 As treasury is a specialized function, it is generally set up as a central level

department.
The function of treasury is broadly divided into three parts. The duties and
responsibilities between defined functions should be clearly segregated
Front Office
 The dealing room where the dealers operate from.
 The size of front office is determined by the volume of work involved.
 The dealers of the front office are authorized to enter into deals on behalf of
the bank.
 Banks develop mechanisms to monitor the activity of the dealers.
 The competency of the dealer directly reflects on the bank’s treasury
operations.
 The activity of the dealer is directed by the volume of available resources:
 If there is long (excess of assets over liabilities) position of fund, then
the dealers will focus on lending.
 If there is a short (excess of liabilities over assets) position of funds,
then the dealers will focus on borrowing.
 The dealer prepares a deal ticket and passes it to the back office for further
processing.

Mid Office
 In Nepal, the concept of Mid Office is yet to gain strength. However, this is
regarded as a very important function of treasury management at an
international level.
 The mid office reviews the risk management policies and practices and
contributes to strengthen it.
 It also advises both front office and back office on various issues

Back Office
 Back office is responsible for carrying out the administrative part of the
treasury management. It is basically a support function.
 Back office passes entries of deals entered into by the dealers on the basis of
the deal tickets duly signed by the dealers.
It also provides confirmation of the deals entered into by dealer

A Central Bank is a financial institution that controls country’s monetary policy

& usually has several mandates including, but not limited to issuing national
currency, maintaining the value of the currency, ensuring financial system stability,
controlling credit supply, serving as a last resort to other banks & acting as
government’s banker. The central bank might be or might not be independent to the
government.

• Open Market Operations : are purchases and/or sales of government

securities in the open market. Central banks use open market operations to
effectively control the money supply – the total amount of money circulating
in the country’s economy. Purchasing government securities expands the
money supply, while selling them actually contracts the money supply.
– Purchases & sales of govt securities in the secondary market :
• Directly affect the amount of reserves in the banking system
• Buying government securities
– Increase the amount of reserves
– Ease the money supply
– In our case, There is Liquidity Monitoring and Forecasting
Framework (LMFF), which regularly monitor the liquidity position if
BFIs (studying NRB and BFIs Balance sheet)

• In US - FOMC
– Influences the money supply through open-market operations
– The seven governors
– Plus five of the 12 Federal Reserve bank presidents – can vote
– All 12 Federal Reserve bank presidents
• Attend each FOMC meeting
• Participate in the committee proceedings
– Carried out at the Open Market Desk of the Federal Reserve Bank of
New York
• Run by a group of economics and finance professionals
• Optimal time and amount of securities to buy or sell
• Early in the morning

Correspondent Banking
 Banks are required to make or receive payments from banks all over the
world in the course of their daily business. So, in order to facilitate these
transactions, banks open their accounts (nostro) in local and international
banks in various currencies as per their requirement.
 The permission of Nepal Rastra Bank is required to open nostro accounts in
foreign currencies.
 The number of correspondent banking relationship is dependent on the
volume of business.
  Bank has to regularly monitor the balance in these nostro accounts to
facilitate transactions.
 Large balances without requirement keeps the funds unnecessarily tied up
while insufficient balance may hamper the transaction. Thus, a balance has
to be struck.

Foreign Exchange Management

 Banks have assets and liabilities in various currencies.
 Banks buy and sell foreign currency both for transaction purpose or
speculative purposes.
 The exchange rates are volatile and this may hamper the bank’s position
adversely.
 Hence, foreign exchange management is a very crucial function of treasury
operation.
Treasury is responsible for determining the exchange rate of the bank

Principles of Treasury Management

 Safety : The funds are to be mobilized in areas where there are least
probabilities of default.
 Liquidity : The banks should have adequate funds to meet their various
requirements
 Profitability : The investments made should provide the maximum returns
possible.

Inter-bank Money Market

 All banks are the members of the market.

