IBF Assignmnet

7/22/2019 IBF Assignmnet

1/24

Treasury Departmentof a Commercial Bank

2013

Submitted To:

Sir Imran Baloch

Submitted By:

Muhammad Ameen (0911119)

Maria Ali (0911229)

Sadia Ali (0911244)

Sidra Abbasi (0911247)

BBA VIII-D

26thMarch 2013


2/24

Page 1of 21

Table Of Contents

1. INTRODUCTION: ............................................................................................................................... 2

2. DEPARTMENTS IN A COMMERCIAL BANK................................................................................ 2

2.1. TREASURY: ................................................................................................................................ 3

2.1.1. Desks in Treasury: .................................................................................................................... 3

2.1.1.1. Fixed Income or Money Market Desk:............................................................................. 4

2.1.1.2. Cash Reserve Requirement: .......................................................................................... 4

2.1.1.3. Statutory Liquidity Requirement: ................................................................................. 4

2.1.1.4. Auctions: ....................................................................................................................... 5

2.1.1.5. Open Market Operations (OMO):................................................................................. 5

2.1.1.6. Call/Term lending/borrowing: ...................................................................................... 72.1.1.7. REPOS/ Reverse REPOS:............................................................................................. 7

2.1.1.8. Outright sale/purchase of securities:............................................................................. 8

2.1.2. Forex Desk: ........................................................................................................................... 8

2.1.2.1. Nostro Account: ............................................................................................................ 9

2.1.2.2. Vostro Account: .......................................................................................................... 10

2.1.3. Equities Desk: ..................................................................................................................... 10

2.1.4. Asset Liability Management Desk:..................................................................................... 11

2.1.4.1. ALM Information Systems ......................................................................................... 12

2.1.4.2. ALM Organizations .................................................................................................... 12

2.1.4.3. ALM Process............................................................................................................... 13

2.1.4.4. Mismatch Management & Performance Measurement............................................... 13

2.1.4.5. Funds Transfer Pricing (Ftp)....................................................................................... 14

2.1.4.6. Liquidity Management ................................................................................................ 15

2.1.4.7. Summary of ALM Functions: ..................................................................................... 16

2.1.5. Propriety desks: ................................................................................................................... 17

2.2. Differences between Islamic bank treasury and Commercial bank treasury.............................. 18

Bibliography ............................................................................................................................................... 22


3/24

Page 2of 21

1. INTRODUCTION:A bank is a financial intermediary that accepts deposits and advances them as loans. It acts as an

agent between surplus units (lenders) and deficit units (borrowers). Banking Companies

Ordinance defines Banking as banking means the accepting, for the purpose of lending or

investment, of deposits of money from the public, repayable on demand or otherwise, and

withdraw able by cheque, draft, order or otherwise; and banking company means any company

which transacts the business of banking in Pakistan and includes their branches and subsidiaries

functioning outside Pakistan of banking companies incorporated in Pakistan

Pakistans financial sector consists of Scheduled Commercial Banks which includes

nationalized, foreign, and private banks; and Non-banking Financial Institutions (NBFIs) which

include Development Finance Institutions (DFIs), Investment Banks, Mutual Funds and Pensionfunds. The Scheduled commercial banks are regulated by State Bank of Pakistans prudential

regulations and have to abide by various rules of capital and reserve requirements.

2. DEPARTMENTS IN A COMMERCIAL BANKWith growing economies, increasing globalization and industrialization, the number of banks

and their roles has increased. Most banks divide their activities into Consumer banking and

Corporate banking. The Consumer Banking is similar to B2C while Corporate Banking is similar

to B2B. These activities are divided among the different bank departments. In general, basic

departmental structure of a bank is depicted in the following diagram


4/24

Page 3of 21

Treasu

ryDivision Money Market Desk

Forex Desk

Equities Desk

Derivative Market Desk

ALM Desk

Proprietary Desk

2.1.TREASURY:The treasury department in a bank has the main objective of managing the banks liquidity and

risk management. It mainly administers the cash requirement of a bank and invests in equity and

debt instruments accordingly. It is also responsible to invest excess cash (net of assets and

liabilities) for earning markup. The functioning has to abide by and follow the requirements of

State Bank of Pakistan.

2.1.1. Desks in Treasury:The work treasury division is divided over a

number of desks. Following are the desks in

Treasury department

Fixed Income or Money Market Desk Foreign exchange or Forex Desk Capital Markets or Equities Desk Derivative Market Desk Asset Liability Management Desk Proprietary trading Desk

Chairman, BOD,

President

BusinessDivision

SupportDivision

Retail

Bankin

Corporate

Banking

Operations

Finance

IT Services

Human Resource

Legal Consultancy

TREASURY


5/24

Page 4of 21

2.1.1.1. Fixed Income or Money Market Desk:Basically, the need for a money market desk at a commercial bank is primarily driven by

the State Banks requirement for commercial banks to maintain the statutory and cash

reserves. According to this requirement, it is mandatory for to maintain a certain amount

of reserves with the State Bank of Pakistan.

