FD Report: Do-it-yourself banking

Those former masters of the universe, the global bankers who brought the world’s financial system to its knees, now have a new problem to contend with. Since the credit crunch started, more corporates have started to set up their own in-house banks.

At this stage, no one is pretending they will supplant Barclays, Société Générale or Deutsche Bank, but they will change the way banks work with corporates and ­ what’s especially important for FDs ­ the way corporates handle many of their treasury functions and, potentially, their commercial payment activities.

E-on, the energy company, is just one of a growing list that have been moving towards in-house banking. “It’s delivered more efficient cash management in the company,” says Rainer Heynck, who runs the in-house bank’s back-office. “Before, we had different databases, but now we have only one.”

In an age of uncertainty, the ability to see what’s happening to cash throughout a diverse business empire is a major benefit. “What I can do, which I couldn’t before, is see the in-house balances of every company. I can see those that might have cash surpluses and those that need credit.”

E-on has set up in-house banking centres in Germany, Sweden and the US. The German operation, where Heynck works, handles the banking for around 80 European entities. At the moment, the main activity is oversight and reconciliation of cash balances among the entities. In the future, the in-house banking team at E.on, which includes Jöerg Bädermann in the front office and Torsten Spieker, the project manager, are planning that all payments between E.on companies will pass through the in-house bank rather than external banks.

“Since the beginning of the credit crunch and the subsequent reduction in available liquidity in the market, we’ve experienced an increase in demand for advanced cash management solutions, including in-house banking,” says Larry Ng, managing director of corporate development for Wall Street Systems, the company which provides the software that powers E.on’s in-house bank.

“While the state of the economy has reduced the overall demand for treasury systems, we have seen cash management requirements taking precedence over treasury and risk management requirements in many cases,” Ng adds.

Banking on FDs
In-house banking ought to be on more FDs’ agendas, argues David Stebbings, head of treasury advisory at PricewaterhouseCoopers UK. He’s fresh back from Amsterdam where he has been advising a Middle Eastern oil company setting up its in-house bank.

Its main purpose in doing so was to create a “payments factory” to process outgoings and receipts for all its companies.

“There are efficiency and cost savings,” says Stebbings. “But there’s also much better control ­ you can see the payments going out from the business more clearly.”

Stebbings sees in-house banks working at two levels. The first is where the company sets up its treasury function as an in-house bank. “An in-house bank effectively centralises all the risk and manages that risk out of one place,” says Stebbings.

By way of example, take the case of a subsidiary company that wants to do a foreign exchange deal. It could handle the deal itself, but if the subsidiary is a small one, it might lack the kind of FX experience and bargaining power that will enable it to get the best result.

Instead, the subsidiary does its deal with the in-house bank. The in-house bank completes the transaction in the markets. By aggregating bids from other subsidiaries, it may be able to strike a better overall deal than a number of subsidiaries could do individually. Certainly, the higher level of dealflow makes it more likely deals will be handled by a trader who is more experienced.

Or take the case of one subsidiary selling euros to hedge a long position. Perhaps there is a another subsidiary elsewhere buying euros to hedge a short position. An in-house bank may have the ability to offset those trades without going to the market.

Payment factory
Stebbings sees the centralisation of treasury functions as the first level of an in-house bank. The second level is to set up an in-house payments factory, such as the Amsterdam operation ­ “but that’s a more complex operation,” he says. Much depends on what systems are already in place.

If enterprise risk management systems such as SAP or Oracle are deeply embedded in the company and working well, then it may be easier to move to a payments factory than if the company’s international systems picture is fragmented. It’s not just a question of system either. Processes are also important (though these are usually mapped by systems.)

However, although there could be a number of reasons why a corporate might want to move to an in-house bank, there seems little doubt about the main driver at present.

“The reduction in available liquidity in the market has left many corporations in a funding shortfall,” says Ng.

“The typical corporation today does not have an accurate view of all its cash assets or the means to efficiently manage these assets in a manner that minimises the need for external funding of operations. Sophisticated organisations are currently looking for technology to provide near real-time visibility of all cash balances on a global basis and proven methodologies to systematically pool these balances to increase the level of internal funding.”

Stebbings agrees that cash pooling is one of what he sees as two key reasons FDs are thinking more actively about an in-house bank. “The rationale for pooling cash and not using the banking systems has gone up greatly in the past year,” he says. “It’s clearly a bigger driver now because pooling makes people money when they’re borrowing at higher margins. If you’re borrowing at, say, Libor plus four or five percent but you can avoid the borrowings by pooling cash, you’re saving four or five percent on the debt.”

