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Liquidity Management Techniques
Pooling and Cash Concentration
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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
Liquidity Management
As always a balance between
the costs and benefits of having liquidity and
the costs and benefits of lacking liquidity
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Liquidity Management
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
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Liquidity Management
• Focusing on maximising Internal liquidity
utilising existing but wasted resources
Pooling / Cash Concentration
First: Notional Pooling
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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’
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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
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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
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Notional PoolingBenefits
• Maximise interest earned• Minimise interest paid by
As much as possible, for as long as possible, in
one place
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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
Notional PoolingBenefits
• 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
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Notional PoolingBenefits
• May improve internal discipline and control
• Do not have to move funds
- reduce costs of transfers
- reduce management time
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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
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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
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Notional PoolingActive Management
Investment of 400,000
Sub 1 + 800 Sub 2 + 700
Sub 3 - 200 Sub 4 - 900
T+ 400
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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?
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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
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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?
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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?
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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.
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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.
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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
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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
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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
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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
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Liquidity ManagementInterest Enhancement
• 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
Liquidity ManagementInterest Enhancement
• There is an offset of 50% so
• They would charge interest at, say, Libor plus1/4
• And pay interest at LIBID – 1/4
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