While unqualified enthusiasm from Lake is hardly shocking, he is far from in-house banking's lone cheerleader. True, in-house banking requires companies to overhaul completely the way they handle financial transactions, but the potential benefits of better managing enterprise cash, cutting net interest expense through fewer external borrowings and lower loan rates and eliminating substantial banking fees is a financial Nirvana few treasurers can pass up, despite the enormity of the endeavor. "It's not done without pain," cautions David Bright, senior manager of banking projects and systems for British Petroleum Finance, which has been engaging in in-house banking for more than a decade. "Old relationships will be blown apart. Local banks will lose business. Engrained ways of doing business will have to change. Subsidiaries will resent a perceived loss of autonomy. But that's the necessary downside of serving shareholders by managing cash more efficiently and reducing the cost of financial transactions."

Bright should know. BP operates one of the oldest, most respected in-house banking operations in the world–actually two in-house banks, one in the U.S. and one in the U.K., linked for efficiency but separated for tax advantages. BP realizes five distinct advantages from its in-house banks, Bright explains:

o Pooling all corporate cash in one place and using it to reduce external borrowings or produce better investment returns;

o Netting all FX positions and going to the market directly for net transactions rather than paying banks to do it for BP;

o Settling transactions among BP subsidiaries internally instead of paying banks to execute funds transfers, allowing BP to save on fees and keep the float;

o Finding the most tax-efficient funding, linked to where the funded entity is domiciled;

o Avoiding the need to replicate the treasury function in various business units around the world.

With an operation as big as BP–the total amount of cash circulating through it, counting FX and investment transactions, approaches $6 billion a day–there was little question that it could benefit from becoming its own bank. "For an enterprise our size, a lot can be saved by avoiding FX margins, credit margins, bank fees, bank float and duplicative treasury activities," Bright notes. He won't say how much exactly, but concedes that BP saves hundreds of millions of dollars a year from operating its in-house banks.

What is surprising these days is that companies with significantly less cash in circulation can also log in not only impressive efficiencies, but also actual returns on their investments in less than two years' time. Eliminating bank transaction fees alone by moving cash among its own subsidiaries can save the typical large multinational millions, or even hundreds of millions, of dollars a year. "An in-house bank radically reduces charges for funds transfers, especially across national borders," says Philip Say, product marketing manager for mySAP Financials. "There are tremendous cost savings from doing this."

Marketplace Expansion

For example, at Lucent–which is one third as large as BP–Schacknies expects his experiment to pay for itself within a year. Smaller companies like privately held Gypsum Management and Supply Inc., with revenues under $1 billion, are also creating in-house banks, although it is too soon to gauge total savings. And even municipal governments, with lots of separate agencies to fund, are latching onto in-house banks, according to Michael Poisson, senior vice president of sales at SunGard Treasury Systems in Calabasas, Calif., although they call it fund accounting.

Why does the concept seem to suddenly make more sense for a wider range of companies? Easy. There is a lot more product out there to consider with more accessible prices and smoother implementation.

A decade ago, only a few high-end providers like Wall Street Systems made in-house bank software. Since then, treasury workstation vendors like SunGard, Trema, Selkirk, XRT, Integrity and Alterna have added increasingly sophisticated in-house banking modules to their workstations, Chakravarti explains. Implementation is easier and less expensive now that companies can install the software in one location and open global access to it over networks like a corporate intranet or even the Internet, Chakravarti points out. The result: What once was cost-effective only for companies with more than $10 billion in annual revenue and many subsidiaries in many countries, now can pay off nicely for a $1 billion company with just a few subs operating in just a few countries, he says.

While hard numbers are practically meaningless because there are so many variables, Chakravarti puts Wall Street Systems at the top–most expensive, most powerful–followed by Trema and SunGard's higher-priced Quantum and GTM systems. In the middle are offerings from Selkirk, XRT, SunGard's lower-priced systems, Integrity, SAP and PeopleSoft. A full workstation that includes basic in-house bank functionality, he notes, can be found for under $500,000, or even under $300,000, for some companies with simpler operations.

