Liquidity Management Techniques

Pooling and Cash Concentration

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

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

Liquidity Management
Focusing on maximising Internal liquidity utilising existing but wasted resources

Pooling / Cash Concentration

First: Notional Pooling

Notional Pooling
With Notional Pooling there is no actual movement of funds. With Notional Pooling there is no comingling 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 Pooling Position prior to pooling

Average Balance + 900,000 Sub 1 Average Balance - 300,000 Sub 3 Average Balance + 350,000 Sub 2 Average Balance - 550,000 Sub 4

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
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Notional Pooling Position if pooled

Average Balance + 900 Sub 1 Average Balance - 300 Sub 3 Average Balance + 350 Sub 2 Average Balance - 550 Sub 4

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

Notional Pooling Benefits

Maximise interest earned Minimise interest paid by As much as possible, for as long as possible, in one place

Notional Pooling Taking Advantage

Tiered Interest Rate Structure 8 7 6 5 4 3

Interest Rates

50

100 200 Balance in 000s

300

400

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Stepped versus Banded

Amount in GBP 1 to 250,000 251,000 to 500,000 500,001 to 1,000,000 Over Company A 1,000,000 Balance 355,000 Interest Rate 0.10 0.20 0.50 0.90 Tier 250,000 Interest rate .001 Interest 250

105,000

.002

210

400,000

250,000

.001

250

150,000

.002

300

250,000

250,000

.001

250

Total Pooled Benefit 1,005,000 .009

1,260 9,045 7,785

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Notional Pooling Benefits

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 Pooling Benefits

May improve internal discipline and control Do not have to move funds - reduce costs of transfers - reduce management time

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Notional Pooling Requirements

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 Pooling Issues

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 Pooling Active Management

Sub 1 + 800
Sub 2 + 700

Sub 3 - 200 T + 400

Sub 4 - 900

Investment of 400,000
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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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Pooling Due 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 crossguarantees 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

Sub 1 + 350

Sub 2 +500

Sub 3 +550

Sub 4 - 650

Concentration a/c
End of day 750 invested
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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
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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 acs may add to central bank reporting and to cost Local rules and regulations may prohibit/complicate cross border movements

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Cash Concentration Using MT101 to concentrate

Instruction
Customer Advice Lead Bank
Debit sending bank nostro Credit customer concentration account

MT101
SWIFT Network

MT103

MT101 Sending bank

Debit customer ac

MT103

Credit vostro ac
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Liquidity Management
Interest 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 28 therefore of value

Liquidity Management
Interest Enhancement Suppose that the bank will normally charge interest on deficits at LIBOR plus and pay on surpluses at LIBID 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.

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Liquidity Management
Interest 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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