Executive Summary:This project is all about Treasury management operations in banks.

Treasury management is the management of an organizations liquidity to ensure that the right amount of cash resources are available in the right place 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. This project covers functions of treasury management operations in bank, organizational structure of treasury, objectives and functions of treasurer which plays an important role in banks. This project also involves the elements in treasury management like cash reserve ratio, statutory liquidity ratio, dated government securities, etc. which should be properly functioned by treasurer. The project includes nature of treasury assets and liabilities and treasury products & services which plays an important role in every banks. The project deals with risk involved in these treasury assets and liabilities and their mitigation. Risks are of two types operational risk & financial risk. The project also includes risk management guidelines which are laid down by RBI. The project covers the future scope / challenges in treasury management etc .

1. INTRODUCTION:Traditionally, treasury managers have been focusing on cash management and investment decisions. For a treasurer, management of cash and other liquid assets like T-bills, CPs, etc continued to be a key function in many organizations. In fact, treasury is a profit centre in many banks. The changing scenario of the banking sector has lead to increasing volatility in the level of market (interest) rate, exchange rates, money supply and general level of prices, which made banks to pay closer attention to the treasury and forex management. Treasury function is playing a pivotal role in financial risk management; exposure management and the use of hedging strategies are now all seen as essential undertakings. In fact, the specialist treasury function is a recent development in many organizations but has grown dramatically since the early 1970s. In general terms and from the perspective of commercial banking, treasury refers to the fund and revenue at the possession of the bank and day-to-day management of the same. 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 management seeks to maximize profit and earning by investing available funds at an acceptable level of risks. Risks and Returns both needs to be managed. If we examine the balance sheets of Commercial Banks (Public Sector Banks, typically), we find investment/deposit ratio has by far overtaken credit/deposit ratio. Interest income from investments has overtaken interest income from loans/advances. The special feature of such bloated portfolio is that more than 85% of it is invested in government securities. The reasons for such developments appear to be as under: Poor credit off-take coupled with high increase in NPAs. Banks' reluctance to cut-down the size of their balance sheets. Government's aggressive role in lowering cost of debt, resulting in high inventory profit to commercial banks. Capital adequacy requirements. The income flow from investment assets is real compared to that of loan-assets, as the latter is size ably a book-entry.

In this context, treasury operations is becoming more and more important to the banks and a need for integration, both horizontal and vertical, has come to the attention of the corporate. The basic purpose of integration is to improve portfolio profitability, risk-insulation and also to synergize banking assets with trading assets. In horizontal integration, dealing/trading rooms engaged in the same trading activity are brought under same policy, technological and accounting platform, while in vertical integration, all existing and diverse trading and arbitrage activities are brought under one control with one common pool of funding and contributions. Thus this project gives insight into the functions of treasurer ranging from cash and liquidity management, reserves management, funds management to transfer pricing, risk management and foreign exchange management. The key factor for effective treasury management are its organizational structure; its involvement in the asset liability committee of bank ; leading and funding policy; asset and liability management skills; investment management skills; investment management skills; policy guidelines; control and supervision; etc. Banks have to ensure that the right amounts of cash resources are available at right time.

1.2 Meaning and Definition:Meaning:Treasury is the glue binding together liquidity management, asset/liability management, capital requirements and risk management. It has an increasingly important job to do. At one end of the spectrum it manages balance sheets and liquidity, and does good things to enhance the yield on assets and minimize the cost of liabilities, mostly through the clever and intelligent use of derivatives. At the other of the spectrum, treasury can help restructure the balance sheet and provide new products. Definition:-

What is a Treasury? Treasure in general refers to money or wealth and Treasury, literally, is the place where such wealth is kept. Thus, one can derive that, "Treasury management is the science and art of managing your wealth. Treasury is a place where stores of treasures are kept; the place of deposit, care, and disbursement of collected funds.

What is Treasury Management? Definition - Treasury management is the management of an organizations 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 costs of the business and control interest rate risk and currency exposure to an acceptable level.

