Functional online liquidity
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Transcript of Functional online liquidity
Online Liquidity Management
Business Process OutsourcingConsultingSystem IntegrationUniversal Banking Solution
Overview
Liquidity Management – The Business Context
JP Morgan’s recent Global Cash Management
Survey’ 2010 has revealed that there has been
a clear attempt by treasurers to manage cash
more skillfully and efficiently in order to avoid
potential cash flow difficulties. Tighter credit
conditions and economic downturn has resulted
in severe liquidity constraints underscoring the
importance of effective liquidity management.
Cash Management refers to the management
of payables and collections, liquidity monitoring
in banking operations i.e. liquidity management,
short-term treasury forecasts, and the
management of financial risks.
Liquidity Management refers to a range of
products / service offerings typically provided
to corporate customers, to help enhance
customers’ return, or minimize overdraft charges
on cash balances with the bank. This can be
achieved by various techniques like Notional
Pooling, Target Balancing, and Forecasting etc.
Good liquidity management ensures the
availability of funds to meet all cash outflow
commitments for day-to-day operations and
deploys cash in an effective manner. It implies
managing cash on a global level for the purpose
of minimizing idle cash, reducing external debt
and optimizing returns on excess cash by getting
hold of better investment opportunities.
This article focuses on improving the
understanding of liquidity management and
various expectations around it (both that of
banks and their customers), before presenting
our Point of View and the difficulties faced by
various technology vendors offering a solution
in this space.
Effective liquidity management is critical to all
organizations, especially in a tough economy.
Since cash is the lifeblood of organizations,
those having a proper set of liquidity management
policies and procedures will improve profits,
reduce the risk of corporate failure and
significantly improve their chances of survival.
Liquidity management also provides strategic
advantage, especially in difficult times.
Organizations with worldwide operations face
multiple challenges while timing the flow
of funds, handling multiple currencies and
regulations, and dealing with different liquidity
management strategies. The core premise of
liquidity management is to provide a centralized
global view of cash to a conglomerate. This
centralized view of cash is achieved by creating
a global liquidity management structure. A
global liquidity management structure links
accounts of different entities operating at various
locations (within a country or across different
ones) and pools their funds into a single location
(either physically or notionally) for re-allocation
or investment. Liquidity management has always
been a core function of corporate treasuries and
banks have catered to this need by providing
liquidity management solutions as part of their
cash management services suite.
The process of liquidity management involves
the following steps:
Online Liquidity Management
• Present liquidity situation is analyzed.• Potential sources and uses of liquidity are identifed.
• Accounts participating in liquidity management structure are identified. • Structure and legal documentation for the same are created.
• Rules governing the liquidity structure are defined. Rules can be defined from following perspectives: • Clients' (Business) perspective • Banks' perspective • Regulatory perspective• Priorties are assigned to the defined rules.
• According to rules defined in step 3, funds that have to be moved are calculated.• Interest is calculated.
• After step 4, actual transaction entries for the funds transfer calculated above are generated.• The transaction entries generated are posted on the respective general ledger systems.
• Reports are generated based on the transactions done during the day (intra day) and at end of the day.• Reports can also be generated at a configured frequency.• Reports can also be generated according to the customers' needs.
Reporting
Transaction Generation and Posting
Execution of Rules and Interest
Calculation
Identifying Rules
Designing Liquidity
Structures
Analyzing Present Sources
of Liquifity
Assessing potential sources and uses of
liquidity - The first step in designing a liquidity
management solution is to identify the potential
sources and uses of liquidity. This step identifies
potential areas of liquidity risk in order to arrive
at a mitigation strategy, which eventually leads
to the creation of liquidity structures.
Creation of liquidity structures - After identifying
the potential sources or uses of liquidity, the
user can create a liquidity structure. A liquidity
structure can be created for various purposes
like Zero Balancing, Target Balancing, Cash
Concentration, and Interest Offsetting etc. For
example - A liquidity structure created for cash
concentration is an arrangement of different
accounts in which fund movement takes place.
The structure can have multiple levels and
span different countries, banks, currencies and
entities. One account acts as a source
account i.e. the account providing funds and
another account acts as a header account i.e.
the account receiving funds. The account in
which all the money is concentrated and pooled
is called a final concentration account.
