overview of treasury management

8/6/2019 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

overview of treasury management

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