Integrated Treasury Management

Dipesh Kumar

Treasury Management Treasury generally refers to the funds and revenue at the

disposal of the bank and day-to-day management of the same.

The treasury acts as the custodian of cash and other liquid assets.

The art of managing, within the acceptable level of risk, the consolidated fund of the bank optimally and profitably is called Treasury Management.

It is the window through which banks raise funds or place funds for its operations.

Functions of an integrated treasury

Reserve Management and Investment

Liquidity and Funds Management

Asset-Liability Management

Risk Management

Transfer Pricing

Derivatives Trading

Arbitrage

Capital Adequacy

Structure of an integrated treasury

The treasury department is manned by the front office, mid office, back office and the audit group. In some cases the audit group forms a part of the middle office only.

The dealers and traders constitute the front office. In the course of their buying and selling transactions, they are the first point of interface with the other participants in the market (dealers of other banks, brokers and customers).

They report to their department heads. They also interact amongst themselves to exploit arbitrage opportunities.

Structure of an integrated treasury

A mid office set up, independent of the treasury unit, responsible for risk monitoring, measurement analysis and reports directly to the Top management for control.

This unit provides risk assessment to Asset Liability Committee (ALCO) and is responsible for daily tracking of risk exposures, individually as well as collectively.

The back office undertakes accounting, settlement and reconciliation operations.

The audit group independently inspects/audits daily operations in the treasury department to ensure adherence to internal/regulatory systems and procedures.

Structure of an integrated treasury

Advantages of integrating treasury operations

Is to improve portfolio profitability, risk insulation and also to synergise banking assets with trading assets.

This is achieved through efficient utilisation of funds, cost effective sourcing of liability, proper transfer pricing, availing arbitrage opportunities, online and offline exchange of information between the money and forex dealers, single window service to customers, effective MIS, improved internal control, minimisation of risks and better regulatory compliance.

An integrated treasury acts as a centre of arbitrage and hedging activities.

It seeks to maximise its currency portfolio and free transfer of funds from one currency to another so as to remain a proactive profit centre.

The Dealing Room

The Treasury has a responsibility to manage market risk in accordance with instructions received from the bank’s ALCO.

This is undertaken through the Dealing Room which acts as the bank’s interface to domestic and international financial markets.

it is the clearing house for such risk and has the responsibility to manage the market risk taken in all areas of the bank, on behalf of customers, and on behalf of the bank, within the policies and limits prescribed by the Board and RMC.

For this reason significant authority is given to the Treasurer, and the Dealing Room staff to commit the bank to market risk.

Thus controls over the activities of these staff are critical to ensure that the bank is protected from undue market risk.

The Middle Office

The duties and responsibilities of the Middle Office vary from bank to bank.

Middle Office is a relatively new concept in the risk management structure, not all banks will have formal Middle Office structures.

Middle Offices are in place primarily to provide market risk monitoring, evaluation and reporting for ALCO and Treasury.

The Middle Office is the first line of review of dealing activities and it provides timely assessment of dealing activities and consolidated market risk exposures of the bank.

The Middle Office

The Middle Office must report to ALCO independent of the Treasury. It is inappropriate that any access to Middle Office systems is given to Treasury staff.

As the Middle Office is the primary source for market risk analysis in the bank, it is essential that “segregation of duty” principles are clearly maintained.

Middle Office provides key market risk analysis to Dealing Room management and ALCO, its reporting line to the ALCO Secretariat must be separate from Treasury to ensure independent risk evaluation.

The Back Office

The key controls over market risk activities, and particularly over Dealing Room activities, are exercised by the Back Office.

It is critical that both a clear segregation of duties and reporting lines are maintained between Dealing Room staff and Back Office staff, as well as clearly defined physical and systems access between the two areas.

The Back Office and Middle Office, where present, are also entrusted with the responsibility of ensuring the timeliness and completeness of data in regard to market risk activities and providing ALCO and management with verified reports from the bank’s books as defined in bank policy and procedures.

Key controls performed in this area are :

The Back Office

Key controls performed in this area are

The control over confirmations both inward and outward.

All confirmations must be verified by Back Office staff for consistency with Dealing Room forms and reports. Any follow up of discrepancies between the two (including confirmations received where no dealer’s record is provided) must be performed independently by the Back Office in a timely manner.

Confirmations must under no circumstances be sent out by or received by the dealing area.

The control over dealing accounts, vostros and nostros must also be timely, accurate and discrepancies followed up independently and in a timely manner.

Revaluations and marking-to-market risk exposures, where required by policy and RBI directives, must be carried out by the Back Office, for bank records, from rates received independent of the Dealing Room.

The Back Office

Monitoring and reporting of risk limits and usage including open positions, product usage, counterparty settlement, overall limits and portfolio limits are the responsibility of the Back Office or Middle Office, where in place.