Identification of rules - The movement of funds
across the liquidity structure is subject to
various rules. The user can identify these based
on his or her requirements. These rules are
determined either by the business needs of the
user or regulatory requirements.
Execution of rules and interest calculation –
Following the creation of the liquidity structure
and setting of rules, the balances of participating
accounts are obtained from the general ledger
systems and the net funds to be moved is
calculated as per the rules. Next, the interest
is calculated.
Transaction generation and posting - Once
the amount to be swept is ascertained, the
Online Liquidity Management
A Multi-Currency Liquidity Structure
transactions for the sweeps are generated by
the liquidity management system and they are
posted on to the respective accounting systems.
Reporting - Reports are generated on the basis
of transactions done during the day and also
on demand for interested parties. The frequency
and criteria of various reports are decided.
Certain geographic regions may mandate
reporting to the Central Bank.
Various products/services that can be offered
as part of a Liquidity Management solution
are as follows:
Notional pooling is a mechanism for calculating
interest on the combined credit and debit
balances of accounts that a corporate chooses
to group together, without actually transferring
any funds. It is ideal for companies with
decentralized organizations that want to allow
some autonomy to their subsidiaries, including
control over bank accounts. Notional pooling is
also referred to as interest offset pooling.
Once a company earns interest on the funds in
a notional pooling account, interest income is
usually allocated back to each of the accounts
comprising the pool. For tax management
reasons, it may be useful for the corporate
parent to charge the subsidiaries participating
in the pool for some cash concentration
administration expenses related to management
of the pool. This scenario works best if the
corporate subsidiaries are located in high-tax
regions where reduced reportable income will
result in reduced taxes.
The main downside of notional pooling is that
it is not allowed in some countries. Very few
banks offer cross-currency notional pooling,
and they are mostly multi-national institutions.
Instead, it is most common to have a separate
notional cash pool for each currency area.
Refer to the example in the References Section
for more clarity.
Sweeping (Target Balancing) is the mechanism
by which funds can be moved automatically
Notional Pooling
Sweeping
Org
aniz
atio
ns’ T
reas
ury
Dep
artm
ent
Transactional andAccounts Data
Liquidity Structure Data
Data Warehouse
Liquidity Engine
Administration and Control
Rules Engine
Accounting
Risk Management and Recovery
Reporting
Forecasting and Analytics
Interest Calculation and Allocation
Interfaces
Trading Systems
FX SettlementSystem
PaymentGateways -
SWIFT, RTGSetc.
from one account to another account based
on pre-defined rules (sweeps) set in the system.
Sweeps can be setup in the system as
instructions between a pair of accounts. One
or more of these instructions clubbed together
as per a customer’s requirement, constitute a
sweeping structure. The sweep arrangement
required for a customer is fulfilled by the
execution of all individual legs or instructions
in the specified order of priority. More than one
structure may be defined for a customer, if the
requirements are complex or varied.
The main benefits of Sweeping are:
• Sweeping also improves the net interest
earning of the corporate entity.
• Sweeping reduces the need for external
financing.
• Sweeping facilitates administration.
Refer to the example in the Appendix for
more clarity.
One of the main purposes of a Liquidity
Management System is to predict the cash
flows that will occur in future periods. These
amounts flow from the Accounts Receivable
and Accounts Payable processes and depend
on expected payment and value dates.
Proper forecasting and positioning maximizes
control and offers good visibility into the cash
flows within an organization. This in turn brings
maximum benefit and helps the organization
during times of crisis.
A model liquidity management system should
look like:
The model has various components and requires
connecting with the bank’s other legacy
systems. As can be seen from the above model
diagram, a bank has various expectations from
a liquidity management system, few of which
are listed below:
Forecasting
Banks’ Expectations
Online Liquidity Management
• Flexible architecture enabling interaction
with various other systems present in the
bank’s IT infrastructure in order to collect
information about the various sources and
uses of liquidity.
• A user interface to create/delete/modify
liquidity structures and assign rules, view
and track transactions and generate
customized reports.
• Capability to define access levels to
sensitive information.
• Capability to create various user profiles
for different types of customers viz. large
corporate, small corporate, or SME.
• Effective auditing/logging capability for critical
processes to ensure recovery in case of
failure scenarios.
