Treasury Management Treasury generally refers to the funds and revenue at thedisposal of the bank and day-to-day management of thesame. The treasury acts as the custodian of cash and other liquidassets. The art of managing, within the acceptable level of risk, theconsolidated fund of the bank optimally and profitably iscalled Treasury Management. It is the window through which banks raise funds or placefunds 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 frontoffice, mid office, back office and the audit group.In some cases the audit group forms a part of themiddle office only. The dealers and traders constitute the front office.In the course of their buying and sellingtransactions, they are the first point of interfacewith the other participants in the market (dealers ofother banks, brokers and customers). They report to their department heads. They alsointeract amongst themselves to exploit arbitrageopportunities.
Structure of an integrated treasury A mid office set up, independent of the treasury unit,responsible for risk monitoring, measurement analysisand reports directly to the Top management for control. This unit provides risk assessment to Asset LiabilityCommittee (ALCO) and is responsible for daily trackingof risk exposures, individually as well as collectively. The back office undertakes accounting, settlement andreconciliation operations. The audit group independently inspects/audits dailyoperations in the treasury department to ensureadherence to internal/regulatory systems andprocedures.
Advantages of integrating treasury operations Is to improve portfolio profitability, risk insulation and also tosynergise banking assets with trading assets. This is achieved through efficient utilisation of funds, costeffective sourcing of liability, proper transfer pricing, availingarbitrage opportunities, online and offline exchange ofinformation between the money and forex dealers, singlewindow service to customers, effective MIS, improvedinternal control, minimisation of risks and better regulatorycompliance. An integrated treasury acts as a centre of arbitrage andhedging activities. It seeks to maximise its currency portfolio and free transfer offunds from one currency to another so as to remain aproactive profit centre.
The Dealing Room The Treasury has a responsibility to manage market risk inaccordance with instructions received from the bank’s ALCO. This is undertaken through the Dealing Room which acts asthe bank’s interface to domestic and international financialmarkets. it is the clearing house for such risk and has the responsibilityto manage the market risk taken in all areas of the bank, onbehalf of customers, and on behalf of the bank, within thepolicies 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 marketrisk. Thus controls over the activities of these staff are critical toensure that the bank is protected from undue market risk.
The Middle Office The duties and responsibilities of the Middle Office vary frombank to bank. Middle Office is a relatively new concept in the riskmanagement structure, not all banks will have formal MiddleOffice structures. Middle Offices are in place primarily to provide market riskmonitoring, evaluation and reporting for ALCO and Treasury. The Middle Office is the first line of review of dealing activitiesand it provides timely assessment of dealing activities andconsolidated market risk exposures of the bank.
The Middle Office The Middle Office must report to ALCO independent of theTreasury. It is inappropriate that any access to Middle Officesystems is given to Treasury staff. As the Middle Office is the primary source for market riskanalysis in the bank, it is essential that “segregation of duty”principles are clearly maintained. Middle Office provides key market risk analysis to DealingRoom management and ALCO, its reporting line to the ALCOSecretariat must be separate from Treasury to ensureindependent risk evaluation.
The Back Office The key controls over market risk activities, andparticularly over Dealing Room activities, are exercised bythe Back Office. It is critical that both a clear segregation of duties andreporting lines are maintained between Dealing Room staffand Back Office staff, as well as clearly defined physicaland systems access between the two areas. The Back Office and Middle Office, where present, arealso entrusted with the responsibility of ensuring thetimeliness and completeness of data in regard to marketrisk activities and providing ALCO and management withverified reports from the bank’s books as defined in bankpolicy 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 withDealing Room forms and reports. Any follow up of discrepancies betweenthe two (including confirmations received where no dealer’s record isprovided) must be performed independently by the Back Office in a timelymanner. Confirmations must under no circumstances be sent out by or received bythe dealing area. The control over dealing accounts, vostros and nostros must also betimely, accurate and discrepancies followed up independently and in atimely manner. Revaluations and marking-to-market risk exposures, where required bypolicy and RBI directives, must be carried out by the Back Office, for bankrecords, from rates received independent of the Dealing Room.
The Back Office Monitoring and reporting of risk limits and usage including openpositions, product usage, counterparty settlement, overall limitsand portfolio limits are the responsibility of the Back Office orMiddle Office, where in place. Reporting prompt resolution of exceptions and excesses are vitalresponsibilities of the Back and Middle Offices and key controlconsiderations. Control over payments systems, particularly those related toDealing Room activities is the responsibility of the Back Office.Under no circumstances should staff with access and/orauthority to the Dealing Room or dealing mechanism have anyauthority, responsibility or access to bank payment systems.