Reporting prompt resolution of exceptions and excesses are vital responsibilities of the Back and Middle Offices and key control considerations.

Control over payments systems, particularly those related to Dealing Room activities is the responsibility of the Back Office. Under no circumstances should staff with access and/or authority to the Dealing Room or dealing mechanism have any authority, responsibility or access to bank payment systems.

Risk Management Techniques VAR Model- Estimated maximum potential loss of

a portfolio

Back Testing - Method of examining whether the VAR numbers being produced reasonably reflect reality

Stress Testing- overcome the shortfall of VAR models, manage risk better in more volatile and less liquid markets

Financial Markets

Credit Market

Money Market

Forex Market

Debt Market

Capital Market

Indian Money Markets

Money Market Market for short-term requirement and deployment

of funds - overnight to one year

In products which are close substitutes for money

The instruments should be marketable, liquid and bearing low-risk facilitates Asset-Liability Management in banks

Enables banks to reduce cost of liquidity by deploying their short-term surpluses

RBI as Regulator of Money MarketThe statutory powers of RBI as regulator of money market are derived from

The RBI Act, 1934 which states that it is one of the objectives of RBI to develop the money market; and

To ensure stability in short-term interest rates

To minimise default risk

To achieve balanced development of various segments of money market

Pressure on the banking system during times of liquidity crunch or

Ease in the banking system during times of liquidity surplus is first felt in this market

Money Market - Important Instruments Call and Notice Money

Treasury Bills

Commercial Papers (CPs)

Certificates of Deposit (CDs)

Repurchase Agreements (Repos)

Collateralised Borrowing & Lending Obligation (CBLO)

Call and Notice Money Maturity - Call - Overnight

- Notice - 2 to 14 days Uncollateralised Participants

- Scheduled Commercial Banks (SCBs), Co-operative Banks and Primary Dealers

(PDs)

Call and Notice Money… Limits on call / notice money exposure are

monitored on a daily / fortnightly basis

Compulsory reporting of all call money transactions on NDS platform within 15 minutes of deal

NDS-Call launched from Sept. 18, 2006 Screen-based negotiated quote-driven system for

all dealings in call / notice / term money markets Membership is open to all market participants

Call and Notice Money… NDS and RTGS Membership essential Dealing is optional – more than 50% share at

present Likely to lead to better price and volume discovery

Call money rates are normally expected to be within the corridor set by the repo and reverse repo rates

Treasury Bills Are instruments of short-term borrowings of Govt. Are Promissory Notes issued at a discount and redeemed at par

Serves as a bench mark for short-term securities

Maturity - 91, 182 and 364 days (14 day bills discontinued since May 2001)

Issued through auction by RBI (1992)

Maintained in the form of SGL entries

Treasury Bills… Demand for T-Bills inversely related to call rates

Supply adjusted taking into account demand conditions and short-term needs of Govt.

Repo transactions permitted in all T-Bills

All issuance of T-Bills (including under MSS & LAF) run online on PDO-NDS system

Minimum amount – Rs. 25,000 and in multiples of Rs. 25,000

Treasury Bills… 91 day

- Auctions on Wednesdays - Notified amount Rs. 500 crore (Rs. 1500 crore under MSS) - Multiple Price based Auction

182 day - Auctions on Wednesdays preceding non-reporting Fridays - Notified amount Rs. 500 crore (Rs. 1000 crore under MSS)

- Multiple Price based Auction 364 day

- Auctions on alternate Wednesdays - Notified amount Rs. 1000 crore (Rs. 1000 crore under MSS)

- Multiple Price based Auction

Commercial Papers Introduced in 1990 Issued by corporates, PDs and select all-India FIs (within the

umbrella limit) Subject to eligibility criteria Unsecured in the form of a promissory note – subject to stamp

duty Maturity - 7 days (Min.) to 1 year (Max.) Minimum size of issues – Rs. 5 lakh and in multiples of Rs. 5

lakh Investors - Individuals, banks, corporate bodies including

unincorporated bodies, NRIs, FIIs FIMMDA, in consultation with market players, depositories and

RBI, prepares related guidelines

Commercial Papers… Should not be underwritten or co-accepted Credit enhancement can be provided by banks / FIs

while non-banks can provide guarantee support Only Scheduled banks can act as IPAs for issuance

of CP. Responsibility of IPA to report CP transactions on NDS within 2 days and to RBI within 3 days

Data on CP issuance made available on RBI’s website since July 2005

Commercial Papers… Banks, FIs and PDs can make investments /

hold CPs only in demat form (October 2001 onwards)

Eligibility –- TNW of Rs. 4 crore + as per latest ABS- Working capital limit sanctioned by banks / FIs- Borrowal A/c classified as Standard- Rating requirement – Minimum P-2

Certificates of Deposit Introduced in 1989 Are securitised, tradable term deposits issued

in ‘demat’ form or as a UP Note (effective June 2002)

Maturity - Banks - 7 days (Min.) to 1 year (Max.)

