Editorial Consultant, Treasury Management International (TMI)
As treasurers look to improve their departments’ resilience to help withstand future crises, in-house banks (IHBs) are back in the spotlight. TMI speaks to four industry experts to understand how IHBs can help restore profitability and reduce risks. We also examine trends such as in-house banking-as-a-Service (IHBaaS) and outline how IHB structures are evolving.
Christof Hofmann Global Head of Payments and Collection Products, Deutsche Bank
After months of Covid-19 ‘firefighting’, organisations are focusing once again on restoring profitability. Treasury departments are therefore recalibrating their roadmaps and exploring optimal set-ups for the emerging business landscape. As a result, IHBs are garnering greater attention.
François Masquelier, CEO, SimplyTREASURY, explains: “The silver lining to every financial crisis is the opportunity to change the organisation, revamp processes, and become more resilient. One of the treasury-related responses to this health and economic crisis is the need for further centralisation of financial operations and enhanced visibility. Therefore, the Covid crisis can be viewed as a catalyst for establishing an in-house bank. After all, the objective of such a central financing arm is to reduce costs, increase efficiency, reinforce internal controls and improve visibility on operations.”
In fact, Masquelier believes that “those multinational corporations not currently operating an IHB will inevitably consider it over the months ahead and address the question of how to implement one.” Christof Hofmann, Global Head of Payments and Collection Products, Deutsche Bank, agrees: “Of course, the crisis is not the sole driver of IHBs, but the benefits of such a set-up will likely increase interest levels in IHBs going forward. Those benefits include the ability to have a central view of your exposures 24/7/365, which in turn leads to vastly improved forecasting, and the flexibility to deploy liquidity across the group – without it being stranded locally.”
WHAT IS AN IHB?
Hugh Davies, Director, Zanders Treasury and Finance Solutions, explains: “In simple terms, an IHB is a centralised treasury function acting as a bank for an organisation’s subsidiaries. The IHB provides financial services such as settlements, funding, intercompany lending, liquidity management and FX management on an arm’s-length basis.”
Improved liquidity and risk management
Most treasury departments have, naturally, focused on the liquidity angle since the pandemic began. Tim Morris, Manager, Zanders Treasury and Finance Solutions, comments: “Liquidity management and funding have been major concerns throughout the crisis, making visibility and mobility of cash across the organisation essential for day-to-day operations. Centralised reporting through a group treasury team allows for a quick and conclusive analysis of liquidity positions. This enables a company to move funds quickly and react according to operational demand during uncertain times. Automated cash pooling in an IHB structure improves visibility and mobility of cash and will remove uncertainty and reliance on manual interventions.”
The ability to easily undertake intercompany loans via the IHB also helps to ensure adequate liquidity is where it’s needed for all participating subsidiaries across the company. However, Hugh Davies, Director, Zanders Treasury and Finance Solutions, says that it’s not been entirely plain sailing for IHBs in recent months, as unfortunately, the crisis has brought about credit-rating downgrades for many multinational groups. Davies comments: “Rating downgrades will influence arm’s-length transfer pricing calculations, something already under th=e scrutiny of the Organisation 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.”
Nevertheless, the business case for establishing an IHB remains compelling. Take the management of FX risk , for example. Morris notes: “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 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 exposures, not just local exposures, is a decisive benefit of an IHB. A reduction in financial transactions will aid treasurers to efficiently and cost-effectively manage FX exposures.”
François Masquelier CEO, SimplyTREASURY
There are further hidden benefits to IHBs, says Hofmann. “Centralised management through an IHB enables treasury functions to be much more agile, making it easier for them to implement new solutions and technologies such as SWIFT gpi. Moreover, cybersecurity and fraud risks can be significantly reduced through IHBs, given that external bank accounts are reduced to a minimum so that cash flow of affiliated group companies can be consolidated and points of entry are streamlined. Since many treasury teams are currently working from home, this benefit should not be overlooked.”
Morris picks up on this theme, explaining that not all organisations were adequately prepared for remote working at the start of the crisis. “Even now, many employees are using their home computers to access company portals, financial software and banking websites, which causes security headaches.”