On the low end are ASP-hosted models. These are primarily in Europe and can be considered a cost-effective, basic in-house bank solution for even a $500 million company, he says.

IDC research suggests that the cost of a low-end in-house bank could be between $175,000 and $300,000, with a high-end system, such as one from Wall Street Systems, going for between $800,000 and $1.35 million, says Scott Tiazkun, research manager for enterprise applications. Even lower prices could appear soon for hosted applications, but IDC has not yet detected an uptick in this option, he adds.

"Simple due-to, due-from accounting with interest allocated and a monthly statement could be pretty inexpensive for a few subsidiaries," notes Glen Solimine, XRT's vice president of sales. "If you had hundreds of subs and needed sophisticated service like multilateral netting, it could be pretty expensive." Solimine is reluctant to quote prices but concedes that "pretty inexpensive" could mean as little as $50,000 or $60,000 and "pretty expensive" could mean more than $1 million but certainly under $2 million.

Bringing Efficiency to Your Cash

Since savings are volume-driven, the biggest companies with the biggest needs pay the highest prices but realize the greatest savings. Regardless of price, the ROI can be fairly consistent–around one year–across a broad range of companies, various vendors suggest.

Another factor driving the recent surge in in-house bank formation is the new requirements associated with the Sarbanes-Oxley Act, which put a premium on the kind of transparency and control of cash flows that such a financial hub provides. "In the past few months, CEOs and CFOs are being asked to sign off on financial statements and are seeking more rigor and diligence in the financial reporting process," says Tony White, director of development for Wall Street Systems. As a result, "they're taking a fresh look at their financial technology infrastructure to see if it is appropriate."

Observes Robert Ruark, senior vice president in Bank of America's global treasury services: "An in-house bank lets treasury own all the cash and assign cost or benefit to the business unit that generates or consumes it. It provides the most efficient use of cash at the corporate level, but it takes a sophisticated treasury structure and people to make it work. You definitely get savings and reduce your need for external working capital, but how quickly you recover your investment depends on how centralized and sophisticated your treasury is to start with."

The demand for an attractive ROI convinces some companies to buy a system less complex than the type offered by the best-of-breed vendors. For instance, to support in-house banking efforts, SAP has built a special module called "In-House Cash" that can be used with its treasury module. Between 50 and 60 companies, including Colgate-Palmolive, have bought that additional software, about a third of the companies that have sprung for SAP's treasury module, Say reports. The SAP software largely displaces external bank transfers and banking fees, compared to the sophisticated financing, intercompany loans and FX netting that a Wall Street system provides. The cost is more like $250,000, versus more than $1 million for an advanced Wall Street Systems in-house banking kit that really makes the most sense for the biggest players.

For instance, the right fit for global, acquisition-oriented WPP Group is a bit more basic than for BP's massive operation. The $6 billion net revenue, $30 billion gross revenue holding company for hundreds of ad agencies, PR firms and market research operations is starting up an in-house bank that will use the new XRT Enterprise Suite (XES) software, reports John Forster, WPP's treasurer. WPP, a beta tester, pushed XRT to develop in-house banking functionality in XES, he adds.

The centralized treasury system and in-house bank let WPP operate its far-flung empire in an entrepreneurial, semi-decentralized fashion, Forster explains. Each WPP unit has treasury-imposed working capital targets, in addition to budgets. "If a business unit is hitting its targets, we leave them alone; if they're missing them by a lot, we're all over them. We make sure they don't use more cash than they truly need," he notes.

But WPP won't be closing many external bank accounts. "We choose to use a great many bank accounts for audit and control reasons," Forster says. "Each business unit has its own depository zero balance account that rolls up to one concentration account. Each has a disbursing account that is funded daily by the in-house bank. We don't want to commingle funds and perhaps muddy the audit trail."

