They say that if an idea seems too good to be true then it probably is. But the concept of virtual accounts appears to be offering a number of major benefits to corporates that few would decline if they knew about them. What are they and how do they work?
Imagine a bank offering that can help rationalise the number of physical accounts held by a company and also allow that company to simplify the management of its accounts. Imagine also if that same solution enabled a business to gain superior visibility over its cash and liquidity and head off accounts receivable (AR) and reconciliation issues at a stroke. And all this without adding layers of complexity or expensive technology.
By most treasurers’ standards, it would seem like a rather good idea. And yet, even though such an offering already exists, the virtual account is far from being mainstream.
What is a virtual account?
Along with their associated account ‘numbers’ (or, perhaps more correctly, ‘identifiers’), virtual accounts are provided to a corporate by its banking partner. Essentially each account is a ‘subsidiary’ or sub-account of the client’s own physical account with the bank; they cannot exist outside of that immediate relationship, hence they are virtual. The identifier serves to segregate any funds from any other funds in the same main account and yet is inextricably linked to that account.
The key to a virtual account is thus the virtual account number/identifier. This may be provided to the client by the bank (in which case it will typically be structured like an IBAN) or to the bank by the client. If the client provides the identifier, it will commonly adopt customer identifiers – customer account numbers, for example – drawn from its own system of record such as an ERP or TMS. Either way, it eases subsequent integration of account data into those systems, potentially facilitating the full automation of payments and collections processes, which for in-house banks, payments on behalf of (POBO) and collections on behalf of (COBO) operations, is just perfect. It may also be possible for the client to generate virtual accounts using its bank’s online ‘self-service’ tool.
Regardless of how the accounts and their identifiers are created, each one will be uniquely assigned by the corporate to each of its own customers that it wishes to bring into the structure (in a large business this may be both external and internal). In theory there is no limit to the number of virtual accounts that a corporate may append to one of its physical accounts and it is entirely feasible to establish a multi-level hierarchy of virtual accounts to mirror the structure of its business relationships.
Why go virtual?
Typically, virtual bank accounts will be used to manage the allocation and reconciliation of high-volume, low-value transactions. According to Finnish banking technology vendor, Tieto, they may also be used in a supply chain context “to satisfy reconciliation requirements for supplier remittances and receipts”. The vendor says that virtual bank accounts can also be used “where customer pre-funding for an activity is required, such as investments”.
In the European market there is a serious driver for the adoption of such a solution right now. As part of the technology preparations for SEPA, many companies have been busy centralising their payments and collections processes. The pressure to re-engineer these processes has inevitably given rise to concerns around receivables, credit and risk processes. This ‘need’ is propelled further by the desire also to draw on internal liquidity rather than rely on bank funding. Anything that can enhance the mechanisms of payments and collections factories must surely be a welcome source of relief.
In the banking space, RBS has been offering virtual accounts to its corporate clients in Asia since 2011. Development and roll-out has taken place in the region because it is home to a number of jurisdictions where, says Vanessa Manning, EMEA Head of Payments and Cash Management, RBS, “local clearing truncates so much information that customers were unable to easily adopt straight-through reconciliation processes”. RBS is not alone in thinking this is a good idea – institutions such as HSBC, Deutsche Bank, UniCredit (see case study below), Allied Irish Bank, Barclays and Bank of America Merrill Lynch (BofAML), as well as providers such as Korea Exchange Bank and Indonesia’s Bank Mandiri, all offer virtual accounts in Asia, for example.
Wherever a business may operate, most are focused on accelerating their cash conversion cycle – applying cash faster and improving their reconciliation and DSO (days’ sales outstanding), notes Manning. Increased DSO obviously has a negative impact on working capital requirements, just as failure to reconcile remittances efficiently can lead to chasing payment from a customer who has already paid – streamlining the credit control process is vital in establishing an accurate picture of individual client and overall income, not just in being able to extend credit to good payers but in quickly tackling delinquent accounts.
