A PROJECT REPORT

ON

STUDY OF TREASURY MANAGEMENT IN

BANKS
SUBMITTED BY
SALUNKHE VAISHALI BHARAT
T.Y.B.Com (B&I) [Semester V]

PADMASHREE ANNASAHEB JADHAV BHARTIYA SAMAJ UNNATI

MANDALS

B.N.N. COLLEGE
DHAMANKAR NAKA, BHIWANDI, 421302
SUBMITTED TO

UNIVERSITY OF MUMBAI
ACADEMIC YEAR
2016-2017

UNDER THE GUIDANCE OF

Ms. URVI GADA

A PROJECT REPORT
ON

STUDY OF TREASURY MANAGEMENT IN

BANKS
SUBMITTED BY
SALUNKHE VAISHALI BHARAT
T.Y.B.Com (B&I) [Semester V]

PADMASHREE ANNASAHEB JADHAV BHARTIYA SAMAJ UNNATI

MANDALS

B.N.N. COLLEGE
DHAMANKAR NAKA, BHIWANDI, 421302
SUBMITTED TO

UNIVERSITY OF MUMBAI
ACADEMIC YEAR
2016-2017

UNDER THE GUIDANCE OF

Ms. URVI GADA

Padmashree Annasaheb Jadhav Bhartiya Samaj Unnati Mandals

B.N.N.College, Bhiwandi.
(Arts, Science & Commerce) Dist.Thane 421 305
SELF FUNDED COURSES
Bachelor of Banking and Insurance (B.B.I.)
Est. June 1966

CERTIFICATE
This is to certify that, MISS. SALUNKHE VAISHALI
BHARAT. (Roll No.07) of T.Y.B Com (B&I), B.N.N College,
Semester V (Academic Year 2016 - 2017) has successfully completed
the project entitled STUDY OF TREASURY MANAGEMENT IN
BANKS and submitted the Project Report in partial fulfillment of the
requirement for the award of the Degree of B.Com (Banking &
Insurance sem.-V) of University of Mumbai.

Ms. Urvi Gada

(Project Guide)

Examiner: -

Dr. Suvarna T. Rawal

(Co-ordinator)

Dr. Ashok D. Wagh

(Principal)

1._______________________

College Seal

DECLARATION
I, Miss SALUNKHE VAISHALI BHARAT

(Roll

No.07) of TY.B.Com.(Banking and Insurance) Semester V,

studying in B.N.N. College, Bhiwandi, hereby declare that
the information contained in the project titled STUDY OF
TREASURY MANAGEMENT IN BANKS is true and
correct to the best of my knowledge and belief.

______________________
__
SALUNKHE VAISHALI BHARAT
T.Y.B Com (B&I)

PLACE: BHIWANDI
DATE:

ACKNOWLEDGEMENT
I am deeply indebted to my project guide, my family and friends who have
supported me all through my project by encouraging and inspiring me. They have
also contributed to the quality of the material presented in the project. I would like
to acknowledge all those whom I owe a debt of gratitude. It is my foremost duty
to express my sincere gratitude towards my mentor, guru and guide, Miss Urvi
Gada ,Assistant Professor, B.N.N. College, Bhiwandi, Dist.Thane, Maharashtra
for her constant encouragement, support and generous attitude which helped me
with new insights not only in understanding different aspects of my project but
also the intricacies of life. It was truly an enriching experience working under her
guidance.
I must thank the Management of B.N.N. College, Dist.Thane, Maharashtra and
our Principal
Dr. Ashok D. Wagh for constantly encouraging me. I also thank our coordinator
Dr. Suvarna T. Rawal, and all Vice-Principal of B.N.N. College for their constant
support and cooperation.

I express my deep sense of gratitude to all my teachers, friends and all

well wishers who were always concerned about my project and contributed
directly or indirectly for the successful completion of my project work.

SALUNKHE VAISHALI
BHARAT

INDEX
CHAPTERS

CONTENTS

PAGE NO.

Introduction

1-3

Profile

4-6

Review of literature

Data Analysis and interpretation

Observations and Conclusions

Suggestions

Bibliography

TREASURY
MANAGEMENT
IN BANK

CHAPTER 1: TREASURY MANAGEMENT

INTRODUCTION
1Meaning & Definition
Treasury management includes management of enterprises holding, with the
ultimate goal of managing the firms liquidity and mitigating its operational,
financial and reputational risk. Treasury Management includes a firms
collections, disbursements concentration, investment and funding activities. In
larger firms, it may also includes trading in bonds, currencies, financial
derivatives and the associated financial risk management.
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
seek to maximize profit and earning by investing available funds at an acceptable
level of risks. Returns and risks both need to be managed. If we examine the
balance sheets of Commercial Banks, 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.
8

 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 loanassets, as the latter is size ably a book-entry.
In this context, treasury management are 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.

Meaning:
Most bank have whole departments devoted to treasury management and
supporting their client needs in this area. Until recently large bank had the
stronghold on the provision of treasury management products and services.
However, smaller bank are

increasingly launching and/or expanding their

treasury management function and offering, because of the market opportunity

afford by recent economic environment (with bank of all sizes focusing on the
clients they serve best),availability of (recently displaced) highly seasoned
treasury management professionals, access to industry standard, third- party
technology providers products and services tiered according to the needs of
smaller clients, and investment in education and other best practices. A number of

independent treasury management system (TMS)n like visual risk are available,
allowing enterprises to conduct treasury management internally.

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 end of the spectrum, treasury can help restructure the balance sheet and
provide new products.
All banks have departments devoted to treasury management, as do larger
corporations. Treasury management modules are available for many larger
enterprise software systems. Banks do not disclose the prices they charge for
Treasury Management products.
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 cost of the business, and control interest rate risk
and currency exposure to an acceptable level.
In other words,Treasury management (or treasury operations) includes
management of an enterprise' holdings in and trading in government and
corporate bonds, currencies, financial futures, options and derivatives, payment
systems and the associated financial risk management.

10

1.2 Objectives of Study

To have in-depth knowledge about the meaning of Treasury Management.

To know about the functions, organizational structure and objective of

Treasury Management in Banks.

To understand the elements of Treasury Management and the functions of

treasurer.

To understand the risk associated with Treasury Management and their

mitigation.

To know what are the RBI guidelines formulated for Treasury

Management.

To know the future scope involved in Treasury Management.

1.3 Scope of Study

Treasury management includes the management of cash flows, banking, money
market and capital-market transactions; the effective control of the risks
11

associated with those activities; and the pursuit of optimum performance

consistent with those risks. This definition is intended to embrace an
organizations use of capital and project financings, borrowing, investment, and
hedging instruments and techniques.

Understanding the Treasury Management Accounting Process in banks

You use accounting templates to define the ChartFields to use for various kinds of
accounting activities, called accounting events. By associating accounting
templates with accounting events, you can automate most of the accounting
process. In addition, you can also manually adjust accounting entries and create
ad hoc entries.
Accounting Templates
The accounting template depicts the correct accounting and debit and credit
configuration for a given treasury transaction and business event. For example,
the purchase of a U.S. Treasury bond may involve the construction of two debit
lines, Bonds Receivable and Unamortized Bond Discount, as well as one credit
line, Cash. The accounting template for this type of transaction would include
three predefined records to depict this particular debit or credit configuration.
The accounting template contains the following characteristics:

A unique template ID.

