Download - Overview of Treasury Management
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TREASURY, INVESTMENT AND
RISK MANAGEMENT
IN BANKS
Submitted by:
Group 6
IMG-4
Akshat Kapoor (043006)
Chetan Sharma (043017)
Niharika Agarwal (043036)
Shobhit Rastogi (043050)
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ACKNOWLEDGEMENT
Surpassing milestones while en-route to a mission gives us so much pleasure, that at times,
we tend to forget the invaluable guidance, help and support extended by the people to whomthe accomplishments solely accrue.
We would like to thus, use this opportunity to express our deep sense of appreciation and
gratitude toProf. Vinay Dutta, our esteemed faculty and mentor for his kind words of advice
and encouragement as well as invaluable inputs at various stages of the finalization of the
case analysis which served as the biggest motivation and guiding light in the completion of
this report.
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Table of Contents
Overview of Treasury Management ................................ ................................ ................................ ... 4
Objectives of Investment ................................ ................................ ................................ ............... 4
Functions of Treasury................................ ................................ ................................ ..................... 4
Models of Treasury Management ................................ ................................ ................................ ...... 5
Core Functions Of Treasury Department-The Dealing Room, The Middle Office And The Back-Office . 7
Work Flow Of Foreign Exchange/Security Transactions ................................ ................................ ...... 8
Commercial Paper ................................ ................................ ................................ ......................... 8
Certificates of Deposits ................................ ................................ ................................ ................ 10
Linkages Of Treasury With Other Business Units ................................ ................................ .............. 12
Asset Liability Management: ................................ ................................ ................................ ............ 14
Global Best Practices And Key Performance Indicators Of Bank Treasury Department ..................... 16
References: ................................ ................................ ................................ ................................ ..... 19
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Overview ofTreasury Management
Treasury management is the management of an organization's liquidity to ensure that
the right amount of cash resources are available in the right place in the right currency
and at the right time in such a way as to maximize the return on surplus funds, minimize
the financing cost of the business, and control interest rate risk and currency exposure
to an acceptable level.
Objectives of Investment
Stabilize the banks income
Offset credit risk exposure in the banks loan portfolio.
Provide geographic diversification
Provide a backup source of liquidity
Reduce the banks tax exposure
Serve as collateral (pledged assets) to secure federal state, and local government
deposits held by the bank.
Help hedge the bank against losses due to changing interest rates.
Provides flexibility in a banks asset portfolio
Makes banks balance sheet look financially stronger.
Functions ofTreasury
Asset Liability Management
Maturity mismatch
Interest rate and type mismatch
Currency mismatch
Sales & Trading
Currency, interest rate, and credit products
Money market and long tenure instruments
Derivative Products
Risk Management
Back office processing, settlement, and accounting
Customer and regulatory reporting
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Models ofTreasury Management
There are two key dimensions to the structure of a treasury organisation. These two
dimensions are:
a) Range of services and
b)
Extent of centralisation of management control
An organization can exercise its choice on the scope of treasury functions it undertakes.
In doing this, it may be governed by a variety of conditions:
It may choose to handle only those needs driven by utilitarian motives such as
liquidity support or, on the other hand, it may consider treasury as a core
organizational process and hence handle the full range of services.
It may choose to outsource portions of the activities required or it may choose to
foster these capabilities in-house.
Independent decisions of organizations on the extent of centralization
It may be efficient to centralize back office processing, while the front office may
need to be decentralized to aid speedy local decision making.
It may be important to have a common risk management strategy, while
execution may be decentralized.
Four Models of Treasury Organisation
LimitedServiceGlobal
FullServiceGlobal
LimitedServiceLocal
FullServiceLocal
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Full Service Global:
Full service refers to a treasury that undertakes most, of the activities as discussed.
Global treasury refers to one that either operates as the only treasury for all markets
across the globe, or ultimately combines all regional or local treasuries (that may exist
due to legal or regulatory reasons) into a central treasury for pooling risks, for policiesor strategies, or for both these. In this sense, management of the treasury function in
this model is very much centralised. Although this model readily lends itself to global
organisations, it could also be used by local businesses that need to access global
markets.