RESPONSIBILITES OF THE TREASURY MANAGER:A treasurer has following responsibilities

A. Funds management B. Forex management C. Risk management D. Others

A. Funds Management: It is the responsibility of the treasurer to ensure that the adequate funds are available for meeting the day-to-day requirements of the firms operations, as also for its long term needs and that no resources of the firm are kept idle. Ideally the treasurer would like to fund the cash outflows from the cash inflows. However, in practice, this may not be possible due to various reasons such as:-

1. Timing mismatch: - Funds generated internally from sales often do not translate into cash instantly.

2. Mismatch of amount. The funds available on hand may not be sufficient to meet the obligations at a given point of time.

B. Forex Management: Whenever a business sources its inputs or produces and\or distributes its products in more than one country, it will have an income or expenditure, or an assets or liability, denominated in more than one currency. Due to increased internationalization of business, forex management has become one of the important responsibilities for a treasurer. The international treasurer has to ensure liquidity in foreign exchange funds without compromising profitability. Foreign exchange management is much more complicated than domestic funds management because of fluctuating exchange rates, international taxation problems, interdependencies of international markets, etc.

C. Risk Management: It has been stated that the primary task of the treasurer is to mobilize the right amount of funds from the right source at the right time at the lowest possible cost and put them to the right use. In this process, the firm is exposed to a variety of risks such as default risk, credit risk, country risk, political risk, exchange rate risk, liquidity risk, etc.

D. Others: Compliance with statutory guidelines Equal treatment to all departments Ability to network Integrity and impartial dealings Willingness to learn and to teach.

The treasurer needs to identify the financial risks to which the firm is exposed and also the level of risks acceptable to the firm. It is also important to know the extent to which the corporation is exposed in terms of transaction and economic exposure. A treasurer should have a clear understanding of various operations of its subsidiaries abroad, before taking any risk management strategy as simple adjustments sometimes clears the firms with exposures and avoids the costs and time involved in taking a risk management strategy. Since every attempt to improve profitability has an attendant risk, he has to maximize returns and minimize costs at the level of risk acceptable to the firm. Not only does the treasurer identify and gauge the risks, but he has to actively engage in minimizing the risks by using various hedging techniques such as options, futures, swaps, collars, floors, caps, etc...

FUNCTIONS OF THE TREASURY DEPARMENT IN BANKS:Since 1990s, the prime movers of financial intermediaries and services have been the policies of globalization and reforms. All players and regulators had been actively participating, only with variation of the degree of participation, to globalize the economy. With burgeoning forex reserves, Indian banks and Financial Institutions have no alternative but to be directly affected by global happenings and trades. This is where; integrated treasury operations have emerged as a basic tool for key financial performance. A treasury department of a bank is concerned with the following functions: Risk exposure management, which embraces credit, country, liquidity and interest rate risk consideration together with those risks associated with dealing in foreign exchange. Asset and liability management, where liquidity, interest rate structures and sensitivity, together with future maturity profiles, are the major considerations in addition to managing day-to-day funding requirements. Control and development of dealing functions. Funding of investments in subsidiaries and affiliates. Capital debt/ loan stock raising. Fraud protection. Control of investments. This functions operate under authorities and limits delegated to it by the Asset and Liability Management Committee (ALCO), which in turn operates under authorities and limits delegated from the risk management committee. The main component of the Treasury division is the Dealing Room and Back office. Mid-office works in close association with the Treasury and in fact has a major role in the monitoring of risks assumes by treasury, but independently reports to ALCO.

The important functions of these three units are briefly mentioned below: A. The Dealing Room:The treasury has a responsibility to manage market risks in accordance with instructions received from the banks ALCO. This is undertaken through the dealing room which acts as the banks interface to international and domestic financial markets. The dealing room is the centre for market risk management activities in the bank, as stated earlier, it is the clearing house of such risk and has the responsibility to manage the treasury risks taken in all areas of the bank, on behalf of customers, and on behalf of the banks, within the policies and limits prescribed by the Board and risk management Committee. For this reason significant authority is given to the treasurer and the Dealing Room staff to commit the bank to market Risk. Thus controls over the activities and these staff are critical to ensure the bank is protected from undue market risk. All activity in the dealing area must be under the most stringent control, with risk commitments reported accurately and promptly to risk management. In general authority is granted to the treasury function to manage and control risks on the balance sheet created by the activities of the bank arising from its operations with its customers. However some proprietary dealers are authorized to buy and sell risk on the banks behalf to generate profits from market price changes.

