Is an In-House Bank or Payment Factory right for your organisation?Written by Krister Backlund

We live in a time of change, and corporate financial processes are no exception. As a result of new technology and regulations, companies must review their financial processes in order to remain competitive. We are currently seeing organisational changes such as establishment of shared service centres and changes to the responsibilities and mandates of treasury departments. Other changes arise in technology in the form of virtual accounts, scanning services, In-House Banks and SaaS solutions as well as in standards such as CGI XML 20022 and introduction of new regulations. How should organisations seek to handle these changes?

• Could an In-House Bank or Payment Factory form part of a solution to achieve the level of efficiency required?

• What does the implementation of an In-House Bank or Payment Factory demand of an organisation?

• Is there a Business Case for the implementation of a Payment Factory or an In-House Bank?

This article seeks to provide a factual basis for assessing why your organisation should implement an In-House Bank. Further, it outlines what is required so that your organisation can answer the above questions.

Cash management is changingThere are a number of motivating factors behind the changes currently taking place, occurring within corporations and banks with external and internal drivers.

New regulations are putting banks and corporations under pressure. The banks are being forced to prioritise compliance with regulations rather than developing new products. At the same time, technological legacies make it difficult for them to deliver what their customers want and need. Banks are adopting different approaches in order to engage customers. These range from lock-in effects to the identification of innovative solutions, within the scope of the new prevailing conditions, with the aim of attracting new customers.

The finance department is under pressure to demonstrate increased efficiency. Key performance indicators which track efficiency, for example, measuring the number of employees in the financial department in relation to turnover, are becoming more commonplace. In order to make intended improvements on efficiency, companies are placing greater demands on their banks, internal organisations and system suppliers. Companies are seeking a greater degree of automation, fewer IT solutions and user-friendly interfaces requiring minimal manual input. A greater degree of mobility on the part of the finance department personnel, requires location-independent solutions, with mobile services and real-time information as fundamental requirements.

What are the requirements for implementing an In-House Bank?The complexities associated with implementing an In-House Bank should be neither under nor overestimated. What is clear, however, is that it can represent a highly profitable investment for many organisations. The Vision, Strategy and Policy of the treasury department are fundamental to this process. This being the case, active support from management is vital for effecting this type of change, since it concerns more a shift of approach than the implementation of new system support.

The company’s operational structure must be able to accommodate the introduction of an In-House Bank. Implementation of an In-House Bank is not only about automating and centralising payment flows. Parts of the processes previously managed by the bank

will now be handled internally. An In-House Bank also requires someone to manage internal agreements, such as interest rates and limits, in addition to the other activities requiring attention.

The company’s banking arrangements are fundamental to the implementation of an In-House Bank. The capacity of selected banks to meet standards such as XML20022 will assume even greater importance to carry out straightforward implementation and being able to easily change banks. Support in the form of virtual accounts is a key requirement for carrying out COBO (collection on behalf) payments.

The difference between an In-House Bank and Payment FactoryThe terms Payment Factory and In-House Bank are used in different ways by different market players. “In-House Bank” is often used in order to describe the role performed by the treasury department in many companies. When we talk about systems, however, in simple terms, a Payment Factory can be classed as a system used for centralisation and automation

of payment flows, whereas an In-House Bank is used to insource management of accounts from the bank into the internal organisation. It is important for an In-House Bank to enable POBO (Payment on behalf of*) payments as well as to minimise internal payments at the bank. COBO (Collection on behalf of*) payments can be performed within In-House Banks. Once this is achieved, the number of external accounts can be kept to a minimum.

The link between an In-House Bank and Payment Factory is outlined in the illustration above. The different components can be coordinated or used in isolation as units in the illustration.

• Cash Management – in this function, the company keeps track of balances and projected cash flows.

• Payments and Collections – this function is used to manage incoming and outgoing payments. The payment regulations in effect for validation and optimisation form a central part of the process.

• In-House Bank – manages the company’s accounts as well as all terms, such as interest rates and internal limits. External accounts are replaced by internal ones, which thereby enables POBO (Payment on behalf of) and COBO (Collections on behalf of).

POBO and COBO - what are they and how do they work?

POBO and COBO payments, as well as elimination of internal payments within the bank, are key components implementing an in-house bank. With this in mind, I will provide a brief explanation of these concepts.