Minimum size of issues – Rs. 1 lakh and in multiples of Rs. 1 lakh (from June 2002)

Certificates of Deposit… Can be issued on floating rate basis if the

compilation is objective, transparent and market-based

Issued by Commercial banks (except RRBs) and select FIs SCBs can issue without any ceiling on quantum

or interest rate FIs within umbrella ceiling (100% of NOF)

Certificates of Deposit… FIs can issue for periods not less than 1 year

and not exceeding 3 years Investors – Individuals, Corporates, Trusts,

NRIs (on non-repatriable basis) Provides an avenue for investment at better

rate in the banking sector FIMMDA has issued standardised procedure,

documentation and operational guidelines for issue of CDs (June 2002)

Certificates of Deposit… CDs are high cost liabilities, subject to stamp duty

Some of the top rated banks are getting their CDs rated, though not mandatory

Presently, greater demand because of –- issuance of guidelines on investments by banks in non-SLR debt securities- reduction in stamp duty on CDs w.e.f. March 2004- no TDS

Certificates of Deposit…

ban on premature closure of CDs- no loans or buy back of CDs- greater opportunity for secondary market trading (transferability period withdrawn)

- MFs are turning to CDs market because SEBI has prohibited them from placing funds with banks as deposits

Repos Are Re-purchase Agreements or Ready Forward Contracts

Where the parties agree to sell and buy back the same security at an agreed price at a future date

Is a combination of security trading (purchase / sale) and money market (lending / borrowing) operations

All Government securities are eligible

Repos are governed by SCRA, 1956

All transactions are to be effected in Mumbai through SGL A/c - DVP III system (w.e.f. April 2004)

Repos… Banks & PDs can undertake both Repos and Reverse Repos

Non-bank entities (Insurance Companies, MFs, FIs) with Current A/c and SGL A/c can undertake Repos

All G-Sec. transactions (both outright and repos) are compulsorily settled through CCIL

Advantages Facilitates investment of surplus cash Borrowers can raise funds at better rates Collateralised Convenient for adjusting SLR / CRR positions simultaneously

Inter-bank Repos Since 1999 Banks, Mutual Funds and FIs were main

participants (PDs can also participate) Non-scheduled UCBs and listed companies

with gilt accounts with SCBs allowed to participate – subject to eligibility criteria and safeguards

Electronic trading platform CROMS

LAF Repos Since 2000 Has emerged as the principal operating

instrument of monetary policy to moderate daily liquidity in the banking system

Repo - Injection of liquidity by the Central Bank against eligible collateral

Reverse Repo - Absorption of liquidity by the Central Bank against eligible collateral

LAF Repos… W.e.f. April 2004, RBI conducts only

overnight fixed rate repo and reverse repo at Mumbai

Repo Rate – 6.00%Reverse Repo Rate – 5.00%

Decisions on LAF are aided by a daily liquidity forecasting exercise

Minimum bid – Rs. 5 crores & in multiples of Rs. 5 crore

LAF Repos… All eligible transferable GOI dated Secs / T-Bills Bids submitted electronically through NDS by 10.30

am Introduction of second LAF from November 28,

2005 RBI, subject to variations in liquidity, announces

every Friday the possibility and quantum of MSS issuances (t-bills and dated securities) for the succeeding week

LAF Repos… To restore LAF as a facility for equilibrating very

short-term mismatches To modulate liquidity absorption through reverse

repo auctions

Collateralised Borrowing & Lending Obligation (CBLO) Operationalised as a money market instrument by

CCIL from January 2003 - 155 members

Anonymous, order driven, electronic trading and online matching facilitating price discovery and transparency

Maturity – 1 day (Min.) to 1 year (Max.)

Collateralised

CBLO… CCIL is the Central Counter Party providing

guaranteed settlement Banks, FIs, Insurers, MFs, PDs, NBFCs, PFs,

Corporates, etc., can be members Borrowers are public & private sector banks,

PDs Lenders are mutual funds, insurance

companies, public & private sector banks Low costs compared to Call money

CBLO… Provides CBLO holders an exit option before

maturity RBI effects automated value-free transfer of

securities between market participants and CCIL

Transactions in CBLO are exempted from maintenance of average CRR

Unencumbered CBLO in CSGL with CCIL eligible for SLR

Money Market Mutual Funds Detailed scheme announced in April 1992

Purpose – To provide additional short-term avenue to investors and to bring money market instruments within the reach of individual investors

Regulated by SEBI but RBI clearance is required before being registered by SEBI

Minimum lock-in period – 15 days

Permitted to invest in rated corporate bonds and debentures with residual maturity of upto one year.

