The Ins and Outs of In-house Banking
How regulatory and technological changes of the recent past have made the benefits more accessible to a broader swath of businesses.
Cost and process efficiencies remain top priorities for the finance function, but some organizations are passing up the opportunity to gain better control of companywide cash through in-house banking. IHB can help companies of all sizes improve process efficiency, reduce costs, and realize greater control over their cash. Still, there’s a great deal of resistance to in-house banking within some organizations, typically stemming from concerns about regulations, controls, and restrictions on intercompany relationships intended to block tax dodging.
It’s true that IHBs require extensive supporting documentation, as well as proof that relationships between affiliated entities are appropriately arm’s-length (e.g., appropriate interest rates on loans) to achieve regulatory compliance. Essentially, companies must take steps to prove that they aren’t using in-house banking to avoid taxes in the jurisdictions where they have operations. When they take these steps, the benefits are typically well worth the effort.
Shifting IHB Options
In-house banks are most commonly used by large, multinational companies that have complex external bank account relationship structures, large numbers of affiliates within the enterprise, and substantial volumes of both vendor payments and intercompany invoices. Historically, these were the organizations that had adequate resources to manage many of the same activities as commercial banks, but via manual processes and spreadsheets.
Old-school IHBs provided internal account holders with resources and services such as centralized intercompany and third-party payment and receivable processing, liquidity management, foreign exchange (FX), and internal lending and borrowing facilities. To do so, the treasury and accounting teams on the back end interacted with a variety of disparate, standalone systems for banking, payables and receivables management, intercompany invoicing, intercompany loan tracking, FX trading, and market data management. Most smaller companies didn’t have a large enough staff to take on this work, which was time-consuming, subject to error, difficult to replicate, and complex.
Today, however, widely available IHB technology has changed the back-end processes, making management of an in-house bank much more automated, efficient, and effective. It’s not possible to build an in-house bank using IHB solutions alone; an in-house bank requires foundational structures and contractual relationships established by the treasury, finance, and legal departments. However, the technologies available today make in-house banking feasible for companies that are far less complex than the giant multinationals that originally developed the concept.
What is common across all organizations working to design an optimal IHB structure: They need to analyze their internal corporate and external banking structures, the objectives of their intercompany financial relationships, the breadth of their needs around payment and receivable processing, their governance policies for FX exposure management, and tax and legal regulations for the relevant countries of operation.
The most critical decisions typically pertain to which legal entity or entities should serve as the in-house bank owner(s); which processes should be included; whether the IHB should be structured as a profit center; which entities, from which countries, should participate in the IHB (and for which processes); and who should be held accountable for FX exposures.
POBO, ROBO, COBO, and Cash
As technology has made IHB structures more feasible for smaller organizations, the increasing international standardization of payment formats has paved the way for greater centralization of payment processes. Driving this trend are the Common Global Implementation (CGI) initiative, which promotes wider acceptance of ISO 20022 XML as the international standard format for payments, and Europe’s Single Euro Payments Area (SEPA), which has greatly simplified bank transfers denominated in euros. Together, these changes in payment regulations have opened up new possibilities for companies to streamline their accounts payable (A/P) and accounts receivable (A/R) processes and have incentivized companies to set up payment and collection factories.
To take advantage of these expanding opportunities, in-house banks can serve as payments-on-behalf-of (POBO) and receivables- or collections-on-behalf-of (ROBO/COBO) service providers. When combined with the right IHB structures, the POBO and ROBO/COBO models enable an organization to centralize, consolidate, and rationalize its bank accounts and banking relationships to provide greater control, increased levels of transparency, and reduced banking costs.
Organizations wanting to incorporate POBO into their IHB should look for IHB technology that seamlessly integrates with their A/P system and enables automated payment optimization. The software should be designed to evaluate the specific requirements of each external payment, then determine the most effective bank account and least expensive payment type (e.g., wire, ACH, SEPA) which will work for that particular transaction. The IHB solution should also aggregate payments of each type and automatically route them for execution.
On the liquidity management front, an in-house bank serves as the organization’s global cash pooling center, allowing corporate affiliates to deposit funds when they have excess cash and withdraw funds when they need additional cash flow to cover expenses. When considering IHB solutions from the perspective of liquidity management needs, a treasury team should seek out technology that will integrate seamlessly with their bank statement management system, to allow for automated capture of cross-company pooling and funding activity. They should also ensure that the technology includes robust loan management functionality that will fully accommodate the wide variety of interest calculation models and withholding tax requirements typically encountered with a global in-house banking solution.
Settlement of Intercompany Invoices
Another key function of an in-house bank is streamlining settlement of invoices between internal entities. In most large enterprises, affiliates generate invoice activity for goods and services through their normal course of business. The number of internal bilateral relationships, and the volume of intercompany activity, can be immense. When appropriate, an IHB solution can support these activities as well, especially when the technology is embedded into the organization’s core enterprise resource planning (ERP) system.
In an optimal structure, the IHB solution completes multilateral, multicurrency intercompany settlement via straight-through processing, from end to end, and finalizes intercompany transactions using book (accounting) settlement, rather than cash payment. Straight-through processing fully automates the matching and clearing of the intercompany A/P and A/R invoices being settled, which results in substantial efficiency gains for most organizations.
When considering IHB management solutions from the perspective of intercompany settlement processing, treasury professionals should look for technology that will integrate seamlessly with their A/P and A/R systems. The software should also include robust algorithms that automate invoice matching and clearing. Without direct integration or sufficiently robust algorithms, the end-to-end automation is much less likely to be successful, increasing the need for manual intervention and materially reducing the solution’s efficiency.
