution for settling intercompany transactions.

Over time, the solution might be extended to the set-up and operation of internal bank accounts, to reduce some external banking operations, eliminating the related bank charges. Eventually, the use of these accounts can be extended to facilitate funding through internal overdraft facilities and the centralised investment or deployment of surpluses. These extensions will naturally be subject to the transfer pricing legislation applicable to IHB operations.

IHB benefits for general finance

The implementation of an IHB tightens and formalises many aspects of a corporate’s treasury operations; leading to gains in control, efficiency and transparency and to the reduction of operational – and perhaps also market – risk through improved internal and external dealing and payment processes.

This general procedural improvement is also often related to other initiatives to enhance the management of finance operations, as IHB process, discipline and technology is extended beyond the traditional boundaries of the treasury department. Examples include a range of working capital optimisation projects in areas such as debtor and receivables management, which essentially work to accelerate invoice collections. IHB functionality may also be usefully extended to performing operations on behalf of business units – payments-on-behalf-of (POBO) and receivables-on-behalf-of (ROBO) – making further use of treasury’s professional expertise for improving the quality and efficiency of the organisation’s cash management.

Payment factories

IHBs can evolve into payment factory solutions, taking advantage of the technical and control benefits of centralising and standardising the company’s global payments management. Central payments control and visibility enhance the quality and security of this most sensitive business function. The complexities of managing different global payments channels with a global network of bank accounts is integrated with professional IHB operations.

Maximising IHB benefits

Organisations seeking to take maximum benefit from IHB and related implementations need to work closely with their technology partner so that all parties can work effectively to deliver the best solutions.

Today’s powerful and flexible technology enables finance professionals – as opposed to technologists – to perform the required configuration operations using non-technical and intuitive tools. The practical results can be delivered quickly through robust and secure systems, keeping the business user in close touch with the processes they are operating. This means in practice that the IHB solution very closely reflects the business processes which it is supporting. This marriage of technology and business is the key to delivering a successful IHB project.

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