0701014 domestic treasury operations and risks involved
A PROJECT REPORT
“DOMESTIC TREASURY OPERATIONS AND RISKS INVOLVED”
BANK OF MAHARASHTRA
SHARMILA A. CHOUDHARY
UNDER THE GUIDANCE OF
Dr .SHARAD JOSHI
UNIVERSITY OF PUNE
In partial fulfillment of the requirement for the award of the degree of
Master of Business Administration (MBA)
Vishwakarma Institute of Management
PUNE – 48
It’s a great privilege that I have done my project in such a well-organized and
diversified organization. I am great full to all those who helped and supported me in
completing the project.
I express my gratitude to Mr. SANJAY ARYA (D.G.M.), who gave me this
opportunity to undergo summer training at Bank of Maharashtra. He has been a great
mentor and supplemented my study with requisite sources and inputs. He has been a
constant source of knowledge, information, help and motivation for me. The project
has been a great experience and I am indebt to Ms. INDRAYANI DEEKSHIT
(A.G.M) and Mr. ABHAY SHAHAPURKAR (CHIEF MANAGER) for their time
and efforts. I am also thankful to all the officials who helped me during the training.
I am thankful to our director and my project guide Dr. SHARAD JOSHI for helping
me in completing the project.
Last but not least, I am also thankful to all college staff and my friends for helping me
directly or indirectly in my project.
Efficient funds management, sail an organization or an
economy for that matter, through even the toughest times.
It is regarded as one of the most crucial functions.
Banking industry is a backbone of economy in every
country. It is banks, through which government can steer
the monetary stability and long-term sustainability within
the geographical boundaries. Banks deal purely in money.
The industry holds the cash for the investors and lends it
in turn. Thus, cash (or funds) management becomes vital
function at the banks.
Apart from meeting various statutory reserve
requirements, a treasury department explores various other
investment options both in the domestic and international
Risk can be defined as “Possibility of suffering losses”.
“The chance of something happening that will have an
impact upon objectives. It is measured in terms of
consequences and likelihood”.
PROFILE OF THE ORGANIZTAION
Profile of Bank of Maharashtra
Registered on 16th Sept 1935 with an authorized capital of
Rs 10.00 lakh and commenced business on 8th Feb 1936.
Known as a common man's bank since inception, its initial
help to small units has given birth to many of today's
industrial houses. After nationalization in 1969, the bank
expanded rapidly. It now has 1375 branches (as of 31st
March 2008) all over India. The Bank has the largest
network of branches by any Public sector bank in the state
The bank has fine tuned its services to cater to the needs
of the common man and incorporated the latest
technology in banking offering a variety of services.
Technology with personal touch.
The 3 M's
• Mobilization of Money
• Modernization of Methods and
• Motivation of Staff.
Bank wishes to cater to all types of needs of the entire
family, in the whole country. Its dream is "One Family,
One Bank, Bank of Maharashtra ".
The Bank attained autonomous status in 1998. It helps in
giving more and more services with simplified procedures
without intervention of Government.
Our Social Aspect
The bank excels in Social Banking, overlooking the profit
aspect; it has a good share of Priority sector lending
having 38% of its branches in rural areas.
Bank is the convener of State level Bankers committee.
Bank offers Depository services and Demat facilities at
Bank has a tie up with LIC of India and United India
Insurance Company for sale of Insurance policies. All the
branches of the Bank are fully computerized.
Bank of Maharashtra – Important Landmarks
1935 - Registered on 16th
1958 – Bank’s shares listed on Bombay Stock Exchange.
1960 – License to deal in all foreign currencies.
1969 – Nationalised on 19th
1975 – Tax consultancy cell launched.
2002 – Record profit rose by 222% amounting to
Following chart depicts the review of performance in the
past 3 financial years.
Parameter Mar-06 Mar-07 Mar-08
(Rupees in Crores)
Total Deposits 26906.2 33919.3 41758.3
Aggregate Deposits 26527.4 33663.2 41580.4
Gross Advances 17079.8 23462.3 29798
Net Bank Credit 16872 23220.9 23462.3
CD ratio 64.39 69.7 71.66
% of Priority Sector Adv. to Net Bank
Credit 42.71% 41.24 48.63
% of Agricultural Adv. To Net Bank
Credit 16.3 16.73 21.04
Total Investments 11354.3 11298.4 12283
Gross NPAs 944.08 820.28 766.27
% to Gross Advances 5.53 3.5 2.57
Net NPAs 334.06 277.38 254.05
% to Net Advances 2.03 21.21 0.87
Operating Profit 364.07 613.2 672.63
Net Profit 50.79 271.84 328.39
Other Income 177.24 265.05 280.17
Capital Adequacy Ratio 11.27 12.06 10.75
Per Employee Business ( in lacs ) 306.18 413.03 526.54
No. of Branches 1300 1345 1375
Of which Metro 248 264 351
OBJECTIVES OF THE PROJECT
Introduction of Treasury Department.
To comprehend Various Functions of a Treasury
To study the operations of Treasury Department.
To examine the scope of the Dealing (Various
Domestic Treasury Instruments).
To identify the Potential Risks Involved At
Various Stages of Operations.
To manage and reduce the identified risks.
The report is prepared with better understanding of the
Bank’s Treasury- DOMESTIC segment and its settlement
process. This was possible as I received training from
trained and specialized dealers in the dealing room as well
as the officers in the Back Office and Mid office.
When I decided the topic for the project there were many
questions that came to my mind, which are as follows:
What is treasury?
What are the functions of treasury?
Why does treasury play such an important role?
What are the various risk involved and how can they be
Based on the questions I made the rough framework of the
project and decided to approach the officers of the bank.
I have also read the Investment policy, Treasury manual,
circulars, documents and visited various websites to
enhance my knowledge. I have included what I have seen
and learnt during my training period in my project.
Report will focus on the Domestic Treasury products and
also on the Risks Involved at Various Stages of
TREASURY OPERATIONS -
Idle funds are usually source of loss, real or opportune,
and, thereby need to be managed, invested, and deployed
with intent to improve profitability. There is no profit or
reward without attendant risk. Thus treasury operations
seek to maximize profit and earning by investing available
funds at an acceptable level of risks.
Money is one of the essential driving forces of any
business. In order to employ and deploy these monetary
resources effectively and efficiently, not only banks but
also the corporate entities have realized the need for a
specialized department to look after these operations.
That’s how the treasury department has gained the
importance in recent times.
In the further parts of this project, we will have an
inclusive look at the treasury operations in a bank.
Treasury forms a vital part of any commercial bank’s
activities. It is the window through which the Bank raises
funds from or places funds in either financial or interbank
markets. The treasury unit acts as the custodian of cash
and other liquid assets. Apart from employment and
deployment of funds, the department also has to take care
of the liquidity i.e. managing the availability of the
monetary resources whenever they are required. The art of
managing, within the acceptable level of risk, the
consolidated fund of the bank optimally and profitably is
called treasury management.
Traditionally, in banks in India, the role of Treasury was
limited to ensuring the maintenance of the RBI –
stipulated norms for Cash Reserve Ratio (CRR) – which
mandates that a minimum proportion of defined liabilities
must be kept on deposit with the central bank – and the
Statutory Liquidity Ratio (SLR), which obliges banks to
invest a specified percentage of their liabilities in notified
securities issued by the Government of India and State
Governments or guaranteed by them.
RBI- The central bank of India, uses the instruments like
CRR and SLR along with some others viz. repos (and
reverse repos), open market options, etc. to manage the
liquidity in the economy.
