How the in-house bank improves visibility and liquidity controls

Could in-house bank structures have more effectively managed the challenges of a global crisis? What does this mean for the future of in-house banks? Could they increase liquidity control and visibility? We consider the case for an in-house bank as a mitigant for corporates in a global crisis.

The first months of COVID-19 forced companies to define a response to both a health crisis and an economic crisis. Health and safety measures and invoking business continuity plans (BCP) were the priority. In addition, corporates looked to implement action plans to instill financial resilience, organizational prudence and cost-saving measures in preparation for economic uncertainty.

Extremes on both sides

The timing, severity and impact of COVID-19 has been mixed across industry sectors, and we have seen extremes identified on both sides of our client base. Traditional sectors such as retail, travel and hospitality have been hit hard, whereas fast moving consumer goods such as pharmaceuticals and technology clients have seen little or no repercussions. A similar pattern has been seen throughout treasury, with clients who had invested in digitization and automation experiencing a smoother transition post-outbreak, whereas clients with outdated technology had a slower transition with system connections and process changes holding up a return to normal treasury service standards. To make matters worse, the health crisis also introduced a strain on personnel and a heightened risk of cybercrime.

The economic downturn has added pressure on treasury performance with increased FX volatility and liquidity issues. For treasurers, the focus was on improving and re-financing operational cash flow by marshalling internal and external liquidity to cover daily operational requirements. This necessitated enhanced visibility and mobility of cash and ability to secure additional funding where necessary.

The role of the in-house bank

Against this backdrop, we explore the effectiveness of an in-house bank (IHB) structure in this crisis, and whether the need for an IHB has been intensified as a result. An IHB in simple terms is a centralized treasury function acting as bank for an organization’s subsidiaries, providing financial services such as multi-lateral netting, settlements, intercompany lending, liquidity management and foreign exchange (FX) transaction management on an arm’s length basis as well as Payments and Receivables ‘on behalf of’ (PoBo/RoBo).

It is important to state that more highly regulated markets may impact the structural design and processes within an IHB, limiting its effectiveness. However, breaking down the advantages of an IHB can help pinpoint areas for improvement within day-to-day treasury operations. There are of course tax considerations, but from an operational perspective, would an IHB structure have delivered benefits at the start of the COVID-19 crisis, when with little notice, mandatory changes to working arrangements were implemented by organizations all over the world? Could an IHB be the answer to ensure your treasury department is better prepared for the unexpected and more agile with respect to liquidity and FX management going forward?

For many, business continuity plans will likely have prepared for alternative worksites. But in other cases, employees were required to access company portals, financial software and banking websites from home, causing security concerns. Under an IHB structure, depending on the scope of the services managed, apart perhaps for some services that are often better accessed locally, for example payroll, guarantees, petty cash), operating companies are able to process more transactions more internally with group treasury responsible for managing a streamlined connectivity with external banking partners. This limits the number of users required to access the full range of financial systems and banking portals, thereby reducing the security exposure. In combination with eliminating manual processes, the opportunity for cybercriminals can be significantly restricted through an IHB structure.

FX risk and liquidity management

Economic uncertainty and the possibility of recession have created FX volatility in the markets, with emerging market currencies seeing the greatest impact. Adverse market conditions have both increased the cost of hedging due to wider spread forward points and reduced the ability to hedge with market restrictions and banned products. The ability to net positions and manage global exposure (not just local exposures) by using internal transactions to hedge FX exposures of Opco’s within an IHB is a decisive benefit. A reduction in financial transactions will help treasurers to efficiently and cost effectively manage FX exposures.

Liquidity management and funding have been a major concern throughout the crisis, making visibility and mobility of cash across the organization essential for day to day operations. Centralized reporting through a group treasury team allows for a quick and conclusive analysis of liquidity positions. This enables a company to move funds fast and react according to operational demand during uncertain times.

