For a corporation aiming to reap the rewards of centralizing its treasury functions, setting up an in-house bank (IHB) should be a strategic component of the plan. An IHB can increase efficiency, enhance control and improve risk management capabilities. Establishing one is often a logical next step for organizations that may already have reorganized their treasury functions through a shared service center or payments factory.
THREE STEPS TO TREASURY HEAVEN?
A corporate pathway to an in-house bank
It’s comparatively rare for corporations to move straight from a decentralized structure to an in-house bank. Commonly, there are one or two steps along the way which help to build experience of, and confidence in, centralized resources.
Step 1: Introduce a standard Treasury Policy, setup netting and pooling where possible, review banking providers and accounts to reduce complexity and cost.
Step 2: Look to introduce a shared service canter or payment factory to centralize common tasks such as accounts payable and accounts receivable.
Step 3: Consider an in-house bank, centralizing risk management.
Many multinational corporations have already used the momentum provided by becoming SEPA compliant to drive the harmonization of their treasury functions across multiple jurisdictions, paving the way for an easier move towards an IHB. It’s a journey that is also becoming less fraught as treasury and banking technology becomes more capable.
The functions of an In-House Bank
So, what can an IHB do? It can centralize both liquidity and risk, offering services such as payment processing, collections, short-term intra-company lending, investment services and foreign exchange (FX) to the wider business. Individual subsidiaries and operating units can interact with the IHB in much the same way as they would with an external financial institution, while the corporation benefits, not just from efficiencies and cost savings, but also from an improved flow of financial information.
At Western Union Business Solutions (WUBS), the IHB structure allows for much greater visibility of its cash positions. The company helps businesses make and receive payments around the clock in all time zones and in over 130 currencies through a global network that spans 200 countries and territories, so timely, accurate information is essential.
The IHB had to be able to handle multiple payment types including international wire, domestic wire, low-value batch payments and –drafts or checks, while at the same time ensuring a clear flow of information into and out of WUBS’s treasury management system (TMS).
Today the IHB’s bank account maintenance tool manages its global accounts in a central location while its cash management reports display balances in real time. A direct connection to SWIFT allows the treasury team to initiate SWIFT MT103/202 global funding transactions, while a counterparty trade function allows treasury to buy and sell funds.
However, as Derrick Walton, head of operations at WUBS, points out, the level of bank technology integration differs from region to region, while banking regulations can change frequently and without notice – so it’s essential to view the IHB as an ongoing project and continually review its systems and processes.
With this in mind, perhaps the most critical factor in setting up an IHB is ensuring that you have senior management’s commitment, the necessary budget dollars to finance the project, and the support and commitment of operations, finance, legal, accounting and tax personnel. Given the resources needed to pursue this project, it is critical that treasury build the business case which demonstrates that setting up an IHB is the right course of action for the corporation to take.
While the size of a corporation can be an important factor in this decision - the larger the organization, the greater the potential benefits tend to be - it is not the only consideration. Perhaps more important is the complexity of a company’s operations. A smaller corporation may turn out to be a good candidate for an IHB if the corporation has a large number of inter-company transactions, numerous bank accounts and is spread across multiple countries.
Companies which are already highly centralized may have little to gain by adopting an IHB, so it is important to analyze the expected business benefits in detail. Alternatively, a company with decentralized operations, and which has non-integrated enterprise resource planning (ERP) and treasury management systems, may struggle to implement an IHB structure within a set timescale.
The tax implications of setting up the structure should also be explored, with internal tax expertise involved in the project at an early stage. Proposed changes to Section 385 and the Base Erosion and Profit Shifting Tax (BEPS) initiative could have significant effects on the effectiveness of the IHB. Your tax counsel should be brought in to explain the implications to you during the planning stage.
Regulatory factors will also need to be taken into account, from central bank reporting requirements to the types of liquidity management structures permitted in the relevant markets. Companies should also determine at the outset how the value of an IHB will be measured and managed.
At Brown-Forman, the company behind Jack Daniel’s and many other premium wine and spirits brands, the case for an IHB was well made at the outset. The company’s USD 4.0bn annual sales are increasingly global, with the U.S. representing 46%, Europe 31%, Australia 9% and the rest of world 14%. That geographic diversity has brought with it growing offshore cash balances and a complex banking structure with over 200 bank accounts in 25 currencies across 40 countries.*
Brown-Forman’s solution is to implement an IHB at its treasury center in The Netherlands, which will both pay-on-behalf-of and receive-on-behalf-of the group’s business entities. The company set five key objectives for the IHB:
- Risk, control & compliance: reduce counterparty and sovereign risk, increase control and enhance governance
- Liquidity optimization: make more efficient use of cash, with just one balance to invest or lend per day instead of many; reduce operating working capital trapped ‘in process’
- Cost reduction: Reduce bank fees, FX fees and transaction fees
- Efficiency and scale: Improve straight through processing (STP) and reduce error rates
- Operational capability: Centralize treasury, so increasing capability to support business objectives and respond to change
The IHB structure to meet these objectives includes physical currency pools in EUR, GBP and USD. Each participating subsidiary will have IHB accounts in the currencies they transact, with the processing handled by an IHB module with the company’s existing SAP ERP system.
If the IHB meets these objectives, Brown-Forman should recoup its investment in the project in a little over five years through costs savings and efficiencies.
HOW WE CAN HELP
Planning for a successful IHB
The Brown-Forman example shows what can be achieved through an IHB, but before the company started on its chosen path it had already spent considerable time and resources in the planning stage. The implementation of an IHB should be seen by treasurers as a transformation project and its design should not be planned in isolation but in partnership with the overall business. Development should start at the top, with key stakeholders being considered, as treasurers will need to demonstrate to all areas of the business how the in-house bank can add value to their specific operations.
While the benefits of the IHB may be clear to head office, setting one up represents a major change and can meet with internal resistance. Subsidiaries that had individual bank accounts in the past may no longer have them under the in-house bank model: they will need to be persuaded of the benefits of giving up that control. External customers, meanwhile, will need to pay into a central account rather than an individual bank account.
Determining the scope of the project may pose another challenge. A company may wish to set up an in-house bank to cover all its operations. While this may be entirely achievable for a company with operations in a small number of markets, a multinational company with operations in restricted markets such as Brazil or China may not be able to apply an in-house bank across its entire organization.
For countries such as these, it is advisable that corporates create bespoke models which sit outside the main in-house banking structure but within its function. In doing so, oversight and control can still be centrally maintained.
Ideally, the bank itself should be located somewhere where it can provide the most value to the business for the bank to achieve its maximum benefit. However, a number of areas such as the wider business operating model, its memorandum and articles of association, current operational locations, tax and regulation must be carefully considered in the selection process.
Once all the factors have been considered, implementation can begin, ideally driven by a CFO-level sponsor, led by the group treasurer or assistant treasurer and overseen by a steering committee which includes representatives from key stakeholders in the subsidiaries as well as from corporate headquarters.
The right combination
While an IHB brings many benefits, it can’t function in isolation. Success will depend on many partnerships, both internal and external - not the least of which is a banking provider with the experience and scale to support the corporation through what will be a challenging- but ultimately rewarding - transition.
* "Is an In-house bank right for your organization?" AFP Conference Session, October 2016