Options that determine how the correct ChartField combination is
selected.

An attribute (calculation type) that describes how the accounting monetary

amount is calculated or derived.

An attribute that designates whether the accounting build requires review.

Accounting Events
An accounting event describes an event in the treasury business process that
triggers the construction of a pending accounting build.
Oracle delivers the following treasury accounting event types with the system:

Deal transactions.
12

Facility, deal, wire, and letter of credit fees.

Bank transfers.

Bank statement processing transactions.

Hedges.

Electronic File Transfer (EFT) requests.

Internal account interest.

Investment pool transactions.

To automate accounting entries, you assign each accounting event type to a

corresponding accounting template for all accounting events except bank
transfers. Bank transfers do not have accounting templates because the accounting
is derived from the bank and business unit of the bank. The template controls
which ChartFields and monetary amounts to use in each accounting entry.
For treasury deals, you define the accounting event at the instrument level. You
associate each instrument with various accounting events, depending on the
instrument base type. In addition, you define each accounting event based on the
accounting treatment (Held to Maturity, Available for Sale, Trading, or Other) and
assign each accounting template to the appropriate accounting treatment. At deal
entry, you select the appropriate accounting treatment. The system then
automatically associates the appropriate accounting template, based on the
accounting treatment of the instrument type.
The following diagram illustrates the process flow:
Image: Process flow for treasury accounting
Process flow for treasury accounting from general accounting event to Journal
Generator

13

runit and Intraunit Processing in Accounting

The PeopleSoft centralized processor generates the due-to and due-from entries
for both interunit and intraunit balancing. PeopleSoft Treasury Management
provides functionality to support interunit and intraunit processing using the
centralized processor on the Accounting Template and Accounting Entries pages.
Interunit and Intraunit Balancing Methods
Interunit refers to balancing transactions that involve two general ledger business
units. The bank accounts contain the ChartFields and the rules by which their
values should be determined.

14

Intraunit refers to balancing transactions within the same general ledger business
unit in which the transaction involves more than one value on the lower level
balancing ChartField. For all transactions that Treasury Management generates,
the system obtains the ChartFields from either the bank account or an accounting
template. Inherited ChartFields obtain their values from the corresponding
ChartField on the offsetting entry.
Treasury System Transaction Definitions
To facilitate interunit and intraunit processing, you segregate your interunit and
intraunit payable and receivable accounts by the type of transaction. The interunit
and intraunit system transactions are a predefined list of transactions, with one
system transaction for each major type of Treasury transaction that generates
interunit and intraunit entries. By defining transaction codes and associating them
with system transactions, you control the level by which you segregate your
Interunit and intraunit balances.
Important! Oracle delivers predefined system transactions, which you can view on
the System Transaction Definition page. You should not change the information
on this page because it affects the intraunit and interunit processing.
See Running the Centralized Interunit and Intraunit Processor.
This table associates a system-defined transaction with a PeopleSoft accounting
source:
Accounting Source

System Transactions

Deals

TRDEAL

Hedges

TRHEDGE

Letter of Credit, Deal, Facility, or EFT Fees TRFEE

Bank Statement Items

TRBSP

EFT Requests

TREFT

Bank Transfers

TRBAX

Interunit Interest

TRIUINT

Manual Entry

TRMANUAL
15

Accounting Source

System Transactions

Investment Pools
TRINPOOL
Intraunit and Interunit Accounting Entries Generation Using the
Centralized Processor
Here is an overview of the process:
1. Specify an anchor entry in the accounting template as a model for any
interunit and intraunit entries.
The anchor entry cannot be a line where the ChartField is determined by
Bank Account.
2. Process treasury accounting using the Automated Accounting process
(TR_ACCTG), which invokes the centralized processor. The centralized
processor automatically creates any necessary offset entries that are tagged
with the source identifier label System IU (viewable on the Additional
Details tab of the Accounting Entries page) and inserts these data into the
accounting tables.
3. If you make any changes to an accounting entry line, you must click the
Update Accounting button to invoke the centralized processor and
regenerate accounting entries.

16

1.4 Review of Literature

Managing of Treasury transactions in banking SystemWithin a multi

currency economy
Author: Nidal Rashid Sabri
Diama K. Abulabn
Dima W. Hanyia
The Palestinian economy has no national currency which led to having three
currencies in use for deposits, saving, wealth measurement and trade transactions.
Thus leads to make challenges to the management of banking treasury activities
and balances of each single currency in the Palestinian economy. Therefore, this
research aimed to target this issue, using three research instruments. Three
research instruments were used including: Examining the related laws, imposed
by the PMA on banks working in Palestinian economy as well as individual
banking regulations, structures interviews with banks treasurers, and a relevant
questionnaires was directed to a selected samples of treasury staff and employees
regarding challenges to the management of banking treasury and closeting of
foreign currency positions. The study found that management of the banks
working in the Palestinian economy imposed more strict levels then that imposed
by PMA and decreased it to 1% to 3%, of the total owner equity instead of 5%,
while others (42%) reduced the maximum permitted surplus of a currency to a
value ranged between 200,000 US$ and 500,000 US$. For closing the surplus of
currencies, the majority of banks close it in the last hour of working day. The
majority of treasuries' staff strongly agreed that there is a need for additional
legislation to cover all related transactions to facilitate the work of the treasury.

1.5 Needs and Benefits

17

Treasury management is the process of managing and organizing the finance to

optimize the economic growth in the organization. It is the process of planning,
organizing and managing the organizations holdings, corporate bonds,
currencies, financial futures, options, derivatives, payment systems and associated
risks.

Treasury is the place of deposit reserved for storing treasures and disbursement
of collected funds.
Teigen Lee E

Need
Treasury management is mainly required to optimize the economy of the
organization and provide an ability to manage financial risks.

Benefits:

It. Increase the sale of the product.

It provides better guideline and methods to manage risk

It help to optimize assets and debt performance while minimizing

the need for external funding.

It enables the organization to analyze variety of data which

includes fund, transaction, foreign exchange rates ,market data and
third party information.

1.6 Objective of treasury management

1) Arranging funds in profitable manner.
18

2) Availability of funds in right quantity .

3) Availability of funds in right time.
4) Deployment of funds in profitable manner.
5) Deployment of funds in right quantity.
6) Deployment of funds in right time.
7) Effective dealing in forex, money and commodity markets to reduce risks
arising because of fluctuating exchange rates, interest rates and prices which
can affect the profitability of the organization.
8) Maximize the return on the available cash,
9) Minimize interest cost on borrowings,
10) Mobilise as much cash as possible for corporate ventures.

19

1.7 Tools of treasury management

Treasury manager is required to work in a fast changing and competitive
environment. For carrying out his activities, he has to certain tools and
techniques. Most of the tools originate from the finance department and as such
cannot be considered to be an exclusive prerogative of the treasury department.
Yes it is the treasury manager which is using these tools most extensively. The
tools are being described below:
Analytic and planning tools: In treasury function, planning and budgeting are
essential to achieve targets and to keep effective control on costs. Analysis of the
data and information is necessary for planning and budgeting. Performance
budgeting is referred to as setting of physical targets for each line of activity. The
financial outlay or expenditure needed for each is earmarked to choose the least
cost mode of activity to achieve the targets. Productivity and efficiency improves
by decentralization of responsibility and that is achieved by performance
budgeting, where each department or section is made a profit center and is
accountable for its targets, financial involvements and profits in financial terms,
relative to the targets in physical terms. This type of planning involving
performance budgeting is best suited for service industry say financial services
company or bank where every department can function in a decentralized manner
and achieve the targets.