2.1.1.2. Cash Reserve Requi rement:Cash Reserve Requirement or CRR is the amount of money that banks have to keep with

the State Bank of Pakistan as part of reserves. It is a portion of depositors money that the

bank holds, to be kept safe to ensure the banks have certain amount of secured liquidity at

all times. The State Bank also uses this tool to control the lending pool of banks. At present,

the Cash Reserve Ratio fixed by the SBP is 5 per cent on weekly average basis subject to

daily minimum of 3 per cent of time and demand liabilities1. (State Bank of Pakistan, 2012)

2.1.1.3. Statutory L iquidity Requirement:Commercial banks are required to keep some fraction of their assets in the form of cash,

Treasury Bills (T-Bills) or other approved securities. This fraction is called Statutory

Liquidity Ratio. Its main objective is to ensure that banks have sufficient funds in the form

of liquid assets. Currently this ratio (excluding Cash Reserve Requirement) is 15 percent oftime and demand liabilities. The form of eligible liquid includes T-Bills, PIBs (not more

than 5% of TDL), cash or foreign currency (State Bank of Pakistan, 2012). The State Bank

of Pakistan has decided SLR is determined on fortnightly basis on Friday (the close of

business) (The Daily Dawn, 2012)

1Demand Liabilities: deposits of the customers which are payable on demand e.g current deposits, savings deposits,

short term deposits etc

Time Liabilities: Fixed deposits, cash certificates, cumulative and recurring deposits, time liabilities portion of

savings bank deposits, staff security deposits, margin held against letters of credit, if not payable on demand, &

deposits held as securities for advances which are not payable on demand and Gold deposits (Institute of Banking

and Finance)


6/24

Page 5of 21

2.1.1.4. Auctions:Money market desk is also responsible to take part in auctions of T-bill, as T-bill is also a

money market instrument (government bond with maturity of less than a year). This desk

could participate in money market transactions either through the primary or the

secondary market. However, only approved financial institutions, known as Primary

Dealers, can participate in the primary market via the auction of T-Bills and PIBs.

Currently there are 12 PDs in Pakistan, namely National Bank, HBL, United Bank,

Citibank, Faysal Bank, Standard Chartered Bank, JS Bank, Pak Oman Investment

Company, MCB Bank Ltd, NIB Bank and Bank Alfalah. For example, HBL can place its

cash in T-Bills by participating in State Banks fortnightly auction of T-Bills through

competitive bidding. Lets suppose if HBL bids at a price of 97.96 for a 3 month T -Bill at a

value of 200 million. If this bid is accepted, HBL would be able to earn a yield of:

The non-PD commercial banks can only deal in T-Bills and PIBs in the secondary market by

trading with these PDs. Banks can also bid their investment in Non-Competitive bidding, in this

case they surely get their bid accepted, however the yield in non-competitive bids is the weighted

average of all the competitive bids.

2.1.1.5. Open Market Operations (OMO):OMO is a tool used by central bank to inject or to with draw excess liquidity from Money

Market. State Bank of Pakistan sells/buys government securities (PIBs , T-Bills, Ijara

Sukuk etc) to withdraw/inject liquidity or control the money supply. The money market

desk takes part in OMO, it earns yield when SBP sells securities and earns margin when

SBP buys back securities, while on SBPs end - OMO is a tool to manage the economys

money supply

Example: State Bank of Pakistan conducted its Open Market Operations i.e.; Sale of Government

of Pakistan Market Treasury Bills /Pakistan Investment Bonds to State Bank of Pakistan through

Reverse Repo OMO (Injection) contract on March 22, 2013. The Reverse - Repo Agreement was


7/24

Page 6of 21

for 7 days, the total amount offered was 485,700 million and amount accepted was 444,700

million. The accepted yield was 8.98% (State Bank of Pakistan, 2013)

SBP, monitors the daily liquidity position on the market, and conducts OMO when desired.

OMO is conducted through Reuters and bids are received through fax by the PDs.

The Money Market Dealer at the start of the day needs to update a money market blotter.

Blotter is a record of all transactions over a span of period (usually one trading day), in which all

details of the trade including the size of transaction, the type of order (buy order or sell order),

the price of order, etc are recorded (Investopedia, no date). The dealer hence has a clear picture

of all inflows and outflows of the day, and is able to manage the assets and liabilities and

equalize both sides of the equation.

(Orchestr Trade, 2011)

Based on the net position of the bank (net lender or net borrower), bank needs money to balance

its position (squaring the position).