Full Service Local
Here, each treasury is a self-contained local unit dictated purely by the needs of th e local
business. Thus, the treasury management function is, by and large, decentralised. While
this sort of treasury is usually the norm for a business with a local or regional spread, it
may be adopted for a global organisation that operates as a collection of highly
independent business units. Again, the range of services offered is the full gamut, as
described in the full service global model above.
Limited Service Global
This model is different from the full service global model in that the range of services
offered is limited. This could largely be due to the fact that certain activities are kept
outside the purview of treasury and are handled directly by business units, if onlybecause the scale of these activities is not large enough to warrant the attention of the
central treasury. Examples are treasuries with limited or no foreign exchange trading
activities, with the exposure being either managed directly by the concerned export or
import department or not managed at all. For those activities that are included in the
treasury in such a model, pooling is at a central level.
Limited Service Local
This model is akin to having virtually little or no treasury activities, beyond local cashand liquidity management. These are very small decentralised treasuries where the
concerned managers may also have other responsibilities in the finance department.
Some activities such as accounting and regulatory reporting are common across all
models, irrespective of whether it is done by the treasury back office or by the common
functions of the organisation. How to choose one from among these models of treasury
organisation? The section below takes a close look at the key factors that impact a
decision on the right model for the treasury: scale or spread, focus, or complexity
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Core FunctionsOfTreasury Department-The Dealing Room, The
Middle Office And The Back-Office
FRONTOFFICE
Dealing
MIDDLE OFFICE
Risk management
Treasury accounting
Documentation
Financial analysis and budgets
Regulatory reporting
Systems and telecommunication
BACKOFFICE
Input andC
ompletionVerification by confirmation
Reconciliation
Settlement
Dealing Room Operations (FrontOffice)
Know the actual requirement of funds or amount of surplus funds to be deployed
Keeping a constant watch on interest rates and yields in the market
Looking for parties to trade
Actually effecting any sale-purchase or borrowing-lending transaction
Preparing the deal slips containing the necessary details and passing it on to the
back office for settlement.
BackOfficeOperations
Input and completion of the details of the deal
Verification of the deal by both inward and outward confirmations
Settlement of the deal depending on the event which may also include netting
Reconciliation of nostros, positions and boo ks
Middle OfficeOperations
Risk management
Treasury Accounting
Documentation
Financials, analysis, budgets
Regulatory reporting
Systems and telecommunications
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DETAILED PROCESS CHARTOFFRONTOFFICE, BACKOFFICE AND MIDDLE OFFICE
OPERATIONS IN TREASURY DEPARTMENTOF A BANK
WorkFlow OfForeign Exchange/Security Transactions
Commercial Paper
Commercial Paper (CP) is an unsecured money market instrument issued in the form of
a promissory note. It was introduced in India in 1990 with a view to enabling highly
rated corporate borrowers/ to diversify their sources of short-term borrowings and to
provide an additional instrument to investors. Subsequently, primary dealers and
satellite dealers were also permitted to issue CP to enable them to meet their short-
term funding requirements for their operations.
Following are the details of commercial papers as per RBI:
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Issuer:Corporate, primary dealers (PDs) and the All-India Financial Institutions
(FIs) are eligible to issue CP.
Eligibility :
the tangible net worth of the company, as per the latest audited balance
sheet, is not less than Rs. 4 crore
company has been sanctioned working capital limit by bank/s or all-Indiafinancial institution/s; and
The borrowal account of the company is classified as a Standard Asset by
the financing bank/s/ institution/s.
Credit rating: All eligible participants shall obtain the credit rating for issuance
ofCommercial Paper either from Credit Rating Information Services of India Ltd.
(CRISIL) or the Investment Information and Credit Rating Agency of India Ltd.
(ICRA) or the Credit Analysis and Research Ltd. (CARE) or the FITCH Ratings
India Pvt. Ltd. or such other credit rating agency (CRA) as may be specified by
the Reserve Bank of India from time to time, for the purpose.
Maturity:CP can be issued for maturities between a minimum of 15 days and amaximum up to one year from the date of issue.
