In-house bank (IHB)
In-house bank (IHB) is a powerful set of processes and systems that help MNCs increase efficiency, reduce risk, and tighten control. Implemented properly, IHB centralises foreign exchange, funding (and with it interest rate risk), liquidity, intercompany, payments and collections. If that sounds like a big deal – it is!
The term “In-house bank” is loosely used in two ways.
Some people use IHB to refer to treasury centres, which typically transact intercompany loans, deposits, and FX with subsidiaries (who continue to use stand-alone banks accounts and so forth).
IHB as discussed here is anchored by the use of (multi-currency) intercompany current accounts that replace bank accounts altogether for operating subsidiaries.
In full IHB, operating subsidiaries have no bank accounts in their own name at all – they do all their payments and collections through their IHB intercompany current accounts.
The table below compares certain aspects of operating subsidiary processes standalone vs treasury centre vs IHB:
ICA=Intercompany Current Account
As will be apparent from the above, IHB is the ultimate treasury centralisation tool. As such, the scope of IHB can be very wide, and the implementation correspondingly complex, especially in restricted markets.
Whereas connecting operating subsidiaries to a treasury centre typically shifts their wholesale banking needs (loans, deposits, FX) from banks to treasury centre, full IHB centralises all operating subsidiary banking needs.
Not all IHB implementations include all possible aspects of IHB but here are some of the operating subsidiary activities that are often included:
FX risk management.
IR risk management.
Payments on behalf (including payroll, administrative and statutory payments).
Receivable/collections on behalf.
Intercompany settlement (balance netting through intercompany current accounts, as opposed to payment netting).
Many IHBs additionally provide business support services in the financial aspects of contracting such as FX and counterparty risk, subsidiary capital structure, and taxation of financial transactions. IHBs often centralise and manage guarantees for operating companies in businesses where this is pertinent.
Given the scope of IHB, regulatory constraints are a major issue in restricted country roll outs. Countries in Asia often present regulatory challenges. The consensus is that only five countries in Asia qualify as light regulation markets – Singapore, Hong Kong, Japan, Australia and New Zealand. In these countries, full IHB is possible (though quirks in Japan’s domestic practices – for example, statutory payments – can be challenging for holistic payments on behalf).
The regulations that most constrain IHB include exchange controls, capital structure limitations, regulatory bank accounts and so forth. In general, IHB implementations work with local regulators, advisors, and banking partners to optimise processes in order to achieve maximum efficiency while complying with regulatory constraints.
As an example, countries that do not allow netting of cross border flows often allow aggregation of inflows and outflows separately – aka gross in/gross out – which still allows considerable cost savings and control improvements.
Another example is agency dealing where intercompany FX is not allowed.
All cross border treasury operations have tax impacts (as do some domestic ones). IHB is normally more focussed on cost and control than on tax, and IHBs tend not to generate massive profits because of their focus on processes and control, but clearly tax can be a significant cost element. Massive profit shifting using intercompany loans at off market rates is largely a thing of the past, after a decade of global focus on BEPS (base erosion and profit shifting).
Recently, under the auspices of the OECD, 130 countries have signed up for a “bold new framework for international tax reform” of which a 15% minimum corporate income tax rate is a corner stone. There is some speculation that this might reduce the attractiveness of low tax jurisdictions for IHB. From an Asian perspective, Singapore and Hong Kong – the preeminent IHB locations – are indeed low tax jurisdictions, but IHBs are normally located there because of their centrality to Asia, their deep and broad financial markets and talent pools, rather than to shelter profits.
Given the importance of intercompany funding in IHB (bank balances and loans are replaced by intercompany balances in the intercompany current accounts), withholding taxes on related party interest can be a material issue. This drives Asian IHBs to Singapore and Hong Kong.
Transfer pricing can be an issue for IHBs both in terms of market rates and service charges. The key here is to follow well documented arm’s length pricing. The efforts of the past decade of work on BEPS has made transfer pricing a hot topic with many tax authorities, but it has also often brought clarity as to what is acceptable (for example, through precedence). Bank pricing may not be considered fair between related parties. In some cases, the tax authorities on each side of transactions may not agree about what constitutes fair pricing. Mostly these issues can be resolved with open communication with the relevant authorities.
Although one can demonstrate IHB process arithmetic in Excel, in practice, IHB requires robust technology to succeed. Mostly, this takes the form of ERPs or TMSs. Some companies have developed IHB functionality in house, but commercial software for IHB is such a well-developed market that building rather than buying probably does not make sense for most MNCs.
For corporates using a single instance or well-integrated ERP that has IHB functionality, this is often the path of least resistance. It should be noted however that buying and implementing the required modules can be surprisingly expensive and time consuming – it is normally not just a question of flipping a switch.
For corporates whose ERP does not support IHB or who have heterogenous accounting systems, a TMS can provide the glue and requisite functionality to support an IHB implementation. Implementing a TMS will normally be cheaper and simpler than implementing a new ERP, and many groups use specialised ERPs that are necessary for their specific business processes.
Despite the challenges in regulated countries, IHB is a powerful tool to reduce costs and improve controls. Hundreds of IHBs are operating successfully across Asia, and many more are in implementation. Although IHB is not a quick and easy fix, the rewards are worth the effort. Detailed planning and investigation, as well as solid advice and open dealing with regulators, help to ensure successful outcomes.