Besides placing funds in Government or other low risk fixed income securities, the money

market desk participates in a number of activities to use the excess funds at the end of the day to


8/24

Page 7of 21

earn markup or to borrow funds to square its position. These include clean lending, Outright

purchase of securities, Repo, Reverse Repo Etc.

2.1.1.6. Call/Term lending/borr owing:This refers to clean lending or borrowing among banks. Such form of transactions is done

without the use of any security as collateral. Clean lending is not highly present in the market

due to the availability of REPO and Reverse REPO. However, banks do get involved in such

transactions usually for overnight borrowing in order to meet their short term requirements

(Squaring their positions). For instance, if HBL is short by 200 million on Thursday 20th

March,

and expects to get enough inflows next day to cover the shortage, the money market desk could

square this position by borrowing 200 million from UBL on an overnight basis. In such

transaction, HBL would pay interest for one day only and this interest would be based on theKIBOR. But if this transaction had occurred on Friday, HBL would have had to pay the interest

for 3 days as the transaction would then mature on Monday. HBL in this transaction does not

give any collateral to UBL; hence it is called clean borrowing.

2.1.1.7. REPOS/ Reverse REPOS:Repo and reverse repo refers to purchase and repurchase of short term securities. The term of the

transaction may vary as per the mutual contract between the parties. Basically, it is a form of

collateralized borrowing. In Repo transactions, the borrower of cash sells its securities to the

lender with an agreement to buy back the same security at a stated maturity. Repos can be done n

the basis of several securities, however, T-Bills are the most common security used in these

transactions. The lender of cash makes money by earning the differential on the discounted price

of the security over the period of transaction. For example, if HBL needs to fulfill its short term

liquidity requirements of PKR 300 million for a week, it may borrow from another commercial

bank through repo. HBL has various marketable securities which includes T-Bills with days to

maturity of 60 days. ABL agrees to get in to a repo transaction with HBL at 9.7%. The face value

of the security is 350 million. HBL would receive an amount of

(

)


9/24

Page 8of 21

by selling the T-Bills. On maturity, HBL would buy back the same security at a price of

(

)

Hence the amount of interest that HBL paid is

One of the benefits of a repo transaction is that the security used in the transaction is

exchangeable. This means that the HBL desk can request ABL desk to switch the underlying

security with another comparable security. This is beneficial in the sense that if HBL attracts a

large client who wants to place his fund in a T-Bill of 55 days maturity; HBL can cater to this

corporate client by placing another security with ABL and getting the previously placed security.

Reverse Repo works in the same way, here at maturity the repo transaction becomes a reverse

repo when the securities are bough back and cash is given. In the above transaction, at maturity

of Repo, when HBL buys back the security and gives cash, is a reverse repo transaction.

2.1.1.8. Outr ight sale/purchase of secur i ties:Money market desks also perform the function of portfolio manager for the bank by the purchase

and sale of government securities such as T-Bills and Pakistan Investment Bonds. The desk may

decide this on the basis of banks own strategy and market conditions. For instance if HBL

perceives that the policy rates would increase from 9.5% to 10.5% as a consequence of IMF

policies, the money market desk may sell its short term securities to gain benefit later on when

the interest rate rises.

2.1.2.Forex Desk:The basic function of the foreign exchange desk of a commercial bank is to facilitate large

corporate clients who are involved in international trade. They facilitate importers and exporters

to settle their transactions that involve foreign currency e.g. PSO needs to makes its payments in

US Dollars to oil companies and Nishat Mills receive payments in US Dollars from its

international customers which need to be transferred into PKR. The foreign exchange desk helps

the bank earn profits through the spread between bids and ask price. Lets suppose that PSO is a


10/24

Page 9of 21

client of HBL and needs to make a payment of USD 20 million on March 21st. PSO would

approach HBL to get a quote for the exchange rate. If the deal between the two parties strikes at

Rs. 99.5 per USD, HBL would make the payment to PSOs supplier and debit PSOs account

with the equivalent amount. HBL would then cover its USD short position by asking for quotes

from forex brokers. The forex desk would aim to get the best rates in order to maximize their

profits. In order to do so, the forex desk would start buying USD in smaller quantities to get

better quotes. For instance, if they are able to get USD 5 million at Rs. 99.2, another 5 million at

Rs.99, and 10 million at Rs. 99.25; they would be making a profit of

This is an example of spot transaction where the client approached the bank on the day of

payment.

Besides spot transactions, forex desk also participates in forward currency contracts. Taking the

same example, PSO approaches the bank a month before the actual day of payment. PSO

perceives that the PKR would depreciate and hence they might face a higher cost, therefore they

want to enter into a forward contract with HBL so that they can lock the forex rate. Assuming

that the USD is trading at PKR 98 during this time, HBL would quote a higher rate to PSO as the

forex desk also perceives the Dollar to appreciate over a period of the month. So if the deal

strikes at Rs. 99.10 per USD, the forex desk would start accumulating dollars from that day

onward to buy it over the minimum cost possible and thus make profit by the wider spreads.

