Why In-House Banks are Expanding into Asia
IHBs are a sophisticated treasury structure, predominantly used by leading European multinationals. Companies such as ABB, Siemens, Philips, Ericsson, Deutsche Post/DHL, and Statoil were on the forefront of establishing IHBs in the 1980s and 1990s. Early adopters from Asia such as Sony followed thereafter, while US firms such as Intel and DuPont have more recently begun leveraging the advantages of the IHB model in their international operations.
Under the IHB model, a central entity provides group companies with loans, foreign exchange (FX), cash management, and other services. Group companies may even hold their operating bank accounts with the IHB rather than external banks. In turn, the IHB buys these services from banks where necessary, while trying to internalise and net-off as many transactions and exposures as possible.
Figure 1 – Basic Structure of an IHB:
Source: Standard Chartered
In this way, the IHB can deliver significant benefits to the group by:
For the largest of companies, savings from implementing an IHB can reach tens of millions of dollars, providing a strong incentive to invest in such a structure.
At the same time, there are significant challenges to overcome when setting up an IHB. They include a considerable design and implementation effort and various regulatory hurdles, especially in the emerging markets.
Some of the important considerations at the outset of establishing an IHB include:
Due to the complexity of these requirements and regulatory hurdles in Asia, many IHBs initially focused their operations on Europe, often operating a more traditional treasury set-up in Asia. However, the past four to five years have seen a significant increase in the number of multinationals that have brought their Asia treasury and cash management operations into the IHB.
While this expansion began in less restricted markets such as Hong Kong, Singapore and Australia, the IHB model has more recently evolved to encompass some of the more restricted markets in Asia (although this has required modifications to the traditional operating model of the IHB).
POBO/ROBO Structures in Asia
A key focus of European and US IHBs has been on implementing payment services or POBO transactions in Asia. POBO refers to a situation where the IHB executes payments of behalf of group companies using a bank account owned by the IHB. Less common – but of increasing importance in Asia – are ROBO transactions, where the IHB receives collections on behalf of group companies using a bank account owned by the IHB.
Figure 2 – The Process Flow for POBO/ROBO Transactions:
Source: Standard Chartered
The central premise of POBO/ROBO services is that the IHB acts as an aggregator and processor of payments and collections for group companies. Transactions are passed through a central bank account for each core operating currency, enabling the consolidation of liquidity positions of different group companies and greatly simplifying liquidity management, forecasting, and funding operations.
However, this typically gives rise to the creation of intercompany loans (or deposits and loans) as the IHB funds the payment runs and receives collections on behalf of other group companies.
In Asia, the crux of the issue lies in restrictions over FX and intercompany loans, which have effectively limited the use of traditional POBO/ROBO structures. In many parts of the region, the use of local currencies for cross-border transactions is restricted to specific situations such as settlement of imports, exports, capital injections and dividend payments.
There are also special rules, limits or outright bans on cross-border intercompany loans in many of these jurisdictions, although there is often more flexibility with foreign currency dominated loans. Moreover, the types of transactions that can be processed through non-resident account accounts by the IHB are often restricted. The combination of these factors means IHBs are unable to use an account held in their own name to process POBO/ROBO transactions.
To overcome these challenges, IHBs can deploy different variations of the POBO/ROBO model to cater for different markets:
In effect, these hybrid structures enable IHBs to process payments and collections on a global scale, and the use of IHBs by European and US multinationals has continued to grow in Asia despite the various challenges.
Asian multinationals have also begun to adopt the evolved IHB model. Malaysia’s national oil company, Petronas, for example, implemented a sophisticated IHB structure three years ago with its base of operations in Kuala Lumpur. Today, upwards of a dozen large Asian multinationals are thought to be actively considering this type of structure, with several in the advanced design or implementation planning stage.
This augurs well for the continued expansion of the IHB model in Asia, but careful due diligence is required for each market as there are often specific requirements that will drive specific elements of the IHB’s operations in Asia.
For example, various tax issues may need to be taken into consideration, including the setting of appropriate interest rates on intercompany loans and management fees to meet transfer pricing requirements in various jurisdictions, careful evaluation of withholding tax impacts on intercompany interest payments, and thin capitalisation rules that may limit the deductibility of interest on intercompany borrowing.
From a location perspective, if the IHB is to be based in Asia, there may be a requirement to register the IHB as a financial institution in some markets, just as this is a requirement in parts of Europe today.
Specific market nuances will also impact the operation of the IHB. Some Asian markets such as South Korea have strict data privacy rules, which restrict the IHB’s ability to hold company data offshore. This potentially limits the ability of the IHB to service group companies in that market using an offshore data centre. Some local clearing systems are also unable to carry sufficient information about the parties to a payment transaction, creating potential audit issues.
Likewise, some level of local customisation of IHB systems may be required to support certain central bank reporting obligations or linkages to special clearing systems that support payment of payroll taxes, customs, duties and other statutory payments.
By adopting different models, the IHB concept can be extended to various markets in Asia despite significant regulatory hurdles. This can deliver the benefits of lower funding, FX and operational costs as well as increased process standardisation, higher efficiency, improved visibility and better control over positions beyond just Europe. However, having a strong understanding of the legal, tax, accounting and technology issues is critical to successfully extending the IHB model to Asia.