1 Liquidity Management Techniques Pooling and Cash Concentration

1

Liquidity Management Techniques

Pooling and Cash Concentration

2

Liquidity Management

Having funds available to meet all known and unknown commitments

- In the right currency- In the right place- At the right time

Minimise cost of funds and debit interest

Maximise use of surplus funds and interest earnings


As always a balance between

the costs and benefits of having liquidity and

the costs and benefits of lacking liquidity

3


How may a company improve liquidity?•External-Through borrowing-Through suppliers•Internal-Better practices on inventory, receivables short term investment-Better control of cash resources around the group

4


• Focusing on maximising Internal liquidity

utilising existing but wasted resources

Pooling / Cash Concentration

First: Notional Pooling

5

6

Notional Pooling

• With Notional Pooling there is no actual movement of funds.

• With Notional Pooling there is no co-mingling of funds

• Credit balances are offset against debit balances and the net is used to work out the debit or credit interest paid or received

• Also referred to as ‘interest offset pooling’

7

Notional PoolingPosition prior to pooling

Average Balance Average Balance + 900,000 + 350,000

Average Balance Average Balance - 300,000 - 550,000

Credit interest at 4 % = 1,250,000 x .04 = 50,000 Debit interest at 6 % = 850,000 x .06 = 51,000 Net cost to group = - 1,000

But if notionally pooled

Sub 1 Sub 2

Sub 3 Sub 4

8

Notional PoolingPosition if pooled

Average Balance Average Balance + 900 + 350

Average Balance Average Balance - 300 - 550

Net position = + 400,000 So 400,000 x .04 = 16,000 an improvement of 17,000

Sub 1 Sub 2

Sub 3 Sub 4

9

Notional PoolingBenefits

• Maximise interest earned• Minimise interest paid by

As much as possible, for as long as possible, in

one place

10

Notional PoolingTaking Advantage

Tiered Interest Rate Structure

8Interest 7Rates 6 5 4 3

0 50 100 200 300 400 Balance in 000’s

Stepped versus BandedAmount in GBP Interest Rate

1 to 250,000 0.10

251,000 to 500,000 0.20

500,001 to 1,000,000 0.50

Over 1,000,000 0.90

Company Balance Tier Interest rate Interest

A 355,000 250,000 .001 250

105,000 .002 210

B 400,000 250,000 .001 250

150,000 .002 300

C 250,000 250,000 .001 250

Total 1,260

Pooled 1,005,000 .009 9,045

Benefit 7,785 11


• Improves the balance sheet by offsetting surplus balances against group debt

• Reduces and may eliminate short term borrowing (will probably still need credit lines as back up with limits on individual subs)

• Reduces overall exposure to banks

12


• May improve internal discipline and control

• Do not have to move funds

- reduce costs of transfers

- reduce management time

13

14

Notional PoolingRequirements

• Pooling agreement• Cross guarantees• Legal right of set off• Tax indemnity• Ability to link accounts for interest

calculations. Obvious, but not every bank will have the capability

• Interest apportionment• Board resolutions

15

Notional PoolingIssues

• Bank charges

• Resident non-resident issues

• Tax issues (arms length)

• May be treated as a form of lending with no transfer of funds ownership

• Interest offered may be low / or charged high, so Treasury may wish to actively place funds or borrow

16

Notional PoolingActive Management

Investment of 400,000

Sub 1 + 800 Sub 2 + 700

Sub 3 - 200 Sub 4 - 900

T+ 400

17

Types of notional Pooling

• Single currency, single country

• Single currency, cross border

• Multi-currency, single country

• Multi-currency, cross border

• What is possible?

• What is offered?

• What does it cost the bank?

18

How Banks Charge for Pooling

• Interest rate spread• Reserve asset charge (cost recovery)• Set up fee• Management fee (monthly per account)• Interest apportionment fee• Account maintenance fees• Electronic reporting fee• Money movements, receipts/payments• FX if involved

19

PoolingDue diligence

• Is pooling permitted?

• Tax issues– Withholding tax – Res/non Res issues– Arms length rule– Is debit interest an allowable deduction?– Is thin capitalisation an issue?– Location?

20

Pooling Due diligence

• How do laws of offset relate to – Multi entities?– Multi currencies?– Cross border aspects?– How does the bank cover?– Are cross–guarantees necessary?– Are Central Bank reserve ratios calculated

gross or net?

21

Pooling Due Diligence

• Impact on group of using one bank

• Should all operational accounts be included in the pool?

• Impact of cut-off times for movement in and out of pools

• Value dating practices for cross border movements into and out of the pool.

22

Cash concentration

Sometimes Notional Pooling is not possible or not wanted– Rules and regulations– Structure of banking industry– Legal issues

Then we may have to cash concentrate i.e. physically move the funds to attain the same benefits.

23

Cash concentration Example of Zero Balance Cash concentration

End of day 750 invested

Sub 1 + 350 Sub 2 +500

Sub 3 +550 Sub 4 - 650

Concentration a/c

24

Cash Concentration

• There are various forms of cash concentration

• Zero balance, as illustrated• Target balance, to keep a specific amount

in each account• Threshold, to move funds only when an

account moves in excess of a figure• Collar, when a threshold is reached, funds

are moved but a balance is left

Cash Concentration

• All will depend on the costs involved versus the needs of the group elsewhere, the sums involved and the overall treasury objective

25

26

Cash Concentration Issues

Drawbacks– Transfers may have to be done manually– Will involve transfer fees– Transfers to/from non resident ac’s may add

to central bank reporting and to cost– Local rules and regulations may

prohibit/complicate cross border movements

27

Cash ConcentrationUsing MT101 to concentrate

Customer

Instruction Advice Lead Bank

MT101 MT103

MT101 MT103

Sending bank

SWIFTNetwork

SWIFTNetwork

Debit sending bank nostro

Credit customer concentration

account

Debit customer ac Credit vostro ac

Liquidity ManagementInterest Enhancement

• As mentioned earlier, sometimes rules and regulations make cash concentration and cash pooling difficult, uneconomic or illegal

• Nonetheless, Banks have developed ways to enable companies to gain some benefit from their balances

• The banks recognise that the balances they hold, even where blocked, are reflected on their balance sheet and therefore of value

28


• Suppose that the bank will normally charge interest on deficits at LIBOR plus ½ and pay on surpluses at LIBID – ½

• To the extent that balances offset each other the bank will adjust these rates

• E.g.

Account No 1 has a surplus balance of

GBP 100 and account No 2 a deficit of

GBP 50. 29


• There is an offset of 50% so

• They would charge interest at, say, Libor plus1/4

• And pay interest at LIBID – 1/4

30

Documents

1 Liquidity Management Techniques Pooling and Cash Concentration