However these trades are subject to State Banks regulation on foreign currency exposure limits.

These trades are carried out through Nostro and Vostro accounts

2.1.2.1. Nostro Account:A Nostro Account is and account is a Domestic Banks Account is a foreign country, example

UBLs account in New York Bank is a Nostro Account.


11/24

Page 10of 21

2.1.2.2. Vostro Account:A Vostro Account is a foreign countrys account in a Domestic Bank; example Ney work Banks account

in UBL is a Vostro account.

The trades through these accounts are subject to exposure limits imposed by State Bank of Pakistan to

control the foreign currency (usually dollar) inflow and outflow in the economy. If a Bank requires more

dollars then its exposure limit then the Bank has to syndicate with other bank to fill the order. (State Bank

of Pakistan, 2002)

2.1.3.Equities Desk:An equity desk in treasury department of a bank is responsible for managing banks equity

portfolio. It searches for different opportunities where the bank can invest and gain maximum

return, thereby, increasing the shareholders worth. An equity desk dealer usually deals in shares

listed on the stock exchange.

Banks in Pakistan may or may not have an equity desk; however, some other desk maybe

performing this function for the bank. In UBL, the equity desk is responsible looking after

banks CFS portfolio,badla and trading. They deal in various products from structured products

to customer specific products. Structured products usually include plain vanilla derivatives.

Moreover, they trade in different stocks listed on the Karachi stock exchange. The trading is

extended to transactions such as future buy/sell contracts, future short sell and leverage products.

The crucial aspect for equity desk workers is the performance of the economy which sets the

price of the stocks and influences their transactions immensely. Hence, correct view and

prediction regarding the economy is important for the equity desk workers. At UBL, equity desk

workers use their expertise to trade on those stocks on KSE which has a potential return and can

be of great benefit to the stockholders of the business.

An equity desk worker goes through the following cycle .


12/24

Page 11of 21

2.1.4.Asset Liability Management Desk:One of the most significant desks operating in a banks treasury department is the Asset and

Liability Management desk. This desk is mainly responsible for overseeing various asset and

liability related activities including the establishment of the guidelines for the banks risk

tolerance levels. ALM is a strategic tool which is required for the management of profit rate risk,

credit risk and liquidity risk faced by the banks. This desk is further responsible for the banks

overall treasury and money market activities. Also, after monitoring and evaluating the various

types of risks a bank is exposed to due to its provision of financial services, the ALM desk

provides the bank an insight by helping formulate strategies for risk management. In short this is

the practice of managing risks which are a product of mismatches between the assets and

liabilities of a bank. This mismatch management help manage risk by matching the assets and

liabilities according to the maturity pattern, by matching the duration or by hedging or

securitization (Choudhry, n.d.)

For a banks ALM desk to be most effective the activities pursued for risk management must aim

to manage the volume, mix, maturity, rate sensitivity, quality and liquidity of assets and

liabilities on the overall basis so as to enable the bank to achieve the predetermined risk ratio.

Three major aims of an ALM desk in a bank are to stabilize short-term profits, to alleviate long-

The dealer asks forquotes from the broker

or dealing systems

He buys/sells thesecurity at the givenrates and records the

information

If the deal is executed,it is recorded on the

equity blotter

Transaction limits, varlimites etc are checked

Upon limit clearance,the transaction is sentto the back office for

validation and

confirmation

At the end of the day,equity desk generates asingle deal ticket for all

buy deals and otherdeal tickets for all sell

transactions


13/24

Page 12of 21

term earnings and to maintain long-term substance of the bank. These goals enable the bank to

stabilize its ALM system and the bank does this by considering three main parameters; Net

Interest Income (NII), Net Interest Margin (NIM) and Economic Equity Ratio (EER)

(khabyadilip, 2011)

According to traditional approach, the major function of a treasury depa rtments ALM desk has

been the management of risk associated with the banking book. In addition to this main function

and the other functions which will be elaborated on later, the following are the tools which are

used by an ALM desk in a banks treasury (Barone-Adesi, 1994).

2.1.4.1. ALM I nformation SystemsThese are the information systems used to collect Real time information about the maturity and

behavior of loans and advances made by the bank and all its branches. For this data collection

process, in order to help the ALM process to proceed, ABC approach is used by banks. This

approach helps analyze the behavior of the asset and liability products which mainly reside in the

top branches of the bank thus accounting for the most significant part of the business. This

further deal with making use of this information collected to make assumptions as to how the

assets and liabilities in other branches of the bank would behave. The data and assumptions

extracted from the information gathered ultimately transforms or is refined with time and

experience of banks management within the ALM framework. This data collection has further

been facilitated by the spread of computerization (rbi.org.in, 2013).

