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:


• 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


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


• 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


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


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

Economy & Finance

Functional online liquidity