Treasury Practice

All in the house

Published: Sep 2022

In-house banks promise greater efficiency and lower risk but corporate treasurers have been slow to implement the model.

Tortoise in natural environment

Defining an in-house bank isn’t straightforward, says Naresh Aggarwal, Associate Director – Policy and Technical at the Association of Corporate Treasurers (ACT). “If you look at in-house banks, you will find several look similar, but most are different from each other. Centralisation takes many different routes.”

An in-house bank is typically described as a dedicated finance or treasury entity that provides financial services including risk management (covering FX, interest rate and commodity hedging), cash management, funding and working capital. These services are offered to internal business units or affiliates of a company.

“Organisations that like to centralise certain activities will create shared service centres which concentrate many of these activities into just one location,” says Mr Aggarwal. “In the past, this location would be physical but it is now more likely to be a virtual location.”

Writing in the ACT’s International Treasury Peer Review, Diana-Iulia Macarascu, Head of Global Treasury Operations, BAT, noted that as businesses have become more complex and integrated, treasury departments are changing. “Today, treasury departments are becoming increasingly centralised and are integrating strategic delivery with operational and regulatory activities.”

The key to delivering ‘world-class’ treasury, she writes, is visibility and connectivity. ‘Empowered centralisation’ aims to eliminate duplication of effort to foster efficiencies and improve outcomes across the entire organisation. “Utilising a shared service centre space, with oversight of the information, policy and technology that supports treasury activities, can provide opportunities to bring centralisation to execution at an organisational level. It is no longer limited to purely transactional activities.”

‘Traditional’ treasury activities such as cash management can be improved to streamline bank relationships, fee monitoring, and payment consolidation to provide further control over transactions. Virtual accounts and automated matching can also enhance the order-to-cash delivery.

By creating an in-house banking infrastructure, a corporate treasurer can reduce financing costs and improve operating flexibility, she says. Centralised hedging strategies and processes allow for aligned systems and procedures, which in turn can improve visibility, netting, accounting and expert execution.

Writing in the same report, Chris Dibben, Director, Global Cash Management at GlaxoSmithKline, noted that technology can support an in-house bank for efficient cash management and consolidation of exposures. “By having an integrated ERP system and TMS, a treasury function can facilitate the settlement of a high volume of intercompany invoices through both cashless and physical netting as frequently as desired,” he wrote. “When combined with software to ensure matching of intercompany invoices, this can be performed each day and lead to the management of FX exposures on a daily basis. Through pulling forecast data into a TMS, the treasury function can look to manage future forecast FX and interest rate risk and perform the necessary valuations and assessments to meet the accounting standards in place – thereby minimising the P&L and cash flow risk to a company.”

In-house banks, combined with virtual accounts, are “powerful tools in the treasury space”, Mark Smith, Global Head of Liquidity Products, Transaction Banking at Goldman Sachs writes in a blog post. Despite this, US treasurers have been slower than their international peers to implement such solutions. Combined, they “can create big advantages for organisations”.

An in-house bank can centralise payables and receivables through shared service centres called payment and receipt factories. A payment factory is a centralised hub that manages an organisation’s payment processes and flows. Smith says a payment factory delivers greater efficiency through better automation, better straight through processing, better reconciliation, and reduced FX costs because cross-currency payments can be consolidated. A receipt factory delivers similar efficiencies to the accounts receivable process, while also improving working capital through faster cash application.

Virtual accounts, which function as subledgers that exist within a traditional bank demand deposit account (DDA), divide and organise the bank account data by assigning each incoming and outgoing transaction a unique identifier (a virtual account number). The number enables the bank’s virtual account engine to attribute all payments to a discreet virtual account. Each virtual account has an opening and closing balance and records all relevant incoming and outgoing transactions. “Crucially, the total of all the virtual accounts always equals the total on the physical account,” writes Smith. “So virtual accounts report the same information that a physical account reports; they are just subledgers within the account.”

Bank-issued virtual accounts can have the same structure as a physical account, says Smith, with individual customers issued a unique virtual account number. “This can greatly assist with receipts reconciliation because remittances from that customer are recognised by the virtual account engine and posted, simultaneously, to the correct physical account and the customer’s virtual account.”

Because of their ability to segregate and organise data within one physical account, virtual accounts can sit at the heart of an in-house bank, operating as the intercompany ledgers between the treasury entity and other group companies, Smith adds. While virtual accounts track intercompany transactions and descriptions, they can also administer intercompany interest, receivables and payables, further reducing the burden on the treasury team.

“Although the effort required to set up an in-house bank shouldn’t be understated, bank-issued virtual accounts can help with implementation, while delivering ongoing improvements to straight through processing and straight through reconciliation,” Smith says.

