Risk is a necessary evil that treasury and finance executives have to deal with in today’s complex and highly-integrated world. But risk management need not be expensive. 

Risk is a necessary evil that treasury and finance executives have to deal with in today’s complex and highly-integrated world. Generally speaking, risk can be categorized into two types: Type I risk describes the likelihood that a company will suffer losses as a result of pursuing a financial reward—business risk. Type II risk describes the likelihood that a company will suffer losses as a result of not taking sufficient actions to mitigate the impact of unfavourable events—country risk, FX risk, bank failure, etc. In this article, we will look into some practical actions that treasury and finance executives can take to protect their company against the impact of Type II risk without breaking the bank.

INTERNAL RISK MANAGEMENT (CONTROLLABLE RISK)

The primary root cause of each fraud and theft case can be summed up in a simple phrase: “lack of control”. A company with poor finance and system controls often presents opportunities for employees, suppliers, customers, and cybercriminals to siphon funds from accounts without being detected. To combat against such risk, treasury and finance executives can incorporate the below practices into their daily business operations:

Choose a technologically-advanced cash management bank. When selecting a cash management bank during the request for proposal (RFP) process, it is paramount to consider how much capital expenditure was invested by the bank in upgrading its IT and security systems. A bank which invests heavily in sophisticated technologies will not only help clients combat cybercrimes but also strengthen its payment approval workflow, thereby eliminates any incident of fraud or human error.

Develop comprehensive finance and treasury policies that are easy to administer and track. A well-written policy should possess at least these three elements: ensure proper segregation of duties when it comes to payment creation and approval, eliminate free-form payments by ensuring payments are created through approved payment templates, eliminate cash and paper checks by encouraging the use of electronic fund transfers (EFT). For businesses where most of the receivables are collected in cash or checks (i.e., retail business), it will be wise to consider an investment in a debit/credit card solution to handle such receivables electronically.

Minimize funds in local banks and concentrate them in cash management bank. In the world we live in today, there is no single international bank that can meet all the business needs of a company’s subsidiaries. This is especially so for subsidiaries operating in countries where capital flows are restricted and legislations are enacted to protect local banks. Hence, a complete elimination of local bank accounts is not a possibility at the current moment and keeping minimal cash in them is the next best option.

Rationalize all bank accounts and currencies traded within the business. The foundation of an effective control lies in a simplified bank account structure that is capable enough to meet the business needs. Foreign currency accounts with low transaction value and volume should be closed as the FX spread incurred on such transactions (i.e., paying through a local currency account) is insignificant compared to the cost of maintaining it. Reducing the number of currencies traded within the business also helps to reduce unnecessary FX exposures.

EXTERNAL RISK MANAGEMENT (UNCONTROLLABLE RISK)

In 2008, the United States suffered a subprime mortgage crisis and witnessed the fall of a banking giant—Lehman Brothers. This event showed the world that giants do fall and it is never a wise choice to concentrate corporate funds with one or two banks. Below are some practical approaches which a company can take to manage Type II external risk:

Choose a cash management bank that has a track record of maintaining a strong balance sheet and credit rating. Apart from the bank’s willingness to provide balance sheet support and its international reach in providing banking solutions, its ability to stay solvent in time of crisis is another important consideration in selecting a cash management bank. Although there are regulations such as Dodd-Frank Act, Basel III, CCAR to prevent another nationwide bank failure, companies should not rely on regulators alone to protect them against potential bank failure.

Diversify your corporate funds into multiple banks of strong credit rating through fixed deposits and money market funds. Never put all your eggs in one basket is one of the key lessons I learned as a treasurer. Diversification is probably one of the easiest and cheapest risk management techniques which one can use to spread the risk of total fund loss. Apart from eliminating concentration risk associated with holding too much cash with a single bank, it also provides companies with an opportunity to establish relationships with other banks which can be helpful for future RFPs.

Trade derivatives contracts with banks of strong credit rating. Pricing should not be the sole consideration when comes to selecting a bank who is willing to take the other side of a trade. Its ability to fulfil its contractual obligations as it falls due is also equally important. Trading with banks who do not honour their obligations is as good as not hedging at all. Sometimes, it is actually cheaper to pay more to trade with a creditworthy bank.

Control exposure in countries where there are restrictions on capital flows. In some part of the world, the central bank requires local subsidiaries to provide supporting documentation to back a transaction before it is remitted into or out of the country. For example, a trade invoice may be needed to back a trade payable, a board resolution to back a dividend payment or a loan agreement to back a loan redemption or interest payment. Ideally, companies should concentrate cash in countries where free flow of funds are allowed. This is to make the repatriation of funds back to the home country easier. Natural hedge should be used whenever possible to limit the net assets exposure a company may have in-country.

When it comes to managing risk, it is always recommended that treasury and finance executives explore cost-free methodologies like the above to mitigate or even eliminate Type II risks before considering more costly options like doing nothing or transferring it.

Boon Long Oh, CTP, is Senior Corporate Treasury Analyst with T.D. Williamson in Singapore. Connect with him via email and LinkedIn.

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