In-house banking provides a number of advantages to financial departments when it comes to managing their cash flow more effectively: it helps them combat fraud, control financial risks and optimize their working capital requirements. Jéromine Adler and Arielle Chave, consultants in Redbridge’s Treasury Advisory team, highlight some of the keys to success when it comes to such projects.
What is in-house banking?
An in-house banking structure aims to replicate the services offered by an external bank. Such services can include liquidity management, payments on behalf of (POBO), collections on behalf of (COBO) and even managing the foreign exchange risk of a group’s sub-entities.
Adopting in-house banking encourages the finance department to revise its practices and rethink its effectiveness and alignment within the organization.
In-house banking can provide a company with a number of benefits.
- Adopting in-house banking compels a company to define an organizational model to improve its flows and rationalize its banking structure, thereby optimizing the working capital requirement. It enables the company to work with a solid, sustainable cash management structure that can support the company’s growth.
- In-house banking also enables groups to manage their currency risk better. That’s because currency risks are concentrated within the same entity. It provides a more direct overview of the financial risks and the treasury team can be more responsive when it comes to managing these risks. What’s more, transaction execution costs can be reduced due to the company’s greater bargaining power resulting from its foreign exchange operations being concentrated, and hence bigger in size.
- In-house banking directly contributes to a reduction in the risk of fraud and improvements in cybersecurity. Group entities reduce their external interactions and delegate responsibilities to the company conducting the in-house banking. The operational risk associated with workflow management is concentrated and opportunities for fraud are minimized.
- A related benefit of in-house banking is a reduction in bank charges: the complicated banking environment that was previously justified at a local level by a large number of transactions, currencies or even types of cash receipts can be streamlined, reducing the associated fees.
Some important considerations
There are a number of factors to think about before successfully implementing an in-house banking function.
- Don’t underestimate the scale of the change management process that will be necessary, both within the company and with respect to its customers and suppliers (especially if a POBO-or COBO-type payment center is being established). When implementing such a project, bank flows should be anticipated and the customer recovery service should be supported to avoid a slip in customer payment terms. Training for stakeholders is needed to demonstrate the medium-term benefits of the new structure. There needs to be buy-in among staff as they will be faced with a heavier workload during the implementation phase of the project.
- Deploy gradually. There will be substantial effort required from everyone involved, and detailed project management will be necessary. To avoid overstretching your teams, the project can be deployed in phases; for example, by country or region. This also enables the organization to learn and test its processes as it goes. In the projects we’ve been involved with, we have found that good preparation of the project upstream – with the drafting of a target operating model that is the result of collegial reflection between experts throughout the company – accounts for a third of the success of this kind of project.
- Ensure that the financial tools your company uses – especially those dedicated to cash management and accounting – are able to support such a structure. The need to manage the allocation of flows and update current accounts manually should be avoided. Work can be carried out upstream to streamline the number of financial applications used by the company. Our customers regularly take the opportunity presented by the implementation of in-house banking to optimize their application environment.
- Investigate the potential tax impacts and documentation requirements related to transfer pricing in the jurisdictions involved, both from the perspective of the participating entities and the parent entity. Strong intra-group relationships are vital if all the benefits of establishing an in-house bank are to be enjoyed to the full. The company’s tax scheme can only be optimized if the tax departments are involved in the project from the outset. We also recommend that the accounting treatment of intra-group flows are validated with the company’s auditors. Ongoing management of post-implementation tax audits and declarations is essential.
We summarize some of the prerequisites for implementing an in-house bank below.
- Confirm the maturity of the organization carrying out the project in view of organizational and practical changes. Not all organizations are eligible.
- Be aware of the tax impacts applicable to the jurisdictions of the companies to be integrated, particularly in cases in which the in-house bank structure includes a POBO- or COBO-type payment center.
- Assess the ability of the application environment to support an in-house banking structure. In the event of disparities in accounting tools, operating the in-house bank may be a complex affair.
- Ensure that both the financial department and the IT department are aware that the project is a priority. This is vital if the project is to have the dedicated business (accounting, treasury, tax and legal) and technical resources that it needs at its disposal.
In-house banking has been around for some time, but there are still some challenges it needs to overcome.
Harmonization of regulations
Depending on the country, the regulations in force may not necessarily be favorable for in-house banking. But this could change. It’s a good idea to monitor prospective regulatory developments to assess whether it may become beneficial to adopt in-house banking and, conversely, where it may become less favorable to do so.
The increasing importance of technical skills
The successful implementation of an in-house banking project is dependent on the people working on it having the right skills. Beyond the involvement of the CIO, the treasury resources need to be able to combine expertise in both operations and technology. External assistance will sometimes be required.
Despite the cross-functional requirements of this kind of project and the extra work needed to get it up and running, the creation of an in-house bank will bolster a company’s treasury practices and should provide an attractive financial return on investment.
Over the last five in-house banking projects we’ve worked on, the set-up costs have been made back after an average of around 1.5 years of operation. This has been possible due to the reduced bank charges and foreign exchange transaction costs and the return on investment of the additional cash that has been invested.
Taking into account the productivity gains and reduced risk of operational fraud these kinds of projects result in, they pay for themselves, on average, within one year.