Rise of in-house banks
The benefits of in-house banks are evident to companies with businesses in multiple countries and substantial FX exposure, although implementation challenges can be considerable.
In recent years, a number of high-profile corporations have sought to develop their own corporate treasury infrastructure through the creation of in-house banks.
Last year, Airbus followed other industrial groups – including Siemens, Daimler, BMW and Peugeot – in forming its own bank.
Roll-out can be challenging if you don’t identify those subsidiaries that significantly contribute to FX risk...
In-house banks are most common in Europe, although the likes of US supply chain company MFC Industrial, and Thai oil and gas conglomerate PTT have also gone down this route.
The ability to offer loans to suppliers is an attraction, but there are also notable FX benefits.
In-house banks enter into FX contracts with subsidiaries and then net all FX exposures from operational inter-company invoices, hedges, cash pools, etc. They are not a direct replacement for traditional transaction banks as they enter into contracts with financial institutions to hedge the company's total net position.
This enables treasury to find natural hedges within the organization, explains Jörg Wiemer, CEO of Treasury Intelligence Solutions (TIS).
“External dealing is allowed for the in-house bank only and not on a subsidiary level, so there is a clear segregation of duties,” he says. “This further reduces operational risk related to the usage of derivative instruments required to manage FX exposures.”
Martin Bellin, managing director of treasury management systems provider Bellin, says there are two approaches to enabling in-house banks to take on group-wide FX risks: “The first is the requirement and obligation to hedge all FX risks with the in-house bank, which manages external hedges – sometimes 1:1 and sometimes aggregated. Some are even taking risks on their own books.
“The second option is a more general approach, where transaction currencies are set in such a way that group companies no longer bear any risks. Netting offers another option to optimize the allocation of risks to the involved parties.”
From a technical perspective, an in-house bank needs to be closely linked to all ERP systems and the treasury system of the user, adds Wiemer at TIS.
Bellin refers to technology as a key implementation challenge, adding: “An effective in-house bank has to have access to all relevant data in order to manage risks, but many corporates still lack a complete overview of the possibilities they have in connection with risks they could easily manage.”
Jörg Wiemer, Treasury
There is no specific value or volume of transactions above which an in-house bank becomes a viable proposition – Wiemer says he has had conversations on the concept with mid-sized companies with a budget of €500,000 – although the best-known examples are found in multinationals such as Siemens.
Treasury Services partner and founder Jan Vermeer observes that benefits inevitably increase in line with higher intercompany volumes.
Companies that are centralizing their FX risk management are in effect using an in-house bank to execute internal trades for their subsidiaries, observes Guenther Peer, vice-president at Reval, who agrees that the concept is more established in Europe than elsewhere in the world.
“Roll-out can be challenging if you don’t identify those subsidiaries that significantly contribute to FX risk by the size or complexity of their business,” he says.
“Changing processes always needs to be clearly articulated to central as well as local management, including the benefits achieved, which in the case of FX can be reduced cost for the local entity as well.”
Treasury and risk-management systems typically form the supporting platform for an in-house bank, adds Peer.
“For FX risk management, there are two integration touchpoints to ERP systems,” he says. “Upstream data is collected for cash forecasting, while settlements or revaluations of trades flow downstream for accounting.”
Issues across regions
As with most centralized treasury structures, legal and compliance issues across the regions covered by the in-house bank need to be carefully researched and understood, says Bruce Meuli, global business solutions executive global transaction services at Bank of America Merrill Lynch.
“This could mean that it may not operate with the same breadth of process scope and responsibility across all geographies,” he says. “The objective of standardization across regions can also be compromised by factors such as local payment instruments, in-country corporate technology capabilities, banking infrastructure maturity and the cost-benefit of providing the full service in-house bank to all regions.
“Internal organizational and cultural issues can also hamper implementation.”
Since an in-house bank provides financial services to group companies and will potentially create intercompany borrowing and lending positions, local legal and tax legislation in some jurisdictions might prohibit the provision of such services to group organizations, adds Sander van Tol, partner at Zanders.
“Depending on the scope of the implementation, operating companies may also lose part of their autonomy over transactions and payments, which can lead to resistance in the implementation and adoption phase,” he says.
With regards to FX risk management, some developing countries do not allow non-residents to trade FX transactions in the country’s home currency or execute local payments on behalf of local subsidiaries, Van Tol continues.
“A solution to this could be to set up a different model where the in-house bank executes the transactions in the name of the local subsidiaries, gaining control over the processes and transactions,” he says.
Meuli accepts there will always be constraints and non-target processes in an in-house bank’s operations.
“Although you have more than one operating model, it is critical to include exceptions in the overall design and to ensure that they are understood and that key operational principles – such as risk and compliance – are not compromised,” he concludes.