In-house banks are becoming increasingly popular among larger multinational corporations.
They may not work for all big companies, though.
Petroleum giants BP and Shell each have one. So do Dutch electronics company Philips and the US communications network provider Lucent. These are just some of the growing number of multinationals that have set up in-house banks (IHBs). According to David Knight, treasury-consulting partner at PricewaterhouseCoopers, in Europe alone there are probably as many as 15 IHBs running today.
So why are multinational corporations starting to behave like banks, and what does it ultimately mean for these companies banking partners? In-house banking is symptomatic of a fundamental shift toward more globally centralized treasury management structures that are aligned more closely with the rest of the business. For most multinationals, IHBs are the next evolutionary step in the drive to enhance working capital and the transparency of financial flows and to ultimately reduce the costs associated with managing multiple bank accounts and payments across multiple subsidiaries. However, although Web-based technologies are facilitating the move toward centralization, building an IHB is not an insignificant undertaking in terms of the technological and cultural re-engineering required for it to work.
The strict definition of an IHB is an operation set up to manage and process inter-company and external payments via internal bank accounts. The in-house entity manages accounts on behalf of the companys subsidiaries and provides them with bank statements pertaining to those accounts, much like a bank does. This entity may also go out into the market and conduct FX and hedging transactions on behalf of its subsidiaries. Thomas Bergqvist, general manager, Northern Europe, for treasury systems vendor Trema, says an IHB handles all the financial interaction between central treasury and the subsidiaries, which also encompasses activities traditionally performed by central treasury on behalf of its subsidiaries, including multilateral netting. An interesting extrapolation of the in-house banking concept is the establishment of captive finance facilities. Siemens Financial Services (SFS) is an example of a captive that provides financial solutions not only to the Siemens Group subsidiaries and the parent company, but to external third parties as well.
In addition to typical treasury services, such as FX and hedging, SFS also provides other financial solutions such as insurance, leasing finance, receivables purchase and management, investment management and export financing. Although 70% of its business is internal, Herbert Lohneiss, CEO of SFS, says captives would not survive without third-party business. A competitive captive goes well beyond the natural monopoly enjoyed by treasury, he says. We are in competition with the banking industry, whereas the treasury of an industrial group is not. Lucents IHB, based in New Jersey, handles 90% of the companys internal and external payment flows across 30 to 40 global subsidiaries. Regional shared service centers in Ireland, Singapore and Latin America still manage local bank accounts and process domestic accounts payable and receivable. The difference with the in-house bank, explains Fred Schacknies, director of Lucents IHB, is that we used to clear everything whether it was inter-company or external transactions through the banks. Inter-company payments and receipts, as well as cross-border third-party payments and investment transactions (FX, derivatives) are now conducted via Lucents IHB.
The Benefits of Bundling
The biggest advantage of centralizing inter-company and external payment flows is optimizing working capital and liquidity. As the IHB creates greater visibility of payments coming in and out of once-autonomous subsidiaries, cash can be more easily mobilized instead of sitting idle in accounts. By settling inter-company transactions in-house, companies can also avoid bank fees, and by consolidating group balances, the IHB is able to obtain better rates of interest and avoid hefty borrowing costs. As Lohneiss explains, By bundling transactions and separating them in terms of FX, interest rate or derivatives, we can get a much better service from the outside world.
With new accounting regulations such as IAS 39 placing the onus on companies to record and justify every hedge, IHBs provide companies with greater transparency and control over these transactions. Schacknies estimates that Lucents IHB has reduced the frequency of external FX trades by a third or more. Its goal was also to pool as much cash as practical under the IHB umbrella. Previously, Lucent had a euro cash pool, but now it is able to pool funds in 16 currencies across more subsidiaries. Also, and more importantly, by settling many deals internally, we have dramatically reduced the need for external cash balancesand thus for cash pooling, Schacknies adds.
Implementing an IHB can also have a profound impact on banking relationships. BP eliminated more than 200 bank accounts by accessing global financial markets directly. In Lucents case, implementing an IHB has not reduced the number of bank accounts, which are retained for local payments. It also retains several global cash management banks and, in markets where they do not provide coverage, uses local banks. Further down the track we expect to see some reduction in local banking relationships, says Schacknies. PwCs Knight says there is a danger that in disintermediating banks by setting up internal accounts, corporates could be cutting off their nose to spite their face, particularly when it comes to obtaining credit.