B. The Middle office:The duties and responsibilities of the middle office Varies from bank to bank. As the middle office is relatively new concept in the risk management structure, not all banks have formal middle office structures. Formal middle office structures are generally seen in larger banks, and banks whose business and activities are heavily geared towards the trading of market risks. However, the need for increasing effectiveness of ALM has increased the need for a Middle office to be formally established in most banks. Middle offices are in place primarily to provide market risk monitoring, evaluation and reporting for ALCO and treasury. The middle office is the first line of review of dealing activities and the function provides timely assessment of dealing activities and consolidated market risk exposures of the bank. The middle office must report independently of the treasury. It is inappropriate that any access to middle office systems is given to treasury staff. As the middle office is the primary source for

market risk analysis, in the bank, it is essential that segregation of duty principles are clearly maintained and as such mid- office should be separated from the dealing room. Middle office will input all data, including revaluation and input of Variables into market analysis models and also all limit data. Whilst the Middle Office provides key market risk analysis to Dealing Room management and ALCO, its reporting line to the ALCO Secretarial is separate from Treasury to ensure independent risk evaluation. The main functions of the Middle Office are: Monitoring performance of the dealing room. Monitoring individual dealers performance. Analysis of use of approved risk limits. Analysis of usage of limits and recommendations in changes of limits or product. Analysis of risk of new instruments and products. Real-time valuation of risk exposures. Verification of information used in gap and cash flow reports. Analysis of gap and cash flow reports. Maintenance & Verification of data used in ALM model. Comment and analysis on output of ALM model maintenance of VAR model. Verification of data used in VAR model. Comment and analysis on output of VAR model. The Middle Office not only has control function, but an analytical function of ALM information which is primarily for the purpose of the ALCO but which is also used to improve Treasury performance.

C. The Back Office:The key controls over market risk activities and particularly over Dealing Room activities are exercised by the Back Office. It is critical that both a clear segregation of duties and reporting lines is maintained between Dealing Room staff and Back Office staff, as well as clearly defined physical and systems access between the two areas. The Back Office is also charged with the responsibilities of ensuring the timeliness and completeness of data in regard to market risk activities and providing ALCO and management with verified reports from the banks books as defined in bank policy and procedures.

Key controls performed in this area are:The control over confirmations, both inward and outward. All confirmations must be verified by Back Office staff for consistency with Dealing Room forms and reports. Any follow up discrepancies between the two (including confirmations received where no dealers record is provided) must be performed independently by the Back Office in a timely manner. Confirmations must under no circumstances be sent out by or received by the dealing area. The control over dealing accounts, vostros and nostros must also be timely accurate and discrepancies followed up independently and in a timely manner. Revaluations and marking-to-market of market risk exposures, where required by policy and RBI directives, must be carried out by the Back office from rates received independently of the Dealing Room. Monitoring and reporting of risk limits and usage including open positions, counterparty settlement and overall limits and portfolio limits are the responsibility of the Back Office. Reporting and prompt resolution of Expectations and excesses are vital responsibilities of Back Office and key control considerations. Control over payments systems, particularly those related to Dealing Room activities is the responsibility of the Back Office. Under no circumstances should staff with access and or authority to the Dealing Room or dealing mechanism have any authority, responsibility or access to bank payment systems.

Linkages with other business units:It order to discharge its responsibilities in the management of risk, Treasury department receives information on all the assets and liabilities generated by branches arising from the commercial or core businesses of the bank. Branches which have surplus funds should transfer the same to the Treasury and such funds will be treated as having been lent to the Treasury. Deficits branches can borrow from the Treasury to fund their authorized assets. Thus, Treasury provides funding for those areas of the bank not able to finance their own operations. It also manages the banks liquidity and its investments in market instruments. Its responsibility for the management of these market risks should be in accordance with the authorization granted to it by policies and strategies laid out by the banks ALCO.