Companies new to in-house banking may be disappointed to discover that some legal entities around the globe cannot participate fully in automated IHB intercompany settlement. Many countries’ regulations and tax laws prevent legal entities within their borders from fully participating in multilateral netting and book-settlement processing. Businesses domiciled in some countries, especially in Latin America and Asia, are explicitly prohibited from participating in these processes. Other countries place corporate IHB structures under such onerous requirements for central bank approvals that entities within their borders are, in effect, unable to participate.
At the same time, some jurisdictions restrict companies from netting payables against receivables. A physical cash settlement may also be required. Affiliates in these countries may still benefit from participation in IHB processing, if they are able to multilaterally aggregate their intercompany payables and receivables. They may not achieve every benefit of IHB participation, but multilateral netting can greatly reduce their volume of physical payments, and they can still benefit from the IHB solution’s straight-through processing automation and reconciliation of invoices.
Successful navigation of global regulatory restrictions and requirements requires treasury to engage the assistance of the organization’s tax and legal departments.
Fraud Protection
An in-house bank also has the potential to reduce the organization’s risk of fraud by:
- Employing technology and financial systems that minimize manual intervention by employees around the world, thus maximizing centralized control by the treasury group over banking activities across the organization;
- Establishing consistent processes, governance, and controls over payment activities, which helps ensure that oversight is effective and payments are transparent; and
- Consolidating bank relationships, bank accounts, and global cash, to provide better visibility and fewer opportunities for fraudulent transactions to occur.
Advances in artificial intelligence (AI) and robotic process automation (RPA) now also make it possible to tightly integrate comprehensive fraud protection algorithms into the centralized in-house banking POBO payment management process. These technologies enable wide-ranging analysis to be performed on underlying payment data, to identify and draw attention to potentially fraudulent transactions.
For example, the algorithms can search for payments in amounts that are slightly below the threshold for additional approvals, or for payments that are made to a vendor directly following a change in the beneficiary payment instructions stored in that vendor’s master record. Transactions that meet these descriptions might be fraudulent, and the algorithms can draw extra attention to them, to ensure they receive additional review.
Tips for Implementing an In-house Bank
In the ideal scenario, a company’s in-house bank serves as the nerve center for the treasury function and as the hub for liquidity management and payment activities enterprisewide. Business objectives behind establishment of an IHB structure often include improvement of governance controls and compliance, standardization and automation of processes, establishment of effective bank relationship management, optimization of global liquidity, increased efficiency of internal and external financing and investment, and mitigation of the FX and tax impacts of global operations.
These are laudable objectives for nearly every organization. To achieve these goals, treasury teams should ensure that their in-house bank implementation follows a few best practices:
1. Consult with affected groups throughout the organization. The tax and legal functions are key in this process; failing to consult them early in the design of an in-house bank can lead to serious issues down the road, such as unexpected tax liabilities or financial penalties for not adhering to statutory requirements in individual countries.
In addition, many organizations are already using some IHB-related functions—such as POBO, ROBO/COBO, or intercompany netting—but may be using these processes in a narrow and limited manner, rather than considering them from the perspective of a more broad-based IHB model. A discussion among the relevant stakeholders should help treasury staff uncover where the organization stands in each area that they want to transition to a more comprehensive in-house banking solution.
2. Tap external expertise to ensure solution optimization. Once the treasury team consults other internal stakeholders to get a lay of the land, the organization may benefit from engaging a trusted external consulting adviser with expertise in the in-house banking space. The guidance and insight of an expert may accelerate the team’s analysis of a project’s potential; help in building a business case; and bring to light any potential challenges, pitfalls, and risks. Additionally, the adviser should be able to provide guidance on how to optimize IHB management technology and integrate it with the organization’s business processes.
3. Implement incrementally. It often makes sense to approach implementation of an IHB solution in smaller, more manageable chunks, rather than in one big bang. Thus, the organization would focus on a particular geographic region or choose a group of countries in which corporate entities stand to benefit the most from an in-house bank, with the fewest tax or legal barriers to implementation. (North America and Western Europe usually fit that bill.)
Then the company should consider implementing one IHB function at a time. For example, the initiative may start with a foundation of moving cross-company cash pooling and intercompany loan management into the IHB, then later add POBO, followed by ROBO or COBO, etc. Approaching the project in multiple steps of limited scope enables the organization to quickly realize business benefits, while prudently managing budget, avoiding overwhelming staff members, and gradually gaining upper-management confidence and commitment to expansion of the IHB. Fully implementing the IHB takes longer with this approach, but it also minimizes risk.
The organization should create a step-by-step plan for incrementally implementing core IHB capabilities, based on the value proposition each offers to the business. Companies generally start by addressing the organization’s biggest pain points first. After the organization has established the IHB structures and processes that are core to its operations, it can more easily roll out additional in-house banking functions and expand the approach into other regions and countries.
Treasury must consult the tax and legal teams at each step in the initiative, to ensure that all planned IHB structures and processes support the organization’s unique business obligations, objectives, and priorities.
4. Minimize the number of different technology solutions in use. When choosing technology to support the IHB, look for a solution that natively incorporates as much of the underlying data—and invoices that require settlement—as possible. The goal is to minimize the need for custom interfaces. Many ERP systems have sophisticated IHB capabilities embedded into their finance modules. Check with the IT department or ERP software provider to see what IHB functionality the organization can take advantage of—and may already own.
In-house banking management structures and technology can provide substantial financial and operational benefits to treasury departments and other stakeholders across the organization, at both the corporate headquarters and affiliate levels. More and more companies are expressing interest in leveraging an IHB to increase efficiency, reduce costs, and improve visibility and control.
Although in-house banking still may not be the right solution for every company, technological innovation and loosening regulatory constraints are making IHB solutions more attractive for a wider range of companies. Organizations of all sizes can now realistically evaluate the prospective benefits of making the switch to in-house banking.