Often cheaper and faster than using external banking infrastructures, in-house banks can revolutionise a company’s cash flows and significantly reduce the expensive time cash spends stuck in the banking system. But given that corporates must streamline their payment processes and increase the visibility and control over cash flows first, Treasury Today explores the role of a treasurer in implementing the structure.
Predominantly established by medium-sized businesses upwards, an in-house bank (IHB) acts as the main provider of bank services, which are traditionally provided by commercial banks, to all group subsidiaries – on a regional or global scale. Rather than relying on local external banking partners, therefore, each subsidiary directs its cash flows through accounts held at the IHB. The internal bank is then responsible for netting out the resultant debit and credit balances across the whole group. This structure can result in huge savings of both time and money, as well as boasting limited disadvantages (see Table 1), so what do treasurers need to know?
Firstly, it must be noted that IHBs should not be seen as the first port of call when trying to streamline cash flows and payment processes. There are several other elements that are needed in conjunction: efficient external payment processes, shutting down bank-specific payment tools and electronic payment stations, making sure you have straight through processing established and cleaning master data and bank account management, for instance.
The reoccurring advice is to start with the standardisation and automation of payment processes and then establish an in-house bank to achieve the added value from this. For instance: a consolidation of FX transactions and a greater ability to recycle cash within currencies.
Table 1: Advantages and disadvantages of an IHB
Advantages
Disadvantages
Economies of scale achieved.
Group treasury must be confident that each subsidiary will submit all its transactions via the in-house bank.
The number of bank partners and bank accounts is streamlined.
Loss of interaction between local subsidiaries and local banks may reduce local competence regarding treasury and banking issues.
More competitive rates are offered to subsidiary borrowers and lenders, compared to those that may be obtained locally.
Group treasury has greater control, improved transparency and access to more accurate data.
Group treasury can operate the in-house bank as a profit centre.
Communicating benefits
The implementation of an in-house bank should be seen as a transformation project, and its design is not to be planned in isolation but in partnership with the overall business. The structure’s benefits need to be articulated to the key stakeholders. Treasury should demonstrate to all areas of the business how an IHB can add value. Since treasury teams are under increasing pressure to drive down internal operational costs and to increase visibility and control, the argument for IHBs is persuasive.
What’s more, core banking partners should be brought into the early stages of development to provide the banking infrastructure and consultancy expertise necessary. This is because when all of the internal transactions have been carried out by the IHB, any remaining investment, financing and hedging needs will be fulfilled by the company’s preferred group of external, relationship banks. IHBs should be seen as complementary to existing bank landscapes.
It would be wrong to assume that traditional banking relationships suffer – the set-up may actually deepen them. IHBs are often run with the support of just one of two banks, to carry out final stage transactions, so they are likely to handle more flows than previously. This isn’t to say, however, that IHB structures necessarily suit every company. The benefits of IHBs are dependent on the presence of several factors, including:
The number of countries (and different currencies) involved with the company’s outgoing payments.
FX volume and extent of hedging activities.
The number of transactions – internal and external – treasury is responsible for.
Total amount of bank fees.
Group structure and geographical distribution of operations.
How centralised treasury management is, including the IT structure (ERP systems, interfaces and electronic banking systems, for instance).
Some global considerations
By extending the IHB structure into payables and receivables, regulatory hurdles in some regions are encountered. This meant, for some time at least, corporates had favoured a more traditional set-up – in Asia, Latin America and Africa for example. But recently, the popularity of IHBs in Asia has been on the rise; expansion has been occurring rapidly in some of the less restricted markets such as Hong Kong, Singapore and Australia. In these markets, the IHB processes payments and collections through its own accounts but where the use of local currencies for cross-border transactions is restricted, an account held in the name of a local entity can be used. Even in extreme cases where the IHB can only operate as a processing agent – utilising local accounts held by subsidiaries, rather than accounts held with the IHB, to process payments and collections – benefits of standardisation and greater control can still be felt.
Careful due diligence, in terms of the legal, tax, accounting and technology issues, is required for each market in order to address whether any level of local customisation of the IHB structure is necessary. Often, specific in-country requirements will drive an IHB’s operations.
These considerations also relate to other regions like Latin America and Africa, both of which are very diverse with regulations varying from country to country. Significant constraints exist in what form payments-on-behalf-of (POBO) and collections-on-behalf-of (COBO) can take. Therefore, a one-size-fits-all policy cannot be applied and there is a need to be flexible. Treasurers can lean upon banking partners, tax advisors and legal advisors to ensure the correct understanding of whether an IHB structure can be implemented and if so, to ensure that this is done correctly.
Some considerations in Asia
The regulatory hurdles in Asia meant, for some time at least, corporates in the region favoured a more traditional set-up. But recently, the popularity of IHBs in Asia has been on the rise; expansion has been occurring rapidly in some of the less restricted markets such as Hong Kong, Singapore and Australia. In these markets, the IHB processes payments and collections through its own accounts but where the use of local currencies for cross-border transactions is restricted, an account held in the name of a local entity can be used.