The Treasury is also responsible for providing branches with prices for those products and services, such as foreign exchange, interest rate and derivative products, in which it has the market risk expertise. It does so by reference to current market conditions and prices. Its internal pricing should take account of its own position, of price trends and the costs associated with its responsibility for managing the banks liquidity and funding risks and any guidelines provided by ALCO. The Treasury, therefore, day-to-day responsibility for the proper management and control of all day-to-day market risks generated by all business units in the bank in accordance with the policies, guidelines and instructions laid down by the bank, or by its ALCO on its behalf. These policies and guidelines are established by reference, among other things, to the banks capacity to absorb losses, its appetite to accept risk and the guidelines provided to the bank by RBI. The ALCO may allocate to the Treasury a portion of the balance sheet within which it may take limited market risk on a proprietary basis. It may thus be seen that Treasury management is part of the broader subject of risk management. Banks effectiveness at managing its market risks, including the effectiveness of it mechanism to monitor, report and supervise market risks on the balance sheet is centralized on its Treasury function.

ELEMENTS OF TREASURY MANAGEMENT:1. Cash Reserve Ratio and Statutory Liquidity Ratio Management:CRR, or cash reserve ratio, refers to the portion of deposits that banks have to maintain with RBI. This serves two purposes. First, it ensures that a portion of bank deposits is totally risk-free. Second, it enables RBI control liquidity in the system, and thereby, inflation. Besides CRR, banks are required to invest portion (25 per cent) of their deposits in government securities as a part of their statutory liquidity ratio (SLR) requirements. The government securities (also known as gilt-edged securities or gilts) are bonds issued by the Central government to meet its revenue requirements. Although the bonds are long-term in nature, they are liquid as they have a ready secondary market. What impact does a cut in CRR have on interest rates?

From time to time, RBI prescribes a CRR, or the minimum amount of cash that banks have to maintain with it. The CRR is fixed as a percentage of total deposits. Banks are now required to maintain 7.5 per cent of their deposits with RBI. The deposits earn around 4 percent interest, which is less than half of the average cost of funds for banks. For e.g. if the total amount of deposits with banks is Rs 7,00,000 crore then, every one percentage point cut in CRR means the banking system will have nearly Rs 7,000 crore more available for lending. As more money chases the same number of borrowers, interest rates come down. Does a change in SLR impact interest rates?

SLR reduction is not so relevant in the present context for two reasons: One, as a part of the reforms process, the government has begun borrowing at market-related rates. Therefore, banks get better interest rates compared with the earlier days for their statutory investments in Government securities. Second, banks are still the main source of funds for the government. This means despite a lower SLR requirement, banks investment in government securities will go up as government borrowing rises. As a result, bank investment in gilts continues to be higher than 30 per cent despite RBI bringing down the minimum SLR to 25 per cent a couple of years ago.

Therefore, for the purpose of determining the interest rates, it is not the SLR requirement that is important but the size of the government-borrowing programme. As government borrowing increases, interest rates, too, look up. Besides, gilts also provide another tool for RBI to manage interest rates. RBI conducts open market operations by offering to buy or sell gilts. If it feels interest rates are too high, it may bring them down by offering to buy securities at a lower yield than what is available in the market.

2 Dated Government Securities:The Government securities comprise dated securities issued by the Government of India and state governments. The date of maturity is specified in the securities therefore it is known as dated government securities.

The Government borrows funds through the issue of long term-dated securities, the lowest risk category instruments in the economy. These securities are issued through auctions conducted by RBI, where the central bank decides the coupon or discount rate based on the response received. Most of these securities are issued as fixed interest bearing securities, though the government sometimes issues zero coupon instruments and floating rate securities also. In one of its first moves to deregulate interest rates in the economy, RBI adopted the market driven auction method in FY 1991-92. Since then, the interest in government securities has gone up tremendously and trading in these securities has been quite active. They are not generally in the form of securities but in the form of entries in RBI's Subsidiary General Ledger (SGL).

The investors in government securities are mainly banks, FIIs, insurance companies, provident funds and trusts. These investors are required to hold a certain part of their investments or liabilities in government paper. Foreign institutional investors can also invest in these securities up to 100% of funds-in case of dedicated debt funds and 49% in case of equity funds.

Till recently, a few of the domestic players used to trade in these securities with a majority investing in these instruments for the full term. This has been changing of late, with a good number of banks setting up active treasuries to trade in these securities. Perhaps the most liquid of the long term

instruments, liquidity in gilts is also aided by the primary dealer network set up by RBI and RBI's own open market operations.

Features: RBI, as an agent of the Government, manages and services these securities through its Public Debt Offices (PDO) located at various places. At present, there are dated securities with a tenor up to 20 years in the market. These securities are open to all types of investors including individuals and there is an active secondary market. These securities are eligible for SLR requirements. These securities are repoable.

