In the world of Banking & Financial Services, an inter-company loan involves the transfer of cash from one unit of a banking entity to another. Most often such a transfer helps replenish a business unit that may otherwise be suffering a cash deficiency, It could also be for moving money from across geographical subsidiaries into a bigger unit wherever the funds are aggregated for investment purposes. It might even be for shifting money among subsidiaries that use a local currency, instead of transferring funds from a remote location and subjecting them to exchange rate fluctuations. Inter-company loans are useful as they don’t require credit applications, allowing quick transfers with extended repayment terms.
But here’s the problem
For regulatory and tax purposes, every inter-company lending contract needs to be clearly documented with outlined interest and principal reimbursement terms at each subsidiary entering into such contracts. Financial institutions are expected to report adjustments in each subsidiary arising from exchange rate modifications, interest rate changes, shifting improvements, asset formation, VAT results and more.
This reporting is generally performed via general reconciliation and accounting processes. In case of inconsistencies, Excel spreadsheets are exchanged between subsidiaries and counter-party affiliates to account for the discrepancies. Unfortunately, while there are tools that highlight the variations, there is not much insight available on the reason for these variations. Also, several changes would have been made to the transfer agreement’s terms & conditions over the years and retrieving them can’t be easy.
The frequency of changes to notification arising due to global incidents might also result in inconsistencies, raising doubts about the validity of the data submitted to regulatory authorities. This translates to complicated bookkeeping and reconciliation processes that require collaboration between various entities, along with the looming threat of being penalized by local regulators and global comptrollers for any unresolved discrepancies recorded during reconciliation.
The good news… digital technology can help
A modern framework enabled by Distributed Ledger Technology (DLT) can address such concerns. DLT reduces the traditional reliance on a central ledger managed by an entity for holding and transferring funds/ financial assets. For instance, an inter-company loan transfer occurs between a banking entity’s two subsidiaries located in different regions. DLT can record the loan contracts in the ledgers of both the parties involved, record new contracts when initiated and track any changes made to the contracts. Bi-directional alignment of corporate systems ensures that entities report the same details in their accounts at both ends.
Distributed Ledger Technology’s powerful efficiency
Before aligning the corporate systems, a DLT framework uses the indicative fields in the initiated agreement to formulate and verify the counter-party contract on the participant subsidiary network. The reviewed contract is recorded by the counter-party subsidiary ledger. The ledgers are thus updated with verified contracts and the same specifics are reported. The DLT network processes the contract lifecycle events from both geographies. Records will then be checked for accuracy by the respective subsidiaries on DLT and aligned with client processes. The resulting data will be consistent across all related entities. Auditors will also be able to track changes to the original arrangement and verify the distribution of administrative funds and repayment processes.
DLT ensures data consistency across all participants eliminating the need for data reconciliation and reduces the several frustrating iterative steps that are characteristic of any inter-company loan reconciliation system. It solves the problem of central recordkeeping without the need of a central agency, providing participants a platform for a single source of truth. The data in the distributed ledger is immutable, subject to high levels of authentication, and reflects the truth based on an agreed-upon validation mechanism.
Advantages and adoption
The advantages of DLT in simplifying diverse processes and market situations are being considered by numerous multinational banking and financial institutions as DLT can provide efficiency and cost savings. Recent developments suggest that DLT bears promise but also that there is still a long way to go before that promise may be fully realized. Much work is needed to ensure that the legal foundations of DLT frameworks are sound, governance structures robust, technology solutions meet industry needs, and that appropriate data controls are in place and satisfy regulatory requirements. It must also be said that changes and related efficiency gains are more likely to be incremental than revolutionary.
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