Many businesses are also focused on the consolidation and rationalisation of their bank accounts: virtual accounts can be used to eliminate the need for many physical accounts. This can reduce counterparty risk (especially where smaller local banks are used) and remove associated account management costs. “A virtual account has a far lower impact in terms of the cost, central bank reporting and audit requirements than a physical bank account has,” comments Manning. But it is not just the immediate cost that is saved. Fewer accounts can mean increased standardisation and automation of processes which in turn facilitates automatic processing and matching which is faster, more accurate and cheaper than doing it manually.
Typically, virtual bank accounts will be used to manage the allocation and reconciliation of high volume, low value transactions.
BofAML is currently piloting its virtual account offering with a number of large corporate clients and, says Ad Van der Poel, Co-Head of Product Management, Global Transaction Services, EMEA, for BofAML, businesses are expressing interest in the concept, mostly around receivables reconciliation.
Banks offering virtual accounts are unlikely to let the concept rest without further development. In the context of receivables reconciliation, virtual accounts may be, as Van der Poel says, “just a very granular level of reporting”, but he argues that the centralisation of treasury or set up of shared services centres to handle both COBO and POBO really does have mileage.
By opening virtual accounts for each entity within a group and appending sub-level virtual accounts to these, clients of those entities can effectively remit to a central account (whether national, regional or global) using their own unique virtual account identifier. “In this case it is not so much used to identify the payer but more as a tool for visibility and control over what each entity is doing,” explains Van der Poel. As a variation on (or even replacement of) the pooling concept, it can facilitate genuine benefits around liquidity management.
With high-volume, low-value payments being the bread and butter of virtual account deployment, Van der Poel offers an example of how they might be used in this context.
A business may own real estate in three countries, with multiple properties in each country and multiple tenants in each of those properties. That business may have a single bank account in its name, or one for each country. If the tenants of each property pay their rent into the bank account, in some cases it may be difficult for the business to identify where certain payments come from and what they represent. In this example, it could be that the tenant did not complete the payment details correctly or it may be that the banks involved in the process (including the clearing bank which may limit the number of characters permissible in the reference field of a payment instruction) either did not have access to or pass on all the invoice data. Payee error tends to occur more in the consumer space than in the professional accounts payable function but errors do occur nonetheless.
To resolve the problem for the property owner in the example, one physical deposit demand account (DDA) could be established in the owner’s name and one virtual account could be created for each country. Below each country level, one virtual account could be set up for each property in each country. Taking this down another level, it would be possible to then create a virtual account for the tenant in each property. This hierarchy of accounts may sound complex but in reality there is only one physical account supporting that structure. In the example, each tenant pays into the account assigned to them, which is connected to the property’s account, upwards to the country account and on to the physical account. Payment at the tenant end shows immediately in the physical account.
As another example of how a business might benefit from the adoption of virtual accounts, consider the franchise business model, says Van der Poel. The franchisor is in a central position, supporting its network of franchisees with goods and services for which the latter must at some point be invoiced. If the franchisee is typically paid in cash (as for example a fast food restaurant would be), it will normally have a bilateral agreement with a cash collection service, there being many such agreements across the full franchise territory.
However, the franchisor could make a bilateral agreement with a cash collection agency to collect and deposit into virtual accounts cash from all of its franchisees across a certain territory – each franchisee having its own unique identifier and account linked to the central DDA held by the franchisor. Via the virtual accounts, it could net-off its invoices for goods and services payable by the franchisee, paying out the balance. “If the franchisor takes the idea no further than this, it will still offer savings around the cash collection process, provide it with increased visibility over all funds coming in at a centralised level, and make savings across the whole invoice-to-pay process.”
Rules and regulations
“Any centralised receivables programme which would see a company regionally collecting into one account on behalf of other jurisdictions would continue to have the normal tax and legal consequences for ‘on behalf of’ traffic,” says Manning (referring to both COBO and POBO models). Adoption of the model “does not mitigate nor cause any new actions”. However, she adds, “the need remains for banks to work with customers to make them aware of transactions that can be done onshore, offshore or on-behalf of, and the considerations around that.”