3 Money Market Operations:The bank engages into a number of instruments that are available in the Indian money market for the purpose of enhancing liquidity as well as profitability. Some of these instruments are as follows: A. Call Money Market Call/Notice money is an amount borrowed or lent on demand for a very short period. If the period is more than one day and up to 14 days it is called 'Notice money' otherwise the amount is known as Call money'. Intervening holidays and/or Sundays are excluded for this purpose. No collateral security is required to cover these transactions.

Features: The call market enables the banks and institutions to even out their day-to-day deficits and surpluses of money. Commercial banks, Co-operative Banks and primary dealers are allowed to borrow and lend in this market for adjusting their cash reserve requirements. Specified All-India Financial Institutions, Mutual Funds and certain specified entities are allowed to access Call/Notice money only as lenders. It is a completely inter-bank market hence non-bank entities are not allowed access to this market. Interest rates in the call and notice money markets are market determined.

 In view of the short tenure of such transactions, both the borrowers and the lenders are required to have current accounts with the Reserve Bank of India. It serves as an outlet for deploying funds on short-term basis to the lenders having steady inflow of funds.

B. Treasury Bills Market:In the short term, the lowest risk category instruments are the treasury bills. RBI issues these at a prefixed day and a fixed amount. Treasury bills are available for a minimum amount of Rs.25, 000 and in multiples of Rs. 25, 000. There are three types of treasury bills. 91-day T-bill - maturity is in 91 days. Its auction is on every Friday of every week. The notified amount for this auction is Rs. 500 cr. 182-day T-bill - maturity is in 182 days. Its auction is on every alternate Wednesday (which is not a reporting week). The notified amount for this auction is Rs. 500 cr. 364-Day T-bill - maturity is in 364 days. Its auction is on every alternate Wednesday (which is a reporting week). The notified amount for this auction is Rs. 1000 cr.

Features: A considerable part of the government's borrowings happen through T-bills of various maturities. Based on the bids received at the auctions, RBI decides the cut off yield and accepts all bids below this yield.

The usual investors in these instruments are banks who invest not only to part their short-term surpluses but also since it forms part of their SLR investments, insurance companies and FIs. FIIs so far have not been allowed to invest in this instrument.

 These T-bills, which are issued at a discount, can be traded in the market. Most of the time, unless the investor requests specifically, they are issued not as securities but as entries in the Subsidiary General Ledger (SGL), which is maintained by RBI. The transactions cost on T-bill are non-existent and trading is considerably high in each bill, immediately after its issue and immediately before its redemption.

The yield on T-bills is dependent on the rates prevalent on other investment avenues open for investors. Low yield on T-bills, generally a result of high liquidity in banking system as indicated by low call rates, would divert the funds from this market to other markets. This would be particularly so, if banks already hold the minimum stipulated amount (SLR) in government paper.

C. Inter-Bank Term Money:Inter-bank market for deposits of maturity beyond 14 days and up to three months is referred to as the term money market. The specified entities are not allowed to lend beyond 14 days. The market in this segment is presently not very deep. The declining spread in lending operations, the volatility in the call money market with accompanying risks in running asset/liability mismatches, the growing desire for fixed interest rate borrowing by corporates, the move towards fuller integration between forex and money markets, etc. are all the driving forces for the development of the term money market. These, coupled with the proposals for Nationalization of reserve requirements and stringent guidelines by regulators/managements of institutions, in the asset/liability and interest rate risk management, should stimulate the evolution of term money market sooner than later. The DFHI, as a major player in the market, is putting in all efforts to activate this market.

The development of the term money market is inevitable due to the following reasons Declining spread in lending operations Volatility in the call money market Growing desire for fixed interest rates borrowing by corporate Move towards fuller integration between forex and money market

 Stringent guidelines by regulators/management of the institutions

D. Certificates of Deposits:After treasury bills, the next lowest risk category investment option is the certificate of deposit (CD) issued by banks and FIIs.

