Bringing a little light into the darkness
The concept of Virtual Accounts is nothing new. The initial idea was to assign an individual virtual account number to a specific client or product. For example, real estate companies can assign rental payments more easily if they have an individual virtual account number for each property. The concept proves very useful in particular if tenants have repeatedly indicated the wrong reference number on the transfer form.
In order to illustrate this Use Case optimally, Virtual Accounts brought further advantages compared to physical accounts. In particular:
- the account opening and closing process is far less bureaucratic,
- the accounts are structured in a flexible manner and are thus easier to assess,
- the allocation of liquidity between the accounts occurs in real time.
Over time, banks and corporates identified other possible uses for Virtual Accounts. Saving KYC expenses, reducing costs or reducing the number of physical accounts to a minimum have been an issue for many years now.
However very few corporates have implemented Virtual Accounts to date. Why is this so?
Due to the high technical complexity as well as to the heterogeneous implementation rate in banks and in regions worldwide, it is extremely difficult to compare the services offered by the various banks. Many corporates are waiting for others to lead the way. Banks are partly doing the same. The market is now sending clear signals that the knot is loosening, slowly but surely. Banks are strengthening their solutions and interest within corporates is increasing. This document brings a little light into the darkness and clarifies the current potential uses and limitations of Virtual Accounts. Regarding the structure, we address the three following questions:
- How does the Virtual Account solution differ from traditional Cash Pooling?
- What are the potential uses for Virtual Accounts?
- What limiting factors should be taken into account?
1. Difference between traditional Cash Pooling and Virtual Accounts
Cash Pooling remains Cash Pooling – also with Virtual Accounts.
The basic idea behind Cash Pooling – the pooling of a group’s liquidity – does not change due to the use of Virtual Accounts, but the design generally does. In a Cash Pool, all the bank accounts of the Cash Pool participants are managed under a header account. The Cash Pool participants are defined in internal policies, framework conditions and agreements. So far so good, but what has changed?
In a traditional Cash Pool, physical cash receipts and payments are executed at individual account level. Depending on the case at hand, the liquidity is added or removed from the sub-accounts to the header accounts. Sub-accounts are frequently settled in such a way that their balance is equal to zero and the entire liquidity is concentrated under the header accounts. This process (“Sweep”) is generally performed on the accounts at the end of the day. Since the balance of the sub-accounts is modified by the Sweep, the information on the amount of the receivables or payables against the header account is missing. In this case, clearing accounts are generally maintained. These gather information on the Sweeping processes from the account statements.
With Virtual Accounts, counterparties only see a VIBAN (virtual IBAN). For you, the Virtual Account looks like a real account and the corresponding account number is specified by the counterparty as the target account as per normal.
Even if your counterparties do not notice it, payments in the context of a virtual Cash Pool are transferred at header account level. In this structure, the Virtual Accounts function like clearing accounts since they do not process any payments. Your bank thus recognizes the VIBAN as such and of course knows to which header it belongs. Since there is no physical money in the Virtual Accounts, they must not be cleared either in order for the liquidity to be gathered under the header account. A clearing account is thus (often) obsolete. The clearing against the header account is performed in real time.
Another essential characteristic of Virtual Accounts is that these are generally not subject to the same regulatory requirements as physical accounts. They are not real accounts, which makes the burdensome administration much easier compared to physical accounts. For example, in many banks, KYC processes are necessary only in a very limited number of instances if Virtual Accounts must be set up.
Furthermore, many banks offer the possibility to implement flexible structures very easily. Payments can thus be grouped more easily, which facilitates the allocation of payments.
2. Potential uses for Virtual Accounts
As a rule, the sole argument of the cost savings resulting from the use of Virtual Accounts compared to physical accounts is still not sufficient to develop a Business Case. The savings compared to the project costs are generally too low.
According to the banks, Virtual Accounts offer other significant advantages compared to physical accounts. A hierarchical account structure that is easy to implement, functions in real time and requires little administrative effort? Great!
Several potential uses result from this:
- Reduction of administrative effort: With Virtual Accounts, companies can reduce the administrative effort in relation with bank and clearing accounts. The time saved can be used to strengthen analysis and reporting capabilities, for example. The insights gained help improve decision-making.
- Real-time availability: The keyword “real time” has already been mentioned above. There is no waiting time between the computation of balances under the header accounts and Virtual Accounts. Anyone who maintains a physical Cash Pool will generally appreciate this. For example, clarifications regarding unsuccessful payments could be initiated directly and problems with the corresponding payments could be resolved on the same day.
- Reduction of number of accounts: Physical accounts can be replaced by Virtual Accounts. Furthermore, it is no longer necessary to maintain clearing accounts since the Virtual Accounts can take over this function. This allows to save time for account administration.
- Increase in transparency: The hierarchized account structures can be easily set up and adapted. Accounts can thus be structured easily, for example by supplier and dealer or even by product category and region. The possibilities are endless. Payments can thus be grouped in logical packages depending on the business in question.
Should we thus start using Virtual Accounts right away? Not so fast, there are still a number of limiting factors that should be taken into account.
3. Limiting factors for the potential uses for virtual accounts
The banks’ service portfolio is heterogeneous and so are the limiting factors. However there are certain points that regularly catch our attention in relation with Virtual Accounts. In this respect, it is important to note that the services provided by the banks are designed differently. In our experience, many of the limitations concern individual banks. You should thus not be deterred by this.
Regional availability: For a bank, setting up Virtual Accounts implies a good deal of research work regarding the regional, regulatory and technical requirements. Since these are rather consistent throughout Europe, it comes as no surprise that this is where many banks have offered their service in the first place. Many countries were thus covered with relatively low effort. A few other economically relevant regions worldwide, such as North America, regularly do well in coverage analyses. In other regions, the availability of such a service is still low. It should thus prove difficult to represent all the worldwide Cash Pools with Virtual Accounts as of tomorrow.
Taking over of account numbers: If an existing account is converted into a physical account, it is possible that the existing account number cannot be taken over. For outgoing payments, this is often not a problem, but assigning a new account number to an account into which many different clients make payments can prove challenging. However it is possible with certain banks to retain account numbers in case of such a conversion.
COBO and POBO: Reference was made to the history of Virtual Accounts at the beginning of this article. In some regions, because of the initial Use Case, certain banks only cover Collections and no Payments On Behalf. Regarding Collections, a Virtual Account generally reaches its limits with cash payments. Now and then, we also observe that banks cannot record debit entries under Virtual Accounts.
Multi IBAN: Do you wish to place a Virtual Account with a foreign IBAN prefix under a German header account? This is possible with certain banks – but not with others.
Several other limiting factors exist. We do not wish to go beyond the scope of this document but we would like to draw your attention to the fact that you should start by analyzing your own requirements in detail. The results should then be compared thoroughly with the individual service portfolio of the banks in question.
In this complex environment, many Treasurers have long adopted a “wait-and-see” attitude, whether due to the current crisis or to the unfolding home-office creativity or other reasons. We observe that banks continue to develop their product portfolio and that corporates show increasing interest towards this topic. Even if several factors need to be considered and Virtual Accounts are certainly no universal remedy, these often bring companies that offer a variety of accounts, especially in the European area, an advantage (Business Case) that offsets project-related efforts appropriately.
Source: KPMG Corporate Treasury News, Edition 103, July/August 2020
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