Activity in foreign exchange was confined to meeting
merchants’ requirements for imports and exports and
customers’ deposits. The rupee’s exchange rate has
become volatile. There is sufficient fluctuation both
intraday and interday to earn trading profits on buying and
selling the currency. The forward market in India is
another potential source of profits as, more or often than
not, it deviates from interest parity conditions (which state
that forwards will differ from spot rates exactly to the
extent of the interest differential). Cross–currency
(dollar/yen, sterling/dollar, dollar/Swiss franc) trading
opportunities are, of course, older and have come to life in
Indian banks after liberalization.
Traditionally the banks used to accept the deposits and
lend the money keeping the margin (interest rates) in
between. After meeting the mandatory deposit
requirements (SLR & CRR), the surplus money demands
an efficient and effective employment. Thus, banks lately
have started exploring various options like investment in
the capital, bond markets, foreign exchange, etc. in order
to get the returns on it.
An active Treasury also ‘arbitrages’ (earns profits without
risk) by borrowing cheap and investing high in money and
bond markets. New products, such as derivatives, enable
spotting and capitalizing on such opportunities. Another
key function of Treasury is asset-liability management and
hedging (i.e., insulating) the Bank’s balance sheet from
interest and exchange rate fluctuations. This involves
reordering the maturity and interest rate pattern of assets
and liabilities, either through direct portfolio actions or
derivatives (e.g., swaps and futures) to reduce, minimize
or eliminate the risks arising from mismatches between
the two sides of the balance .
ROLE OF TREASURY
OPERATIONS OF TREASURY:
Reserve Management & Investment:
Meeting CRR/ SLR obligations
Having an appropriate mix of investment portfolio
to optimize yield and duration.
Duration is the weighted average 'life' of a debt
instrument over which investment in that
instrument is recouped. Duration analysis is used
as a tool to monitor the price sensitivity of an
investment instrument to interest rate changes.
Liquidity & Funds Management:
Analysis of major cash flows arising out of asset-
Providing a balanced and well-diversified liability
base to fund the various assets in the balance sheet
of the bank
Providing policy inputs to strategic planning group
of the bank on funding mix (currency, tenor &
cost) and yield expected in credit and investment.
Asset Liability Management & Term
ALM calls for determining the optimal size and
growth rate of the balance sheet and also prices the
Assets and Liabilities in accordance with the
prescribed guidelines. Successive reduction in
CRR rates and ALM practices by banks increase
the demand for funds for tenor of above 15 days
(Term Money) to match duration of their assets.
Treasury manages all market risks associated with
a bank's liabilities and assets. The market risk of
liabilities pertains to floating interest rate risk and
assets & liability mismatches. The market risk for
assets can arise from (i) unfavorable change in
interest rates (ii) increasing levels of
disintermediation (iii) securitization of assets (iv)
emergence of credit derivatives etc. While the credit
risk assessment continues to rest with Credit
Department, the Treasury would monitor the cash
inflow impact from changes in asset prices due to
interest rate changes by adhering to prudential
Treasury is to ensure that the funds of the bank are
deployed optimally, without sacrificing yield or
liquidity. Treasury unit has an idea of the bank's
overall funding needs as well as direct access to
various markets (like money market, capital
market, forex market, credit market). Hence,
ideally treasury should provide benchmark rates,
after assuming market risk, to various business
groups and product categories about the correct
business strategy to adopt.
Treasury can develop interest rate swaps and other
rupee based/ cross-currency derivative products for
hedging bank's own exposures and also sell such
products to customers/ other banks.
This function focuses on quality of assets, with
Return on Assets (RoA) being a key criterion for
measuring the efficiency of deployed funds.
SOURCES OF PROFITS OF
Investments: where the Bank earns a higher yield than its
cost of funds. An example is buying a corporate bond
maturing in three years and yielding 7%, financed by
deposits of the same maturity costing 6%.
The investments made by the treasury department can be
categorized as follows:
Spreads: Spreads between yields on money market
assets and money market funding. The Bank may, for
instance, borrow short-term for 5% and deploy in
commercial paper returning 6%.
Arbitrage: A classic example is a buy/sell swap in
the forex market, where the Bank converts its rupee
funds to a dollar deposit, earns LIBOR and gets back
to rupee on deposit maturity. This generates a risk –
free profit (“arbitrage”), if LIBOR plus the forward
Held Till Maturity Held For Trade Available For Sale
premium on dollar/rupee is more than the domestic
Relative Value: This is a form of arbitrage in which
the Bank exploits anomalies in market prices. The
Bank may have an ‘AAA’ bond, which yields only
6%, compared to another with the same rating and
maturity, but of a different issuer, which offers 6.5%.
It is worth selling the first bond and investing in the
second to improve the yield by 0.5% without any
incremental risk, as both bonds have the same credit
Proprietary Trading: The focus of proprietary
trading is entirely short-term, as opposed to
investment. The aim is to earn trading profits from
interday (or even intraday) movements in security and
forex prices. They are mostly directional trades.
Treasury may buy (say) 9.81% Government of India
security 2013 at Rs.129.50 at a yield of 5.89% in
anticipation of the yield falling to 5.80%, on
fundamental (or technical) grounds. If this happens,
the bond appreciates and the Bank exits the position
with a profit.
Forex trading: is also directional, involving, for
example, buying dollar/yen in the expectation that the
dollar will appreciate or selling euro/dollar hoping that
the euro will decline.
Customer Services: Bank Treasuries offer their
products and services to (generally) non-bank
customers. The income to banks in these activities
comprises fees for and / or margins on trade execution.
Profits would be higher on structured (i.e., non-
standard) transactions compared to plain vanilla (e.g.,
a straightforward buy/sell USD/INR) deals.
Treasuries are also involved in Investment Banking
where their responsibility covers trade execution on behalf
of the Bank’s clients in the cash or derivatives markets.
These may generate good margins, depending on the
complexity and skills required to design and put through
customized structures in the market.
Integrated Treasury Operations
Broadly, Treasury department deals into to verticals viz.
domestic and forex (i.e. Foreign Exchange). Traditionally,
the forex dealing room of a bank managed the foreign
exchange dealings mainly arising out of merchant
transactions (FX buying from & selling to customers) and
consequent cover operations in inter-bank market. The
domestic treasury/ investment operations were
independent of forex dealings of a bank. Treasury
operations were treated as cost centre, specifically devoted
to reserve management (CRR & SLR) and consequent
fund management. Treasury also undertook investment in
both government and non-government securities.
The need for integration of forex dealings and domestic
treasury operations has arisen in the backdrop of interest
rate deregulations, liberalization of Exchange Control,
development of forex market, introduction of derivative
products and technological advancement in settlement
systems and dealing environment. The integrated treasury
performs not only the traditional roles of forex dealing
room and treasury unit but also many other functions as
described above. Apart from that, an integrated treasury is
a major profit centre. It has its own P&L measurement.
TREASURY DEPARTMENT SET-UP AT
BANK OF MAHARASHTRA
The Treasury Division has a clear cut demarcation
between Front office, Mid office and Back Office
The Front Office shall undertake actual Treasury
operations while the Back Office shall undertake all
accounting and related operations in terms of the
guidelines issued in the Investment Management Policy.
The Mid Office shall track the magnitude of market risk
on a real time basis and shall not be involved in the day to
day management of Treasury. The Mid Office shall report
to ALCO/Treasury about adherence to various prudential
and risk parameters and provide an aggregate of the total
market risk exposures assumed by the Bank.
The dealing rooms either of domestic treasury fall under
front office. Dealers in the dealing room are responsible to
undertake and execute the investment decisions. There are
proper guidelines and the norms laid down to govern the
dealings in both domestic treasury.