Denomination: CP can be issued in denominations of Rs.5 lakh or multiples
thereof.
Issuing and Paying Agent (IPA): Only a scheduled bank can act as an IPA for
issuance ofCP.
Dematerialized Form: CP can be issued either in the form of a promissory note
(Schedule I) or in a dematerialized form through any of the depositories
approved by and registered with SEBI. Banks, FIs, PDs and SDs are directed to
hold CP only in dematerialized form.
Process of Issue
The issuer obtains the credit rating from the notified CRA
The issuer appoints the Issuing and paying agent (IPA)
The IPA issues CPs in demat form through depository or directly in
physical form.
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Certificates of Deposits
Certificate of Deposit (CD) is a negotiable money market instrument and issued in
dematerialized form or as a Usance Promissory Note against funds deposited at a bank
or other eligible financial institution for a specified time period.
Eligibility
CDs can be issued by
Scheduled commercial banks excluding Regional Rural Banks (RRBs) and Local
Area Banks (LABs); and
Select all-India Financial Institutions that have been permitted by RBI to raise
short-term resources within the umbrella limit fixed by RBI.
Minimum Size of Issue and Denominations
Minimum amount of a CD should be Rs.1 lakh, i.e., the minimum deposit that could beaccepted from a single subscriber should not be less than Rs.1 lakh and in the multiples
of Rs. 1 lakh thereafter.
Investors
CDs can be issued to individuals, corporations, companies, trusts, funds, associations,
etc. Non- Resident Indians (NRIs) may also subscribe to CDs, but only on non -
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repatriable basis, which should be clearly stated on the Certificate. Such CDs cannot be
endorsed to another NRI in the secondary market.
Maturity
The maturity period ofC
Ds issued by banks should be not less than 7 days andnot more than one year.
The FIs can issue CDs for a period not less than 1 year and not exceeding 3 years
from the date of issue.
Reserve Requirements
Banks have to maintain appropriate reserve requirements, i.e., cash reserve ratio
(CRR) and statutory liquidity ratio (SLR), on the issue price of the CDs.
Transferability
CDs in physical form are freely transferable by endorsement and delivery. CDs in
demat form can be transferred as per the procedure applicable to other demat
securities. There is no lock-in period for the CDs.
Trades in CDs
All OTC trades in CDs shall be reported within 15 minutes of the trade on the FIMMDA
reporting platform.
Loans / Buy-backs
Banks / FIs cannot grant loans againstCDs. Furthermore, they cannot buy-back their
own CDs before maturity. However, the Reserve Bank may relax these restrictions for
temporary periods through a separate notification.
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Linkages OfTreasury With Other Business Units
Treasury Management System (TMS) has a central role in the control
environment of treasury. It provides functionality for front, middle and back
office activities and controls, with a trend towards straight through-processing.TMS provides the basis for critical information such as forecasting, valuation and
reporting.
The one main reason why linkage of treasury functions with other business unit s
is important is because it helps us gain an end-to-end visibility over the cash
flows. Hence, it provides the ideal way of cash management for banks.
The overall purpose of cash management is to ensure that the bank has the cash
it needs, at the right place, and at the right time and optimization of the cash
management process ensures that cash is efficiently used to fund all its the
commercial activities. Thus, cash management remains the main priority intreasury functions.
With reference to the treasury department:
Front office requires decision support tools and Internet dealing tools to
reduce cost and risk
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Back office needs confirmation and reconciliation tools to avoid errors and
to guarantee data integration
Middle office needs to produce reports for their ChiefFinancial Officer that
show their global market and credit risks
And for all this, cash managers are the only link between the treasury and the
core business processes of a bank.
1. Cash management Concentrated presentation of liquidity as wel l as integration of payment
advices
Determination of optimal liquidity transfers resulting in one cash position
per currency
Interest statements
Central overview of all accounts, all signatories and account statements
Decentralized recording and administration of all bank accounts,
signatories and related documents
2. Deposits and Withdrawals New deposits made
Advance tax payments
Funds that might be needed immediately or in a short time are deployed
for short-term, like overnight money market.