Zero based budgeting (ZBB): Another tool of analysis and performance is

ZBB wherein each manager establishes objectives for his function and gain
agreement on them with top management. Then alternate ways for achieving these
targets are defined and most practical way for achieving the targets is selected.
This alternative is then broken into incremental levels of effort required to achieve
the objective. For each incremental level of activity, costs and benefits are
assessed. The alternative with the least cost is then selected.

20

Financial statement analysis: financial analysis of a company is necessary to

help the treasury manager to decide whether to invest in the company. Such
analysis also helps the company in internal controls. The soundness and intrinsic
worth of a company is known only by such analysis. The market price of a share
depends, among other things on the sound fundamentals of the company, the
financial and operational efficiency and the profitability of that company. These
factors can be known by a study of financial statements of the company.

Cost of capital: cost of capital is the minimum rate of return expected by its
investor it acts as a cut off rate or a hurdle rate or the minimum acceptable rate of
return from an investment. It is the weighted average cost of various sources of
finance used by the company. The cost of capital is the minimum rate of return
expected by the investors which will maintain the market value of shares at its
present value. If the firm is not able to achieve the cut off rate, market value of its
share will fall. Hence to achieve the objective wealth maximization, a firm must
earn a rate of return more than its cost of capital.

Depository system: the depository system functions very much like the
banking system. A bank holds funds in accounts whereas depository holds
securities in accounts for its clients. A bank transfer funds between accounts
whereas a depository transfers securities between accounts. In both systems the
transfer of funds or securities happens without the actual handling of funds or
securities. Both the banks and the depository are accountable for the safe keeping
of funds and securities respectively. In the depository system, shares certificate
belonging to the investors are to be dematerialized and their names are required to
be entered in the records of depository as beneficial owners. Consequent to these
changes, the investors names in the companies register are replaced by the
name of depository, however, does not have any voting rights or other economic
rights in respect of the shares as a registered owner. The beneficial owner

21

continues to enjoy all the rights and benefits and is subject to all the liabilities in
respect of the securities held by a depository.

Role of IT in treasury management

(1) Helps in automate of repetitive tasks and process which results in
(2)
(3)
(4)
(5)
(6)
(7)
(8)

avoiding delays and minimization of human errors.

Aids implementing internal control system.
IT helps in saving time a lot.
In fraud and error detection methodology.
Effective forecast of cash flow.
Proper communication system among the operating units.
IT helps in web based treasury management system.
IT helps treasury management to focus on data along with experience and
knowledge

22

1.8 Treasury Management In Banks:

Fund based businesses in the banking and financial sector are involved in lending
to or investing in the market, the funds they raise from the market. They perform
an important intermediating role. Loan companies seek to capitalize on the
spread between borrowing and lending rates. Investment companies aim to benefit
from movements in the capital market. Following are the treasury products used
for controlling the overall funds of the banks:

1) Liquidity Management: The objectives of liquidity management are

to maintain statutory prescription, meet contractual and maturing cash
outflows and to profitable deploy surplus cash. Sound liquidity
management involves prudently managing cash flows; have an appropriate
relationship to approaching cash outflows.

2) Audit: Audit of an integrated treasury is a complex task requiring high

level of skills, knowledge of market practices and the relevant regulatory
environment. Treasury income constitutes significant portion of a banks
income, many a time equal to the entire income received from advances
and the extensive branch network of banks .

3) Money Market: the money market is a market for short term financial
assets that are close substitutes for money. The important feature of a
money market instrument is that it is liquid and can be turned over quickly
at low cost and it provides an avenue for equilibrating the short term
surplus funds of lenders and the requirement of borrowers. There is strictly
no demarcated distinction between short money market and long term
capital market and in fact there are integral links between the two markets
as the array of instrument in the two markets invariably forms a
continuum.

23

4) Foreign Exchange Market: The foreign exchange marketer forex

market as it is often called is the market in which currencies are traded. In
addition, there is no central marketplace for the exchange of currency, but
instead the trading is conducted over- the-counter unlike the stock market,
this decentralization of the market allows traders to choose from a number
of different dealers to make trades with and allows for comparison of
prices.

5) Derivatives: The term derivatives stand for contract whose price is

derived from or is dependent upon on underlying asset. The underlying
asset could be financial asset such as currency, stock and market index, an
interest bearing security or a physical commodity. Today, around the
world, the derivative contracts are traded on electricity, weather,
temperature and even volatility.
According to Securities Contract Regulation Act,(1956) the term derivative
includes:
1) a security
secured

derived

from a debt instrument, share, loan whether

or

unsecured, risk instrument or contract

for differences or any other of security;

2) a contract which derives its value from the prices, or index of prices of
underlying securities

24

CHAPTER 2: TREASURY
2.1 Organizational structure of treasury
There is no standard structure for treasury department of a bank. Depending on
the responsibilities assigned and power delegated, it can be aptly structured.
Typically, banks maintain three independent tiers at the functional/operational
levelTier I Dealing Desk (Front Office): The dealers and traders in different
markets- money, stock, debt, commodity, derivatives and forex- operate in their
respective areas. They are the first point if interface with other participants in the
market. The number of dealers depends on the size and frequency of the
operations. In case of larger in each bank, operations would be carried out by
separate and independent set of dealers in each market. But, for a relatively
smaller treasury, operations would be done by one or more dealers jointly in all
the markets.
Tier II Settlement Desk (Back Office): Once the deals are concluded, it is for
the back office to process and settle the deals. Indeed, the back office undertakes
settlement and reconciliation operations.
Tier III Accounting, Monitoring and Reporting Office (Audit group): This
department looks after the activities relating to accounting, auditing and reporting.
Accountants record all deals in the books of accounts, while auditors and
inspectors closely monitor all deals and transactions done by the front and the
25

back office, and send regular reports to authorities concerned. This department
independently inspects daily operations in the treasury department to ensure
internal/regulatory system and procedures.

Head of Treasury

Chief
Dealer

Market
Intelligence
Research and
analysis

ManagerFunds/Reser
ve

ManagerSettlements
Documentation

DealerRupee
Money
Market.
Department

DealerForex.
Currency/
Investment

Head of
Settlement
s

Manager
Settlement
s
Custodian

Head of
Accounting
Monitoring and
Reporting

Accounts/
Monitoring

Audit/Reporti
ng

Dealer- Corpo
Merchant/
Service

26

The three departments should be compartmentalized and they act independently.

The heads of each section reports directly to the Head of the Treasury. A treasury
can have more functional desk depending on the size and structure of the bank,
and activities undertaken by the bank.