Domestic dealing room has to take the decisions regarding
right mix of the instruments available for investment in
domestic market. Banks put more emphasis on the ‘fixed
interest bearing securities’. Some of these securities are
classified as ‘SLR Securities’ whereas, some are classified
as ‘NON-SLR Securities’. Possession of SLR Securities
would contribute towards the statutory SLR maintenance.
There are also some other factors that are being taken into
consideration even while investing into the Fixed Interest
Securities. The rate of the interest, duration of maturity,
current market scenario, credit rating of the instrument,
etc. needs to be looked into.
Before concluding any deal the Dealer has to ensure the
He holds the sanction from the competent
The security to be purchased/ sold should not be
under shut period
There is sufficient stock of the security/securities to be
sold and ensure that the existing balance at the time of
deal is mentioned in the deal slip. The dealer will ensure
that at no point of time there will be oversold position in
any security. However, in terms of RBI, Banks successful
in the auction of Govt. Securities, may enter into contracts
for sale of the allotted securities, on the day of auction, in
accordance with the following terms and conditions:
The contract for sale can be entered into only once
by the allot-tee bank on the basis of an
authenticated allotment advice issued by RBI. The
selling bank should make suitable noting /
stamping on the allotment advice indicating the
sale contract number etc., the details of which
should be intimated to the buying entity. The
buying entity should not enter into a contract to
further resell the securities until it actually holds
the securities in its investment account.
The contract for sale of allotted securities can be
entered into by banks with and between entities
maintaining SGL Account / CSGL Account with
RBI for delivery and settlement on the next
working day through the Delivery versus Payment
The face value of securities sold should not exceed
the face value of securities indicated in the
The sale deal should be entered into directly
without the involvement of brokers.
Separate record of such sale deals should be
maintained containing details such as number and
date of allotment advice, description and the face
value of securities allotted, the purchase
consideration, the number, date of delivery and
face value of securities sold, sale consideration, the
date and details of actual delivery i.e. SGL Form
No., etc. This record should be made available to
RBI for verification. Bank should immediately
report any cases of failure to maintain such
Such type of sale transactions of Govt. securities
allotted in the auctions for primary issues on the
same day and based on authenticated allotment
advice should be subjected to concurrent audit and
the relative audit report should be placed before
the Investment Committee / Chairman &
Managing Director once every month. A copy
thereof should also be sent to DBOD (Department
of Banking Operations and Development), RBI
Banks will be solely responsible for any failure of
the contracts due to the securities not being credit
to their SGL A/c on account of non-payment /
bouncing of cheque etc.
RBI has now permitted sale of a government
security already contracted for purchase, provided:
The purchase contract is confirmed prior to
The purchase contract is guaranteed by CCIL
or the security is contracted for purchase from
the Reserve Bank
RBI has advised to adopt a standardized settlement
on T+1 basis of all outright secondary market transactions
in Government Securities effective May 24, 2005.
Standardizing the settlement period to T+1 would provide
participants more processing time for transactions and
hence will help better funds management as well as risk
management. In the case of Repo transactions in
Government Securities, however, market participants will
have the choice of settling the first leg on either ‘T+0’
basis or ‘T+1’ basis, as per their requirements.
So far as purchase of securities from the Reserve Bank
through Open Market Operations (OMO) is concerned, no
sale transactions should be contracted prior to receiving
the confirmation of the deal/advice of allotment from the
Ready forward (Repo) transactions in government
securities, which are settled under the guaranteed
settlement mechanism of CCIL, may be rolled over,
provided the security prices and Repo interest rate are
renegotiated on roll over.
All the deals should be concluded by the dealer on
receipt of relative sanction (sanction may be on
telephone or oral to be confirmed in writing
subsequently) based on delegated authority. In any
deal or transactions, the dealer may negotiate the
terms of sanction with the counter party/broker for
better advantage to the bank and the same may be
subsequently reported to the respective sanctioning
authority for information.
The deals should as far as possible be done
through approved brokers on our panel subject to
5% limit per broker on the basis of yearly
business through brokers(both purchase and sales)
as per R.B.I guidelines. Where the limit of 5% is
required to be exceeded because of a more
advantageous offer, the matter should be reported
to Board for ratification. The existing panel is to
be used for capital market purposes also.
The brokerage is to be paid as per Stock
Exchange/s guidelines. The brokerage on the deal
payable to the broker, if any, (if the deal was put
through with the help of a broker) should be
clearly indicated on the notes/ memoranda put up
to the top management seeking approval for
putting through the transaction and a separate
account of brokerage paid, broker-wise, should be
The deal should be settled through BSE/NSE,
OTCEI or any other recognized stock Exchange as
For any transaction/deals done by trading desk, the
respective dealer should prepare a deal slip
containing all the relevant information. The deal
slip should contain nature of deal, name of counter
party, direct deal or through broker, name of
broker, details of security, amount, price, YTM,
contract date, time, terms of payment, name of the
Stock Exchange, etc. Every deal slip should be
serially numbered and controlled separately to
ensure that each deal slip has been properly
Once the deal is concluded, the broker and the
counter party bank should not be substituted. Like
wise the security sold/purchased in the deal should
not be substituted by another security. The dealer
should immediately pass on the deal slip to the
Back Office for processing.
ROLE OF CLEARING CORPORATION OF
INDIA Ltd (CCIL)
The Clearing Corporation of India Ltd. (CCIL) was set
up in April, 2001 for providing exclusive clearing and
settlement for transactions in Money, Govt. Securities and
Foreign Exchange. The prime objective has been to
improve efficiency in the transaction settlement process,
insulate the financial system from shocks emanating from
operations related issues, and to undertake other related
activities that would help to broaden and deepen the
money, debt and forex markets in the country. The
company commenced operations on February 15, 2002
when the Negotiated Dealing System (NDS) of RBI went
live. CCIL started providing the settlement of forex
transactions since November 2002. CCIL launched the
Collateralized Borrowing and Lending Obligation
(CBLO) in January 2003, a money market product based
on Gilts as collaterals. It has developed a forex trading
platform “FX-CLEAR” which went live on August 7,
2003. CCIL has started the settlement of cross-currency
deals through the CLS Bank from April 6, 2005. At the
request of RBI, CCIL developed and currently manages
the NDS-OM and NDS-CALL electronic trading
platforms for trading in the government securities and call
Excerpts from Investment Policy regarding NON-SLR
“In addition to the prudential limits prescribed by the RBI,
the bank will observe following limits/ Sub limits, caps in
respect of Non SLR Investment-
1. The investment in Non-SLR category shall be to
the extent of 25% of the Gross Investments
(excluding Recapitalization Bonds).
2. The investment in Bonds/Debentures under Non
SLR category shall be to the extent of 15% of the
Gross Investments. (Excluding Recapitalization
3. The investment in Private Corporate Bonds shall
not exceed 40% of the investment in
4. Total holding in AA-Rated Bonds/Debentures
should not exceed 5% of Total Non-SLR.
5. The bank will continue to invest in rated privately
placed issues of Bonds/ Debentures under Non
6. The investment in Bonds guaranteed by central/
state governments issued under Non SLR category
(unsecured) shall not exceed 1/3 of the total
investments in Bonds.
7. The investment under Non SLR category in any
industry will not exceed 3% of gross Investments.
This cap is not applicable to the exposure under
As per RBI guidelines the aggregate exposure of a bank to
the capital markets in all forms (both fund based and non-
fund based) should not exceed 40 per cent of its net worth
as on March 31 of the previous year.