Risk Management Techniques VAR Model- Estimated maximum potential loss ofa portfolio Back Testing - Method of examining whether theVAR numbers being produced reasonably reflectreality Stress Testing- overcome the shortfall of VARmodels, manage risk better in more volatile and lessliquid markets
Money Market Market for short-term requirement and deploymentof funds - overnight to one year In products which are close substitutes for money The instruments should be marketable, liquid andbearing low-risk facilitates Asset-LiabilityManagement in banks Enables banks to reduce cost of liquidity bydeploying 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 todevelop the money market; and To ensure stability in short-term interest rates To minimise default risk To achieve balanced development of various segments of moneymarket Pressure on the banking system during times of liquidity crunchorEase in the banking system during times of liquidity surplus is first felt inthis market
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 aremonitored on a daily / fortnightly basis Compulsory reporting of all call money transactionson NDS platform within 15 minutes of deal NDS-Call launched from Sept. 18, 2006 Screen-based negotiated quote-driven system forall 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 atpresent Likely to lead to better price and volume discovery Call money rates are normally expected to bewithin the corridor set by the repo andreverse 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 andshort-term needs of Govt. Repo transactions permitted in all T-Bills All issuance of T-Bills (including under MSS & LAF) run online onPDO-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 theumbrella limit) Subject to eligibility criteria Unsecured in the form of a promissory note – subject to stampduty Maturity - 7 days (Min.) to 1 year (Max.) Minimum size of issues – Rs. 5 lakh and in multiples of Rs. 5lakh Investors - Individuals, banks, corporate bodies includingunincorporated bodies, NRIs, FIIs FIMMDA, in consultation with market players, depositories andRBI, prepares related guidelines
Commercial Papers… Should not be underwritten or co-accepted Credit enhancement can be provided by banks / FIswhile non-banks can provide guarantee support Only Scheduled banks can act as IPAs for issuanceof CP. Responsibility of IPA to report CPtransactions on NDS within 2 days and to RBI within3 days Data on CP issuance made available on RBI’swebsite since July 2005
Commercial Papers… Banks, FIs and PDs can make investments /hold CPs only in demat form (October 2001onwards) 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 issuedin ‘demat’ form or as a UP Note (effectiveJune 2002) Maturity - Banks - 7 days (Min.) to 1 year(Max.) Minimum size of issues – Rs. 1 lakh and inmultiples of Rs. 1 lakh (from June 2002)
Certificates of Deposit… Can be issued on floating rate basis if thecompilation is objective, transparent andmarket-based Issued by Commercial banks (except RRBs)and select FIs SCBs can issue without any ceiling on quantumor interest rate FIs within umbrella ceiling (100% of NOF)
Certificates of Deposit… FIs can issue for periods not less than 1 yearand not exceeding 3 years Investors – Individuals, Corporates, Trusts,NRIs (on non-repatriable basis) Provides an avenue for investment at betterrate in the banking sector FIMMDA has issued standardised procedure,documentation and operational guidelines forissue 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 CDsrated, though not mandatory Presently, greater demand because of –- issuance of guidelines on investments by banks innon-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 markettrading (transferability period withdrawn)- MFs are turning to CDs market becauseSEBI has prohibited them from placing fundswith banks as deposits
Repos Are Re-purchase Agreements or Ready Forward Contracts Where the parties agree to sell and buy back the same securityat an agreed price at a future date Is a combination of security trading (purchase / sale) and moneymarket (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 CurrentA/c and SGL A/c can undertake Repos All G-Sec. transactions (both outright and repos) arecompulsorily 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 mainparticipants (PDs can also participate) Non-scheduled UCBs and listed companieswith gilt accounts with SCBs allowed toparticipate – subject to eligibility criteria andsafeguards Electronic trading platform CROMS
LAF Repos Since 2000 Has emerged as the principal operatinginstrument of monetary policy to moderatedaily liquidity in the banking system Repo - Injection of liquidity by the CentralBank against eligible collateral Reverse Repo - Absorption of liquidity by theCentral Bank against eligible collateral
LAF Repos… W.e.f. April 2004, RBI conducts onlyovernight fixed rate repo and reverse repo atMumbai Repo Rate – 6.00%Reverse Repo Rate – 5.00% Decisions on LAF are aided by a dailyliquidity forecasting exercise Minimum bid – Rs. 5 crores & in multiples ofRs. 5 crore