Features: Allowed in 1989, CDs were one of RBI's measures to deregulate the cost of funds for banks and FIIs. A CD is a negotiable promissory note, secure and short term (up to a year) in nature. It is issued at a discount to the face value, the discount rate being negotiated between the issuer and the investor. Though RBI allows CDs up to one-year maturity, the maturity most quoted in the market is for 90 days. The secondary market for this instrument does not have much depth but the instrument itself is highly secure. CDs are issued by banks and FIIs mainly to augment funds by attracting deposits from corporates, high net worth individuals, trusts, etc. the issue of CDs reached a high in the last two years as banks faced with a reducing deposit base secured funds by these means. The foreign and private banks, especially, which do not have large branch networks and hence lower deposit base use this instrument to raise funds. The rates on these deposits are determined by various factors. Low call rates would mean higher liquidity in the market. Also the interest rate on one-year bank deposits acts as a lower barrier for the rates in the market.

E. Commercial Paper (CP):Commercial Paper is a short term money market instrument comprising of unsecured, negotiable, short term usance promissory note with fixed maturity, issued at a discount to face value. CPs are issued by corporates to impart flexibility in raising working capital resources at market determined rates. CPs are actively traded in the secondary market since they are issued in the form of Promissory Notes and are freely transferable in demat form. 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. Issuers are Private sector Co., Public sector unit, Nonbanking Co., Primary dealers. All eligible participants shall obtain the credit rating for issuance of Commercial 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. The minimum credit rating shall be P-2 of CRISIL or such equivalent rating by other agencies. The issuers shall ensure at the time of issuance of CP that the rating so obtained is current and has not fallen due for review and the maturity date of the CP should not go beyond the date up to which the credit rating of the issuer is valid. Individuals, banking companies, other corporate bodies registered or incorporated in India and unincorporated bodies, Non-Resident Indians (NRIs) and Foreign Institutional Investors (FIIs) etc. can invest in CPs. However, amount invested by single investor should not be less than Rs.5 lakhs (face value). However, investment by FIIs would be within the limits set for their investments by Securities and Exchange Board of India (SEBI).

Maturity:CPs have a minimum maturity of 15 days and a maximum maturity of 1 year. They are available in the denomination of Rs. 5 lakhs and multiples of 5 lakhs and a minimum investment is Rs. 5 lakhs per investor.

Secondary market trading takes place in the lot in lots of Rs.5 lakhs each usually by banks. The transfer is done by endorsement and delivery.

Features: They do not originate from specific trade transactions like commercial bills. They are unsecured. Involve much less paper work. Have high liquidity.

F. Ready Forward Contracts It is a transaction in which two parties agree to sell and repurchase the same security. Under such an agreement the seller sells specified securities with an agreement to repurchase the same at a mutually decided future date and a price. Similarly, the buyer purchases the securities with an agreement to resell the same to the seller on an agreed date in future at a predetermined price. Such a transaction is called a Repo when viewed from the prospective of the seller of securities (the party acquiring fund) and Reverse Repo when described from the point of view of the supplier of funds. Thus, whether a given agreement is termed as Repo or a Reverse Repo depends on which party initiated the transaction.

Features The lender or buyer in a Repo is entitled to receive compensation for use of funds provided to the counter party. Effectively the seller of the security borrows money for a period of time (Repo period) at a particular rate of interest mutually agreed with the buyer of the security who has lent the funds to the seller. The rate of interest agreed upon is called the Repo rate. The Repo rate is negotiated by the counter parties independently of the coupon rate or rates of the underlying securities and is influenced by overall money market conditions.

The motivation for the banks and other organizations to enter into a ready forward transaction is that it can finance the purchase of securities or otherwise fund its requirements at relatively competitive rates. On account of this reason the ready forward transaction is purely a money lending operation. Under ready forward deal the seller of the security is the borrower and the buyer is the lender of funds. Such a transaction offers benefits both to the seller and the buyer. Seller gets the funds at a specified interest rate and thus hedges himself against volatile rates without parting with his security permanently (thereby avoiding any distressed sale) and the buyer gets the security to meet his SLR requirements. In addition to pure funding reasons, the ready forward transactions are often also resorted to manage short term SLR mismatches. Internationally, Repos are versatile instruments and used extensively in money market operations. While inter-bank Repos were being allowed prior to 1992 subject to certain regulations, there were large scale violation of laid down guidelines leading to the securities scam in 1992; this led Government and RBI to clamp down severe restrictions on the usage of this facility by the different market participants. With the plugging of loophole in the operation, the conditions have been relaxed gradually. RBI has prescribed that following factors have to be considered while performing repo: 1. Purchase and sale price should be in alignment with the ongoing market rates 2. No sale of securities should be affected unless the securities are actually held by the seller in his own investment portfolio. 3. Immediately on sale, the corresponding amount should be reduced from the investment account of the seller. 4. The securities under repo should be marked to market on the balance sheet date.

