FX: The benefits and costs of in-house banking

Analysis of the earnings calls of 1,200 publicly traded North American and European companies undertaken by currency analytics solutions provider FiREapps found that in the third quarter of last year, more than one-in-five reported negative impacts from currency fluctuations.

The total cost of these currency impacts came to $10.7 billion, but the firm questions whether the actual cost was even higher, given that a number of companies that had quantified quarterly impacts in the same period of 2015 – some running to more than $1 billion – did not quantify any impact in the third quarter of 2016.

FiREapps acknowledges that these companies might simply have not suffered any FX-related losses during that period, but it also suggests that the absence of data could be due to their inability to accurately assess their exposures.

In this context, it is significant that approximately 10% of the firm’s clients have established in-house banks and a further 15% have set up centralized reporting structures that mimic many of the functions of in-house banks, according to FiREapps CEO Wolfgang Koester.

Bruce Meuli, GTS advisory director for EMEA at Bank of America Merrill Lynch (BAML), observes that the key functions of in-house banks include management of intercompany payments and netting – reducing external bank payments and fees – and centralization of liquidity structures or cash pools to maximize cash flows and balances across the enterprise.

The authors of the Deloitte report ‘Cleaning up the mess under the bed – Why intercompany accounting is increasing corporate risk’ explain that intercompany accounting negatively impacts FX when it is unable to deliver a full list of approved intercompany balances for settlement.

“As it has oversight and (typically) direct control of the majority of cross-border payments and cash in- and out-flows, it follows that the in-house bank is ideally placed to manage FX risk exposures,” says Meuli.

“The transfer of business entity-level risk allows more effective measurement, identification and management of FX risk by a dedicated group of specialists.”

Martin Bellin, founder and CEO of treasury management systems and solutions provider Bellin, highlights two different strategies for taking on group wide FX risks.

The first is the requirement and obligation to hedge all FX risks with the in-house bank, with the latter managing external hedges – either 1:1 or aggregated. The second approach is more general, where transaction currencies are set in a way that group companies no longer bear any risks.

Ryan Heaslip, solutions consultant at Reval, explains that for multilateral netting, settlements between subsidiary companies and the netting centre are settled to the in-house bank.

“For currency netting, treasury utilizes various netting models to create internal back-to-back FX trades between the in-house bank and subsidiaries,” he says.

However, defining the systems and processes used for data capture, hedging pricing, trade settlement process and mark to market is a significant undertaking.

Job Wolters, director of corporate clients at Zanders, a Dutch treasury consultancy, says he has seen corporates rolling out in-house bank processes and systems to areas where, from a transaction volume point of view, there is no business case, but rather a desire to bring local processes up to the same level of security and control as the home jurisdiction.

However, in countries with less developed corporate technology capabilities and banking infrastructure, such standardization ambitions can be compromised.

According to Bellin, the key challenges to establishing such structures are political and technological, adding: “An effective in-house bank has to have access to all relevant data in order to manage risks. Excel-based reporting will not lead to an optimized solution. 

“In addition, there are political issues – if problems are not acknowledged at management level, there is no motivation to invest money and resources in systems and no leverage to convince the group to participate.”

As risk and transaction execution is effectively transferred to the in-house bank under a service relationship, subsidiaries need the assurance that there is realizable benefit for them – both in terms of services provided and cost-benefit.

The good news is that in-house banks are not the preserve of the largest multinational corporations. The level of intercompany transactions, geographical diversity, the complexity of payments and FX flows, the opportunity to optimize offsetting liquidity needs at business entity level and the capability of technology and process maturity can be just as critical as overall transaction volume when it comes to considering the viability of setting up an in-house bank.

“It is more about creating a process for cash pooling and/or cost savings in aggregating hedges with the intent of maintaining entity-level accounting,” says FiREapps’ Koester.

Operating cash pool and recoding in-house accounts means in-house banking structures are already applicable to SMEs, concludes Bellin.

“Almost every company with international business is exposed to FX risks,” he says. “Even if the company invoices only in its domestic currency, it is still exposed since its market prices will change in line with FX rate changes.

“These extremely important aspects should be centrally managed by professionals.”