Given the current context of sluggish economic growth, growing protectionism, increased regulatory oversight and technology disruption, the conservative treasurer could be forgiven for favouring the status quo of staying with business as usual.
On the other hand, the brave might argue that, faced with all these uncertainties, now is the right time to streamline processes, review current structures and adopt an agile model, which will enhance responsiveness to support strategic decisions from the board. In-house banks (IHBs) may be the operating model to work towards.
IHBs are business units or departments within the treasury functions, typically modelled to execute key operations such as funding, liquidity management, intercompany lending, foreign exchange (FX) management and settlements. Designed to support business growth and bring further control and visibility to treasury operations, IHBs often represent the ultimate achievement for any treasurer wishing to transform the treasury department within their organisation.
There are different levels of IHBs, especially in terms of operational coverage, all with a common goal towards centralisation.
While the objectives of the IHB are to reduce risks and minimise costs – or in some rare cases, to generate profit – the benefits are:
- Gain greater visibility of cash flows.
- Better reliance on efficient cash flow forecasting and planning.
- Ability to offset FX exposures and hedge group positions.
- Optimising liquidity and funding.
- Lower the volume of external payments.
- Reduce the number of bank accounts.
- Allow netting of intercompany invoices.
The central theme towards IHB is centralisation. IHB can only work where at the strategic level, the chief financial officer (CFO) or treasurer choose to drive the treasury organisation in a centralised manner. With that, the benefits of having IHB are highlighted in Deloitte’s 2015 Global Corporate Treasury Survey:
Where to begin?
The adoption of the IHB model can be done progressively, either by layering different treasury activities within the IHB, or by adding new geographies/business units as participants to the treasury structure.
A recommended approach would be to centralise operations in the following sequence:
- Optimisation of group credit lines and internal funding.
- Enable internal FX transactions.
- Setting up multi-lateral netting.
- Implement liquidity structures to support the IHBs.
- Institutionalise payments on behalf of (POBO).
- Facilitate collections on behalf of (COBO).
The IHB maintains multiple internal current accounts to reflect the various intercompany transactions with subsidiaries. Each month an internal bank statement is published and interest is either settled quarterly or included in the year end profit and loss (P/L).
While IHBs usually charge their services through cheaper interest and FX spreads than the subsidiaries would have paid with their external banks, some other centres do not charge interest, but a monthly pre-defined management fee.
In Asia, some companies will operate an IHB in their local currencies if most of their business is domestic, while others will typically segregate the activities of the IHB into two distinct groups:
- Fully-owned operating companies (OpCos) in free market economies, such as Hong Kong, Singapore, Japan and Australia.
- Fully-owned OpCos operating in regulated countries, such as China, Indonesia and Malaysia.
For this second group, the IHB will perform central operations on an agency model and settle through external bank accounts. While it may not achieve some of the benefits described earlier, it will still give the authority to the central treasury and optimise processes.
In reducing the number of bank accounts and bringing them in-house, external flows are translated into inter-company balances, thereby bringing in a number of additional tax complexities – withholding tax for non-resident accounts, thin capitalisation and transfer pricing. Also, the rolling out of the Organisation for Economic Cooperation and Development’s (OECD) base erosion profit shifting (BEPS) project will also have a direct impact on IHB structures. Treasurers need to collaborate with their tax advisers to better understand the tax regulatory landscape.
In-house banks technology
To promote efficiency, a centralised treasury structure will need to have a robust treasury technology infrastructure as its spine. While it is still acceptable to use Microsoft Excel spreadsheets at the OpCos level, the new business process workflows, controls and enhanced collaboration will require the adoption of an IHB cash module or other treasury technology platforms.
OpCos need to be able to submit their various FX or funding request to the IHB, which will then provide a quote and approval for internal dealing requirements. In some large organisations, an order management system, such as FX portals, are being used in a same way that commercial bank branches would deal with their central treasury.
Through a centralised system, OpCos can also gain visibility on their IHB position and know what their contribution to the group liquidity is.
Operating like a bank, the IHB model accelerated the adoption of SWIFT for corporates. Traditionally, SWIFT was the payment/message technology used by global banks to move funds. Today, more than 1,700 corporates use SWIFT and the share of Asian companies joining the community is growing year-on-year.
Have your operating bank run your in-house bank?
Interestingly, while the idealistic goal of an IHB is to operate with zero bank accounts for its subsidiaries, it cannot work without at least one banking partner providing liquidity solutions and foreign currency accounts onshore or offshore to the IHB. Liquidity structures can be a mix of cash concentration (sweeping) and notional pooling. As cross currency pooling can be restricted in some locations, the central treasury can still consolidate cash through in-country or regional pooling structures.
While it was common a decade ago to use treasury management systems (TMSs) to generate balancing transfers, calculating the monthly interest on internal accounts or external pool structures, banks have invested in technology to run liquidity operations on behalf of their customers. These banks are able, through their own channels of e-banking, to deliver the necessary liquidity reports and results. Consequently, a company’s TMS just has to match the numbers and raise the accounting entries. There are also some commercial banks that propose to companies to outsource the IHB function and that is achieved through virtual account technology.
Collaborative change communication
In order to embark on setting up IHB, it is critical to ensure buy-in from all stakeholders, especially the various finance managers at the OpCos level, for them to give up access and control to domestic cash.
Imagine if you were a child being suddenly told that you cannot have pocket money anymore and your piggy bank savings would be used to fund your sister’s school fees. It would require some patient parenting to justify such measures.
Open communication and transparency is key in changing the mind-set of stakeholders. It comes through showcasing the gains for the group, and also recognising that collaboration is essential for achieving these milestones.
Like in any project, change management needs to be closely monitored and a detailed business case for change needs to be clearly articulated.
Treasury transformation is very often exciting and complex at the same time. It has taken some established organisations years to finalise their IHB structure. In return, these IHBs introduced robustness and flexibility which have helped those companies to be more proactive towards external events.
Treasurers should always be forward-looking and above it all, to stay laser-focused on the future state of the treasury organisation – targeting operating models, new financial products, and treasury technology.
Behind every successful treasurer is a village of supporters – senior management, central and local finance/treasury teams, cash management banks as well as tax and treasury advisers – to help them along on this journey.
Last month BNY Mellon and Volante Technologies announced that they had been collaborating to enable BNY Mellon to become the first bank to successfully originate a real-time payment over the Clearing House’s (TCH) new Real-Time Payments (RTP) network.
Liquidity management is a cornerstone of every treasury and finance department. Those who overlook a firm’s access to cash do so at their peril, as has been witnessed so many times in the past
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