POBO - Payments on behalf of (payments in someone else’s name): The debit account for the outgoing payment is replaced by another

account. The subsidiary does not have a bank account in the currency of the payment, or has no account at all. Instead, it only has an account in an In-House Bank. The parent company’s bank account is used as the debit account when the bank performs the payment (the parent company’s bank account is also mirrored in the In-House Bank). The subsidiary’s account in the In-House Bank is debited, with a credit applied to the transaction account of the In-House Bank.

COBO - Collections on behalf of (payments received in someone else’s name): The subsidiary does not have an external account in order to receive the payment. Therefore, the customer has been instructed to make the payment to the parent company’s bank account. When the parent company’s account is credited, the payment is mirrored in its In-House Bank account. The reference information serves to identify the subsidiary to which the payment is linked, with this subsidiary’s In-House Bank account credited and the parent company’s In-House Bank transaction account debited. In the case of COBO payments, identifying the recipient can be more difficult. Using a bank which provides virtual account management can provide an effective solution to this problem. We will revisit the subject of virtual account management in a future article.

The route to an In-House Bank?The route to an In-House Bank is a process, which involves a number of steps. Naturally, it is important for companies to assess their current situation before proceeding. It is important to bear in mind that this is not an IT project or an isolated Treasury project, although as project-owner, Treasury is tasked with leading and coordinating the process. The organisation as a whole must be engaged, with subsidiaries, IT units, shared service centres and legal departments, this is key to the to the project’s success. It can be difficult for the internal organisation to handle a project of this nature without involving external resources. Previous experience working with similar projects can be invaluable. Commissioning external consultants is often considered expensive, however, preventing costly errors may enable savings in the long term. This may also serve to ensure that the project progresses and reaches completion as quickly as possible, even though internal resources may be stretched from time to time. It is important to emphasise that each company is unique. If you have the ambition to become a best-in-class treasury, you can’t simply duplicate what others have done previously. The point of departure must be the company’s unique circumstances and agreed objectives, which then provide the solution for the path it needs to take.

Examples of stages towards the implementation of an In-House Bank with Straight Through Processing include:

1. Centralised ownership of accounts and funds.

2. Improved banking and account structure.

3. Replacing banks’ bilateral connections with SWIFT.

4. Standardisation and automation of outgoing payment flows.

5. Moving internal payments from the bank.

6. Centralising incoming payment flows.

7. Closing accounts to be replaced by internal accounts in an In-House Bank.

In summary

Thanks to standardisation and technological developments, implementing a Payment Factory or In-House Bank is also a viable option for mid-size enterprises. Standardisation has also made the implementation easier. To determine if an In-House Bank is suitable for your organisation, and to form the basis of your business case, a number of factors must be evaluated, including the number of subsidiaries, payment flows in overseas currencies, the nature of banking arrangements, operational structure, efficiency of payment processing and currency risks, etc. As referred to earlier, a pre- study is the first logical step towards implementation of an In-House Bank. Introduction of an In-House Bank is a key part of the process to become a best-in-class treasury, so why wait?

For further information go to www.tieto.com/tcb Contact: Krister Backlund, Lead Business Analyst krister.backlund@tieto.com + 46/ 70 350 6909

Is there a business case?

There is no doubt that a positive business case exists for the implementation of an In-House Bank for the majority of companies of a certain scale and complexity. The implementation of standards and STP (Straight Through Processing) enabled by an In-House Bank are integral to this business case. The savings provided by the implementation of an In-House Bank are as follows:

• Keeping better track of and gaining easier access to the company’s liquid assets.

• More efficient integration and standardisation of cash management processes.

• Simplified IT infrastructure, with fewer systems and bank connections.

• Reduced bank costs, fewer accounts and fewer cross-border payments.

• Simplified risk control, making it easier to secure compliance with KYC and AML.

• Payment history data available in one location.

Each area provides both qualitative and quantitative improvements to be included in the business case. The full effect of all savings will not be immediately apparent, rather, it could take some years until this is the case. However, the total savings made are significant.

There are likely to be significant hidden costs associated with processing payments locally among the company’s subsidiaries. These costs are included in the processing of such costs itself. In this context, it is vital to focus on identifying hidden inefficiencies in payment processes. This will ensure improvement of the business case as well as the realisation of intended improvements when the project is carried out. This is of importance not least when the time comes to follow up the savings generated by the project.

At a minimum, the following costs should be included when assessing the business case: project costs, implementation costs, licence costs and operational costs.