What is an In-House Bank?
In recent years many multi-national corporations have established their own, “in-house banks.” The in-house banks are not officially regulated or licensed financial institutions. However, they act much like a commercial bank by offering payment processing, liquidity management and collections functions to various subsidiaries of a large, global corporation. Technology is a key enabler to in-house banking. In my opinion, banks are becoming more and more of a technology business every day. Most of the services banks perform are not conducted by people, but instead by vast computing networks. As banking goes digital, the barriers to establishing a banking function are reduced.
Who uses In-House Banks?
Multi-national corporations have the most to gain from establishing an in-house bank. A multi-national corporation in this context could be one with its own operations in various countries around the world. Or it could a corporation that sells to customers or buys from suppliers in various countries around the world. Alternatively stated, in-house banks benefit companies with the need to make payments and collect receivables on a multi-national basis. Often such companies are organized into various legal entities, subsidiaries or operating companies.
What Services does an In-House Bank Provide?
For all practical purposes, individual legal entities, subsidiaries and operating companies can interact with an in-house bank as if it were a real, external financial institution. In-house banks provide bank accounts to each of the individual subsidiaries. The subsidiaries’ accounts are credited or debited based as payables and receivable transactions are performed. The in-house bank provides the individual subsidiaries intra-day and end-of-day bank statements reflecting the transactions processed.
More specifically, in-house banks offer the following services to their internal customers:
- Payment Processing of domestic and international disbursements via check, ACH or wire transfer.
- Collections of domestic and international receivables via card, check, ACH or wire transfer
- Short Term Lending for cash flow deficit scenarios including chargeback of interest expenses incurred.
- Investment Services for cash flow surplus scenarios including allocation of interest income generated.
- Information Reporting services including cash flow forecasting, current account balances and exception reporting.
Why create an In-House Bank?
With an understanding of what an in-house bank does, you might be asking a more fundamental question. Why not just use a real bank? Below are two examples of how establishing an in-house bank at a multi-national corporation can yield significant business benefits:
- Intra-Company Payments – Multi-national corporations often have a need to exchange funds between different subsidiaries. These funds transfers are often payments resulting from an exchange of goods or services within the larger enterprise. Historically, intra-company payments occurred through the banking system. The buying subsidiary would issue a credit transfer to the supplying subsidiary through each entity’s primary bank. The corporation therefore paid one (or more) banks a transaction fee to affect which should really be a general ledger entry. In-house banks obviate the need to pay a third party financial institution for a physical transfer of funds between two subsidiaries. Instead a process called multi-lateral netting occurs. Credit and debit transfers between various entities are evaluated on a daily basis. The net value of the transactions is exchanged between the virtual accounts of each subsidiary.
- Cross-Border Transactions – Multi-national corporations often buy goods from suppliers in other countries. Historically, each legal entity in each different country managed an independent treasury function, accounts payable and collection activities. While such an operating structure provides autonomy and flexibility for local needs, it misses several opportunities for cost reductions in cross-border transactions. For example, OpCo UK, a subsidiary of a multi-national corporation with operations in 30 countries worldwide, buys goods from a supplier in Germany. Traditionally, OpCo UK would instruct their local bank in London to convert funds in its account from British Pounds to Euros then transfer the funds via an international ACH payment to the supplier’s account in Germany. OpCo UK’s local bank charges transaction fees for the foreign exchange. Additionally, the UK bank charges a premium for a cross-border payment. Using an in-house bank, OpCo UK could have requested that OpCo DE request that its local bank in Germany make a domestic ACH payment to the supplier on its behalf. The result is the avoidance of an expensive foreign exchange and international payment fee from the bank.
Advantages of In-House Bank
To summarize, there are five primary advantages of utilizing an in-house bank:
- Better pricing, service and flexibility from banking providers through aggregation of spend into a centralized treasury function.
- Reduce banking fees from intra-company funds transfers by avoiding physical cash transfers.
- Reduce banking fees from foreign exchange and cross-border payment transactions through local in-country payment processing.
- Pooling of cash and credit balances enables higher return on investment through the aggregation of funds.
- Loans can be provided to subsidiaries with a short term cash deficit. Lending internally is much less expensive than paying interest to a third party.
In-house banks are just one of several strategies being employed by multi-national companies to transform back office operations. Most multi-national corporations are also developing shared service centers for payments, centralizing treasury functions globally and consolidating the number of banking relationships they maintain. More about these back office transformation forces in a future post.