LAF Repos… All eligible transferable GOI dated Secs / T-Bills Bids submitted electronically through NDS by 10.30am Introduction of second LAF from November 28,2005 RBI, subject to variations in liquidity, announcesevery Friday the possibility and quantum of MSSissuances (t-bills and dated securities) for thesucceeding week
LAF Repos… To restore LAF as a facility for equilibrating veryshort-term mismatches To modulate liquidity absorption through reverserepo auctions
Collateralised Borrowing &Lending Obligation (CBLO) Operationalised as a money market instrument byCCIL from January 2003 - 155 members Anonymous, order driven, electronic trading andonline matching facilitating price discovery andtransparency Maturity – 1 day (Min.) to 1 year (Max.) Collateralised
CBLO… CCIL is the Central Counter Party providingguaranteed settlement Banks, FIs, Insurers, MFs, PDs, NBFCs, PFs,Corporates, etc., can be members Borrowers are public & private sector banks,PDs Lenders are mutual funds, insurancecompanies, public & private sector banks Low costs compared to Call money
CBLO… Provides CBLO holders an exit option beforematurity RBI effects automated value-free transfer ofsecurities between market participants andCCIL Transactions in CBLO are exempted frommaintenance of average CRR Unencumbered CBLO in CSGL with CCILeligible for SLR
Money Market Mutual Funds Detailed scheme announced in April 1992 Purpose – To provide additional short-term avenue to investors and tobring money market instruments within the reach of individual investors Regulated by SEBI but RBI clearance is required before beingregistered by SEBI Minimum lock-in period – 15 days Permitted to invest in rated corporate bonds and debentures withresidual 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 banksBonds 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 putcall 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 overGOI 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 theInformation Memorandum The principal redemption dates & schedule isas per the Information Memorandum The day count basis & floating ratebenchmark (in case of a floating rate bond) isas per the Information Memorandum
Corporate Debt Minimum amount of Bonds / Debentures areas per the Information Memorandum The settlement of Bonds / Debentures iscompulsorily 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 thedeal Brokers are the intermediaries, but do not takepart in settlement process Brokers have to also report all the transactionsto the unified corporate bond platform of theBSE
Settlement Mechanisms Trades typically done on same day, T+1, T+2 Securities only in demat form Settlement can be through either High Valuecheque or RTGS or normal clearing cheque.RBI cheques cannot be issued for settlementof Bonds / Debentures Settlement on DVP basis
Corporate Debt - QuotingSystem Pricing, typically, at a relevant spread overGOI securities Quotes & deals done on an annualised yieldbasis. Price is derived from the agreed yields Primarily, wholesale in nature No transfer stamp duty for secondary markettransfer Day count convention is typically A/365
CRR / SLR Maintenance &Reporting Maintenance of CRR u/s 42(2) of RBI Act1934 Maintenance of SLR u/s 24 of BR Act 1949 Maintenance of CRR/SLR on NDTL ofSecond Preceding Fortnight Reporting of CRR as per Form A return onfortnight basis Reporting of SLR as per Form VIII Return onfortnightly 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 opensup for the next day
Forex setup at Banks Forex Centers (Category B Branches) All those branches who handle export-importbusiness (customer-related) Merchant Market Dealing Room Positions covering Interbank market
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 certainminimum lot size Banks and licensed financial institutionsparticipate in the interbank market.
Merchant Forex Market Market where Merchants (exporters,importers and others) sell and buy Forex fromADs It is also a retail market no lot size restrictions Rates in merchant market will be with a profitmargin over interbank rates
International conventions International forex markets the currency arerepresented by three letter notations followedby “SWIFT” Quoting pairs most often use USD as basecurrency Exceptions: GBP, EUR, NZD, AUD
Direct and Indirect Direct: number of home currency units perone unit of foreign currency Ex: 46.50 number of rupees per one USD Indirect: number of foreign currency units perone unit of home currency Ex: 0.0215 number of USD per one INR(inverse of direct quote)
Bid and Ask1.3725 / 35market maker is willing to buy market maker is willing to sellmarket take can buymarket take can sell
Settlement Spot Market is the predominant market Spot – contract today and settlement on thesecond working day ‘ready transaction’ or ‘cash transaction –settlement is on the very day (Cash today) Value tomorrow