Reconciliation is a control process. It refers to checking two sets of records, finding out the discrepancies, and rectifying them.
Why are two sets of records maintained?
One record is maintained by the Client, which is called a ledger. Another record is maintained by the Company/Bank, which is called a Statement. Reconciliation happens for both Cash and Depot (stock).
Cash Reconciliation is done to make sure the cash balance matches and Depot (stock) reconciliation helps to check the balances of stocks.
The ledger will show the accounting record of the Client. The statement will show the actual balance as per the Company/Bank.
Ideally, both the balance should match, however, there can be differences for many reasons. Some of the reasons for discrepancies in the financial market are as follows:
1 Timing Issue:
It takes T+3 working days for a trade to get settled in the US. The moment the buyer places the order, he will record it in his ledger, however, Custodian will record the transaction only when it gets settled. So, there is a time lag and so, this difference will exist till the settlement date and automatically, it would be rectified.
2 Stock Split:
Quite possible that the no. of shares are reflected in the ledger lower than the actual statement. It could be because of the Stock Split, which Custodian must have realized but not the Client and so, there can a discrepancy for this reason.
3 Bonus Issue: This reason is quite similar to the reason for the Stock Split. Statement of the Custodian will show more stock as per the Bonus Issue issued by the underlying company.
4 Dividend: There can be differences between the cash balances between the Client and the Custodian due to the Dividend payment. The company would have paid the dividend and so, the Custodian’s cash balances would be higher. The client might be unaware of it and have not recorded it in his cash ledger.
5 Interest: If the underlying asset is a bond, discrepancy because of Bond interest is common. The bank might show more balances because of the interest paid by the bond issuer, which the client might not have recorded.
6 M&A, Name change of the Company:
Quite possible that the name of the company got changed due to M&A or name change of the company. This can lead to the discrepancy between the name of the company on the ledger and the statement of the Bank.
Reconciliation can happen at various levels. It can be classified as Internal and External reconciliation.
Internal Reconciliation:
It happens with different systems, however, within the same company. Here, data in different books are matched within the same company.
Discrepancies happen because of feed issues between Front Office, Middle Office, and Back Office. Different types of Internal reconciliation could be Front Office to Middle Office, Middle Office to Back Office, and Front Office to Back Office reconciliations. In Trade Life Cycle, internal reconciliations happen in Trade Capture, Enrichment, and Validation stages.
External Reconciliation:
It can happen between the Client and the Broking firm for the no. of trades placed. It can happen between the Client and the Custodian for the no. of shares and amount held. It can happen between Custodian and Depository, It can happen between Custodian and Sub-Custodian. These are called external reconciliation as these are happening between one party to another.
Different types of External Reconciliations are as follows:
Broker Reconciliations:
This happens between the client and the broker to make sure that the orders are placed as per the instructions given by the Client. This helps to agree on the brokerages charged by the broker and to be assured that the orders are executed properly.
Nostro Reconciliations:
Domestic Banks maintain accounts with other Foreign Banks (also called Correspondent banks) to execute their transactions in the Foreign country. This account is called Nostro Account. Domestic Banks keep an account called Nostro Mirror account (ledger account). So, reconciliation happens between the Nostro account and Nostro Mirror Account.
Exchange Reconciliations:
The broker reconciles on daily basis between his orders and the netting file sent by the Exchange on daily basis.
Custodian Reconciliations:
Mutual Fund Administration team reconciles with the Custodian’s account. The Fund Manager places orders, Fund administration team keeps a record of all the transactions done by the Fund Manager. It is further reconciled with the Custodian. Custodian maintains the actual records (statement).
People from Commerce/Accounting backgrounds must have gone through reconciliation topics in their academics wherein, they have to find out the discrepancies between Cash Book, maintained by the Customer, and Passbook, maintained by the Bank. Some of the reasons for discrepancies could be as follows:
1 : Timing issues of Cheque clearance:
The customer would record it in his Cash Book as soon he deposits the Cheque, however, Bank would record it only when the Cheque gets cleared. So, there would be discrepancies till the Cheque is cleared.
2 : Incorrect recordings by the Customer:
Typo errors are highly possible when too many transactions are done by the Customer, which can lead to discrepancies. The customer might mention the amount incorrectly in the Cash Book or he may make other mistakes like, mentioning the name of the Payee incorrectly and so on.
3 : Interest credited by the Bank, unknown to the Customer:
Bank will credit interest to the Customer’s account and so, the balance would go up, however, if it is not recorded in the Cash Book till the Customer becomes aware of it. This leads to being more
4 : Bank charges levied by the Bank:
Bank may levy charges for its service, which might not have been realized by the Customer and so, he would not have recorded it in the Cash Book
5 : Debtor depositing cheque in the bank account:
Quite possible that the Customer’s debtor deposited Cheque in the Customer’s account and missing to inform the Customer. Once the check gets cleared, more balances would be shown in the Bank account as the Customer must have not recorded them in the Cash Book.