2.2 FUNTION TREASURY DEPARTMENT

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:
a) Reserve Management & Investment: It involves (i) meeting CRR/SLR
obligations, (ii) having an appropriate mix of investment portfolio to
optimize yield and duration. Duration is the weighted average life of a
debt instrument over which investment in that instrument is recouped.
Duration Analysis is used as a tool to monitor the price sensitivity of an
investment instrument to interest rate charges.
b) Liquidity & Funds Management: It involves (i) analysis of major cash
flows arising out of asset-liability transactions (ii) providing a balanced
and well-diversified liability base to fund the various assets in the balance
sheet of the bank (iii) providing policy inputs to strategic planning group
of the bank on funding mix (currency, tenor & cost) and yield expected in
credit and investment.

27

c) Asset Liability Management & Term Money: ALM calls for

determining the optimal size and growth rate of the balance sheet and also
prices the Assets and liabilities in accordance with prescribed guidelines.
Successive reduction in CRR rates and ALM practices by banks increase
the demand for funds for tenor of above 15 days (Term Money) to match
duration of their assets.
d) Transfer Pricing: Treasury is to ensure that the funds of the bank are
deployed optimally, without sacrificing yield or liquidity. An integrated
Treasury unit has as idea of the banks overall funding needs as well as
direct access to various market ( like money market, capital market, forex
market, credit market). Hence, ideally treasury should provide benchmark
rates, after assuming market risk, to various business groups and product
categories about the correct business strategy to adopt.
e) Derivative Products: Treasury can develop Interest Rate Swap (IRS) and
other Rupee based/ cross- currency derivative products for hedging Banks
own exposures and also sell such products to customers/other banks.
f) Arbitrage: Treasury units of banks undertake this by simultaneous buying
and selling of the same type of assets in two different markets to make
risk-less profits.
g) Capital Adequacy: This function focuses on quality of assets, with
Return on Assets (ROA) being a key criterion for measuring the efficiency
of deployed funds. An integrated treasury is a major profit centre. It has its
own P&L measurement. It undertakes exposures through proprietary
trading (deals done to make profits out of movements in market interest/
exchange rates) that may not be required for general banking.

28

h) Coordination: Banks do operate at more than one money market centers.

All the centers undertake similar transactions with differing volumes.
There is a need to coordinate the activities of these centers so that
aberrations are avoided (situations where one center is lending and the
other one is borrowing at the same time). The task of coordination of
foreign exchanges positions is no different.
i) Control and Development: Treasury operates as the focal point of
dealing operations. Dealing operations could include cash/spot, forward,
futures, options, interest and currency liability swaps, forward rate
agreements and the like. Treasury is the sole owner and performer of these
transactions.
j) Fraud Protection: The decade of nineties has witnessed more frauds in
trading than banking books. The amount and variety of such
embezzlements have been directly relatable to the operational level. The
ground level task of this kind is to be undertaken at the treasury.

29

The traditional treasury functions can be depicted as below

Traditional Treasury Functions

Cash
Management

Currency
Management

Fund
Management

Corporate
Management

Risk
Management

The traditional treasury functions can be depicted as below

Cash management:
It deals with managing the collections and repayment of cash.

Currency management:
It deals with foreign currency and exchange rate management.

Fund management:
It is the process of planning and outsourcing the short, medium and long term
cash needs.

Corporate management:
It deals with achieving strategic financial goals.

30

Risk management:
It deals profits and protecting assets.

ls profits and protecting assets.

2.3 Elements of treasury management

2.3.1 Cash Reserve Ratio (CRR)
The core business of banks is mobilizing the deposits and utilizing the same for
credit accommodation. However, it should be taken into consideration that the
banks are not allowed to use the entire amount for extending credit. In order to
promote certain prudential norms for healthy banking practices, most of the
developed economies require all banks to maintain minimum liquid and cash
reserves. As such, banks are required to ensure that these statutory reserve
requirements are met before directing on their credit plans.
Maintenance of CRR
As per the RBI Act 1934, Scheduled Commercial Banks are required to maintain
with RBI an average cash balance, the amount of which shall not be less than
three per cent of the total of the Net Demand and Time Liabilities (NDTL) in
India, on a fortnightly basis and RBI is empowered to increase the said rate of
CRR to such higher rate not exceeding twenty percent of the Net Demand and
Time Liabilities (NDTL) under the RBI Act, 1934. At present, effective from
October 2 ,2004, the rate of CRR would be 4 per cent of the NDTL. Thus, all
Scheduled Commercial Banks are required to maintain the prescribed Cash
Reserve Ratio based on their NDTL as on the last Friday of the second preceding
fortnight.
With a view to providing flexibility to banks in choosing an optimum strategy of
holding reserves depending upon their intra period cash flows, all Scheduled
Commercial Banks are required to maintain minimum CRR balances upto 70 per
31

cent of the total CRR requirement on all days of the fortnight with effect from the
fortnight beginning December 28, 2002. If any Scheduled Commercial Bank fails
to observe the minimum level of CRR on any day/s during the relevant fortnight,
the bank will not be paid interest to the extent of one fourteenth of the eligible
amount of interest, even if there is no shortfall in the CRR on average basis.
Computation of Demand & Time Liabilities
Liabilities of a bank may be in the form of demand or time deposits or borrowings
or other miscellaneous items of liabilities.
'Demand Liabilities' include all liabilities which are payable on demand and they
include current deposits, demand liabilities portion of savings bank deposits,
margins held against letters of credit/guarantees, balances in overdue fixed
deposits and cumulative/recurring deposits, outstanding Telegraphic Transfers
(TTs), Mail Transfer (MTs), Demand Drafts (DDs), unclaimed deposits, credit
balances in the Cash Credit account and deposits held as security for advances
which are payable on demand.
Time Liabilities are those which are payable otherwise than on demand and they
include fixed deposits, cumulative and recurring deposits, time liabilities portion
of savings bank deposits, staff security deposits, margin held against letters of
credit if not payable on demand, deposits held as securities for advances which
are not payable on demand and Gold Deposits.
Money at Call and Short Notice from outside the Banking System should be
shown against Liability To Others. Loans/borrowings from abroad by banks in
India will be considered as 'liabilities to others' and will be subject to reserve
requirements. When a bank accepts funds from a client under its remittance
facilities scheme, it becomes a liability (liability to others) in its books. The

32

liability of the bank accepting funds will extinguish only when the correspondent
bank honors the drafts issued by the accepting bank to its customers.
Other Demand and Time Liabilities (ODTL) include interest accrued on
deposits, bills payable, unpaid dividends, suspense account balances representing
amounts due to other banks or public, net credit balances in branch adjustment
account, any amounts due to the "Banking System" which are not in the nature of
deposits or borrowing.
Liabilities not to be included for NDTL computation
The under-noted liabilities will not form part of liabilities for the purpose of CRR:
a) Paid up capital, reserves, any credit balance in the Profit & Loss Account of the
bank, amount availed of as refinance from the RBI, and apex financial institutions
like Exim Bank, IDBI, NABARD, NHB, SIDBI etc.
b) Amount of provision for income tax in excess of the actual estimated liabilities.
Amount received from DICGC (Deposit Insurance and Credit Guarantee
Corporation) towards claims and held by banks pending adjustments thereof.
d) Amount received from ECGC (Export Credit Guarantee Corporation) by
invoking the guarantee.
e) Amount received from insurance company on ad-hoc settlement of claims
pending Judgment of the Court.
f) Amount received from the Court Receiver.
g) The liabilities arising on account of utilization of limits under Bankers
Acceptance Facility
h) Inter bank term deposits/term borrowing liabilities of original maturity of 15
days and above and upto one year with effect from fortnight beginning August 11,
2001.