2.1.4.2. ALM OrganizationsThe major responsibility of risk management lies with the management which decides the risk

management policy of the bank including the decision about setting limits for liquidity, interest

rate, foreign exchange and equity price risks. Also, an Asset-Liability Committee (ALCO) is

formed which consists of senior management including the CEO. The ALM desk, which is our

main focus and mainly consists of operating staff, is responsible for analyzing, evaluating and

reporting the risk profiles to ALCO. The staff in ALM desk prepares forecasts pertaining to the

possible changes to the banks risk appetite due to external market conditions related to balance

sheet and recommend what actions could be taken considering the banks limitations (rbi.org.in,

2013).


14/24

Page 13of 21

2.1.4.3. ALM ProcessThe ALM process or the scope of the ALM function could be described by considering the

following steps involved in the process (Baid, 2012);

Identifying risk parameters. Identifying types of risk the banks ALM desk or the overall bank is subject to. Measurement of the risks identified based on the risk parameters worked upon. Strategies employed for the management of the risks identified. Risk policies established and risk tolerance level of the firm evaluated and identified.

The entire ALM process defines the scope of the ALM functions performed by the ALM desk.

This mainly includes the following elements or criterion judging the ALM functions

effectiveness (Baid, 2012);

Liquidity risk management, which it does by overseeing the money market activities. Management of Market risk, which includes the interest rate risk. Funding and capital planning, which includes taking care of transactions like asset

purchased or sold and liability taken or repaid with respect to the banks funding

requirement.

Profit planning and growth projection, which the desk does so by evaluating the cost ofthe risks involved along with the evaluation of the banks profitability position and past

and present growth rates.

Trading risk management which involves risks expected to be experienced in the tradingactivities of the bank, especially in case of international trading.

Considering these tools used by the ALM desk of the treasury department of bank, following

activities are carried out (Report, 2008);

2.1.4.4.

Mismatch Management & Perf ormance Measurement

The first activity that an ALM desk performs is the mismatch management between the assets

and the liabilities. This is sometimes also known as the mismatch position of the balance sheet.

Mismatch balance sheet represents a bank probable to experience an interest rate and liquidity

risk profile. This mainly involves the ALM desk working towards managing the regulatory


15/24

Page 14of 21

capital with the active positioning of balance sheet in a way so as to enable the bank to earn

maximum profits. The management of this mismatch is essential for a bank owing to its need of

meeting the clients demand and maximizes the return on capital. The bank does this through gap

management. This term describes the situation where the practices of varying assets and

liabilities lead to the gap in response to the expectations about the future interest rate course and

the shape of the yield curve. This is the difference between the floating-rate assets and liabilities.

In order to manage this mismatch through gap management, the ALM desk conducts various

analyses which are mainly designed to identify the reasons behind this mismanagement, see if

the mismatch is static or dynamic (stable or continuously changing), and check the sensitivity of

net interest income and market-value under multiple scenarios. All these integrated together help

the banks ALM desk reduce the mismatch between assets and liabilities. In case of mismatch

management, the bank also decides on whether taking a neutral approach to dealing with ALM

risks or will it go for a more aggressive approach. After considering this, the bank makes the

decision of the resources to be allocated to the measures taken for the management of this

mismatch (Report, 2008).

Performance measurement is one other activity conducted by the ALM desk of treasury. The

desk does this by using the three parameters of Net Interest Income (NII), Net Interest Margin

(NIM) and Economic Equity Ratio (EER). Majority banks make use of NII as the main measure

for the performance measurement. While some advanced banks make use of market or economic

value as the secondary measure of performance. The process involves the bank making various

assumptions which must be realistic and align with the market situation as well as the current

scenario the bank is operating in. lastly, the access to timely and accurate data of the ALM desk

from other desks of the treasury department would help the desk in risk management and other

activities (Barone-Adesi, 1994).

2.1.4.5. Funds Transfer Pri cing (Ftp)Funds Transfer Pricing system or FTP is the fundamental tool that is used by banks for risk

management and asset and liability management. The tool mainly involves the ability to the

bank to become immune to the risks that it might face as has been discussed before and provide

the bank with economic and product transparency. The main purpose of this process is to identify

the interest rate margins and using those margins curtails the interest rate and funding risk or the


16/24

Page 15of 21

liquidity risk. The process involves locking the margins on loans and deposits by assigning them

a transfer rate that reflects the re-pricing and the cash flow profile of each item on the balance

sheet. The system also helps in the centralization and management of the interest rate mismatch

by isolating the business performance of each of its portfolios into different discrete portfolios,

each assigned an individual metrics for measurement (Report, 2008).

