Prior to the financial crisis, the primary reason for setting up an In-House-Bank was to save costs in the area of transactional banking. Inter-company cash flow settlements through internal accounts instead of via external bank accounts, an internal netting of inter-company invoices and current account bookings were often the main drivers behind establishing an In-House-Bank. Experiences since the crisis however have changed the reasons corporates are now establishing an In-House-Bank.
With Basel III coming into force, banks now have to realise a RAROC (Risk Adjusted Return On Capital) of 15 % compared to 8 % with Basel II. As a result banks require ancillary business in return for funding in order to achieve their RAROC targets. Cash management has therefore become a typical side business that is traded off by corporates in return for bank funding. However, suppliers of funding may not have a cash management infrastructure which suits the client’s needs. This situation creates idle cash which increases the funding required by corporates which can see them forced to pay interest to the banks to borrow their own money.
In order to solve this issue, corporates are increasingly looking for a bank independent cash pooling structure. In such a structure zero balance cash pooling is managed through a software platform, where accounts maintained with different banks and in different countries are pooled. However, such a pooling structure cannot work without automated internal current account bookings related to the cash pool sweeps. This is increasingly becoming a driver for setting up an In-House-Bank.
Recent developments in the OTC derivatives market are also increasingly making corporates look towards In-House-Banks. Banks have started to charge additional spreads for OTC derivatives which has increased the cost of hedging risk, and the recent EMIR regulations have increased the organisation costs (and in the future also bank costs) related to risk management. Corporates are therefore now looking to minimise external hedge transactions in order to minimise the cost of hedging.
In the centralisation of risks via inter-company trades, EMIR is an additional administrative cost to corporates. Setting up an In-House-Bank will bring significant savings and advantages in this area. Instead of centralising FX risks via inter-company forwards, corporates are increasingly concluding FX spot transactions that are immediately settled on the internal accounts. As spot transactions do not need to be reported for EMIR this solves an organisational problem and, via the internal accounts, corporates can start to hedge portfolio risks instead of transactional based hedging. This minimises the need for external hedges and it fully eliminates the need for internal FX Swaps.
In the most advanced way, corporates will replace OTC derivatives by exchange traded futures to lower the cost of hedging risk, which in the end also has a positive effect on the competitiveness. This requires special features in the In-House-Bank to quantify the portfolio risks.