Within this overall ceiling, the bank’s direct investment in
shares, convertible bonds/ debentures, units of equity-
oriented mutual funds and all exposures to Venture
Capital Funds (both registered and unregistered) should
not exceed 20 per cent of its net worth.
Recently the RBI has increased the CRR rates by 75 basis
points in a gradual progression, it has also increased the
REPO rate (the rate at which banks borrows money from
RBI and vice versa for REVERSE-REPO). This led to the
interest rate hike in loans by the leading lending banks
like HDFC. Though it seems that the implications end
there but it has so many micro and macro indirect
implications. If HDFC has increased the lending rate for
housing loans, it will also lead to fall in the revenues of
the most interest rate sensitive industry – Real Estate. So,
if someone wants to invest in DLF (Real Estate), he needs
to consider all the direct and indirect factors concerning
the industry as whole and the company itself.
Real Time Gross Settlement (RTGS) is an online system
for settling transactions of financial institutions, especially
banks. RTGS is a large value funds transfer system
whereby financial intermediaries can settle inter-bank
transfers for their own account as well as for their
customers. The system effects final settlement of inter-
bank funds transfers on a continuous, transaction- by-
transaction basis throughout the processing day.
The statistics of transactions for the month of March 2004
shows that in the inter-bank market transactions involving
45000 instruments and aggregating Rs. 179,000 crore
were settled. High value instruments (317,000) settlement
aggregated Rs. 274,000 crore. However, settlement of
MICR instruments (145 lakhs) accounted for only Rs.
54,000 crore. RTGS will eliminate settlement risk in the
case of inter-bank and high value transactions.
The deals are undertaken into the dealing rooms.
The notion of "trading room" (sometimes used as a
synonym of "trading floor") is widely used in financial
markets to refer to the office space where market activities
are concentrated in investment banks or brokerage houses.
Financial trading rooms often consists of open-space large
offices where financial workers (often referred to as
"traders") monitor the markets, develop financial
products, or engage into trading activities with other
counterparties (through the telephone or through
electronic interfaces). Contemporary trading rooms are
highly technological spaces. The different trading or sales
desks are equipped with financial data technologies such
as the ones provided by companies such as Bloomberg or
The Mid-Office in TIBD, Bank of Maharashtra
performs under the Risk Management department which is
responsible for identifying and managing the risks
centrally. This department takes into account the whole of
the banks’ operations. The duty of the mid office is to
look after the compliance and control matters. It reports to
the Risk Management department and not the DGM at
TIBD. This reporting matrix ensures the non prevalence of
the collective malpractices. As mentioned earlier, each
dealer is assigned a particular limit within which he’s
allowed to trade. It’s the duty of the mid office executive
to look after whether the dealer is acting in the permissible
limits or not. He also sees to it that the settlement is being
made through proper channels and as per the set norms by
both RBI and Banks policies. He also ensures that the
accounting and record keeping is being done properly and
is reviewed periodically. The dealings usually happen
over the phone. So, to keep the track of these dealings, the
calls are recorded for compliance purposes. If any issue
arises regarding the deal, both the parties to the deal can
go back to these tapes and verify the matter. Mid office
has to make sure that these tapes are preserved for the
minimum period prescribed by norms.
If an executive of mid office happens to come
across any deviation from the set doctrines, he escalates
the matter to the Risk Management department.
Subsequent actions are taken into the matter by the
department. Mid office also does the calculation of the
permissible limits of the risks. On a daily basis it reports
the risk involved in any instrument.
E.g. Value-at risk is calculated in order
to determine what would be the permissible limit of
risk that can be allowed, if the decision is to be made
for the investment in a particular instrument.
DOMESTIC TREASURY PRODUCTS
The Domestic operations of Treasury can be broadly
classified in to three categories as mentioned below:
Money Market Operations
Debt Market Operations
Capital Market Operation
MONEY MARKET OPERATIONS
The Money market provides an avenue for equilibrating
the short-term lending and borrowing needs of participants
for periods ranging from O/N up to a year. In this process,
it provides a focal point for the RBI to influence the
liquidity in the system and thereby transmit the monetary
policy impulses. The instruments traded in the money
markets are close substitutes for money and are less risky,
marketable and liquid. Money Market operations facilitate
effective management of short-term asset-liability miss-
matches for the bank. It enables the bank to reduce the
cost of liquidity by deploying their short-term surpluses
and thereby maintaining the liquidity position at an
The most commonly traded money market instruments
are as under:
Call/Notice Money: Call/ Notice Money is a liquidity
management tool whereby commercial banks, cooperative
banks, primary dealers lend and borrow between
themselves. Non-bank institutions are not permitted in the
call/notice money market. The call/notice money market
forms an important segment of the Indian Money Market.
Under call money market, funds are transacted on
overnight basis and under notice money market funds are
transacted for the period between 2 days and 14 days. The
need arises mostly for covering short-term liquidity
mismatches as well as for covering shortfall in
maintenance of Cash Reserve Ratio (CRR).
Specific Risk Factors
• Operational Risk
Empowered authorizations of deals before
settlement activities commence. Complete,
updated records of counterparty
signatures/powers of attorney of counterparties
should be maintained.
• Financial Risk
Credit risk relating to counterparties exists.
Collateralized Borrowing and Lending Obligation
(CBLO): CBLO is a money market instrument
operationalised by Clearing Corporation of India in
January 2003. It is a discounted instrument with
maturity ranging from 1day up to 1year, backed by
collaterals, and redeemable at par. CBLOs are traded
electronically, on-line, on an anonymous order
matching system facilitating price discovery and
transparency. Banks, financial institutions, primary
dealers, mutual funds, NBFCs and corporate can be
What is CBLO?
CBLO is explained as under:
• An obligation by the borrower to return the money
borrowed, at a specified future date;
• An authority to the lender to receive money lent, at a
specified future date with an option/privilege to transfer
the authority to another person for value received;
• An underlying charge on securities held in custody
(with CCIL) for the amount borrowed/lent.
Treasury Bills: These are the instruments of short-term
borrowings of Government issued in the form of
promissory notes at a discount and redeemable at par.
Treasury Bills are liquid and the same are issued by
RBI on behalf of the Government. RBI presently
issues Treasury Bills in three maturities, i.e., 91 days,
182 days and 364 days. Treasury Bills have a Primary
as well as a Secondary market.
Specific Risk Factors
• Documentation Risk
Authencity of document and counterparty
signatures / powers of attorney.
• Credit Risk
In case of default on a rediscounted bill, the
discounting bank has (ownership) rights to
the underlying bill.
• Interest Rate Risk
Price is sensitive to short-term interest rates.
Commercial Paper: Commercial Paper (CP) is a short
term unsecured money market instrument issued at a
discount in the form of a promissory note. CP’s are issued
by reputed companies that carry high credit rating, have a
strong financial background and facilitate borrowing
short-term resources from the market. RBI has made it
mandatory to issue CPs in electronic/ dematerialized form
with effect from 30 June 2001. Corporate, Primary
Dealers, Satellite Dealers and All-India Financial
Institutions that are permitted to raise short-term resources
under the umbrella limit fixed by RBI are eligible to
issue CP and are called the “Issuers”. CP's can be of any
maturity between 15 days to 364 days. CP can be issued in
denominations of Rs.5 lakh or multiples thereof. Amount
invested by single investor should not be less than Rs.5
lakh (face value).
Specific Risk Factor
• Liquidity Risk
Arises if there is no buyer of the paper before
maturity. May happen if there is a sudden significant
credit downgrade or money market becomes tight.
• Interest Rate Risk
If money market rates shoot up, existing CP will
suffer price losses as these are short-term instruments
whose prices are determined by the short-end (up to
one year) portion of the yield curve.