The relaxations over the years made by RBI with regard to repo transactions are: 1. In addition to Treasury Bills, all central and State Government securities are eligible for repo. 2. Besides banks, PDs are allowed to undertake both repo/reverse repo transactions.

3. RBI has further widened the scope of participation in the repo market to all the entities having SGL and Current with RBI, Mumbai, thus increasing the number of eligible non-bank participants to 64. 4. It was indicated in the Mid-Term Review of October 1998 that in line with the suggestion of the Narasimham Committee II, the Reserve Bank would move towards a pure inter-bank (including PDs) call/notice money market. In view of this non-bank entities will be allowed to borrow and lend only through Repo and Reverse Repo. Hence permission of such entities to participate in call/notice money market will be withdrawn from December 2000. 5. In terms of instruments, repos have also been permitted in PSU bonds and private corporate debt securities provided they are held in dematerialized from in a depository and the transactions are done in a recognized stock exchange. Apart from inter-bank repos RBI has been using this instrument effectively for its liquidity management, both for absorbing liquidity and also for injecting funds into the system. Thus, Repos and Reverse Repo are resorted to by the RBI as a tool of liquidity control in the system. With a view to absorbing surplus liquidity from the system in a flexible way and to prevent interest rate arbitraging, RBI introduced a system of daily fixed rate repos from November 29, 1997. Reserve Bank of India was earlier providing liquidity support to PDs through the reverse repo route. This procedure was also subsequently dispensed with and Reserve Bank of India began giving liquidity support to PDs through their holdings in SGL A/C. The liquidity support is presently given to the Primary Dealers for a fixed quantum and at the Bank Rate based on their bidding commitment and also on their past performance. For any additional liquidity requirements Primary Dealers are allowed to participate in the reverse repo auction under the Liquidity Adjustment Facility along with Banks, introduced by RBI in June 2000(Details given below).

The major players in the repo and reverse repurchase market tend to be banks that have substantially huge portfolios of government securities. Besides these players, primary dealers who often hold large inventories of tradable government securities are also active players in the repo and reverse repo market.

The Repo/Reverse Repo transaction can only be done at Mumbai between parties approved by RBI and in securities as approved by RBI (Treasury Bills, Central/State Govt securities).

Uses of Repo: It helps banks to invest surplus cash It helps investor achieve money market returns with sovereign risk. It helps borrower to raise funds at better rates An SLR surplus and CRR deficit bank can use the Repo deals as a convenient way of adjusting SLR/CRR positions simultaneously. RBI uses Repo and Reverse repo as instruments for liquidity adjustment in the system.

G. Commercial Bills:Bills of exchange are negotiable instruments drawn by the seller (drawer) of the goods on the buyer (drawee) of the goods for the value of the goods delivered. These bills are called trade bills. These trade bills are called commercial bills when they are accepted by commercial banks. If the bill is payable at a future date and the seller needs money during the currency of the bill then he may approach his bank for discounting the bill. The maturity proceeds or face value of discounted bill, from the drawee, will be received by the bank. If the bank needs fund during the currency of the bill then it can rediscount the bill already discounted by it in the commercial bill rediscount market at the market related discount rate.

The RBI introduced the Bills Market scheme (BMS) in 1952 and the scheme was later modified into New Bills Market scheme (NBMS) in 1970. Under the scheme, commercial banks can rediscount the bills, which were originally discounted by them, with approved institutions (viz., Commercial Banks, Development Financial Institutions, Mutual Funds, Primary Dealer, etc.).

With the intention of reducing paper movements and facilitate multiple rediscounting, the RBI introduced an instrument called Derivative Usance Promissory Notes (DUPN). So the need for physical transfer of bills has been waived and the bank that originally discounts the bills only draws

DUPN. These DUPNs are sold to investors in convenient lots of maturities (from 15 days up to 90 days) on the basis of genuine trade bills, discounted by the discounting bank.