In many banks, FTP is also used as a tool for the management of the balance sheet structure

which is done through an analytical process which in turn helps in the identification and

understanding of the competitive advantage of the bank, helping in the allocation of assets and

protection of the franchise. The FTP rates are structures to include interest rate risk and funding

liquidity risks which are derived from the transfer yield curve constructed from the appropriated

premiums (Knowledge Base, 2011).

2.1.4.6. L iqui dity ManagementThe liquidity management function of the ALM desk mainly involves the management of the

funded liquidity risk which is embedded in the balance sheet of a bank. This process involves the

funding of the long-term loan mortgages and other securitized assets with short-term liabilities.

The ALM process helps the ALM desk assess the resilience of funding and liquidity sources.

Maturity transformation is another function of the ALM desk which it carries out, owing to the

need to meet the customers requirements and liquidity, interest rate and currency mismatches

management. According to the traditional approach, the ALM desk analyzes and manages

liquidity within the pre-set limits defined by the bank (Report, 2008).

The liquidity management also includes the ALM desks responsibility to recognize the liquidity

risk, properly articulate the risk tolerance level of the bank and using this tolerance level

scrutinize the balance sheet on regular basis. ALM desk follows five principles for the

governance of the liquidity risk, which includes diversifying sources and terms of funding,

identifying, measuring, monitoring and controlling risk, understanding the relationship of

liquidity and other risks, establishing tactical and strategic liquidity management platforms and

preparing contingency plans for implementation under various probable scenarios (Report,

2008).


17/24

Page 16of 21

The ALM desk also makes use of five liquidity management tools. Namely these are Static

funding gap, Dynamic cash-flow gap, Liquidity asset ratios, Concentration ratios and Liquidity

stress measurement. Static funding gap mainly measures the gap or deficit in the banks ability to

fund the maturing assets from maturing liabilities. This is mainly done based on the maturity

bucket basis. Dynamic cash-flow gap mainly measures the marketable asset liquidation with the

help of maturing assets and liabilities measurement. Liquidity asset ratios are the ratios of liquid

assets over liquid liabilities. Liquid in this context mainly includes cash and cash equivalents,

trading account securities, repos investments into government securities etc. Concentration ratios

are ratios helping the bank assure the funding compared to assets and liabilities or capital from a

particular source. Liquidity stress measurement is all about evaluating the banks stress situation

by seeing the multiple ratios performance in high stress and low stress situations (rbi.org.in,

2013).

2.1.4.7. Summary of ALM Functions:According to the traditional approach, ALM desk of a treasury department is responsible for the

risk management of the bank, which mainly includes the following functions or activities

conducted by the ALM desk (Global Money Markets; Asset Liability Management, 2013)

Interest rate risk management which mainly includes the management of interest rate riskfrom banking books and includes interest income sensitivity analysis, maturity gap and

duration gap analysis, sensitivity of the book to the changes in the yield curve.

Liquidity risk management which includes the measurement of the regulatoryrequirements which lead to knowing the proportion of banking assets which will be held

as short-term instruments.

Reporting on hedging of risk which involves updating senior management with thebanks risk exposure.

Setting risk limits which involves setting, implementing and enforcing the risk limits andmonitor the compliance with these limits.

Capital requirement reporting which involves compilation of the capital requirementreports and informing regulatory authorities


18/24

Page 17of 21

After the traditional approach, various developments took place in the ALM desks function in

the treasury department. These developments added the following functions under the ALM desk

as well (Global Money Markets; Asset Liability Management, 2013);

Making use of VAR (Value-at-risk approach) tool for assessing the risk exposure. Integration of market and credit risk Usage of new risk-adjusted measures of return Optimization of portfolio return. Proactive management of the balance sheet

Thus these are the various activities and functions of the ALM desk of the treasury department.

2.1.5.Propriety desks:Proprietary desk is another function of the treasury in a bank, where traders work solely with the

aim to generate profits for the bank itself and not for customers. The money used in these

transactions is of the banks own money rather than its customers money. Trading takes place in

stocks, bonds, options, commodities, derivatives, or other financial instruments for banks own

account. The traders have a clear of capital gains on the banks money.

The trading takes place for the bank's own account and capital. These traders work in isolation

with the other processing departments so that there is no conflict of interest or situation where

the trader might want to benefit the customer than the bank. Also, the objective of these desks is

to earn profits that are above those that could be earned in their normal market-making trades.

A crucial point in propriety desk is the risk of insider trading and the outflow of non-public and

price sensitive information. An activity most commonly known as fronting running where a

propriety desk knowingly purchase shares ahead of the customers trade so as to benefit the price

increases which would be beneficial when the customers deals are processed.

