Notional pooling is a cash management strategy used by large corporations to optimize the efficiency of their cash flow and reduce interest charges. In notional pooling, multiple bank accounts (usually spread across different subsidiaries or divisions within a corporation) are combined for the purposes of calculating interest, but the bank accounts still remain legally separate.
Here’s how it works:
Each bank account in the notional pool maintains its own balance, which can be a debit (overdrawn) or a credit (positive) balance. At the end of each day, the bank calculates the net balance of all the accounts in the pool. If the net balance is positive, the corporation may earn interest. If it’s negative, the corporation may owe interest.
But importantly, the money does not actually move between accounts. This is what makes the pooling “notional”. Instead, the bank notionally aggregates the balances when calculating interest.
Notional pooling has several benefits:
- It helps corporations manage their cash more efficiently and reduce borrowing costs, as the positive balances of some accounts can offset the negative balances of others.
- It allows different parts of the corporation to manage their own bank accounts while still contributing to the overall corporate cash position.
- It can aid in maintaining legal and fiscal separation between different parts of the corporation, which can be important for tax and regulatory reasons.
However, notional pooling also has challenges and complexities, particularly around tax and regulatory compliance. In some jurisdictions, tax authorities may view notional pooling as a form of loan between the different accounts, which could have tax implications. Similarly, banking regulations in some countries do not permit notional pooling. As a result, corporations typically need to work closely with their banks and advisors to effectively manage a notional pooling system.
Example of Notional Pooling
Consider a corporation that has three subsidiaries: Subsidiary A, Subsidiary B, and Subsidiary C. Each subsidiary has its own bank account, with the following end-of-day balances:
- Subsidiary A: $20,000 (credit)
- Subsidiary B: -$10,000 (debit, i.e., an overdraft)
- Subsidiary C: $5,000 (credit)
Without notional pooling, Subsidiary A and C would earn interest on their positive balances, and Subsidiary B would be charged interest on its overdraft.
However, with notional pooling, the bank aggregates the balances of the three accounts to calculate a net balance for interest purposes. In this case, the net balance would be $15,000 (i.e., $20,000 – $10,000 + $5,000).
If the net balance is positive, the corporation as a whole could earn interest on $15,000. Conversely, if the net balance was negative, the corporation would pay interest only on the net overdraft amount, not on the gross amount of each individual overdraft.
This allows the corporation to optimize its cash management. In this example, the credit balance of Subsidiary A and C helps to offset the debit balance of Subsidiary B, reducing the corporation’s overall interest charges.
But remember, even though the balances are aggregated for interest purposes, the accounts themselves remain separate, and there’s no actual transfer of funds between the accounts. This is what makes the pooling “notional”.
This is a simplified example. Real-world notional pooling arrangements can be much more complex, involving many more accounts, potentially in multiple currencies and across different countries. As noted earlier, corporations using notional pooling need to carefully manage the tax and regulatory implications.