Automated cash pooling in conjunction with an IHB structure improves visibility and mobility of cash and will remove uncertainty and reliance on manual interventions. The ability to easily transact other group financing transactions, like intercompany loans, also helps to ensure adequate liquidity is where it is needed for all participating subsidiaries across the company. However, it has not all been plain sailing, as unfortunately the crisis has brought about a change in the credit worthiness of both the IHB as well as its participants for many multinational groups. Rating downgrades will influence arm’s length transfer pricing calculations, something already under the scrutiny of the Organization for Economic Co-operation and Development (OECD). This will need to be properly and transparently accounted for with intercompany loans and within cash pooling structures. Intercompany lending terms may also need to be reviewed to grant flexibility to subsidiaries.

Operational efficiency and standardization increases

Treasury headcount reductions across the globe (or re-deployment to more value-add activities) and the respective budgetary savings are a considerable motivation when assessing the business case for an IHB structure. On one hand, companies gain control of operations in centralized locations, but on the other hand they lose local experience and bank relationships in key operational hubs. There can be local resistance, but generally subsidiaries hardly experience the difference between having an external bank account or an IHB account. They receive an IHB account statement that can be reconciled as if it was an external bank account statement and do settlements as before, leaving minimal or no impact. In most case the bank account statement reconciliation is even easier since the IHB uses the standards as defined in its ERP environment. It is recognized however that for some companies, local knowledge and support from entrenched bank relationships can prove vital in times of stress and therefore the impact of centralizing more transactions banking activity away from local partners a crucial considerations in assessing the case for an IHB.

Figure 1: Cash pooling & automated sweeping

What does the future hold?

For many corporates, the crisis has evolved from treasury continuity to managing treasury and risk uncertainty. Data gathering and analytics will help companies to understand where policies and procedures could be improved to achieve financial stability. Scenario planning is being widely used to prepare for the unexpected. It has become quite clear that the automated processes, visibility and mobility of cash and the resultant improvements in cash forecasting provided through an IHB structure have benefited many companies during this crisis and will feature strongly in treasury plans going forward. Much of the associated IHB administration can also now be automated by many of the applications offered by various vendors in the market.

Furthermore, companies are starting to examine where and how Virtual Account structures, now offered increasingly widely by external banks, are able to replace physical accounts and in conjunction with an IHB, drive further benefits in terms of liquidity management, operational efficiency and cost reductions.

The next step, as companies emerge from the crisis and start to look to restoring profitability, is to learn the lessons, to adapt and improve, and build upon sound foundations. As with most things, technology probably holds the key and there is a wide variety of financial technology available in the market supporting back, middle and front office operations. Digitization is a common theme within solutions that aid treasury continuity and help to manage uncertainty. Looking ahead at the exponential technology becoming available, we see the opportunity to strengthen IHB fundamentals and to create robust structures that will help companies withstand future shock events.

Figure 2: Benefits of an IHB structure

Application programming interfaces (APIs) have allowed treasury departments to move from intraday reporting and batch processing to real-time reporting and processing. Advances in cloud computing and SaaS (Software-as-a-Service) solutions have aided business continuity by providing flexible, scalable and secure virtual offices. Artificial intelligence will aid cash forecasting, liquidity management, payables and scenario analysis by processing historical data to perform tasks and resolve issues based on past workflows. Robotic process automation (RPA) can alleviate time spent on high volume, repetitive tasks, allowing focus to be maintained on key tasks. Combining IHB structures with the latest technology will allow treasury departments to push towards a partial (or fully) automated and virtual treasury, working in real-time, while providing a flexible and secure working environment.

Conclusions

In retrospect, an IHB structure would have significantly helped during the pandemic due to the enhanced control, visibility, flexibility and security provided. If you are considering an IHB structure, now could be the time to act. If you already have an IHB structure in place, improvements in technology will push new levels of precision and autonomy. IHB design for implementation or improvements can often be a daunting endeavor but to get started, a treasury scan or benchmarking study can add value by identifying areas critical for improvement, comparing your treasury operation to peer groups and best market practices.

COVID-19 has intensified the need for an agile, adaptive and digital treasury organization. If implemented with the correct technological enhancements, an IHB will help to achieve these goals and prepare for future events. As the crisis evolves, we are starting to see the spotlight move back to restoring profitability. Treasury departments will need to recalibrate their roadmaps, including consideration of IHB’s if not already in place, in order to build for the emerging landscape.

Contact

If you would like to discuss this topic further, please contact the authors, Hugh Davies (on the right) or Tim Morris.

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