What it means
Large companies often hold many bank accounts, one for each subsidiary, country or currency. At any moment some accounts are in credit and others are overdrawn, and the bank usually pays a low rate on credit balances and charges a higher rate on overdrafts.
That spread means money is wasted when one account is overdrawn while another sits in credit. In notional pooling, the bank treats the accounts as if they were one account for the purpose of calculating interest.
It looks at the net balance, which is the total credits minus the total overdrafts, and charges or pays interest on that figure only. No cash is physically transferred, so each entity keeps its own account and its own legal position.
The alternative is physical cash pooling, also called a zero balancing arrangement, where cash is swept each day into a central account. Notional pooling avoids the movement of cash, which can help in countries where intercompany loans create tax or legal issues.
It also avoids creating a web of internal loans that have to be documented and priced. Banks that offer notional pooling usually require cross-guarantees, meaning each company in the pool backs the overdrafts of the others, and they take the net position into account for their own capital rules.
Some jurisdictions restrict or discourage the structure, and banks may charge a fee. Treasury teams should compare the benefit with the cost and the legal complexity.
The structure is most useful for groups with stable, predictable balances in several entities that share a bank and a currency. It is less suitable when entities have very different credit risk or when local rules do not allow offsetting.
In practice
Real-world examples
Example 1
A retail group has twelve stores, each with its own account at one bank. Some stores hold cash after busy weekends while others are overdrawn waiting for deliveries to be paid. The bank offsets the balances for interest purposes, and the group saves interest without moving any money.
Example 2
A multinational with subsidiaries in four countries wants to avoid setting up internal loans between them because of tax complexity. The treasurer chooses a notional pool in a single currency. Each subsidiary keeps its own legal balance, and the group still benefits from netting.
Example 3
A construction company has projects that generate cash at different times. The chief financial officer asks the bank to pool the project accounts for interest purposes. Over a year, the pool reduces overdraft interest by $85,000.
Think of it
Think of a family living in a large house where each member has their own piggy bank. Instead of one person paying high interest to borrow money while another earns pennies of interest on savings, the bank looks at all the piggy banks together as one total household fund.
Formula
Calculation
Net interest with pooling = (net credit balance x credit rate) or (net overdraft x debit rate)
Suppose a group has three accounts with the same bank: Company A has a credit balance of $800,000, Company B is overdrawn by $300,000 and Company C is overdrawn by $200,000. The bank pays 2% on credit balances and charges 6% on overdrafts. Without pooling, interest earned = 800,000 x 2% = $16,000 and interest paid = (300,000 + 200,000) x 6% = $30,000, a net cost of $14,000. With pooling, the net balance = 800,000 - 300,000 - 200,000 = $300,000 in credit, which earns 300,000 x 2% = $6,000, so the group improves by 6,000 - (-14,000) = $20,000 a year.Case study
Seen in the real world
Valemont Industries is a fictional manufacturing group created for this illustration. It had six subsidiaries with separate accounts, and its treasurer found that on a typical day about $2,000,000 sat in credit in some accounts while about $1,500,000 was overdrawn in others.
After negotiating with its main bank, the group set up a notional pool. The bank agreed to calculate interest on the net balance and required each subsidiary to provide a cross-guarantee for the group's overdrafts.
The illustrative outcome was an annual interest saving of around $60,000, along with simpler reporting for the head office. The group also noticed that its legal team now had to review the guarantees whenever a company joined or left the pool, which added some administration.
Watch out
Common mistakes
- Assuming that money physically moves between accounts, when the balances are only combined in the bank's interest calculation.
- Ignoring the cross-guarantees, which can expose a healthy company to the debts of a weaker one.
- Assuming it is allowed everywhere, when some countries restrict or prohibit the structure and banks often limit the currencies they accept.
Questions
People also ask
How is notional pooling different from cash pooling?
Cash pooling physically sweeps balances into a central account, while notional pooling leaves the money where it is and only nets the balances for interest.
Does it help with liquidity?
Not directly, because cash does not move, so a company that needs cash in one entity must still transfer it.
What does it cost?
Banks may charge a fee or a margin, and the legal and administrative work should be included in the comparison with the interest saved.