Writing in a blog, Barbara Babati, Head of Marketing at Finnish cash and treasury management solutions provider Nomentia, noted that most major banks offer virtual accounts, which some refer to as an in-house bank. However, such accounts are limited compared to an actual in-house bank, she contends. “It is a good first step for a smaller treasury group to centralise cash management, but the limitations should not be forgotten. Virtual accounts are highly dependent on banks – this may be a good solution if the company does not have countless banking partners. When you have multiple banks, the virtual accounts should be set up at each bank, however, it adds unnecessary complexity to your operations. Working with virtual accounts is also reliant on the banks to set up the banking structures and match incoming payments to invoices. Batching invoices to a single payment is also not possible. The solution is also entirely maintained by the bank.”

A first step in any in-house bank project should be to determine what you want to achieve, says Aggarwal. “In-house banks, shared service centres – none of these structures is a panacea. You have to work out what it is in response to,” he says.

There are many independent consultants who can help treasurers scope out a project and pose questions such as whether the in-house bank is separate from the finance function of semi-integrated. “Once you answer those types of questions, you then look to clarify what the structure itself will look like. This includes where it is located, who will work in it and what technology systems you should use,” says Aggarwal.

There are, of course, challenges in setting up in-house banks and shared service centres. Aggarwal says legal, tax and accounting implications are important to consider. Locations with a favourable tax environment should be considered, for example, as some countries impose withholding taxes on bank interest.

Other questions to consider include whether the in-house bank will make payments-on-behalf-of (POBO) and collections-on-behalf-of (COBO). When an in-house bank is used for POBO and COBO, all incoming and outgoing payments go through the group treasury so that the entity that pays or collects is mentioned in the reference field of each payment file. The payments are then settled between the group and the entities not by using external bank accounts but by using internal accounts hosted via the group’s ERP system. This may affect how a management charge is applied to the business. Technical tax, accounting and legal entity questions need to be resolved before decisions are made, he adds.

There are also cultural challenges to be considered, says Aggarwal. “A manager or employee within the treasury team may not want this to happen – change can be threatening, but the Covid pandemic has changed many of the rules of working.”

The pandemic accelerated the pace of many centralisation programmes within corporations, says Aggarwal. “With most treasury employees now working from home and remote technology having proved itself, virtual in-house banks can be more easily deployed.” Cloud technology means treasuries can deploy and treasury management systems, maintain or upgrade them “overnight”. Cloud technology moves an in-house bank further towards a virtual, rather than a physical, location, he says.

Heidi Dittmar, Head of Service and Delivery at fintech Broadridge says the in-house bank operations Broadridge supports are under many of the same cost pressures as their financial institution clients. “They face the same challenges with regards to responding to the new ISO 20022 message transformations and the speed at which cross-border payments need to be processed today, for example,” she says. “Outsourcing their SWIFT connectivity and messaging requirements to a mutualised service makes a lot of sense.”

In establishing and running an in-house bank, corporate treasurers need help in managing multiple bank relationships that cover their global operations, says Dittmar. “It’s essential that a service provider delivers seamless and highly secure connectivity with a user interface that makes it easy to consolidate money flows. This should enable analysis by operation, currency, bank etc to provide transparency for any complexity of global cash management or money market transactions, which increasingly is a cornerstone within the corporate industry to drive the decision process.”

Nomentia’s Babati believes in-house banks are becoming more popular, noting that “pioneering treasurers” are using them to centralise payments, collections and loans as well as to optimise liquidity and risk management.

“As the in-house bank is a proven concept that can be adopted at the own pace of an organisation, group treasurers are starting to show increasing interest in an in-house bank solution,” she says. “While the concept may be clear for many, the question may still arise: do we really need an in-house bank? How does it compare to virtual accounts or cash pooling? What are the core features? How do we implement it?”

The more subsidiaries a company has, the greater the benefit of implementing an in-house bank, she argues. An in-house bank is a “great tool” for centralisation and treasurers should ask whether they will get more from that than from a payment factory, for example.

“When you work with a payment factory and you roll it out for all your subsidiaries, you will need to connect all the bank accounts that are used for settling payments,” writes Babati. “Working with a cash management vendor that can provide a payment hub and bank connectivity will tackle the challenge of connecting all your banks, however, it’s more time-consuming than setting up internal accounts within the in-house bank for each subsidiary. The more banks you work with and the more bank accounts you have, the more reasonable it could be to consider an in-house bank over a payment factory.”

Aggarwal describes the moves towards shared service centres and in-house banks as a “slow march”. Treasuries are beginning to realise that risk can be better managed in a centralised environment, as well as operational issues such as staffing. “With an inhouse bank, instead of having treasury staff scattered around the world, you can have fewer staff in one location – virtual or physical.” Additionally, the risk of payments fraud can be minimised as payments are released from only one location. “An in-house bank enables a treasurer to put in place very strong preventative controls that can be checked on a more regular basis than when such controls are scattered around with varying degrees of responsibility.”

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