Commercial banks provide various types of services to their customers. One such area of service is that of liquidity management. Commercial banks offer several liquidity management arrangements to their clients. Notional pooling is one such arrangement that is very popular amongst corporations that have many subsidiaries. In this article, we will have a closer look at the concept of notional pooling as well as its advantages and disadvantages.

What is Notional Pooling?

Cash pooling is a cash concentration system that is followed by companies that have several subsidiaries. Normally, banks monitor the cash balance at an account level. This means that if the balance in an individual account is positive, the bank pays interest on the same. However, if the balance in the same account is negative, the bank charges interest.

In a notional pooling system, the balances are not calculated for every account. Instead, the balances of all the accounts of a particular company are considered to be the same and an aggregate balance is calculated at the company level. Once again, if the balance is positive, the bank pays interest to the corporation. However, if the balance is negative, the bank charges interest to the corporation.

It is important to note that the money is not physically moved between accounts. Hence, all subsidiaries have complete legal control over the money in their accounts. However, for the purpose of interest calculation, the amounts from various accounts are notionally pooled together. Hence, the practice is called “notional pooling”

Most commercial banks offer their customers a choice when it comes to the allocation of interest income. On the one hand, it is possible for the banks to allocate the interest income directly to the parent corporation. However, banks can also offer to distribute the interest payments back to the constituent accounts based on the amounts which they contributed.

Advantages of Notional Pooling

Corporations receive several distinct advantages as a result of notional pooling. Some of these disadvantages have been mentioned below:

• Lower Costs: Notional pooling systems definitely have a cost advantage as compared to other such liquidity management arrangements. For instance, notional pooling systems charge lower fees as compared to other arrangements. Also, the cost of overdraft payments for a company is also drastically reduced thanks to notional pooling.

  If a company has 10 accounts and has a positive net balance, it will not be charged overdraft fees and charges even if some of its accounts have a negative balance. This arrangement allows companies with several bank balances to allow many charges and fees.

• Convenience: The notional pooling system is very useful for the treasury department of large companies. This is because of the fact that companies do not have to ensure that each amount has the required balance.

  Even if the overall net balance is positive, the company will not have to pay interest charges. Hence, the administrative activity required internally to ensure that all bank accounts have the required funds is eliminated. This is what makes notional pooling attractive to many corporations.

• Cross-Currency Pooling: Some banks even offer notional pooling across various currencies. In such cases, the corporation is able to save a lot of money. This is because they are not required to actually exchange the currency. Hence, there are no transaction charges that the company has to pay. Now, the charges for exchanging currencies can be quite high. Hence, the ability to avoid these charges is quite useful for the company.

Disadvantages of Notional Pooling

From the above points, it may seem like notional pooling is an ideal solution. However, that may not be the case. There are certain disadvantages of notional pooling as well. Some of the prominent disadvantages have been mentioned below:

• Regulatory Hurdles: The problem with notional pooling is that it faces regulatory hurdles in many parts of the world. For instance, notional pooling is allowed by the regulatory bodies in Europe. However, it is not allowed by the regulatory body in the United States. This is because the United States has stricter rules when it comes to the commingling of funds across various subsidiaries.

  In many parts of the world, notional pooling is considered to be a mechanism to comingle funds from various different legal entities. In some other parts of the world, notional pooling is not completely prohibited. However, it is only restricted to companies that are fully owned subsidiaries.

• Single Bank Network: Another problem with notional pooling is that it can only be done if the company holds all its accounts in the same bank. Only when all the accounts are in the same bank, will the bank have visibility over the funds deployed via various accounts.

  Now, companies prefer to have their bank accounts scattered across more than one bank. This is because they do not want to be overly dependent upon the service of one bank. Hence, notional pooling is not a viable solution for several companies.

• Complex Calculations: Another problem with notional pooling is that it requires complex calculations to allocate accrued interest back to the subsidiary companies. Also, there are several regulatory processes that need to be followed while paying this interest. Otherwise, it could lead to audits from the local tax authorities. All banks do not have the software required to perform such complex calculations. Hence, notional pooling becomes a challenging task once it is implemented.

The fact of the matter is that notional pooling is an important service provided by commercial banks to their corporate clients. Corporations all over the world are increasingly using this service in order to streamline their liquidity management.