What is Cash Management?
Cash management is a process that includes several steps, such as collection of payments, control of disbursements, coverage of shortfalls, forecast of cash requirements and investment of surplus cash. One of the most important tasks for the treasurer of a bank is to maintain the flow of cash across all the banking activities.
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Traditionally, a bank used to perform these activities in paper form but technological ad- vancements has changed and improved the various activities related to cash management, bringing overall efficiency in the functioning of a bank. Effective cash management services of a bank help in reducing the time required for a transaction, which in turn has a positive impact on the profitability of a bank.
The following are the benefits of cash management in a bank:
- Reduced quantum of borrowing: By eliminating cash engagement in uneconomic activities, a bank ensures availability of cash only for profitable proposals and activities. As a result, the need for borrowing funds is reduced, resulting in a reduction in the borrowing cost as well as interest payments.
- Better control of financial risk: Better cash management ensures availability of cash and its effective use in case of financial risk as well as management.
- Opportunity for profit: Cash management in banks ensures the timely repayment of the debt taken by the bank to finance its various financial activities.
- Strengthened balance sheet: Effective cash management in a bank ensures liquidity across all its activities. This results in a better balance sheet position of the bank. It also facilitates better control over the working capital of the bank.
- Increased confidence on the bank: A bank with sufficient liquidity always wins the trust of its customers.
- Improved operational efficiencies: The centralisation of cash management approaches and activities result in economies of scale, which in turn help improve the operational efficiencies of a bank.
Liquidity Management
The level of liquidity refers to the ability of a bank to meet all its financial obligations. It involves the conversion of assets into cash to ensure uninterrupted flow of cash. This cash is used to meet current liabilities and maintain the availability of cash for day-to-day business operations. Banks are generally assessed on the basis on their liquidity and their ability to meet cash and collateral obligations without incurring losses.
In order to transform short-term deposits (liabilities) into long-term loans (assets), banks are inherently exposed to liquidity risks. This process of transformation often faces asset and liability maturity mismatches, which is managed by the available liquidity. This is also known as liquidity management. Effective liquidity management enables a bank to increase its assets (loans and investments) and meet its obligations on time (withdrawal of deposits).
Prudent liquidity management is essential to maintain solvency of a bank. Bank regulators, such as the Reserve Bank of India (RBI) have specified certain ratios that need to be maintained by all banks. This gives a measure of their liquidity positions.
These ratios are:
Cash Reserve Ratio (CRR)
Banks are mandated to maintain a certain proportion of their deposits in the form of cash. In reality, banks do not hold these as cash and instead deposit the amount with the RBI. This minimum ratio of deposits that needs to be held as cash is known as the Cash Reserve Ratio (CRR).
If the CRR is 5%, for example, the bank would need to keep Rs 5 with the central bank and use the remaining Rs 95 for investments and lending activities. Thus, the higher the CRR, the lower is the amount that banks can use for lending and investment purposes and vice versa.
In this way, the RBI is able to reduce the amount banks lend out to their borrowers. CRR is a tool used by the RBI to control liquidity in the banking system. The current CRR specified by the RBI is 4% (as on August, 2015).
Statutory Liquidity Ratio (SLR)
Banks are required to maintain a certain portion of their net demand and time liabilities as liquid assets in the form of cash, gold and unencumbered securities. The ratio of liquid assets to demand and time liabilities is known as Statutory Liquidity Ratio (SLR). The current SLR specified by the RBI is 21.5% (as on January, 2016).
Process of Cash Management
As already discussed earlier, the process of cash management includes several steps such as collection of payments, control of disbursements, coverage of shortfalls, forecasting of cash requirements and investment of surplus cash.
Due to emerging global trends, the concept of global cash management is characterised by highly tax and dynamic accounting standards that require a bank managing its cash to have a close working relationship with the tax and accounting staff. In addition, coordination between the treasury and the operation department of the bank is required for efficient cash management.
The following are the main steps performed by banks while managing their cash:
Collect data for cash forecasting
Banks should collect all the information about the expected receipts and disbursement of cash for the different periods. The effectiveness of the cash management process depends on the quality of the data collected.
Develop models for accurate cash forecasting
Uncertainty in cash flow is a normal situation that banks generally face because of the numerous transactions pertaining to the receipts with disbursements of cash that take place in the day-to-day functioning of a bank. The quality of this forecasting model is directly proportional to the quality of data that is used by a bank.
Therefore, a bank should systematically evaluate the average quantum of money that is deposited and withdrawn from the bank. Each model of cash forecasting analyses forecasts pertaining to various time ranges such as seasonal, monthly, daily.
In addition, cash requirement is also characterised by cyclical patterns and trends. Therefore bank should ensure that they are opting for an adequate model satisfying the requirements related to different time frames. After obtaining the forecast figures, the information is integrated with the estimated figures by using a rolling format, which helps to continuously update the information used in the estimated trends.
This further helps a bank in disbursements in accordance with the incoming receipts. It is important to note that a rolling forecast results in accurate forecasting and helps bank to face cash-critical periods.
Review the cash management system regularly
As already discussed, the primary function of a bank is lending money that is deposited by its customers. The quantum of the cash deposited and the cash lent keeps on fluctuating frequently. Therefore, the process of cash management is reviewed on a regular basis.
Consequently, it helps in identifying the areas of improvement in the existing processes. This review evaluates cash management in banks, including areas related to the financial and operational performance of the bank, and the charges and yields on the investments. The review also considers various risks such as fraud, liquidity crisis and erosion of cash. These risk factors, if not considered, can affect the flow of cash throughout the payment system.
In addition, it is important for a bank to create a centralised mechanism for cash management that is able to cater to its needs at a global level.
Foreign Currency Cash Forecasting
Cash forecasting can be defined as a planning tool that helps in estimating the flow of cash in and out of an organisation. In the case of banks, it helps them in assessing the requirement of cash needs and evaluating its liquidity position.
The following are the reasons for banks to forecast their cash flows:
- To minimise external borrowing costs: This ensures reduction in the borrowing cost due to accurate assessment of fund requirement.
- To maximise investment outcomes: Reduction in the borrowing cost results in the maximising of investment returns for banks.
- To manage currency exposures: Cash forecasting in banks help the treasury to manage its currency positions across the globe.
Forecasting helps the treasury of the bank plan how to meet obligations pertaining to foreign currency payments.
