Published: January 01, 2000
Financial markets and the banking environment have changed substantially in the wake of the financial crisis, creating both challenges and opportunities for corporates in Latin America. New regulations, most notably Basel III, are changing the ways banks allocate capital while interest rates have remained at historically low levels for an unprecedented period. These conditions are prompting corporates to improve the efficiency of their cash management structures. As a result, many organisations are turning their attention to in-house banking models.
In-house banks (IHBs) have existed at many US and European companies for years, managing a range of functions such as cash management, foreign exchange and funding, on behalf of various entities within a group, and effectively replacing external bank providers for individual entities. Until the financial crisis, the move towards IHBs was driven largely by aspirations to streamline treasury. Now, the starkly different environment – and the chastening experience of the financial crisis – means the main driver for many corporates is to harness as much of their internal liquidity as possible.
As in Europe and the US, companies in Latin America are redoubling efforts to improve efficiency. For example, there is broad recognition among corporates that inter-company lending is often managed poorly in Latin America, with idle balances in key markets such as Brazil receiving no or limited remuneration. Similarly, there is an acknowledged need to optimise trapped cash in some markets in the region. An IHB offers a focused way to overcome such challenges. Moreover, IHB models have the potential to improve efficiency, lower costs, enhance visibility and manage risk more effectively across a wide range of additional areas.
Multinational companies have complex procurement processes, diverse suppliers and customer bases that extend across the world. Global trade – while operationally essential – introduces complexity and inefficiency in many treasury functions. When external liquidity was widely and cheaply available, these inefficiencies could be overlooked. Now that it is not, and internal liquidity is consequently highly prized, corporates are looking to IHBs to eliminate as much of that inefficiency as possible. An IHB structure facilitates the optimisation of working capital by enabling positive and negative balances to offset each other. It therefore alleviates the need to access funding from third parties for subsidiaries short of cash, and compensates those subsidiaries that are long with more attractive yields than might otherwise be available.[[[PAGE]]]
The practicalities of an IHB are relatively straightforward. Various entities within the group hold accounts with the IHB rather than with external bank providers in the countries where they are located. Interaction between the subsidiaries and the IHB is identical to that between a subsidiary and an external bank. Each subsidiary’s account is credited or debited accordingly to receivables and payables flows, and balance statements and detailed transactional reports are provided for all accounts. The IHB can manage all the settlement processes associated with inter-company loans. It can also consolidate payments across the group for efficient processing, and agglomerate FX, helping to reduce the number of trades required and lower costs.
By bringing many external bank accounts in-house, visibility is significantly increased while control is also enhanced through the closure of many local accounts (which should always be kept to a minimum). Instead, the IHB manages a single set of accounts with one or more banks. This rationalisation process can lower costs and dramatically improve liquidity management, as balances are consolidated into a single location. Moreover, improved visibility and forecasting gives a company greater flexibility in its investment choices.
Implementing an IHB cannot be done overnight. However, provided there is senior level commitment, with a clear set of strategic goals, clean legal/fiscal clearance and the right infrastructure (both technical and staff) it is possible to introduce an IHB in within a year. It is important to note that it is not necessary to move all functions, for all entities, in all countries to the IHB in one move. Instead, companies may find it easier to focus initially on a single function such as liquidity (short-term lending and investment services), visibility and control, or accounts receivables and payables. Similarly, they might initially focus on reducing costs in countries that have flexible tax regulations associated with the electronic movement of funds, such as Mexico and Panama (in contrast to Colombia, where taxes are applicable if funds go to a company overseas with a different tax code).
While all companies can usually benefit from in-house banking, the benefits differ depending on the characteristics of a company, and therefore different goals may need to be prioritised. For example, companies in the metals and mining sector are typically capital intensive and therefore benefit from the greater credit lines and flexibility that can be extended to an IHB. In contrast, retail companies, which generate lots of cash, may have little requirement for capital but might have significant trapped cash, due to regulations in the countries where they do business.
While the basic structures of an IHB are relatively simple, the factors that must be considered by companies when creating an IHB are wide-ranging and complex. Most importantly, companies need to decide where to locate the IHB in order to maximise fiscal efficiency and regulatory flexibility. The benefits of an IHB are only realisable if it is in the right location.
For the Southern Cone countries of Argentina, Brazil, Chile, Paraguay, and Uruguay, the latter is often selected for several reasons, including its free trade treaties with Brazil and Argentina, its off-shore US dollar account capabilities, and its tax benefits (without being a tax haven). For corporates with operations across the Americas, Panama and Costa Rica are commonly selected as preferred locations. Panama is often chosen as a hub for fiscal reasons while Costa Rica offers quality staff and cost efficiency. Alternatively, an IHB can be domiciled outside Latin America: Ireland and Switzerland are often chosen for fiscal or financial benefits.
Decisions about which entities to include in an IHB, and what structures to employ, can only be taken after carefully scrutinising the articles of incorporation, which govern the management of a corporation and its relationship with the group, of all entities under consideration. Existing account structures (and the purposes of each account) must be analysed: for example, some local accounts may need to be retained for tax purposes. Similarly, existing movements of cash, and their purpose, must be examined. Thorough analysis is essential: an in-house structure could have serious fiscal and operational implications if not set up properly.
As a result, many companies engage relevant experts, such as consultants or relationship banks (which can usually provide examples in the sector or country), to assist. These experts can share tips for success. For example, it is best practice to implement robust service level agreements between entities and the IHB, and robust and disciplined forecasting structures must be put in place. Companies also need to address the technical requirements of an IHB in terms of connectivity and how it will integrate with company’s Enterprise Resource Planning (ERP) systems. However, it is ultimately the company’s responsibility to articulate the objectives of its IHB and align the structure to support the company’s strategic goals.
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