Even in extreme cases where the IHB can only operate as a processing agent – utilising local accounts held by subsidiaries, rather than accounts held with the IHB, to process payments and collections – benefits of standardisation and greater control can still be felt. Careful due diligence, in terms of the legal, tax, accounting and technology issues, is required for each market in order to address whether any level of local customisation of the IHB structure is necessary. Often, specific in-country requirements will drive an IHB’s operations in Asia. In South Korea, for instance, strict data privacy rules will restrict any IHB holding company data offshore.
Location, location, location
In order to provide the most value to the business, the location of the IHB needs to be considered too. This selection process will involve wider elements of an individual company’s operating model, such as: current business operational locations, whether certain countries have specific requirements, associated tax and regulation issues and the company’s articles of association. For those countries with nuances, it is advised that control is centrally maintained, even if the country’s bespoke model sits outside the main IHB structure. For instance, the IHB executes the transactions in the name of the local subsidiaries.
To avoid centralisation and standardisation being compromised by country-specific concerns – local payment instruments, technology capabilities and banking infrastructure maturity, for instance – explicitly entails a large amount of research prior to implementation of a full service IHB available to all subsidiaries of a group. Including exceptions and nuances in the overall design will ensure treasury’s key priorities, compliance and operational risk for instance, are not undermined.
However, the end visibility this affords is important to the success of an IHB. By having more control over all payment traffic, treasury can provide strategic information to the board – in turn, allowing them to make informed decisions. Any organisation considering rolling out an IHB structure should evaluate the costs, of course. But other factors to address before implementation include: educating the workforce, deciding upon new workflows and who will carry out what. Clear segregation of duties is needed when operating an IHB. There are various banking functions, such as bank account services, financing and hedging services and payment services, which can be brought in-house but it might not be in every case worthwhile to implement all.
Any changing of processes need to be well articulated to local teams. Starting with the benefits may ease some of the potential frustration as a result of losing control. For instance, from the local entities perspective, the IHB bank account will function like any other bank account. Employees can settle payments and receipts, as well as monitor such activities. Additionally, IHBs are closely linked to the company’s ERP system and treasury systems; subsidiaries can export statements to integrate with AR/AP and accounting systems.
Internalising banking services
The centralisation of treasury operations has been an increasingly valuable proposition for some time now, but one which recent technological advancements and regional harmonisation are allowing to gather momentum. Although an IHB structure can also be used to enhance operations whilst keeping a decentralised structure, one of the major drivers for establishing one is the centralisation of liquidity.
Working capital optimisation, bank fee reduction and returns on idle cash are some of the many benefits corporates can expect from an IHB, which, in the current climate, would be well received. However, it is that same climate where the greatest threats to IHB structures originate – currency restrictions, political sanctions and regulation are the key things to bear in mind in 2016.
Case study
Founded in 1895, Firmenich SA is a private Swiss company in the perfume and flavour business. Employing 6,000 people globally, Firmenich is the largest privately owned company in the industry and ranks number two worldwide.
The challenge
As part of a global financial transformation project – to ensure that it had the necessary structure and governance to operate with rigour and discipline moving forward – Firmenich was looking to replace its traditional decentralised cash management solution with a global solution.
One of the company’s requirements was to reduce the number of external banks used by the affiliates to one core bank while offering, at the same time, the possibility to opening internal bank accounts with the in-house bank (IHB). Firmenich also wanted to deliver uniform payment and security processes, to ensure compliance with its risk management and internal control standards and to deliver true automation.
The solution
After putting the mandate out to tender, Firmenich selected BNP Paribas for Europe, Citi for the rest of the world with the exception of the CHF covered by UBS to be their partners for the new solution. Working together with the banks Firmenich implemented a global cash management solution covering all 28 affiliates allowing them to join its global cash pooling solution as well as its inter-company netting process. This was completed by the implementation of a payment-on-behalf-of (POBO) structure serving more than 20 affiliates.
In less than two years, Firmenich has set up a global IHB. This was made possible by the existence of a single SAP instance (ECC6 version) implemented earlier to which two new SAP modules (IHC and BCM) were added to run the IHB. Today, the IHB is:
Heading a global cash pooling structure (26 affiliates zero balanced on a daily basis on master accounts held in Switzerland and UK), offering full control on the cash around the globe.
Running an internal netting (ICO) process to settle the payables and receivables of 25 affiliates.
Paying on behalf of 22 affiliates using only three banks.
Providing a complete change in the payments process of the company, transforming inter-company payments into internal settlements with no cash transfer and cross-border payments into domestic payments.
Key benefits include: reduced reliance on bank credit lines, reduction in bank charges, productivity gains (on average, 800 intra-group invoices are processed on a weekly basis without any rejection) and a daily view on more than 95% of the total cash of the group, out of which more than 75% is captured by the cash pooling structure.
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