The banks that will succeed as partners of IHBs are likely to be those that have strong transaction capabilities, membership of multiple clearing systems and core integration capabilities, says Michael Mueller, head of market management, Europe, Deutsche Bank Global Cash Management. The global banks have a broader range of services to offer, says Anne Collard, head of JPMorgan Chases treasury services consulting group, EMEA. In an effort to re-intermediate itself further into the corporate supply chain, JPMorgan is one of the first banks to launch an outsourced in-house banking solution based in Dublin, which allows corporates to outsource the management and cost of setting up an IHB as part of a broader managed services solution.
Building on expertise established in the treasury-outsourcing arena, the extended solution features multi-bank reporting and payment capabilities and has a number of corporate clients, one of whom has already implemented an IHB. We dont manage your companies; we just run the processes for them, Collard explains. Corporates will be able to receive full data visibility and reporting via Web screens. Collard maintains that the banks existing core payments infrastructure, and its track record in terms of resiliency, contingency and operational risk, means it is well placed to provide corporates with further economies of scale.
This underscores some of the technical and organizational challenges companies face in trying to behave like banks. If the IHB is to gain acceptance from the subsidiaries, it must provide a level of service that is equal to or surpasses that provided by external banks. From the corporates perspective, they need a well-defined set of processes and controls in place, Knight explains. Ensuring that the right organizational framework and culture is in place for managing an IHB or captive finance facility is more challenging than setting up a centralized treasury, says Lohneiss.
In order to win the approval of its internal customers, the IHB or captive also needs to provide a competitive level of service, benchmarked against that offered by external providers. How we remain competitive is a challenge, says Lohneiss. We are not a huge company; our balance sheet is about E9 billion. In order to remain competitive, IHBs or captives often operate as separate entities (SFS and BP Finance are good examples) within the parent company. In the case of SFS, it has a separate P&L; sheet.
In terms of the timely provision of account information, Web-based cash management tools allow for the more streamlined and seamless flow of information between subsidiaries and central treasury. Bergqvist points out that scalability is also important in terms of providing subsidiaries around the globe with 24-hour access. If you install this in the US, how do you service customers in Asia and Europe? he asks. Treasury management systems were not originally designedtohandlecommercial payments/transaction traffic, says Knight. Instead they were built to handle the financial transaction activities of the company including debt/investments and risk management. First and foremost, the major challenge is to get it right, says Mueller, adding that an IHB needs to run a system that not only executes payments but reports back failed transactions. You need an inter-company accounting facility that reconciles transactions on current accounts, he says.
Setting up an IHB also presents an opportunity for rolling out a more integrated treasury management system so that all subsidiaries speak the same language. Lucent, for example, had multiple accounting systems from different vendors but is now rolling out a global ERP system. In this way, we have been able to fully integrate with most of the subsidiaries, says Schacknies.
Perhaps the biggest integration challenge IHBs face is linking into the back-office treasury management systems of their external banking providers. Schacknies says interfacing with three or more banks was challenging. We need these banks to provide information in multiple countries, but there are a number of different data-exchange formats, he explains. Lohneiss adds that achieving a high degree of standardization on a global basis is challenging, as many banks did not necessarily adhere to standards.
SunGard believes its eTreasury eXchange platform, which connects more than 1,000 companies and financial service providers, solves this problem by providing a single point of connection from its treasury management system out to multiple banks. So a company with 10 or 15 banking relationships needs to interface only to SunGards systems. Given the technical and cultural re-engineering required to build a successful IHB, there are serious questions for many companies about whether the benefits really outweigh the costs and operational challenges. However, for companies with a large production base and subsidiaries around the world, IHBs or captives can be an effective way of enhancing working capital on a global basis and increasing transparency of payment flows. But it needs to have a clearly defined economic and competitive rationale and deliver a quality of service that is comparable to or better than that provided by an external bank. A finance company will only survive in the long run if it can provide substantial proof that its partnership with the internal group provides value to the company as a whole, says Lohneiss. This is not something you can prove once and for all; it has to be proven on a day-to-day basis.