3. LoansLoan-making is the chief function of any bank and interest income is also the
main source of any banks income. Here two things are to be looked at:
Have a prior commitment to be paid
4. Risk Management Mark-to-market valuation
Interest-rate gap analysis
Net currency position
Limit reviews
Risk analysis/cash-management valuation/reports
5. Inter-BankTransactions Inter-bank clearing: fully automated netting of internal invoices
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Central management of payment transactions, decentralized recording of
payment orders
Optimal payment-method management (risk and cost minimization,
execution of foreign payments as domestic payments)
Thus, an integrated treasury would be the best form helping us in many
ways:
a) Acts as a common source of cash flow and liquidity analysis
b) Provides a centralized system of data collection from various locations
c) Has greater efficiency and reduces costs.
Asset Liability Management:
In general, Asset liability management is managing the risk in the balance sheet i.e.
managing both assets and liabilities in a prudent manner. More specifically, it is
concerned with strategic balance sheet management involving all market risks. It also
deals with liquidity management, funds management, trading and capital management.
Any item which is on liability side is a resource and these resources can be raised only
after incurring a cost. These liabilities are eventually converted to assets and every bank
makes an effort to earn as much as possible on these assets. ALM issues are as follows:
1) Keeping cost of Liability as low as possible and yield on assets as high as
possible.
2) Every time liability is raised, immediately asset should be created. The time lag
between raising liability and creation of asset cut into profit. So, all mismatches
between liability and asset pattern should be reduced to the minimum.
3) To keep the cost of liability low and yield on assets high, bank must essentially
know how much is the cost of raising overall liabilities and how much is the
return on assets. Bank also need to know various risks that could cut into its
profits.
Through ALM bank does the following:
Monitoring interest margins or spreads.
Managing interest rate Risk.
Managing liquidity Risk.
Building Capital Adequacy.
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Monitoringinterestmargins or spreads:
Spread or Interest margins = Earning on assets Cost of liability.
After deregulation banks are now free to fix their interest rates on advance above Rs. 2
Lacs by announcing prime lending rate. However, in the free market environment now
interest rates will be more driven by the forces of market and no bank even if it has
desire to keep its cost low, can offer less rates being offered by other banks on deposits
as in that case no depositor will put in his money. Market pressure will force banks to
keep deposit rates higher and advance rates lower than the competitor to gather
business. To manage this aspect there is a need to evaluate cost and based on this cost
analysis, formulate strategies so that spread remains intact. Improvement in Net
Interest Margin will mean more profits and its deterioration will result in lower profits.
Managing interest rate Risk: If saving bank interest rates are reduced, people will
prefer to put deposits in 30 days or 15 days. If 3 years interest rates are increased,
deposits will shift from 1year and 2 year maturity to 3 years maturity. So, basically,deposits/liabilities are seen to be interest rate sensitive. Similarly spread of a bank,
premature withdrawal, securities and investments are interest rate sensitive.
To offset interest rate risk, matching of borrowings and lending is solution. If any
mismatch of asset and liability exists it would lead to gaps. To avert interest rate risk
this gap must be filled up. A gap is considered as positive if assets under that category
are heavier than liability and it is considered as negative if liabilities are more than
assets.
Managing Liquidity risk: In the case of bank it is very difficult to achieve perfect match
between assets and liabilities as number of transactions are very large and thereforenecessarily banks have to carry this risk. To overcome this problem Gap Analysis can be
used. Here, one will try to find gaps between assets and liabilities in terms of its
maturity and ensuring that pricing of assets and liabilities of same maturity yields a
positive net interest margin.
Capital Adequacy Risk: Asset carries risk weightage so growth of assets is therefore not
possible unless and until capital grows in tandem. Growth in Long term deposits have a
negative impact on profit if capital constraints exist as money has to be deployed in low
yield Zero risk Government Securities. A bank suffering from capital constraints may
not be able to raise further capital from market as its performance parameters may not
be good. So a bank not making profit and creating surplus may lose the opportunity to
access capital market as it will receive lukewarm response.
