Time for Real-time Cash Management?
It isn’t an understatement to say that over the last few years, the cash management function in banking has been something of a poor relation in the world of the ‘back office’. I find it surprising that banks still retain batch processing and manual cash management at the core of their practices. In my discussions with the banks across Europe, I’ve seen a recurrent theme of banks shying away from real-time, or at least near real-time data and retaining their batch-based information.
Because of the often siloed nature of many institutions, banks rarely seem to examine whether their cash management protocols perform well or whether they could be tweaked to an optimal level. Banks should start asking questions about these processes such as: “do we have just enough or too much cash languishing in accounts?”; “is this cash accruing little or no interest?; and “how can we avoid overdue charges?”
There is, of course, always the argument that as long as the bank hasn’t erred, the liability lies elsewhere. Further, having cash dormant in an account allows a claim for use of funds. This is a double-edged sword though – the processes involved are very time-consuming and the firm can still end up with charges on its own books – slightly mitigated by the gains made from usage of cash in accounts, but still painful nevertheless.
Given the slim margins in banking these days, it would be advisable for banks as well as corporate treasuries, to start applying the principles and practice of delivering greater return on capital employed (ROCE) through better cash management processes. It’s a simple concept – lower your costs in handling cash and improve your investment decisions and it will have a direct effect on ROCE. I think most bankers would concur that this is desirable, the challenge is, how to achieve it.
So how do you kick off this drive to improve profit generation from better cash management functions? Some would argue that it’s enough just to let the cash manager update their spreadsheet manually whenever there is a new day trade or potential settlement break. Some would also say that it’s fine for the cash manager to call his contacts at the Nostro agent to ask them about the current balance, new bookings or to get them to check a relatively-well updated statement. I have my doubts as to whether this is the best way of dealing with the issue.
Let’s address one misconception. The phrase ‘real-time data’ doesn’t always mean that updates are required every nano-second. It’s about having timely transaction data – real-time information from internal and external sources – that is secure, can influence the firm’s cash balances and in turn, add value to decision making for lending and funding decisions at the earliest possible opportunity.
To illustrate this, take the example of a cash manager who receives an overnight batch from their internal systems on predicted cash flows for a period of one to five days. Any daily activity data that could influence the balances, like settlement breaks and trading activity, is passed on via phone, email or fax. These manual processes are risky because they are not real-time, reliable or particularly secure. With manual intervention like this come the increased risk of manual errors and the lack of a clear audit trail.
Cash managers would be better off deploying a system that allows for multiple feeds from a variety of sources. That batch file sent overnight could still be used, but it would be supplemented by real-time feeds with details of other movements and status updates, which could also include data from front-office systems and custodians. It’s fairly straightforward to mark these cash-flows so that the cash manager is alerted to exceptions (such as a settlement break on a transaction), which may already be included on the cash balance and equally so if there is a new trade that hasn’t registered on the ledger or back office systems.
This allows the cash manager to make an informed decision either way as to whether they include new trades or updated information in their balance or not. From there it’s relatively simple for intra-day updates to be sent through the cash management system, such as cancellations, trade confirmations and amendments. All of these real-time processes and the data they provide help the cash manager make the most accurate calculations of balances for the purposes of lending and funding decisions.
It’s tempting to think that this could only apply to banks, but corporates could benefit just as much from real-time cash management. Real-time information for corporates can have a huge impact across the whole cash management value chain, from e-invoicing and even e-ordering. Banks, under pressure form the regulatory and process demands from SEPA, are looking to differentiate themselves from competitor service offerings – real time cash management is one such tool, that of course has the added benefit for banks in improving their cash prognosis service and in turn all the add-ons that come with that, such as proactive credit and investment advice for their clients.
Corporate cash management isn’t the only area that can be improved. Banks can also improve internal cash management systems can too. Traditionally, banks would look at spot cash flows to divine trends in the short term. However, it’s perfectly possible to have a horizon view over the longer term, thus letting the cash manager use their market knowledge to the best possible effect when making lending and funding decisions.
A cash manager can do one of two things when cash in expected in say a two week time frame – one, they can wait until funds are placed and received before making investment decisions and all the downsides that this brings, or two, they can take that decision today. Much of the success of that decision rests with their market knowledge, but a great proportion of that is based on the data they have at their fingertips. Optimisation in decision-making can only be achieved through good information flow and an integral part of the quality of information flow is having an integrated cash management system, delivering relevant and up-to-date information.
So, supposing you have improved you cash management systems, what else can you do to further optimise this process? I discussed earlier how important internal real-time data is but the cash management cycle wouldn’t be complete without also mentioning receipt of real-time data from Nostro agents.
Many might recall a few years ago that SWIFT introduced a number of new ISO 20022 messages for the communication of real-time account information to enable receipt of account and transaction statements in real-time. These can be used by Nostro banks in either ‘pull’ mode (sending reply messages within 60 seconds of receiving a ‘request’ message) and ‘push’ mode (Nostro banks who can set up batch processes and who automatically send-out real-time Nostro (RTN) based on particular SLA agreements with their clients, often several times a day). Of the two, it seems that the push mode is gaining traction over the pull mode, simply because many banks still rely on fairly old systems in which it is usually easier to implement push mode batch processing than message requests within pull mode.
It would be great in a perfect world to have lending decisions based solely on internal data. However, it isn’t a perfect world – not everything is settled in time and data is missed, or repeated and cash receipts aren’t expected. Any cash manager would confirm this. In fact they’d probably go further and say that settlement breaks often occur and receipts aren’t always advised in advance.
Use of RTN has many benefits for the cash management function. It allows cash managers to map cash, that is, to allow banks to reconcile expected movements with actual movements. Pretty basic, except when you factor in that banks can move from the traditional end-of-day settlement reconciliation (usually completed the following day), to reconciliation on the same day.
Of course, this means that any errors can be found and investigated on the day that they appear or become apparent and corrected while markets are still open. This prevents breaks from occurring in the first place and lowers the likelihood of claims and the resultant burden on claims departments, who will have fewer claims to handle.
RTN assists the decision making process for lending and funding because the quality of data is better, preventing account overdrafts or having too much cash tied up in with low interest or worse, no interest at all. Although claims departments can reclaim overdraft charges and claim use of funds, this is only has only a relieving effect.
Real-time information access to cash positions helps banks facilitate intra-day liquidity management, enabling them to take advantage of differentials between borrowing and lending rates during the day.
Further, RTN gives the ability to forward look on projected cash balances so that expected movements that won’t settle on time can be identified, carried forward and included in the next days’ balance. RTN also gives up to date and accurate information on the banks own balances and movements and improves cash management for its own client accounts. For financial institutions, RTN provides a valuable method to monitor payments and receipts made on behalf of clients in real time, in exactly the same way a bank does. For banks this means:
The last point is crucial for financial institutions as most corporate clients would already have a plan for what do with funds received. It’s needed to either fulfil other payment obligations or invested for clients to generate higher yields than if it were just placed in a holding or escrow account.
When you consider the benefits of using real-time data, both from internal and external sources, banks shouldn’t be hesitating to invest in their cash management systems. Banks who use a single, global cash management solution will optimise their funding and lending business and at the same time, de-risk their operations associated with manual work.