Reduced security levels and changes to digitise treasury processes have opened the door for cybercriminals. “They seek out weaknesses in controls and attempt to infiltrate companies fraudulently; they also use phishing techniques to gain sensitive data, such as personally identifiable information, banking and credit card details, and passwords. As Christof mentioned, under an IHB structure, subsidiaries interact internally and only the group treasury units are required to connect with 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 cybercrime can be significantly restricted through an IHB structure,” Morris believes.
Despite the obvious benefits, setting up an IHB is not entirely straightforward. There are numerous considerations and hurdles to take into account, not least internal resistance to change. Hofmann cautions: “In the process of establishing an IHB and centralising treasury operations, power is taken away from local business entities. They no longer have the autonomy to make an emergency payment, for example, which can be unsettling for them. As such, managing change from a people perspective is a vital part of any successful IHB journey.” Local regulation can also be a headache for IHBs, especially when the organisation operates across disparate geographical markets. “Some IHB services will be prohibited in certain countries. This limits the extent to which the IHB can standardise its processes and also leads to a requirement for local knowledge,” explains Hofmann.
Tim Morris Manager, Zanders Treasury and Finance Solutions
On the subject of local insight, Davies notes: “Countries all over the world have dealt with the pandemic in a variety of ways, which will see a staggered return to normality for operations. Local knowledge and entrenched bank relationships could prove to be vital when reacting to unforeseen issues worldwide. These can be crucial considerations when assessing the business case for an IHB.”
In spite of this, Hofmann says there are examples of corporates that are successfully running IHBs across a host of different countries. One tip he shares is to build ‘clusters’ of countries where IHB services are permitted. “Say the IHB has the potential to offer 15 services. In some countries, the IHB will be able to deploy all 15, in other countries, the IHB might be limited to 10 because of regulatory constraints. Rather than limiting all of the countries to just 10 services, it is more efficient to build clusters of countries where 10 and 15 services can be delivered. There is no need to settle for the lowest common denominator,” he notes.
By far the most significant constraint surrounding IHBs, however, may be the existing technology landscape, often coupled with the resource requirement for establishing one in the first place. Masquelier comments: “Although centralisation and standardisation are among the best ways to respond to the challenges raised by Covid, all companies will also be looking to cut costs. As such, from the treasurer’s perspective, the challenge will be ‘selling’ such a project internally, and convincing the C-suite to invest in the relevant technology.”
He continues: “While digitisation has been accelerated because of Covid-19, human resources remain low and stretched. Any technology implementation will likely need to happen without increasing staffing or employing an external consultant. Yet an IHB requires resources at implementation to be able to increase the productivity of the team. And if you develop an IHB with the same level of staffing, you need much better technology and automation to increase productivity – which requires additional budget. It is a real challenge in the current environment.”
TOP TIPS FOR SETTING UP AN IHB
Masquelier offers this guidance to anyone embarking on an IHB project: “First, assess the current situation and determine gaps and problem areas. Next, try to define your ideal set-up. In my experience, a vision based on a treasury roadmap is often missing.
“You will need then to outline the potential gains – quantitative and qualitative – of such a project. This step will be critical in convincing the C-suite of the merits of an IHB – ranging from enhanced visibility to improved risk mitigation and operational efficiency.
“As well as selecting the correct technology to support the IHB, it is vital to consider regulations – current and pending. This means understanding reporting and compliance requirements and initiatives such as the new BEPS (base erosion and profit shifting) tax rules.”
A different way
The good news is that an emerging trend could help treasurers to overcome some of the resource issues. This trend is in-house banking-as-a-Service (IHBaaS) – which essentially involves a cash management bank hosting the IHB on behalf of their clients.
In the coming months, Deutsche Bank will be rolling out its new IHBaaS proposition. Hofmann explains: “We will deliver cloud-based IHB solutions for our clients, which can either be used as a complement to an existing IHB set-up, or can be leveraged to establish an IHB for the first time – without the typical resource requirements.”
In terms of how it works, the bank’s IHBaaS platform will replace existing bank portals across the corporation. Hofmann continues: “Local bank portals are replaced by our virtual solution – meaning significantly reduced IT integration requirements. Local entities can request to make payments via the virtual ledger platform, which are consolidated and executed by the IHB. Effectively, your central treasury team gains a fully fledged cash and liquidity management tool that enables them to consolidate and operate your subsidiaries’ cash management activities on a single platform.”