Certificate of Deposit: CDs are securitized, tradable
term deposits issued in demat form or as a Usance
promissory (UP) note. Banks can issue CDs with a
minimum maturity of 7days to 1yr, whereas FIs can issue
for periods not less than 1year and not exceeding 3 years.
CDs are issued in denominations size of Rs.1lakh or
multiples thereof. This instrument provides an avenue for
investments at better rate of interest. Moreover, the CD
market is very liquid and provides ample opportunities for
trading. CDs can be issued to individuals, corporations,
companies, trusts, funds, associations.
Specific Risk Factors
• Credit Risk
CD issues are sometimes rated by credit rating
agencies. Otherwise, one has to go on image,
reputation and financials of issuing bank or FI.
• Liquidity Risk
Liquidity suffers on credit/market downgrade of the
• Interest Rate Risk
CD prices are sensitive to movements in short-term
interest rates (up to 1 year).
Repos/Reverse repos: Repos are re-purchase
agreements or ready forward contracts, whereby the
counter parties agree to sell and buy back the same
security at an agreed price at a future date. It is a
combination of security trading (purchase/sale) and
money market (borrowing/lending) operations.
Repo transaction is a collateralized borrowing by
pledging approved securities and the borrower is
under obligation to buy back the securities at a
specified date. Repo transaction is a secured form
of lending, the underlying securities being the
collateral. Under a Repo transaction there are 2
counter parties, a lender and a borrower. The
Borrower in a Repo borrows cash and pledges
(sells) securities. The Lender lends cash and
purchases the securities and is said to enter into a
Reverse Repo transaction, hence borrowing by
pledging securities is a Repo transaction and
lending by accepting the pledge is a Reverse Repo
transaction. Securities received under Reverse repo
cannot be sold during the tenure of Reverse Repo.
Securities sold under Repo should be recon trolled
at the same holding rate.
Repo and Reverse Repo transactions are
undertaken to manage liquidity and/or for SLR
maintenance. The borrower in the transaction is
short of cash and has excess of SLR and hence
lends securities and borrows cash. The lender in a
Repo transaction has excess of cash and/or is short
in SLR and hence lends cash and borrows security.
Liquidity Adjustment Facility (LAF): Liquidity
Adjustment Facility has emerged as one of the important
tool of liquidity management for RBI.
Presently Reserve Bank of India conducts Overnight
Reverse Repo auctions @6.00% (for absorption of
liquidity) and Overnight Repo auctions @8.50% (for
injection of liquidity) on a daily basis from Monday to
Friday once a day. All Scheduled Commercial Banks and
PDs having Current and SGL Account with RBI are
eligible to participate in the auction. Reverse Repos/Repos
will be undertaken in all SLR-eligible GOI dated
Securities/Treasury Bills and SDLs. A margin will be
uniformly applied in respect of the above eligible
securities i.e.5% for GOI/TB and 10% for SDLs. RBI has
the right to accept or reject the bids under LAF either
wholly or partially. Securities received under Reverse
Repo will count for SLR purpose and vice versa.
DEBT MARKET OPERATIONS
The Debt market operations include the banks
participation in debt issued by the Central Government,
State government, PSUs, and corporate, primarily with a
view to enhance the interest income for the bank and also
to trap trading gains. The debt market can be broadly
divided into the SLR and Non SLR market.
SLR: In terms of Section 24 of Banking Regulation Act,
1949 (10 of 1949) every scheduled commercial bank is
required to maintain SLR @ 25 per cent of the total net
demand and time liabilities in India as on the last Friday
of the second preceding fortnight, in the form of:
(b) Gold valued at a price not exceeding the current
market price, or
(c) Unencumbered investment in the following
instruments which will be referred to as 'statutory
liquidity ratio (SLR) securities’:
Central Government securities (G-Sec)
State Development Loans (SDL)
Treasury Bills (TB)
Shares of Central Government Corporations.
Shares of State Government Corporations.
Government of India Securities (also called G-Secs, Gilts,
Treasury bonds, Guvvies)
Government of India securities are sovereign obligations
of the Union of India. They are defined by:
The price at which the bond is redeemed (i.e., repaid to
the holder/investor). Invariably the same as the face value
Coupon is the interest payable semi-annually on the
face value of the security.
The date on which the bond repays to its holders.
TYPES OF G-Secs
G-Secs are generally fixed rate (coupon) bonds.
The RBI has issued floating rate bonds (FRBs), in which
the coupon is reset every six months or annually. An issue
in May 2003 had the following terms:
Issued at par of Rs.100 face value.
Tenor: 11 years (issue date: May 20 2003, redemption
at par on May 20 2014).
Interest will be paid half-yearly.
Coupon will comprise a variable base rate plus spread.
Put and Call Options
These are bonds, which can be redeemed before maturity
at the option of the investor (put) or issuer (call).
A straight bond with put and call options was issued
enabling Government to redeem the issue at par after five
years and at intervals of six months thereafter. In effect,
the bond has an initial certain life of only five years (even
though it is issued for ten years). If it is not called after
five years, it will survive for six month – periods, with the
call exercise still with the Government at six-month
The same privileges have been given to bondholders.
They can demand premature redemption of the issue (a
put option) after five years or exercisable at six-monthly
intervals thereafter, if the first put after five years is not
State Government Securities
Bonds issued by States of the Indian Union. Also called
State Development Loans (SDLs) to denote their original
purpose of raising funds for the economic development of
States. Thus, 7.8% Karnataka SDL 2012 refers to a
Karnataka State Government security maturing in 2012
and carrying a coupon of 7.8%.
Mostly, issues of State Government securities are of the
fixed interest rate (coupon) type.
Through the RBI. Generally offered on tap at a fixed price
(usually face value).
However, the RBI has, of late, been conducting auctions
of State Loans; especially those perceived as economically
sounder by the market and propose to allow them to
borrow directly from the market. In the case of weaker
States, the RBI uses moral suasion to ensure that their
issues are fully invested. It has also been proposed that the
Government of India borrow on behalf of such States and
lend to them.
New issues are regulated and scheduled by the RBI. The
amount to be raised annually and their tranches are
determined for each State by the Finance Ministry and
Planning Commission, Government of India in
consultation with the RBI, which implements the market
programme. The allotment to each State depends on its
Plan size and means of financing, decided upon by the
Government of India and the respective State
G-Secs and State Government securities are evaluated on
the basis of the following:
Yield to Maturity
Measures the return without taking into account the
capital gain or loss on redemption. (If the security is
bought for less (more) than its redemption value, there is a
capital gain (loss). Thus, if the coupon is 8% and Bank
buys the bond for Rs.105 (including accrued interest), the
current yield is 8/105 = 7.62% p.a.
Yield to Maturity (YTM) also called Internal Rate of
The interest rate which equates the future coupon and
principal redemption cash flows from the bond with its
current market price. Solve for Y in the formula (formula
assumes 180 days coupon intervals and 360 days in a
C C C
C C + F
P = --------- + ------------------- + -------------------- + ------------- +
d/180 (d + 180)/180 ( d + 360)/180
(d+540)/180 (d+(n.180))/180 (1 + Y) (1 + Y)
(1+Y) (1+Y) (1+Y)
Where: P = current market (dirty, i.e., including broken
period interest) of the bond
C = semi-annual coupon
d = no. of days to next coupon
n = no. of coupons left including the final
F = redemption value of the bond
Y= YTM, i.e., cash flow-equating rate of
(also called internal rate of return).
An important assumption in the above calculation is that
the coupon cash flows before maturity are reinvested at
the IRR. The actual (post-facto) IRR will invariably be
different as the coupon reinvestment rates will not be the
same as the YTM calculated today.