33

Change in CRR as RBI's Strategy

In case of any shortfall banks generally tend to borrow from the call money
market to meet the cash reserve ratio (CRR) requirements, which they should
maintain with the Reserve Bank of India (RBI) every fortnight.
When the Reserve Bank of India (RBI) cuts the CRR rates, the general
expectation is that bankers would greet the news warmly as it provides them an
opportunity to retain more funds, which could be used productively. However,
taking into consideration the recent banking scenario the bankers consider it as a
not very fruitful exercise, as the investment avenues are very minimal and highly
risky in nature. Moreover, a decrease in CRR results into lesser funds to be locked
up in RBIs vaults and further infusing greater funds into a system.
When there is a fall in CRR, it increases money with the banks, which could then
be used for productive purposes. However, the question that one needs to ask is
"Why infuse more money into a system which is already flush with liquidity? The
main reason for high liquidity is increasing number of customers approaching
banks to open up deposit accounts.
Moreover, credit risk has always been present in the banking industry because of
its very nature of business. This has gathered momentum in the recent past due to
mounting non-performing assets (NPAs). Almost all the banks are facing the
problem of bad loans, burgeoning non-performing assets, thinning margins, etc. as
a result of which, banks are little reluctant in granting loans to corporates.
This results into a good liquidity position of commercial banks as deposits are
showing a continuous increase whereas, mobilization of funds for productive
purposes is much more restrictive in nature. Also, the bankruptcy of major
corporates in recent past has added to their fear of possible non-recovery of
advances.

34

As such, as and when Reserve Bank of India (RBI) reduces the CRR, it further
enhances loanable funds with the banks and reduces their dependence on the call
and term money market. This will in turn reduce the call rates and the borrowing
cost of the government.
Thus the Impact of CRR cut as RBIs strategy creates a terribly uncomfortable
situation from the banks point of view and Reserve Bank of India (RBI) further
enhances its liquidity position, with no productive avenues available for
investment purposes.

2.3.2 Statutory Liquidity Ratio (SLR)

As per the B.R. Act, 1949 all Scheduled Commercial Banks, in addition to the
average daily balance which they are required to maintain u/s 42 of the RBI Act,
1934, maintain1
a) In cash, or
b) In gold valued at a price not exceeding the current market price, or
c) In approved securities valued at a price as specified by the RBI from time to
time an amount of which shall not, at the close of the business on any day, be less
than 25 per cent or such other percentage not exceeding 40 per cent as the RBI
may from time to time, by notification in gazette of India, specify, of the total of
its demand and time liabilities in India as on the last Friday of the second
preceding fortnight.
At present, all Scheduled Commercial Banks are required to maintain a uniform
SLR of 21.50% of the total of their demand and time liabilities in India.
Computation of demand and time liabilities for SLR
The procedure to compute total NTDL for the purpose of SLR is similar to the
procedure followed for CRR purpose. However, it is clarified that Scheduled
Commercial Banks are required to include inter-bank term deposits/ term
borrowing liabilities of original maturities of 15 days and above and up to one
35

year in 'Liabilities to the Banking System'. Similarly banks should include their
inter-bank assets of term deposits and term lending of original maturity of 15 days
and above and up to one year in 'Assets with the Banking System'
Penalties
If a banking company fails to maintain the required amount of SLR, it shall be
liable to pay to RBI in respect of that default, the penal interest for that day at the
rate of 3 per cent per annum above the bank rate on the shortfall and if the default
continues on the next succeeding working day, the penal interest may be increased
to a rate of 5 percent per annum above the Bank Rate for the concerned days of
default on the shortfall.
RBI GUIDELINES
All the transactions put through by a bank, either on outright basis or ready
forward basis and whether through the mechanism of Subsidiary General Ledger
(SGL) Account or Bank Receipt (BR), should be reflected on the same day in its
investment account and, accordingly, for SLR purpose wherever applicable.
Purchase/ sale of any securities will be done through SGL A/c under the Delivery
Versus Payment (DVP) System.

All transactions in Govt. securities for which SGL facility is available

should be put through SGL A/cs only.

Under no circumstances, a SGL transfer form issued by a bank in favour

of another bank should bounce for want of sufficient balance of securities
in the SGL A/c of seller or for want of sufficient balance of funds in the
current a/c of the buyer.

The SGL transfer form received by purchasing banks should be deposited

in their SGL A/cs. immediately i.e. the date of lodgement of the SGL Form

36

with RBI shall be within one working day after the date of signing of the
Transfer Form.

SGL transfer forms should be signed by two authorised officials of the

bank whose signatures should be recorded with the respective PDOs
(Public Debt Office) of the Reserve Bank and other banks.

Any bouncing of SGL transfer forms issued by selling banks in favour of

the buying bank, should immediately be brought to the notice of the
Regional Office of Department of Banking Supervision of RBI by the
buying bank.

If a SGL transfer form bounces for want of sufficient balance in the SGL
A/c, the following penal action against it is taken:

In case of any default arising in the current a/c, such amount will
be penalised by the RBI @ of 3 % above the Discount and Finance
House of Indias (DFHI) call money lending rate of that day. And
if this rate is lower than the PLR than the penal rate would be 3 %
above the current PLR.

If the bouncing of the SGL form occurs thrice, the bank will be
debarred from trading with the use of the SGL facility for a period
of 6 months from the occurrence of the third bouncing. If, after
restoration of the facility, any SGL form of the concerned bank
bounces again, the bank will be permanently debarred from the use
of the SGL facility in all the PDOs of the Reserve Bank.

37

COMMERCIAL PAPERS (CPs)

Commercial Papers (CPs) are short-term unsecured usance promissory

notes issued at a discount to face value by reputed corporates with high
credit rating and strong financial background. Companies issue CPs
typically to finance accounts receivable and inventories at a discount
reflecting the prevailing market interest rates.

Issuers: private sector Co., public sector unit, non-banking Co., primary
dealers.

Commercial Papers are open to individuals, corporates, NRIs and banks,

but NRIs can invest on non-repatriable / non-refundable basis. FIIs have
also been allowed to invest their short-term funds in Commercial Papers.

CPs have a minimum maturity of 15 days and a maximum maturity of 1

year. They are available in the denomination of Rs. 5 lakh and multiples of
5 lakh and a minimum investment is Rs. 5 lakh per investor.

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

CPs are issued only if the total cost is lower than PLR of banks.

The features of CPs are:

1. They do not originate from specific trade transactions like
commercial bills.
2. They are unsecured.
3. Involve much less paper work.
4. Have high liquidity.

CPs are issued at a discount to the face value. The issue price is calculated
as below.
P = Face value / (1 + D * (N / 365))

Where, F= Face/Maturity value

D= Discount Rate

P = Issue price of the CP

N = Usance period (No. of days)
38

Types of Papers
Commercial paper can be issued either directly or through a dealer.

If the paper is issued by the company directly to the investors without

dealing with an intermediary, it is referred as direct paper.

If CPs is issued by an intermediary (i.e. dealer / merchant banker) on

behalf of its corporate client, it is known as dealers paper.

39

CERTIFICATE OF DEPOSIT (CDs)

Certificate of Deposit (CDs) are usance promissory notes, negotiable and

in marketable form bearing a specified face value and number.