• Flexible architecture to interact with
downstream interfaces - internal legacy
systems using the liquidity data and external
networks such as SWIFT, Faster Payments
to route payments.
• Banks’ customers require automated and
accurate cash flow forecasting solutions
for better cash utilization. Further, M&A
activities and regulatory pressures around
management of liquidity risks are forcing
organizations to review their cash flow
forecasting infrastructure. Hence, a liquidity
management solution should predict the
liquidity positions for a particular client and
currency to assist them in making decisions
for better liquidity management.
• Flexibility to maintain various charge schemes
and apply charges for maintaining liquidity
structures for customers.
• The ability to identify rules associated with the
liquidity structure and process (transactions
and interest calculation) accordingly.
Customers also have various expectations from
a liquidity management system, some of which
are listed below:
• A user interface to create/delete/modify
liquidity structures.
• One single application for centralizing
the complete liquidity management
process worldwide.
• Flexible architecture to cater to ever-changing
business needs (modifying existing liquidity
management structures depending upon
business needs).
• Easy migration of data from the existing
liquidity management systems to the new ones.
• Seamless tracking of transactions arising out
of the liquidity management process.
• Effective recovery management process.
• Flexible architecture for generating
required reports.
During these challenging times, technology
vendors must make a conscious effort to
keep pace with the ever-changing liquidity
management space, in order help their banking
clients serve their customers (corporate as well
as SME) proactively.
Before looking at the features of a liquidity
management solution, it is necessary to
understand the key challenges faced by banks
in handling various customers. Few of the
Customers’ Expectations
Challenges Faced by Banks/Customers
Online Liquidity Management
challenges faced by banks/banks’ customers
are as follows:
• Maintaining a minimum number of employees
to handle customers’ liquidity management
requests manually by creating individual MS
Excel files for each customer.
• The need for banks’ customers to prepare
the liquidity structure manually (on a piece
of paper) before rushing to the bank to
make it effective. This is a time and effort
consuming process.
• Generating different liquidity management
reports for each customer based on their
specific business needs.
• Proper cash flow forecasting by banks.
• Another major challenge is that banks’ age
old host systems lack the capability to handle
liquidity management requests, forcing them
to rely on online solutions for this purpose.
However, the problem with this approach is
that these features are only available in online
banking and not through other channels.
In order to address the above mentioned
challenges faced by banks and their customers,
a comprehensive liquidity management
solution should:
• Allow banks’ end customers to create their
own liquidity structures for managing their
cash better.
• Interact with various other host systems
present in the bank’s IT infrastructure.
• Have a good forecasting engine/tool for
better prediction/forecasting, hence enabling
banks’ end customers to be better prepared
to face difficulty.
• Have good reporting infrastructure, which
both the banks and their customers can use to
generate reports for better cash management.
• Allow banks and their end customers to view
and track transactions generated by the
liquidity structures set in the system.
• Predict/Forecast liquidity/cash positions.
Proposed Capabilities of Online Liquidity
Management Solution
Online Liquidity Management
Conclusion
References
The complex expectations from online liquidity
management solutions have limited their
popularity. Should these expectations be met,
online liquidity management solutions will
succeed in attracting many corporate customers
of banks. Currently, banks assign individual
teams to handle the liquidity management
requirements of each corporate customer; an
online solution would replace these teams and
deliver tremendous value to both the banks and
their corporate customers by drastically reducing
paper work and easing the maintenance of data
pertaining to liquidity management.
• Liquidity Management: An Introduction,
Sujata Singh - GT News
• www.kpmg.com.sg
• http://www.jpmorgan.com/pages/jpmorgan/
am/news/11th-annual-global-cash-
management-survey
• http://www.accountingtools.com/dictionary-
notional-pooling
• http://www.wallstreetsystems.com/documents/
wallstreetsuite_cash_liquidity_fact_sheet.pdf
• http://www.jpmorgan.com/pages/jpmorgan/
am/news/11th-annual-global-cash-
management-survey
• http://www.accountingtools.com/dictionary-
notional-pooling
• http://www.wallstreetsystems.com/documents/
wallstreetsuite_cash_liquidity_fact_sheet.pdf
Author
Anurag Jain
Consultant - Finacle
Infosys technologies Limited