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Global Best Practices And Key Performance IndicatorsOf Bank
Treasury Department
1. The finance structure is centralized.
If the central staff is spending the majority of its time chasing down wire transfers,
posting transactions or conducting non-value-added activities, the company is most
likely something other than best-in-class. Best-in-class organizations, with a centralized
structure, provide high value-added activities to the business, particularly activities that
provide decision support and improved business performance (e.g., forecasting,
financial trend analysis, risk and exposure management and efficiency improvement
projects).
2. Roles and responsibilities are clearly defined, with management reporting
focused on consistent format and key performance indicators.
3. The finance and treasury cost base (e.g., finance as a percent of revenue) is low.
In international trade finance activities (e.g., letters of credit, currency purchases,
currency hedges and credit dispositioning), best-in-class bank practices have reduced
their all-in costs primarily by knowing each of their component costs, streamlining
operations, negotiating prices, and bundling services for leverage, using a limited
number of providers.
4. Reasonable risk factors are identified and mitigated.
Among fortune 1000 firms have Regional Treasury Centres (RTC) to include risk
management function. They perform netting, pooling, re-invoicing and currency risk
management function.
5. The time cycle prefers analysis to initiating, and tracking transactions.
The only way banks can evaluate and benefit from using alternatives is if treasury has
the freedom to spend less than 20 percent of its time on the basics (creating, posting,
reviewing, approving and reconciling transactions), and spend more than 50 percent of
its time on management analysis. This task/time breakout is indicative of best practice
performance.
6. Resources (time and money) are spent on information gathering, information
management and personal communication.
Treasury workstations, as a technological resource, are used to manage the detailedbanking information. All reasonable expenses are made to implement and maintain an
effective, secure, redundant, 24x7 workstation, and efforts are now under way to
combine other information media into the workstation. Communication methods are
not a function of budget, but a necessity for team performance. Routine finance reviews
are conducted by video teleconference, or at a minimum, audio teleconference.
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7. Active business partnering exists with sales, credit/collections, purchasing.
For best practice adopted by banks treasury and finance operations are often seen as
"partners" by the bank's other functional units. There is a direct correlation between the
ability to get improvement projects accomplished and the ability to reach out and
partner with other functional units of the bank enterprise.
8. Structures are simple.
Treasury department accomplished the goals of globally standardizing the payments
process, migrating vendors to electronics and leveraging banking relationships for
economies of scale.
9. Tax treatment is a factor, but not the factor.
At the CFO level, tax is a major-league consideration in treasury management. Its
international impact can be as much as 14 percent - and that is to the bottom line. In
businesses where margins are tight, tax becomes an even more influential player in the
financial and treasury decision-making process.
10. No rookies work at the department.
The benchmark data reveals that top-performing, centralized treasury and finance
organizations employ staff with different levels of experience from a variety of
backgrounds. In international treasury and finance, the average employee has a
minimum of 11 years' experience and has held at least one other professional,
corporate, position in the international arena.
11. Constant improvement is sought.
Best-in-class banks are always looking for ways to improve, crafting a culture ofworking smarter and more efficiently. Electronic trade processes (e.g., Trade Card) and
improvement consortia (e.g., the Bolero Association) have made "leap frog" innovations
in document handling.
Key Performance Indicators:
y CashForecasting Models.
y Cost ofCapital.
y
Number of Bank Account.y Number of banking relationships.
y Number of outstanding reconciling items < 3 months old.
y Difference of Interest rate of cash accounts V/s Money markets rate per currency.
y Percentage of cash transactions effected electronically.
y Number of days in obtaining value for funds.
y Floating days per bank.
y Cost of cash function as a percentage of total finance cost.
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y Number of cash transactions per FTE.
y Number of unreconciled cash transactions.
y Number of accounts outside cash pooling.
y Return on capital.
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References:
Alfonsi, Michael J., Best Practices in International Treasury Management,
Association for Financial Professionals, Nov/ Dec 1999.
New Trends in Treasury Management, Ernst & Young, March 2011
A Better Overview of Treasury Management, Siemens Financial Services, March
31st, 2010
Treasury Organisation: Picking the Right Model, Infosys, 2009.
http://www.rbi.org.in/scripts/FAQView.aspx?Id=25