Scheduled commercial banks and the major financial institutions can issue
CDs within the umbrella limit fixed by RBI.

Individuals, corporate, companies, funds, associations, trusts and NRIs are

the main investors in the CDs (on non-repatriable basis).

CDs are issued for a period of 14 days to one year (normally one to three
years by the financial institutions) at a minimum amount of Rs. 5 lakh and
in multiples of Rs.5 lakhs thereafter with no upper limit.

There is no specific procedure to issue CDs. It is available, on tap, with

the bankers.

CDs are the largest money market instruments traded in dollars. They are
issued by either banks or depository institutions, mostly in bearer form
enabling trading in the secondary market.

The features of CDs are:

It is title document to a time deposit, riskless, liquid and highly

negotiable and marketable.

It is issued at a discount to the face value.

It is freely transferable by endorsement and delivery.

CDs are maturity-dated obligations of banks forming a part of

time liabilities, and are subjected to usual reserve requirements.

It does attract stamp duty.

CDs issued are within the limit as specified by Reserve Bank

of India (in case of FIs only).

CDs are also issued in demat forms. Thus various advantages

of dematerialization can be availed.

40

BILL FINANCING

Monetary policy and Bill financing refers to the use of the official
instruments under the control of the Central Bank of the country to
regulate the availability, cost and use of money and credit.

The bank standard rate is the rate at which the bank is prepared to buy or
rediscount bills of exchange or other commercial paper eligible for
purchases.

A bill of exchange has been defined as an instrument in writing containing

an unconditional order, signed by the maker, directing a certain person to
pay a certain sum of money only to, or to the order of, a certain person or
to the bearer of the instrument.

Bills of exchange can be classified as demand or usance bills,

documentary or clean bills, D/A or D/P bills, inland or foreign bills, supply
bills or government bills or accommodation bills.

Bills can also be classified as traders bills, bills with co-acceptance, bills
accompanied by letter of credit and drawee bills.

Originally discounted bills can be rediscounted by banks for their

corporate clients with financial institutions, as long as such bills arise out
of genuine trade transactions.

RBI has instructed the banks to restrain from rediscounting bills outside
the consortium of banks and initially discounted by finance companies and
merchant bankers. Further discounting should be only for the purpose of
working capital / credit limits and for the purchase of raw materials /
inventory. Accommodation bills are not to be discounted under any
circumstances.

The specific features of a negotiable instrument are:

There must be three parties to the exchange, namely drawer,

drawee and payee.
41

REPOS & REVERSE REPOS

Repo is a money market instrument, which enables collateralized short term
borrowing and lending through sale/ purchase of debt instruments. Under a repo
transaction, the seller of the instrument enters into an agreement with the buyer to
repurchase the instrument at a predetermined price and date. A repo is also called
as a Ready Forward transaction as it is a means of funding by selling a security on
spot and repurchasing the same on a forward basis. The main objective of trading
in Repos is to meet temporary short-term liquidity requirements in the short-term
money market.
For the lender of cash, the securities offered by the borrower serve as a collateral;
whereas for the lender of securities, the cash borrowed serves as a collateral.
Repos, thus are called as collateralized short term borrowings.
The lender of the securities (borrower of cash) is said to be doing a repo, whereas
the lender of cash (borrower of securities) is said to be doing a reverse repo.
A reverse repo is a mirror image transaction of a repo. In this transaction, the
investor purchases with an agreement to resell the securities. Hence, whether a
transaction is a repo or a reverse repo depends on who initiated the first leg of the
transaction. One factor which encourages an organization to enter into a reverse
repo is to earn some extra income on its idle cash.
Though there is no restriction on the maximum duration for a repo, generally repo
transactions do not exceed 14 days. It is essential for the participants of the repo
market to hold SGL & current accounts with the RBI. Repo transactions are also
reported on the WDM segment of the NSE.

42

RBI GUIDELINES

Ready forward contracts may be undertaken only in (i) Dated

Securities and Treasury Bills issued by Government of India and (ii)
Dated Securities issued by State Governments.

Ready forward contracts in the securities specified above may be

entered into by a banking company, a co-operative bank or any person
maintaining a Subsidiary General Ledger Account with Reserve Bank
of India, Mumbai.

Such ready forward contracts shall be settled through the Subsidiary

General Ledger Accounts of the participants with Reserve Bank of
India or through the Subsidiary General Ledger Account of the
Clearing Corporation of India Ltd. with Reserve Bank of India, and

No sale transaction shall be put through without actually holding the

securities in the portfolio.

43

2.3.1 RBI GUIDELINES FOR INVESTMENT BY BANKS

The Reserve Bank of India has issued guidelines on classification, valuation and
operation of investment portfolio by banks from time to time as detailed below:
Investment Policy
i) While framing the investment policy, the following guidelines are to be kept in
view by the banks;
(a)

No sale transactions should be put through without actually holding

the security in its investment account. However, banks successful in
the auction of primary issue of Government securities, may, enter
into contracts for sale of the allotted securities.

(b)

The brokerage on the deal payable to the broker, if any, should be

clearly indicated on the notes/ memoranda put up to the top
management seeking approval for putting through the transaction
and a separate account of brokerage paid, broker-wise, should be
maintained.
For engagement of brokers to deal in investment transactions,
the banks should observe the following guidelines

Transactions between one bank and another bank

should not be put through the brokers' accounts.

If a deal is put through with the help of a broker, the role of

the broker should be restricted to that of bringing the two parties to the
deal together.

While negotiating the deal, the broker is not obliged to

disclose the identity of the counterparty to the deal. On conclusion of the

deal, he should disclose the counterparty and his contract note should
clearly indicate the name of the counterparty.

44

With the approval of their top managements, banks should

prepare a panel of approved brokers which should be reviewed annually,

or more often if so warranted

A disproportionate part of the business should not be

transacted through only one or a few brokers. Banks should fix aggregate
contract limits for each of the approved brokers. A limit of 5% of total
transactions (both purchase and sales) entered into by a bank during a year
should be treated as the aggregate upper contract limit for each of the
approved brokers. However, if for any reason it becomes necessary to
exceed the aggregate limit for any broker, the specific reasons therefore
should be recorded, in writing, by the authority empowered to put through
the deals.

Further, the board should be informed of this, post facto.

However, the norm of 5% would not be applicable to banks dealings

through Primary Dealers.

The concurrent auditors who audit the treasury operations

should scrutinize the business done through brokers also and include it in
their monthly report to the Chief Executive Officer of the bank

(c) Banks desirous of making investment in equity shares / debentures

should observe the following guidelines:

Formulate a transparent policy and procedure for investment in

shares, etc., with the approval of the Board.

The decision in regard to direct investment in shares, convertible

bonds and debentures should be taken by the Investment
Committee set up by the banks Board. The Investment
Committee should be held accountable for the investments made
by the bank.
45

(d) A copy of the Internal Investment Policy Guidelines, duly framed by

the bank with the approval of its Board, should be forwarded to the
Reserve Bank certifying that the same is in accordance with the RBI
guidelines and that, the same has been put in place.