Indeed, says Van der Poel, “it is important to consider that virtual accounts are not yet subject to direct regulation”. Although nothing has yet been formalised, industry hearsay suggests that virtual accounts have attracted the regulators’ attention around their use as a POBO mechanism (but not COBO). “Because a virtual account doesn’t really exist in its own right, this forces an interesting discussion,” he comments. “We need to keep an eye on how regulation evolves and on what the opportunities or limitations may be.”
Each bank will thus need to undertake “full and proper legal, regulatory and tax analysis” in each country in this respect.
Too good to be true?
As a relatively easy add-on to a normal corporate bank account, the virtual account concept can deliver a raft of efficiencies around account ownership and management. For the treasurer it means being able to centralise cash whilst retaining some segregation and delineation without the increased complexity and cost of running physical accounts. For the finance function in general it can accelerate collections and release liquidity from a corporate’s internal working capital flow by reducing the dependency on information from the payer, their bank or clearing institution. It can also give broader and deeper real-time visibility over physical account data and enhance the credit control process. Still too good to be true?
B. Braun’s healthy option
Head of Treasury – Cash Management
Through its SAP-based in-house bank and payments factory, global healthcare market giant, Germany-based B. Braun is able to receive payments files and make payments on behalf of (POBO) transactions for around 100 group entities throughout the Eurozone using SEPA and working with different banking partners. The plan is to include Singapore and the US in the near future and eventually roll this out to most of the group’s 200+ entities located in more than 60 countries.
As part of B. Braun’s HR function, some locally managed payroll payments are, for a variety of reasons, made in-country, not through its SAP-based payments factory. In such cases it has adopted the virtual account solution provided by UniCredit. “Creating a virtual account is very easy; the bank gives us access to an online portal, we say what we want and that’s it; we can start work,” explains Rainer Stirn, Head of Treasury – Cash Management for B. Braun.
Currently UniCredit is providing each in-country HR unit with its own IBAN-based virtual account number, aligned with a single ‘real’ account held by group headquarters. This enables each entity to send its payment files (which could contain several hundred individual payments) via headquarters to the bank which will make the payments (via SEPA), finally debiting the ‘real’ account.
“The advantage for us is that headquarters receives an electronic bank statement referencing each virtual account transaction. Our SAP system is able to post these items automatically to the correct in-house cash account,” notes Stirn. For him, the solution has quickly and easily provided a “perfect loop” for these payments. Although it handles most major currencies, he notes that SEPA has worked extremely well with the virtual concept “with few adjustments required”, SAP and the whole infrastructure having already been set up to process these payments.
The next phase of the roll-out of the virtual account solution will enable B. Braun to process incoming payments from customers via its centralised collections on behalf of (COBO) operation. This will use much the same system as for payments but in reverse. Each entity in the group has its own IBAN-based virtual account number linked to its own in-house bank account. This means that when an invoice is paid using the virtual account number, the system will automatically credit the in-house bank account of the relevant entity. The in-house bank is able to send to the group entity that is being paid an electronic in-house bank statement containing all the details to enable it to clear the open item on its own books. “The final goal is to concentrate the outgoing and incoming payments so that group companies only have an account with our in-house bank” says Stirn.
With multiple bank accounts for group companies and a multi-currency cash-pooling structure, B. Braun is working to reduce that complexity and reduce the number of local bank accounts it needs, notably those opened just to handle foreign currency receipts by group entities. Whilst he admits that it might not work everywhere, now that virtual accounts can centralise cash automatically, Stirn views cash pooling as “a product from former times”. He believes that centralisation using virtual accounts offers considerable savings in terms of time spent managing bank accounts and that most real accounts and cash-pooling transfers suddenly become unnecessary. It is a cost and efficiency saving that B. Braun fully intends to exploit.