Cheque writing facility extended to MMMFs (only for self-withdrawals, no deposit)

Corporate & PSU DebtDebentures

Issued by Financial Institutions / corporates / foreign banks / private sector banks

Bonds Issued by FI’s / PSUs / Nationalised banks

(PSUs are defined where Central Govt. holding is above 51%)

Corporate Debt…. Fixed rate non convertible in nature Secured debentures / bonds with or without put

call options Credit Rating essential Subordinated bonds by banks for Tier II (Upper

& Lower) capital & Perputual Bonds Floating rate bonds linked to INBMK & MIBOR Deep discount, zero coupon, step up coupon Tax free PSU bonds

Corporate Debt Pricing, typically, at a relevant spread over

GOI securities Primarily, wholesale in nature Main market participants for trading &

investment avenue include Banks, PDs, FIs, Insurance Cos., PFs, MFs, etc.

Trading more liquid in shorter tenor papers Trading more liquid in higher rated papers

Corporate Debt The interest payment is as per the

Information Memorandum The principal redemption dates & schedule is

as per the Information Memorandum The day count basis & floating rate

benchmark (in case of a floating rate bond) is as per the Information Memorandum

Corporate Debt Minimum amount of Bonds / Debentures are

as per the Information Memorandum The settlement of Bonds / Debentures is

compulsorily in a demat mode Over The Counter Market NSE - WDM

Trade disclosure system and not trading system, though it has electronic match making ability

Trading System Counterparties known when concluding the

deal

Brokers are the intermediaries, but do not take part in settlement process

Brokers have to also report all the transactions to the unified corporate bond platform of the BSE

Settlement Mechanisms Trades typically done on same day, T+1, T+2 Securities only in demat form Settlement can be through either High Value

cheque or RTGS or normal clearing cheque. RBI cheques cannot be issued for settlement of Bonds / Debentures

Settlement on DVP basis

Corporate Debt - Quoting System Pricing, typically, at a relevant spread over

GOI securities Quotes & deals done on an annualised yield

basis. Price is derived from the agreed yields Primarily, wholesale in nature No transfer stamp duty for secondary market

transfer Day count convention is typically A/365

Market Participants Commercial Banks Primary Dealers Provident Funds Mutual Funds Insurance Companies FI FII’s

CRR / SLR Maintenance & Reporting

Maintenance of CRR u/s 42(2) of RBI Act 1934

Maintenance of SLR u/s 24 of BR Act 1949 Maintenance of CRR/SLR on NDTL of

Second Preceding Fortnight Reporting of CRR as per Form A return on

fortnight basis Reporting of SLR as per Form VIII Return on

fortnightly basis

Foreign Exchange Markets Forex business: International Trade Finance

Export / Import payment settlements Export / Import finance

Capital Movements Profit seeking capital Portfolio diversification

Travel and Tour and others Foreign travelling Education Health, etc

Forex business Foreign Exchange Market

Buying / selling foreign exchange Hedging exposures through derivatives Speculation trading

Exchange Rate Risk Fast changing exchange rates Unpredictable Source of “Exchange Rate Risk”

24 hour Market Global Market 5 days in a week Day opens at Tokyo and Sydney Day closes at Los Angeles trading Before closing at Los Angeles, Sydney opens

up for the next day

Forex setup at Banks Forex Centers (Category B Branches)

All those branches who handle export-import business (customer-related)

Merchant Market Dealing Room

Positions covering Interbank market

Forex Market Interbank Forex Market Merchant Market

Interbank Market Market Maker Market Taker

Operations Cover operations trading

Inter-bank Forex Market Interbank market is only among ADs Opens at 9.00 am and closes by 5.00 pm It is a wholesale market with a certain

minimum lot size Banks and licensed financial institutions

participate in the interbank market.

Merchant Forex Market Market where Merchants (exporters,

importers and others) sell and buy Forex from ADs

It is also a retail market no lot size restrictions Rates in merchant market will be with a profit

margin over interbank rates

International conventions International forex markets the currency are

represented by three letter notations followed by “SWIFT”

Quoting pairs most often use USD as base currency

Exceptions: GBP, EUR, NZD, AUD

Direct and Indirect Direct: number of home currency units per

one unit of foreign currency Ex: 46.50 number of rupees per one USD

Indirect: number of foreign currency units per one unit of home currency

Ex: 0.0215 number of USD per one INR (inverse of direct quote)

Bid and Ask

1.3725 / 35

market maker is willing to buy market maker is willing to sell

market take can buymarket take can sell

Settlement Spot Market is the predominant market

Spot – contract today and settlement on the second working day

‘ready transaction’ or ‘cash transaction – settlement is on the very day (Cash today)

Value tomorrow