He says that, historically, lots of corporates would have had spare cash floating around in subsidiaries, although he acknowledges that this will be less likely now. He argues that cash pooling is merely doing in public-owned companies what private equity houses have been practising for years ­ making sure that every spare pound of cash in a collection of portfolio companies is productively invested.

A bonus saving from cash pooling is a potential cut in bank charges. As Stebbings explains, “If businesses are making cross-border payments and you can avoid them with cash pooling, you can save quite a lot of money.” Clearly, the more internationally diverse the business, the more opportunities there are for bank charge savings on cross-border payments.

But the second main advantage which Stebbings sees FDs seeking from in-house banking is improved control. “Putting everything in one place gives you much better visibility and control,” he says. “If you know where your cash is you can make the most of it.”

More than that, a reasonably sophisticated in-house bank will be able to get a more detailed central picture of treasury payments, such as interest, across a group. And, if the in-house bank extends to a commercial payments factory, there is potential for central analysis of those figures as well, with potential savings. For example, if it proves cheaper to make payments from one country rather than another, it is possible to do so.

The in-house bank concept has been around for a few years now, although as recently as five years ago there were said to be only about 15 operating in Europe, including some of the usual suspects such as Shell, BP and Philips. Since then, the number has grown considerably, although even those deeply involved in the business don’t seem quite sure how many are operating.

However, the point is there are more corporates that could take the in-house banking route than have already done so. So what issues should their FDs bear in mind if considering it?

“Implementing a comprehensive in-house banking solution is a substantial undertaking involving major process re-engineering as well as the deployment of a new technology platform,” warns Ng. He sees a number of factors being important in the success of a project.

Putting it in place
Perhaps not surprisingly, the first is the selection of a software application that provides robust functionality, configurability and scalability. “The application should be powerful enough to meet both current and future functional requirements and transaction volumes and flexible enough to support the ever-changing structure of today’s dynamic global corporations,” says Ng.

Then comes the selection of experienced partners ­ in areas such as treasury software vendors and consultancies ­ that have substantial experience in the successful implementation of complex cash management projects such as an in-house bank or payment factory.

His third factor is the completion of a detailed scoping workshop and development of a phased implementation approach. “It should have measurable success milestones at several points along the project timeline,” he says. Finally, like all major company-wide projects, it will need active executive sponsorship and dedicated project resources.

This is because there is the potential for political conflict in an organisation that has traditionally run decentralised treasury functions around the world. Local FDs may be reluctant to be stripped of some of their power and cash-rich subsidiaries could be jealous about surrendering control over the use of cash balances.

Despite this potential hassle, the gains can be worth it ­ as pharmaceutical company Merck has discovered from its in-house banking experience. “The system has supported the treasury vision, which has yielded million-dollar-savings through the increased visibility of cash, yield enhancement, cost savings and reduced bank charges,” says Ian Johnson, Merck’s senior director of global cash management. Meanwhile, Johnson notes, the gradual transition from multiple bank relationships will increasingly yield reduced bank fees and avoid the need to develop and maintain numerous bank interfaces.

If more firms seek similar benefits, corporate banking could be changing for good.

Cheque dout
One of the handiest business tools ever invented, the humble chequebook, is destined to be added to the long and growing list of superannuated objects now part of history’s scrapheap.

A recent report from business information specialists Creditsafe found that one-third of organisations plan to stop using cheques to pay other organisations within the next year. To add insult to injury, the report also found that 11% of companies surveyed planned to stop regarding cheques as a valid form of payment.

The driver in all this is, of course, cost reduction. Creditsafe estimates that no longer having to process cheques could lead to collective savings of £788m a year for UK SMEs. One of the biggest cost elements in cheque handling is the time required to hand process and account for them inside companies. On average, dealing with cheques takes up half a day every month for SMEs.

Commenting on the report, David Knowles, marketing director of Creditsafe, says, “We could be witnessing the beginning of the end for cheque payments. They are viewed by many businesses as inefficient, time-consuming and a security risk by comparison with BACS transfers and card payments.”

He points out that businesses want traceable, efficient payment systems that do not need to be physically processed. The convenience of being able to use a cheque book to settle a transaction is more than offset by all the baggage that supposedly simple transaction sets in motion. Just as the credit card has replaced the cheque as the favoured form of payment in the personal realm, so businesses now have other, faster, less cumbersome options to settle debts.

Knowles points out that even as payment received, cheques are far less tractable than electronic transfers direct into the company bank account. “With cheque payments, a member of a company’s financial team has to physically pay the cheques into the bank.”

The coming demise of the cheque will, of course, drive a nail through the heart of the most overworked lie of all time ­ “The cheque’s in the post” ­ and it will play havoc with at least one piece of media mythology. There just isn’t a handy electronic equivalent for the notion of “chequebook journalism”.