For example, Bank buys 7.40% 2012 maturing May 3
2012 on April 28 2003 for Rs.110.30. Settlement is same
day. Last coupon was paid on November 3 2002.
Clean price = Rs.110.30
Dirty price should include accrued interest for:
This works out to:
Rs.(175/180 x 3.7) = Rs.3.60
Dirty price = Rs. (110.30+3.60) = Rs.113.9
The YTM formula is:
C C C C
C + F
P = ------------- + -------------------- + -------------------- + ---------------- +
…. + ----------------
d/180 (d + 180)/180 (d + 360)/180 (d+540)/180
(1 + Y) (1 + Y) (1+Y) (1+Y)
P = Rs.113.9
C = Rs.3.7 (semi-annual coupon)
F = Rs. 100
d = 5 (175 days since last coupon)
n = no. of coupons left till maturity
Y = yield to maturity
Substituting and solving:
Y = 2.95% (semi-annual) or 5.98% annualized.
Duration measures the interest rate sensitivity of a bond.
The formula for duration (also called Macaulay duration)
1 1 C 2 C 3 C
n (C + F)
P (1 + Y) (1 + Y)² (1+Y)³
Where: C = semi-annual coupon
F = redemption price of the bond
Y = YTM (semi-annual)
P = market (dirty) price of the
Take the same data as in YTM Example
C = Rs.3.7
Y = 2.95% or 0.0295
P = Rs.113.90
F = Rs.100
Applying the formula, (Macaulay) duration is = 13.8694
(in half years)
Annualized Macaulay duration = 13.8694/2 = 6.93 years
Modified duration is a more accurate measure of interest
rate sensitivity for which Macaulay duration is divided by
the semi-annual yield.
Modified duration= 6.93/1.0295 years
= 6.74 years
(Macaulay) duration is divided by the YTM to get
The modified duration of 6.74 years in the Modified
Duration Example means that every 0.01% change in
YTM will lead to a 0.0674% change in the price of the
bond, either upward or downward, depending on whether
the YTM falls or rises.
For the bond considered in the Modified Duration
Example, the price increase will be Rs. (0.0674 x 113.90)
= 7.68 paisa, if the yield falls 0.01% (as yield and price
are inversely related). This is also called the Price Value
of a Basis Point (PVBP).
Modified duration is an accurate estimate of price
sensitivity of a bond only for small changes in yield.
The duration of bond portfolio is the weighted average of
the durations of individual bonds in the portfolio.
However, this will not accurately measure the interest rate
change impact on the portfolio, unless the yield curve shift
(upwards or downwards) is entirely parallel.
Duration is the spot measure of interest rate sensitivity. It
keeps changing with YTM and time.
If the YTMs of bonds are plotted in ascending order of
maturity, with maturities on the x-axis and yields on the y-
axis, we get a yield curve. The normal yield curve
represents the yield pattern on coupon – bearing G-Secs,
while the spot yield curve is the zero coupon yield pattern
on G-Secs. The spot yield curve is also referred to as the
term structure of interest rates. It shows the hypothetical
yields on G-Secs if they do not pay any interest till
maturity. Thus, the 3-year zero coupon yield would be the
pure yield for that maturity as there is no reinvestment risk
from the need to reinvest coupons as in a coupon –
bearing bond, whose holding period yield is not known
with certainly at the time of investment because the
reinvestment yields on the coupons are unknown.
Yield curves come in different shapes:
Ascending (upward sloping)
Descending (downward sloping)
In an ascending yield curve, medium and long-term yields
are higher than short-term yields, while the opposite is
true of descending yield curves. Most of the time, yield
curves are upward sloping, but at times when inflation is
high and monetary policy is tight, short-term interest rates
may be above medium and long-term.
The shape of the yield curve actually reflects market
expectations on future interest rates: an ascending yield
curve means the market thinks rates will go up and vice-
CAPITAL MARKET OPERATIONS
Capital Market Operations are undertaken by the bank
both in the Primary as well as the Secondary markets. The
bank deals in the Scrips of different companies with in the
specifications laid down by the RBI and the Treasury
Investment in equity shares is classified into 'Available for
Sale' and 'Held for Trading' categories.
Investment in subsidiaries/Joint Ventures (a joint venture
would be one in which, Bank along with its subsidiaries,
holds more than 25% of the equity) is classified into ‘Held
to Maturity’ category.
Specific Risk Factors
Quality of investment portfolio of the fund
Quality of portfolio management of the fund
Interest Rate Risk
Money market funds are much less risky than debt funds
as they invest mostly in short-term instruments.
Quality of investment portfolio of the fund
Quality of portfolio management of the fund
DATA ANALYSIS & FINDINGS
The investment function at bank demands a
careful examination of various factors. Besides calculating
the expected rate of returns, executives must consider the
risks involved in it and try to cushion it up by cover
operations. Bank has a document dedicatedly talking
about the potential risks involved in investments. This
Risk Management Policy is framed, recognizing the need
to effectively identify measure and manage these risks in
view of their implication on the Bank’s Investment
In the era of liberalization and globalization of
the Economy and resultant Economic Scenario in India,
the Investment Portfolio of the Bank is faced with the
challenge of managing a variety of financial and non-
financial risks, viz.,
Interest Rate Risk
This is one of the oldest of all financial risks. In
its simplest form, it refers to the possibility of the issuer of
a debt instrument being unable to honor his interest
payments and / or principal repayment obligations. But, in
modern financial markets, it includes non-performance by
counterparty in a variety of off-balance sheet contracts
such as forward contracts, interest rate swaps and currency
swaps and counterparty risk in the inter-bank market.
These have necessitated prescribing maximum exposure
limits for individual counterparties for fund and non-fund
• Mitigation (sample for non-bank
Investment only in rated instruments
Credit enhancement through margin arrangements
Guarantees/letters of comfort from rated entities
Adequate financial and / or physical assets as
Exposure limits by counterparty, industry,
location, business group, on and off balance sheet
Diversification by industry, sector, location, etc.
• Mitigation (sample for bank counterparties)
Exposure limits for individual bank counterparties
for funded/non-funded assets
Reputation and image of counterparties
Collateralization of transactions through repos
MARKET RISK MANAGEMENT
Market Risk is a generic term to describe both interest
rate risk and event (“systemic”) risk.
• Event Risk
The risk that an unexpected happening,
which is extreme, sudden or dramatic (e.g.
the September 11 terrorist attacks), will
cause an all-round fall in market prices.
Increase proportion of assets in risk-free,
high quality investments of short maturity.
• Interest Rate Risk – Investment/Trading Book
The prices of bonds are affected by changes in
interest rates. When interest rates come down, their prices
go up. The opposite happens when interest rates rise. The
most price – affected bonds in response to rate movements
are those of long maturity – indeed maturity and price
changes are strongly positively correlated.
Duration measures the price sensitivity of a bond
to changes in interest rates. Increasing duration makes the
bond portfolio more sensitive to interest rates while
decreasing duration reduces it.
As bond prices and interest rates are inversely
related, if the Bank expects interest rates to fall, it will
increase duration by buying long-dated securities. Per
contra, in anticipation of a rise in interest rates, the Bank
will lower duration by selling long-dated securities.
• The risk that an asset cannot be
converted into cash when needed is
termed as Liquidity Risk. It’s quite
characteristic of the vast majority of
• The risk of scarcity of funds in the
market to borrow arises for number of
reason. E.g. when the RBI deliberately
• When a bank’s creditworthiness
becomes suspect, there may be no
willing lenders, even though there is no
liquidity shortage in the market.