46

CHAPTER 3: ASSET- LIABILITY MANAGEMENT

The emergence of ALM can be traced to the mid 1970s in the US when
deregulation of the interest rates compelled the banks to undertake active planning
for the structure of the balance sheet. The uncertainty of interest rate movements
gave rise to interest rate risk thereby causing banks to look for processes to
manage their risk. In the wake of interest rate risk came liquidity risk and credit
risk as inherent components of risk for banks. The recognition of these risks
brought Asset Liability Management to the center-stage of financial
intermediation.
3.1 What is Asset/ liability management?
Asset/ liability management (A/LM) is a tool that enables bank managements to
take business decisions in a more informed framework. The A/LM function
informs the manager what the current market risk profile of the bank is and
the3impact that various alternative business decisions would have on the future
risk profile. The manager can then choose the best course of action depending on
his board's risk appetite. Consider for example, a situation where the chief of a
banks retail deposit mobilization function wants to know the kind of deposits that
the branches should be told to encourage. To answer this question correctly he
would need to know inter alia the existing cash flow profile of the bank. Let us
assume that the structure of the existing assets and liabilities of the bank are such
that at the aggregate the maturity of assets is longer than maturity of liabilities.
This would expose the bank to interest rate risk (if interest rates were to increase
it would adversely affect the banks net interest income). In order to reduce the risk
the bank would have to either reduce the average maturity of its assets perhaps by
decreasing its holding of Government securities or increase the average maturity
of its liabilities, perhaps by reducing its dependence on call/money market funds.
Thus, given the above information on the existing risk profile of the bank, the
retail deposits chief knows that the bank can reduce its future risk by marketing its

47

long-term deposit products more aggressively. If necessary he may offer increased

rates on long-term deposits and/or decreasing rates on the shorter-term deposits.
The above example illustrates how correct business decision-making can be added
by the interest rate risk related information. The important thing, however, is that
A/LM is a tool that encourages business decision making in a more disciplined
framework with an eye on the risks that the bank is exposed to. It has to be closely
integrated with the banks business strategy as this affects the future risk profile of
the bank.
This framework needs to be built around a foundation of sound methodology and
human and technological infrastructure. It has to be supported by the board's risk
philosophy, which clearly specifies the risk policies and tolerance limits.
3.2 Purpose of ALM
An efficient ALM technique aims to manage the volume, mix, maturity, rate
sensitivity, quality and liquidity of the assets and liabilities as a whole so as to
earn a predetermined, acceptable risk/reward ratio.
3.3 RBI guidelines on ALM
The Reserve Bank Of India in 1999 has issued comprehensive guidelines for
banks for Asset Liability Management. Guidelines inter alia include directions for
classification of various assets and liabilities, parameterization of various
associated market risks, and frequency of evaluation of exposure. Following three
Statements showing position of maturity of assets and liabilities (Inflow and
Outflow of Funds) are required to be prepared by the banks.
a) Banks should give adequate attention to putting in place an effective ALM
System. Banks should set up an internal Asset-Liability Committee (ALCO),
headed by the CEO/CMD or the ED. The Management Committee or any specific

48

Committee of the Board should oversee the implementation of the system and
review its functioning periodically.
b) Statement of Structural Liquidity: All commercial banks have to distribute the
outflows/inflows in different residual maturity period known as time buckets. On
balance sheet as well as off balance sheet items are required to be included in the
classification:
1 to 14 days
15 to 28 days
29 days to 3 months
3 months to 6 months
6 months to 1 year
1 year to 3 years
3 years to 5 years
5years and above
This statement is required to be prepared, presently at quarterly frequency, as on
last reporting Friday of the quarter. Based on behavioral pattern, Savings deposits
and Current Deposits, which form a significant portion of the banks deposits are
required to be classified into 1 to 14 days and 1 to 3 years time buckets. Term
deposits are classified on actual residual maturity. Similarly based on behavioral
pattern cash credit, overdrafts
and other loans are required to be classified into various time buckets depending
upon expected inflow of funds.
c) Statement of interest rate sensitivity: All assets and liabilities, on balance sheet
as well as off balance sheet, are required to be classified into various time
buckets, given below, based on their maturity for repricing. Thus the cash credit
facility, though perennial in nature which gets repriced with change in prime
lending rate, matures for repricing generally twice in a year, at the time when
49

reserve bank declares credit policy. For the purpose of classification in this
statement this facility is classified into 3 to 6 months time buckets. Installments
falling due in loans are repriced when reinvested. Thus all repayments are
considered due for repricing and are classified accordingly.

d) Statement Of Short Term Dynamic Liquidity: This is required to be prepared

fortnightly and include expected inflows and outflows in next 3 months classified
into 3 time buckets. This classification is capable of reflecting any short fall in
liquidity during next 3 months, hence assumes great importance from ALM angle.
The Board Of Directors through a Committee of Directors is required to monitor
the process of ALM in banks.

Successful implementation of any risk management process has to emanate from

the top management in the bank with the demonstration of its strong commitment
to integrate basic operations and strategic decision making with risk management.
Ideally, the organization set up for Market Risk Management should be as under: -The Board of Directors
-The Risk Management Committee
-The Asset-Liability Management Committee (ALCO)
-The ALM support group/ Market Risk Group

50

CHAPTER 4: RISKS
Risks are inherent quality of both the commercial banking business and the
investment banking implying that all the PIs, Banks and NBFCs are affected
more by risks. The widened resource base, service range and the client base has
further led to a remarkable transition in the risk profile of the financial
intermediaries. The most prominent of the financial risks to which the
institutions are exposed to are classified into the following:
4.1 Types of Risks

Interest-rate Risk -This risk arises when the income of the company is
sensitive to the interest-rate fluctuations.
Liquidity Risk -When there is a mismatch in the maturity patterns of the
assets and liabilities, thereby leading to a situation where the firm is not in a
position to impart enough liquidity into its system, liquidity risk arises.
Credit Risk -This risk originates when there is a default in the repayment
obligation by the borrowers of funds on the due date.
Foreign Exchange Risk (Currency Risk) -This risk is the consequence of the
presence of multi-currency assets and liabilities.
Contingency Risk -The off-balance sheet items such as guarantees, letters of
credit, underwriting commitments etc. will give rise to the contingency risk.
There is a definite linkage between the various risks involved in the investment
and lending business. The interest-rate risk might eventually lead to a credit
risk, while the credit risk itself is closely associated to the forex risk in the
foreign exchange business.
The risks associated with any investment and financing activity cannot be
eliminated for reasons more than one. The most important of these can be
stated as the accuracy levels of forecasting the interest-rate movements since it
leads to the interest-rate risk as well as other related risks. Then there are the
fluctuations that occur in the forex market. Thus, the uncertainties existing in
51

both the domestic and the foreign markets make forecasting and risk
elimination a difficult task.
4.2 Risk management
Though elimination of risk originating due to rate fluctuations is one of the
prime concerns for most businesses, it may not be the same with the banking
business. The income for these investment banks comes mostly by way of the
spreads maintained between the interest income and interest expense since
greater the spread more will be the income. However, the direct correlation that
exists between risks and returns further imply that greater spreads result in an
enhanced risk exposure. It would be more prudent for banks to concentrate more
on managing the assets and liabilities and maintain profitability at a particular
risk exposure limit. Thus it is risk management that holds the key to success/
profitability and not risk elimination.