WPP will also use XES to let business units initiate their own wires, which will be funneled to the New York treasury center, reviewed and released in "mother lode batches," Forster says. The in-house bank also keeps an electronic archive of all transactions that can be used to feed various reports, he adds. "The more we centralize cash management, the better return we can get on investments and the better rate we can get on borrowings," Forster says. "We've been trying to do that for years, but now that we have 100% of our businesses up on XES and the in-house bank, we can do it even more effectively."

Lucent went with Trema after kicking the tires of various software vendors. According to Schacknies, it was more flexible, could perform the necessary functions and came with enthusiastic referrals from happy customers.

So what should an in-house bank look like? The concept is simple: Simulate a bank in a centralized treasury department or finance captive, capture the banking business of the subsidiaries and go to external banks and the capital markets for only a relatively small number of net borrowings, investing, hedging and foreign exchange transactions. But the degree to which a treasury should mimic an independent bank is a judgment call. Basically, everyone wants to offer internal customers basic depository, investment, funds transfer and borrowing services, priced at market rates and reported on statements. BP subsidiaries, for instance, get statements that look "exactly like bank statements," Bright says.

A company's in-house bank essentially eliminates the need for virtually all the old connections between affiliates and banks and replaces them with one communications link to treasury, asserts Mike Thrower, director of marketing for Wall Street Systems, which owns an enviable list of in-house bank clients, including BP and other best-practices leaders like Ford, Hewlett-Packard and Procter & Gamble. These services look and act as if they were being provided by a bank, but at a lower cost and with greater security and convenience, Thrower argues.

A Bank But Not a Bank

Nonetheless, not every in-house bank offers the same variety of credit and investment products as a real bank, and a real split emerges over whether in-house banks should charge risk-based grid pricing like real banks do, rewarding units with lower loan rates for conserving capital, reducing credit risk or collecting A/R aggressively.

BP, for all its experience, thinks risk-based pricing is a good idea, but is not there yet. "It's absolutely the way to go," Bright declares. "If it enforces the right discipline across the business and improves the use of funds, it's just what treasury should be doing. We haven't built many incentives into our loan pricing yet, but we'll be looking at that in the near future," he promises.

And with today's technology, replicating bank loan pricing and structure is relatively easy. "A true approval process, limits, flexible terms and risk-based pricing are all possible," says Alf Newlin, managing director of Financial Sciences Corp. in Jersey City, N.J., another provider of high-end in-house bank software. "Corporations can now afford sophisticated software at least as good as what the banks use."

And in-house bank loans have a distinct advantage over simple, centralized treasury pooling and funding in some cases, Newlin notes. There can be legal barriers to sweeping balances out of accounts for concentration and reversing the process to fund subsidiary accounts, but properly structured and recorded intercompany loans can provide a legal funding pathway, he points out. An in-house bank also can be useful in supporting an asset-securitization program, he adds.

But Wall Street System's Thrower points out most corporate managers don't want rates that are tied to performance. Most apply one flat rate based on a modest spread over the corporation's cost of funds, he reports. If affiliates can't get a lower borrowing rate with less hassle from the in-house bank, they are bound to complain, he notes.

Lucent's Schacknies echoes that thinking. "Our goal has been to make our in-house bank as much like an external bank as possible," the former banker says. "We need to establish an arm's-length relationship with subsidiaries and keep a clean audit trail like a real bank, but there are limits. For example, there is no intent to generate a profit at the expense of our internal customers. We don't have to fight down to the last penny. Also, we're free to be less exacting if that makes us more efficient. We have a tighter relationship with our subs than your typical bank lender/corporate borrower arrangement, and we don't have to capitalize potential loan losses as an external bank would."

While loan prices will "reflect external market conditions as much as possible," risk won't be a factor at Lucent, Schacknies explains. "Incentives make sense when the subsidiaries control their financial management, but we basically do that on their behalf, so our premise will be that all Lucent subs have the same level of creditworthiness."

In-house bank doors are opening at a time when external financing sources like bank lines and commercial paper are getting stingier and when external banks are raising their prices for treasury services at an unprecedented rate. It's a great time for treasurers to be able to tell banks that they'll be having a lot less need for credit and operating services from now on.