• Increase proportion of investments in
• Increase proportion of investments in
near-maturity high quality instruments.
• Maintain credit rating, reputation and
• Securitization of loan portfolio of large
as well as small borrowers.
Let’s now have look at the market risks in the
context of investments.
Market risk arises from adverse changes in market
variables such as interest rates, forex rate, equity price and
commodity price. Even a small change in these variables
can cause substantial changes in the income and economic
value of the Portfolio.
Market risk takes the following forms —
1. Liquidity Risk
2. Interest Rate Risk
3. Equity Risk
4. Foreign Exchange Risk
Liquidity Risk arises essentially from funding long
term assets by short term liabilities, thereby subjecting the
liabilities to roll over or refinancing risk and manifests
itself in different dimensions such as –
Funding Risk – need to re place net out-flows.
Time Risk __ need to compensate for non-receipt
of expected in-flows
Call Risk – due to crystallization of contingent
The liquidity management prescriptions spelling out
funding strategies, liquidity planning under alternative
scenarios, prudential limits, liquidity reporting / reviewing
are laid down in the ALM Policy.
INTEREST RATE RISK:
The management of interest rate risk is critical to
market risk management especially in a deregulated
environment, which has exposed the Banking system to
the adverse impacts of interest rate risk. Interest Rate risk
can be of following types –
Market interest rates of various instruments
seldom change by the same degree during a given
period of time. The situation prevails in the Bank
also as the changing interest rate on advances are
immediately given effect, the change does not
affect deposits/investments to a great extent as
they continue at the contractual rates.
Yield curve risk
The pricing of Investments are based on
different benchmarks i.e. Treasury Bill Yield, G-
Sec Yield, Call Money Rates, LIBOR/MIBOR etc.
In a floating interest rate scenario, the Yield Curve
Risk is high.
Interest Risk Management:
In a rising interest rate scenario, long dated low
coupon securities can be sold and short dated high
coupon securities can be purchased to protect the
value of holding Portfolio.
In a falling interest rate scenario, short dated high
coupon securities can be sold and long dated low
coupon securities can be purchased to enhance the
value of holding Portfolio.
Trading in volatile securities should be undertaken
with due caution and within the laid down
All deal settlements should be tracked till their
In the event of a fall in prices of the Securities, the
stop loss principle shall apply.
VaR limits on the Trading book of Investments
[all AFS-SLR/Non-SLR (excluding overdue
investments, Equity, Mutual Funds and COD
securities) and HFT portfolio]: The following
VaR limits are fixed for the different time span on
the Trading book of Investments [all AFS-
SLR/Non-SLR (excluding overdue investments,
Equity, Mutual Funds and COD securities) and
HFT portfolio] as under:
The Trading Portfolio of the Bank shall be managed in
accordance with the Investment Management policy
guidelines, which spell out the volume, maximum
maturity, holding period, Duration, Stop Loss, Rating
standards etc. for classifying securities in the Trading
The securities held in Trading Portfolio should be
reviewed on a daily basis to evaluate increase / diminution
in their value and to trigger appropriate sale / purchase
action while the Trading Portfolio would be marked to
market on monthly basis for providing depreciation, if
any, in the Portfolio.
Price risk and market risk are to be estimated by adopting
the VAR model. Securities in the Trading Portfolio
should be sold at the earliest opportunity to book profit or
minimize loss within the outer limit of 90 days and such
trading shall be undertaken within the powers delegated to
Stop loss limit: While monitoring the Portfolio Stop
loss limits as prescribed for cutting losses that may
arise be exercised.
Time span 1 Day 10 Days 30 Days
VaR Limit 1% of the Trading
3% of the Trading
6% of the Trading
The limit may be reviewed on Half-yearly basis.
Any incident of abnormal volatility and exceeding the VaR limit should be
immediately reported to the ALCO by the treasurer so that prompt remedial action can
To enable the authorities to exercise the powers
judiciously, the Board has delegated 1% stop loss limit on
the holding cost to the Deputy General Manager TIBD
and above 1% but up to 2% to the General Manager.
Similarly in the case of purchase for Trading Portfolio, the
movement of value of the Security in the preceding month
should be reckoned along with future price forecast while
deciding upon the same.
The Bank has in place an Asset Liability Management
Policy, duly approved by the Board on an annual basis to
address and deal with the above risk issues. The policy
prescriptions and operating guidelines as laid down in the
ALM Policy shall be followed in Market Risk
management as it articulates the market risk management
policies, procedures, prudential Risk limits, review
mechanism , reporting and audit system.
The ALM Policy addresses the Bank’s exposure on a
consolidated basis and articulates risk measurement
systems to be adopted, which would capture all sources of
market risk and the impact thereof on the Bank.
The market risk faced by the Bank would be
essentially managed by the Integrated Treasury.
EQUITY RISK MANAGEMENT:
Bank undertakes buying and selling of shares to
earn profit. In order to minimize the risk associated with
the capital market, the bank adopts the following risk
The shares purchased will be sold only after
getting the delivery in demat form.
The shares will be sold on getting a reasonable
The Dealers will take a view regarding sale of
equity shares /equity oriented mutual fund when
their market value goes below the average holding
The loss/depreciation will be restricted to 10% of
the average cost.
The overall exposure to Capital Market will be
kept within limits prescribed by RBI.
The Trading Equity Portfolio will be valued on
It should be ensured that the exposure to
stockbrokers is well diversified in terms of number
of broker clients, individual inter-connected
Operational Risk Management:
Operational Risk arises in situations involving
settlement or payment risks or business interruptions or
administrative and legal risks. However, the most serious
type of operational risk arises when there is a break down
in internal controls and corporate governance. Operational
Risk differs from other banking risks in that it is typically
not directly taken in return for an expected reward but is
implicit in the ordinary course of corporate activity and
has the potential to affect the risk management process.
Identification of operational risk is, therefore, crucial to
the management. Various areas have been identified
regarding operational risk as under:
Non-adherence to laid down procedure
Non-adherence to compliance required by the
Non-adherence to policy guidelines
Lack of control over security items / numbered
In-adequate checks / accuracy and processing of
In-adequate supervision over accounting system
In-correct reporting of data
Delayed action in circumstances warranting
Incorrect / improper /delayed handling of
Observance of maximum brokerwise limits in
The Basel Committee has identified the following types
of operational risk events as having the potential to result
in substantial losses:
Employment practices and workplace safety
Clients, products and business practices
Damage to physical assets
Business disruption and system failures
Execution, delivery and process management.
Monitoring / Control and Management of operational
risk assumes significance for the Bank and the risk is
sought to be managed in the following manner
Defining of responsibilities and accountability of
various functionaries, segregation of duties, clear
management reporting lines and adequate
Concurrent audit of the Investment Portfolio on
Dealers must operate strictly within the single
deal, portfolio and prudential limits by instrument
and counterparty. Stop loss and risk norms of
duration and value at risk should be adhered to at
No deviation from approved and implemented
work and document flows should be allowed.
The necessary authorizations must accompany
documents as they pass from one stage of the
transaction cycle to the next.
Delegations of powers must be strictly adhered to.
Deals or transactions exceeding powers must be
immediately and formally ratified in accordance
with management/ Board edicts on ratification.
The prescribed settlement systems in each
product/instrument and market must be followed.
Deviations from delivery and payment practices
should not be allowed.
Computer systems – hardware, networks and
software – should have adequate backups. They
should be put through periodic stress tests to
determine their ability to cope with increased
volumes and outlying data combinations.
Custodian’s creditworthiness is paramount in
demat systems of records of ownership and
transfer. Custodial relationships should be only
with those with the highest credit rating.