Hugh Davies Director, Zanders Treasury and Finance Solutions
Indeed, there is a wealth of features that can be adapted to the individual needs of each client – ranging from interest rate - and FX risk management to tweaking the bank account hierarchy. And for those companies which already have an IHB set-up, the platform offers complementary services such as improved reporting at entity level, including intra-day reporting. What’s more, since it is a flexible technology solution for treasurers, there is no need for them to use all of the features from day one – it can be scaled and refined over time to address the organisation’s evolving pain points,” he adds.
The key takeaway around IHBaaS, says Hofmann, is that it is lowering the barriers to entry for establishing an IHB, which will not only make an IHB proposition viable for more corporates than an on-premise installation, but also deliver enhanced benefits. “That’s not to say that it is totally painless to set up an IHB; it is still a significant undertaking. And, as we spoke about earlier, there are also numerous tax and regulatory considerations to bear in mind. Nevertheless, IHBaaS means that IHBs are no longer just for the largest multinationals.”
Masquelier has his reservations, however. “Personally, I am slightly more sceptical on IHBaaS. The outsourcing principle makes sense. But I don’t think treasurers and CFOs will prioritise outsourcing the IHB. I imagine they would first look to outsource payment connectivity and to outsource or automate FX hedging processes and so on. Of course, IHBaaS may have its day. But treasurers are conservative by nature, and I’m not sure if they are ready for such a big move just yet.”
However, Hofmann counters this point on outsourcing, stating that in this model the treasurer is keeping full control of all treasury processes and decisions, and is simply leveraging a central cloud-based technology platform.
IHBS VS LOCAL BANK RELATIONSHIPS
There are pros and cons of IHBs when it comes to existing bank relationships. As Davies outlines: “On the one hand, companies gain control of operations in a centralised location(s), but on the other hand, they lose local experience and bank relationships in key operational hubs.”
Nevertheless, from an operational perspective, subsidiaries hardly know the difference between having a bank account or an IHB account, says Davies. “They receive an IHB account statement that can be reconciled as if it were a bank account statement and complete settlements as before, leaving minimal or no impact.”
Technology advancements
Only time will tell whether IHBaaS takes off at speed, but in the meantime, there are other relevant technology developments for treasurers to watch – especially as they focus on the post-crisis future.
Morris comments: “Technology probably holds the key to future resilience and there is a wide variety of financial technology available supporting back, middle and front office operations. Digitisation is a common theme within solutions that aid treasury continuity and help to manage uncertainty. Looking ahead at the technology becoming available, we see an opportunity to strengthen IHB fundamentals and to create robust structures that will help companies withstand future shock events.”
He continues: “Combining IHB structures with the latest technology, such as RPA and AI, will enable treasury departments to push towards a partial or fully automated and virtual treasury function, operating in real time, in a flexible and secure working environment.” Davies adds: “Working from home could be here to stay for the next 12 to 18 months and the added control, visibility, flexibility and security makes an IHB a valid solution for the long term.”
Looking to the future
Keeping an eye on the road ahead, Davies offers this advice: “Companies considering an IHB structure would do well to take action now. For those with an IHB structure already in place, improvements in technology will push new levels of precision and autonomy. In both scenarios, a treasury scan or benchmarking review can add value by identifying critical areas for improvement, comparing one treasury operation with others – and against best practice.”
Meanwhile, Masquelier reiterates that “establishing an IHB it is a great project for those who have not yet adopted such an approach. It will help treasury functions to face future challenges and will assist in making the wider organisation more resilient to crises”. In fact, he believes that “multinational corporations must consider an IHB as part of the modernisation of their finance function”. And in the wake of Covid-19, the imperative to rethink and rebuild treasury set-ups has never been stronger.
EMERGING TREASURY TECHNOLOGIES
“Application programming interfaces (APIs) have enabled treasury departments to move from intraday reporting and batch processing to real-time reporting and processing. Advances in cloud computing and Software-as-a-Service (SaaS) solutions have aided business continuity by providing flexible, scalable and secure virtual offices. Artificial intelligence (AI) 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, meaning focus can be maintained on key tasks,” says Davies.