The Proprietary desk holds three types of securities, Held to maturity, Held for trade and

Available for sale. The securities that are held for maturity have strict conditions of not to be

used in trade, while the prop desk traders use the other to securities to generate profits.


19/24

Page 18of 21

Prop desk also functions to run the yield curve in a bank, as they sell securities of different

tenures on different yields, it generates a yield curve that reflects banks view on the short and

long term interest rates.

2.2.Differences between Islamic bank treasury and Commercial bank treasuryTreasury department in an Islamic bank and the one operating in a commercial bank have

slightly different operations owing to the obvious difference of Islamic banking conducting

interest free banking while commercial banks conducting interest-based banking. Although the

main function of the treasury is the same in both the banks, that is the management of the

banks funds, yet there are certain transactional differences which surface the society

(Knowledge Base, 2011).

1. Islamic banking treasury plays an important role in the management of funds in anIslamic bank. Being a Shariah complaint institution, the banking transactions are profit

based and not interest based.

2. In an Islamic bank, treasury department manages two types of funds; shareholdersfunds and depositors deposits like current account deposit, saving account deposits,

general or unrestricted investment deposits, specific and restricted investment deposits,

Wakalah deposits and Commodity Murabaha deposits.

3. Excess funds which are not used for financial activities are reinvested by the treasurydepartment in other Shariah compliant instruments. Compared to the conventional or

commercial banking, Islamic banking is more liquid, however the short-term

investments of the IFIs is limited meaning lower returns while in Commercial banks,

returns are highas the short-term investments are unlimited.

4. On the other hand, commercial banks treasury is an interest-based treasury, where themain function, as of Islamic bank is the management of funds. However the element

that differentiates an Islamic banking treasury from a commercial banking treasury is its

operations.

5. The main transactions or products of a treasury of a commercial bank include foreignexchange market products which include spot and forward transactions, which are

not the product of the Islamic banks. Spot transactions are done but not forward


20/24

Page 19of 21

transactions. Time deposits are traded in the commercial banking treasury while are not

traded in the Islamic banking treasury.

6. Commercial bank treasury manages shareholders funds, depositors deposits like currentaccount deposit, saving account deposits, general or unrestricted investment deposits,

specific and restricted investment deposits, and other lending transactions like

commercial bonds and papers which earn interest on them (Treasury Operations in

Islamic Banking, 2011).

7. The two main requirements that an Islamic banking treasury has is the need to maintainthe minimum statutory reserve which is imposed by the central bank and the

maintenance of Banks liquidity requirements.

8. Monitoring and controllingshort and long term risks is another function carried out bythe banks treasury. The treasury is responsible to advice on the type of deposits and

financing assets, especially the type of pricing that must be marketed.

9. In an Islamic treasury, the type of risks that the bank considers mitigating does notinclude the interest rate risk, since the banking transactions are interest-free and profit-

based. An additional risk that Islamic banks may be exposed to, owing to the policy of

keeping banks assets at fixed profit rate, is the commercial displacement risk which

is the risk of movement of deposits from Islamic banks to conventional/commercial

banks.

10.In order to mitigate this type of risk, the Islamic banks are allowed to maintain a profitequalization reserve. Same are the functions of a commercial banking treasury, yet the

difference is that a commercial banking treasury also manages funds from the

commercial papers and bonds, which earn interest on them.

11.The additional risk that commercial banks suffer from is the interest rate risk which isdeemed to be mitigated by the interest rate management by the treasury. Also the treasury

department of a commercial bank overseas the long term interest rate positions and

carries out the banking activities according to this forecast, so as to earn the highest

interest on its investments (Treasury services, 2001-2013).

12.The treasury of an Islamic bank aims to manage the mismatch created in the assets andliabilities owing to the long term assets which include Sukuk, project financing and

real estate financing. While a commercial banking treasury manages the mismatch or


21/24

Page 20of 21

gap in assets and liabilities created by assets like commercial bonds, corporate bonds,

forwards and future contracts, spot contracts, T-Bill is and many other interest-bearing

assets. Liquidity of Islamic banks and short term funding is higher than commercial

banks (Farooq, 2010).

Considering the Treasury management system of both the banks, system is similar of both banks

and includes the following players (Treasury services, 2001-2013);

Front office which includes treasury dealers. Middle office, which works upon the banks real time compliances to the banks credit,

market and liquidity risk.

Back office which is responsible for conducting the back office functions of the treasurydepartment like deal confirmation, settlement, deal maintenance and cancellations.

Apart from that, the Islamic banks being Shariah complaint banks include treasury activities like

trading which encompasses the money market deals, ALM activities like management of the

asset liability mismatch but does not include the desks of Derivatives and foreign exchange,

since these desks trade in derivative securities and foreign securities bearing interest (Farooq,

2010).