Counterparty authorizations/powers of attorney
must be kept current.
The list of approved brokers should be
reviewed periodically to satisfy the Bank’s credit
standards and ethics.
Deal, transaction and legal documentation
should be adequate to protect the Bank, especially
in one-off transactions and structured deals.
Value-at-risk is the maximum loss which will be
suffered in a specified period and at a specified confidence
level due to a fall in the price of a security (or exchange
rate), given historic data on the price behavior of the
security (exchange rate) or assessment of likely future
market movements. The concept is applied to calculate the
risk content of an individual security, a foreign exchange
position, an equity share, a derivative or a portfolio of
The following are the steps involved in the calculation of
VaR for an individual security:
Value at Risk (VaR) is the maximum loss not
exceeded with a given probability defined as the
confidence level, over a given period of time. Although
VaR is a very general concept that has broad applications,
it is most commonly used by security firms or investment
banks to measure the market risk of their asset portfolios
(market value at risk). VaR is widely applied in finance
for quantitative risk management for many types of risk.
VaR does not give any information about the severity of
loss by which it is exceeded. Other measures of risk
include volatility/standard deviation, semi variance (or
downside risk) and expected shortfall.
VaR has three parameters:
The time horizon (period) to be analyzed may
relate to the time period over which a financial
institution is committed to holding its portfolio, or
to the time required to liquidate assets. Typical
periods using VaR are 1 day, 10 days, or 1 year. A
10 day period is used to compute capital
requirements under the European Capital
Adequacy Directive (CAD) and the Basel II
Accords for market risk, whereas a 1 year period is
used for credit risk.
The confidence level is the interval estimate in
which the VaR would not be expected to exceed
the maximum loss. Commonly used confidence
levels are 99% and 95%. Confidence levels are not
indications of probabilities.
Value at risk (VaR) is given in a unit of the
The following are the steps involved in the calculation of
VaR for an individual security:
Take a price series of the asset for which VaR is required.
Example: Asset (8.85% 2015 Government of India bond)
DAY (From yesterday) PRICE (Rs.)
a) Calculate the natural logarithm of a day’s price
divided by the previous day’s price and their mean.
DAY PRICE (Rs.) Natural Logarithm
b) Calculate difference of each natural logarithm
from the mean and square the difference. Sum up
the squares of the differences.
of (diff) ²
Calculate variance =
Calculate standard deviation =
DAY Natural logarithm
of Price diff.
Diff. from Mean (Diff.) ²
½ 0.00256 -0.00344 0.0000118
3/2 -0.000493 -0.00649 0.0000421
4/3 -0.000296 -0.00630 0.0000397
5/4 0.00128 -0.00472 0.0000223
6/5 0.00148 -0.00452 0.0000204
7/6 0.00196 -0.00404 0.0000163
8/7 -0.000982 -0.00698 0.0000487
9/8 -0.000491 -0.00649 0.0000421
10/9 0.000982 -0.00502 0.0000252
Multiply the standard deviation by 1.65 to obtain
the 95% confidence level for maximum loss. This is 1.65
X 0.0058 = 0.00957. Assuming the acquisition cost of the
bond is Rs.110, the maximum loss in the next 24 hours at
95% confidence level and based on historical data is
Rs.110 X 0.00957 = Rs.1.05. (A bigger loss is not ruled
out if something unexpected or unusual occurs, which did
not in the past 10 days).
Of course, the VaR is a function of the standard
deviation of relative price changes (i.e., the price change
from one day to the next). Whether historical data or a
forecast should be used for this purpose is entirely the
judgement of the user. A forecast is better if the
immediate future is going to be very different from
VaR can be calculated for any period as desired.
In every case, the standard deviation as calculated above
is multiplied by the number of working days in the period
for which the VaR is required. The number of working
days in a year is 252 (forex market) and 300 (securities
market), while in a month it is 22 (forex) and 26
(securities).Thus, the annual VaR in the above example is
0.0058 x √ 300 = 10.05%. At 95% confidence, this is Rs.
(110 X 0.1005) = Rs. 11.05. 95% of the time, annual loss
should not exceed this. Monthly VaR is similarly
calculated as 0.0058x √ 26 = 2.96% or Rs. (110 X 0.0296)
= Rs.3.26. Thus, in a month, the loss should be within Rs.
3.26, 95% of the time.
The same methodology can be followed to
calculate the VaR of other assets like foreign exchange
and equity shares. To calculate the VaR of a portfolio,
simply add the VaR of the individual instruments in the
portfolio (on the assumption that their price movements
are wholly uncorrelated). Otherwise, to calculate the VaR
of a portfolio, its daily change in value must be used to
calculate the volatility and VaR as above for a single
CONCLUSION OF THE
CONCLUSION OF THE STUDY
Conventionally, the Treasury function was confined to
funds management- maintaining cash balances to meet
day to day requirements, deploying surplus funds
generated in the operations, and sourcing funds to bridge
occasional gaps in cash flow.
Owing to economic reforms and deregulation of markets
over the last decade, the scope of Treasury has expanded
considerably. Treasury has since evolved as a profit
centre, with its own trading and investment activity.
Till recently, investment in securities and foreign
exchange business constituted two separate departments in
most of the Indian banks. These two functions are now
become part of the integrated treasury, thus adding new
dimension to treasury activity.
With increasing deregulation and more exposure
opportunities over the globe, banks should make the
maximum out of this with the help of Risk management.
This project has helped me to appreciate the role and
functions of Treasury, its global dimensions and typical
organizations of treasury activity in a bank.
The Bank’s Domestic Treasury is functioning within the
RBI regulations and comes across as a well managed
Based on the information gathered during the completion
of my project I wish to suggest the following which the
Bank may look to implement.
1. Operational Risk:
The Mid Office reporting should cover aspects of
operational risk on a regular basis, even though
operational risk cannot be directly taken in return for an
expected reward but is implicit in the ordinary course of
corporate activity and has the potential to affect the risk
2. Stop Loss:
Bank has prescribed Stop Loss limits for its Held for
Trading portfolio. The percentage of Bank’s holding in its
Held to Trading portfolio on an ongoing basis is about
0.1% of its total investments.
Thus to have effective risk mitigation it is suggested that
Bank should look into prescribing a suitable stop loss
limits for its Available for Sale portfolio. The Available
for Sale portfolio is required, as per Regulatory Norms, to
be marked to market on a periodical basis. An effective
stop loss implemented on a timely basis will help the
Bank to mitigate the Mark to Market Losses in Available
for Sale portfolio.
3. Take profit levels:
Bank can document the take profit levels which can be
reviewed periodically. During the course of my study I did
not come across any such document where the take profit
levels where documented.
4. Benchmark rates:
Being very much in the market, the Treasury should
provide the benchmark rates for various activities on a
regular basis. As per present practice TIBD on a daily
basis informs prevailing rates on selected Money and Debt
market instruments but is not directly involved in the
finalizing of the Bank’s rates.
5. Transfer Pricing:
Treasury being an independent Branch unit should come
under the ambit of transfer pricing. At the moment the
Transfer pricing for TIBD is effected at CO.
6. Client business is nil.
7. Bank has very less involvement in derivative
8. Bank can try making the process more automotive
rather than being manual.
9. More professional people are required.
• The treasury department plays the most vital role;
hence the data used by them was very confidential
and critical, so couldn’t have much access to
• The project report scope pertains only to this
organization and is not applicable elsewhere.
• Due to the time constraint, it was not possible to
get all the minute details about the domestic
• The limited working hours was a constraint,
because of which the officers were not able to give
enough time for training.
• The data provided by the staff can’t be held true as