The objective function of the risk management policy in a banking firm is two
fold. It aims at profitability through price matching while ensuring liquidity by
means of maturity matching. Price matching basically aims to maintain spreads
by ensuring that the deployment of liabilities will be at a rate more than the costs.
Similarly, liquidity is ensured by grouping the assets, liabilities based on their
maturing profiles. The gap is then assessed to identify the future financing
requirements. This ensures liquidity. However, maintaining profitability by
matching prices and ensuring liquidity by matching the maturity levels is not a
very easy task. The following tables explain the process involved in price
matching and maturity matching:

4.5 Liquidity risk management

While introducing the concept of asset-liability management it has been
mentioned that the object of any ALM policy is twofold ensuring profitability

52

and liquidity. Working towards this end, the bank generally maintains
profitability/spreads by borrowing short (lower costs) and lending long (higher
yields).
Thus, while management of the prices of assets and liabilities is an essential part
of ALM, so is liquidity. Liquidity, which is represented by the quality and
marketability of the assets and liabilities, exposes the firm to liquidity risk.
Though the management of liquidity risk and interest rate risks go hand in hand,
there is, however, a phenomenal difference in the approach to tackle both these
risks. A bank generally aims to eliminate the liquidity risk while it only tries to
manage the interest rate risk. This differential approach is primarily based on the
fact that elimination of interest rate risk is not profitable, while elimination of
liquidity risk does result in long-term sustenance. Before attempting to analyze
the elimination of liquidity risk, it is essential to understand the concept of
liquidity management.
The core activity of any bank is to attain profitability through fund management
i.e. acquisition and deployment of financial resources. An intricate part of fund
management is liquidity management. Liquidity management relates primarily to
the dependability of cash flows, both Inflows and outflows and the ability of the
bank to meet maturing liabilities and customer demands for cash within the basic
pricing policy framework. Liquidity risk hence, originates from the potential
inability of the bank to generate cash to cope with the decline in liabilities or
increase in assets.
Thus, the cause and effect of liquidity risk are primarily linked to the nature of the
assets and liabilities of the bank.

53

CASE STUDY ON STATE BANK OF INDIA

Treasury
Profile
Profile India's largest bank is also home to the country's biggest and most
powerful Treasury, contributing to a major chunk of the total turnover in the
money and forex markets. Through a network of state-of-the-art dealing rooms in
India and abroad, backed by the assured expertise of informed professionals, the
SBI extends round-the-clock support to clients in managing their forex and
interest rate exposures.
SBI's relationships with over 700 correspondent banks are also leveraged
in extracting maximum value from treasury operations. SBI's treasury operations
are channeled through the Rupee Treasury, the Forex Treasury and the Treasury
Management Group.
The Rupee Treasury deals in the domestic money and debt markets while
the Forex Treasury deals mainly in the local foreign exchange market. The TMG
monitors the investment, risk and asset-liability management aspects of the Bank's
overseas offices.
Rupee treasury
The Rupee Treasury carries out the banks rupee-based treasury functions
in the domestic market. Broadly, these include asset liability management,
investments and trading. The Rupee Treasury also manages the banks position
regarding statutory requirements like the cash reserve ratio (CRR) and the
statutory liquidity ratio (SLR), as per the norms of the Reserve Bank of India.

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Products and Services

Asset Liability Management (ALM): The ALM function comprises

management of liquidity, maturity profiles of assets and liabilities and
interest rate risks.

Investments: SBI offers financial support through a wide spectrum of

investment products that can substitute the traditional credit avenues of a
corporate like commercial papers, preference shares, non-convertible
debentures, securitized paper, fixed and floating rate products. SBI invests in
primary and secondary market equity as per its own discretion.
These products allow you to leverage the flexibility of financial markets,

enable efficient interest risk management and optimize the cost of funds. They can
also be customized in terms of tenors and liquidity options.
SBI invests in these instruments issued by your company, thus providing
you a dynamic substitute for traditional credit options. The Rupee Treasury
handles the banks domestic investments.
Trading
The banks trading operations are unmatched in size and value in the
domestic market and cover government securities, corporate bonds, call money
and other instruments. SBI is the biggest lender in call.

FOREX TREASURY (FX)

The SBI is the countrys biggest and most important Forex Treasury, both
in the Interbank and Corporate Foreign Exchange markets, and deals with all the
major corporate and institutions in all the financial centers in India and abroad.
The banks team of seasoned, skilled and professional dealers can tailor
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customized solutions that meet your specific requirements and extract maximum
value out of each market situation.
The banks dealing rooms provide 24-hour trading facilities and employs
state-of-the-art technology and information systems. SBIs relationships with over
700 correspondent banks and institutions across the globe enhance the strength of
the Forex treasury. The FX Treasury can also structure and facilitate execution of
derivatives including long term rupee-foreign currency swaps, rupee-foreign
currency interest rate swaps and cross currency swaps.

OVERSEAS TREASURY OPERATION

Treasury Management Group
The Treasury Management Group (TMG) is a part of the International
Banking Group (IBG) and functions under the Chief General Manager (Foreign
Offices). As the name implies the department monitors the management of
treasury functions at SBIs foreign offices including asset liability management,
investments and forex operations.
Products and Services

Asset Liability Management (ALM): The ALM function comprises

management of liquidity, maturity profiles of assets and liabilities and interest rate
risks at the foreign offices.

Investments: Monitoring of investment operations of the foreign offices of

the bank is one of the principal activities of TMG. The main objectives of
investment operations at our foreign offices, apart from compliance with the
regulatory requirements of the host country, are (a) safety of the funds invested,
(b) optimization of profits from investment operations and (c) maintenance of
liquidity. Investment operations are conducted in accordance with the investment
policy for foreign offices formulated by TMG.
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The activities include appraisal of the performance of the foreign offices

broad parameters such as income earned from investment operations, composition

and size of the portfolio, performance vis--vis the budgeted targets and the
market value of the portfolio.

Forex monitoring: Monitoring of forex operations of our foreign offices is

done with the objective of optimizing of returns while managing the attendant
risks.

Forex and Interest rate (Foreign Currency) derivatives: TMG also plays an

important role in structuring, marketing, facilitating execution of foreign currency

derivatives including currency options, long term rupee - foreign currency swaps,
foreign currency interest rate swaps, cross currency swaps and forward rate
agreements. Commodity hedging is one of the recent activities taken up by TMG.

Reciprocal Lines: The department is also responsible for maintenance of

reciprocal lines with international banks.

PORTFOLIO MANAGEMENT & CUSTODIAL SERVICES
The Portfolio Management Services Section (PMS) of SBI has been set up to
handle investment and regulatory related concerns of Institutional investors
functioning in the area of Social Security. The PMS forms part of the Treasury
Dept. of SBI, and is based at Mumbai.
PMS was set up exclusively for management of investments of Social
Security funds and custody of the securities related thereto. In the increasingly
complex regulatory and investment environment of today, even the most
sophisticated investors are finding it difficult to address day to day investment
concerns, such as
Adherence to stated investment objectives
Security selection quality considerations
Conformity to policy constraints
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 Investment returns
The team manning the PMS Section consists of highly experienced officers of
SBI, who have the required depth of knowledge to handle large investment
portfolios and address the concern of large investors. The capabilities of the team
range from Investment Management and Custody to Information Reporting.

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