Thus these are the few differences that exist between an Islamic banking treasury and acommercial banking treasury department. This can further be briefed by considering the

following functions of the treasury (Iqbal, 2008);

Planning and operations activities which includes the management of funds, assets andother kinds of funds. Cashflow forecasts, risk forecasts, investment appraisals, tax and

pensions planning, ensuring quality service standards all come under this head in both

systems Islamic and Commercial

Cash and Liquidity management (ALM) which includes the asset and liability mismatchmanagement which is done in commercial and Islamic banks on different liquidity

instruments. In Islamic banking specifically these instruments are Repo, Murabaha,

Wakalah, Mudarabah, Sukuk and Structural deposits.


22/24

Page 21of 21

Funding and capital markets which includes managing capital instruments portfoliowhich includes short and long term investments.

Financial Risk Management which includes interest rate risk for commercial banks apartfrom other risks and commercial displacement risk for Islamic banks.

Corporate governance which involves management of treasury transactions and policies. Stakeholdersrelations who pertain to manage banks relations with investors and other

stakeholders like customers or board of directors.


23/24

Page 22of 21

Bibliography

Baid, P. (2012). Asset Liability management in Banks. Retrieved March 20, 2013, from

Slideshare: http://www.slideshare.net/pankajbaid17/asset-liability-management-in-banks

Barone-Adesi, G. (1994).ALM in Banks.Pennsylvania: University of Pennsylvania.

Choudhry, M. (n.d.). Bank Asset and Liability Management: Strategy, Trading, Analysis.India:

KBC Financial Products.

Farooq, S. (2010). Islamic Bank Treasury and Interbank Markets. Retrieved March 25, 2013,

from Slideshare: http://www.slideshare.net/saydfarook/islamic-bank-treasury-and-interbank-

markets

Global Money Markets; Asset Liability Management. (2013). Retrieved March 20, 2013, from

Wisdom jobs: http://e-university.wisdomjobs.com/global-money-markets/chapter-1914-

359/asset-and-liability-management_the-alm-desk_11837.html

Institute of Banking and Finance. (n.d.). CRR and SLR. Retrieved March 24, 2013, from

http://www.iibf.org.in/documents/CRR-SLR.pdf

Investopedia. (no date). Blotter. Retrieved March 25, 2013, from Investopedia:

http://www.investopedia.com/terms/b/blotter.asp

Iqbal, H. V. (2008). RISK ANALYSIS FOR ISLAMCI BANKS. Washington, D.C.: The World

Bank.

khabyadilip. (2011). Treasury Department in a Bank . Retrieved March 21, 2013, from Blogspot:

http://khabyadilip.blogspot.com/

Knowledge Base. (2011). Retrieved March 25, 2013, from Treasury View:

http://support.treasuryview.com/kb/treasury/treasury-function-overview

Orchestr Trade. (2011). Financial Solutions. Retrieved March 25, 2013, from

http://www.orchestrade.com/solutions/index.html

rbi.org.in. (2013).Asset - Liability Management System in banks - Guideline.


24/24

Page 23 of 21

Report, T. A. (2008).Risk Management and Asset and Liability Management in Banks.Bangkok:

Asian Development Bank.

State Bank of Pakistan. (2013).Domestic Market and Monetary Management Department, OMO

Result. Retrieved March 24, 2013, from State Bank of Pakistan:

http://www.sbp.org.pk/ecodata/Result-OMO.pdf

State Bank of Pakistan. (2002). Foreign Currency Accounts of Authorized Dealers and Sale of

Foreign Currencies. Retrieved March 25, 2013, from State Bank of Pakistan:

http://www.sbp.org.pk/fe_manual/chapters/chapter5.htm#1

State Bank of Pakistan. (2012). Reserve Requirements: Current Practices and Potential Reforms.

SBP Research Bulletin, 8(1), 45-52.

State Bank of Pakistan. (2012). SBP Market Operations. Retrieved March 24, 2013, from State

Bank of Pakistan: http://www.sbp.org.pk/fscd/2007/Presentations/SBP-Market-Operations.ppt

The Daily Dawn. (2012, October 6). SBP moves for liquidity management. Retrieved March 24,

2013, from Dawn.Com: http://dawn.com/2012/10/06/sbp-moves-for-liquidity-management/

Treasury Operations in Islamic Banking. (2011, April). Retrieved March 25, 2013, from Islamic

Banking Way: http://www.islamicbankingway.com/2011/04/28-treasury-operations-in-islamic-

banks.html

Treasury services. (2001-2013). Retrieved mARCH 25, 2013, from ING:

http://www.ingcommercialbanking.com/eCache/ENG/15/195.html

IBF Assignmnet

Documents

Transcript of IBF Assignmnet