What is an In-House Bank?

MAY 1, 2009 / SKEIFER2

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 entitys
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 suppliers account in
Germany. OpCo UKs 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:

1. Better pricing, service and flexibility from banking providers

through aggregation of spend into a centralized treasury
function.
2. Reduce banking fees from intra-company funds transfers by
avoiding physical cash transfers.
3. Reduce banking fees from foreign exchange and cross-border
payment transactions through local in-country payment
processing.
4. Pooling of cash and credit balances enables higher return on
investment through the aggregation of funds.
5. 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.