 The association of these bank is called FEDAN (Foreign Exchange &
Market Dealers Association of Nepal).
 Banks having Surplus fund lend to the banks having deficit fund.
 The I/B market is sub divided into call money, notice money and term
money market
 Call money refers to overnight placement, i.e., funds borrowed by banks
need to be repaid on the next working day.
 Notice Money refers to placement of funds beyond overnight for period not
exceeding 14 days
 Term money market is for the placements of funds with the banks for
periods in excess of 14 days.
  The tenor of such lending usually varies from 1 to 7 days.
The interest for such lending depends upon prevailing interest rate of 91 days T.
bills*, and supply of fund in the inter bank money market

Ratio Analysis and Credentials of Parameters

• Based on the income, expenditure, net interest income, NPAs and capital
adequacy one can comment on the profitability and the long run sustenance
of the bank.
• A comparative study on the performance of various banks can be done using
a ratio analysis of these parameters
• There are a number of ratios that can be used to comment on the different
aspects.
• Profitability => Intermediation costs/ Total Assets
=> Net Interest Income/ Total Assets
=> Other Income/ Total Assets
• Asset Quality => NPAs/ Total Asset
=> NPAs/ Advances
• Staff Productivity=> Net Profit/ Total no. of employees
• Sustenance => Capital/ RWAs

Stress Testing
A simulation technique used on asset and liability portfolios to determine their
reactions to different financial situations. Stress tests are also used to gauge how
certain stressors will affect a company or industry. They are usually computer-
generated simulation models that test hypothetical scenarios.

This is also known as a "stress test".

Stress testing is a useful method for determining how a portfolio will fare during a
period of financial crisis. The Monte Carlo simulation is one of the most widely
used methods of stress testing.

A stress test is also used to evaluate the strength of institutions. For example, the
Treasury Department could run stress tests on banks to determine their financial
condition. Banks often run these tests on themselves. Changing factors could
include interest rates, lending requirements or unemployment.

An analysis conducted under unfavorable economic scenarios which is designed to

determine whether a bank has enough capital to withstand the impact of adverse
developments. Stress tests can either be carried out internally by banks as part of
their own risk management, or by supervisory authorities as part of their regulatory
oversight of the banking sector. These tests are meant to detect weak spots in the
banking system at an early stage, so that preventive action can be taken by the
banks and regulators.
Stress tests focus on a few key risks – such as credit risk, market risk, and liquidity
risk – to banks' financial health in crisis situations. The results of stress tests
depend on the assumptions made in various economic scenarios, which are
described by the International Monetary Fund as "unlikely but plausible." Bank
stress tests attracted a great deal of attention in 2009, as the worst global financial
crisis since the Great Depression left many banks and financial institutions
severely under-capitalized.

What are the functions and importance of Capital Market?

Capital market plays an important role in mobilising resources, and diverting them
in productive channels. In this way, it facilitates and promotes the process of
economic growth in the country.
Various functions and significance of capital market are discussed below:
1. Link between Savers and Investors:
The capital market functions as a link between savers and investors. It plays an
important role in mobilising the savings and diverting them in productive
investment. In this way, capital market plays a vital role in transferring the
financial resources from surplus and wasteful areas to deficit and productive areas,
thus increasing the productivity and prosperity of the country.
2. Encouragement to Saving:
With the development of capital, market, the banking and non-banking institutions
provide facilities, which encourage people to save more. In the less- developed
countries, in the absence of a capital market, there are very little savings and those
who save often invest their savings in unproductive and wasteful directions, i.e., in
real estate (like land, gold, and jewellery) and conspicuous consumption.
3. Encouragement to Investment:
The capital market facilitates lending to the businessmen and the government and
thus encourages investment. It provides facilities through banks and nonbank
financial institutions. Various financial assets, e.g., shares, securities, bonds, etc.,
induce savers to lend to the government or invest in industry. With the
development of financial institutions, capital becomes more mobile, interest rate
falls and investment increases.
4. Promotes Economic Growth:
The capital market not only reflects the general condition of the economy, but also
smoothens and accelerates the process of economic growth. Various institutions of
the capital market, like nonbank financial intermediaries, allocate the resources
rationally in accordance with the development needs of the country. The proper
allocation of resources results in the expansion of trade and industry in both public
and private sectors, thus promoting balanced economic growth in the country.
5. Stability in Security Prices:
The capital market tends to stabilise the values of stocks and securities and reduce
the fluctuations in the prices to the minimum. The process of stabilisation is
facilitated by providing capital to the borrowers at a lower interest rate and
reducing the speculative and unproductive activities.
6. Benefits to Investors:
The credit market helps the investors, i.e., those who have funds to invest in long-
term financial assets, in many ways:
(a) It brings together the buyers and sellers of securities and thus ensure the
marketability of investments,
(b) By advertising security prices, the Stock Exchange enables the investors to
keep track of their investments and channelize them into most profitable lines,

Liquidity management
LIQUIDTY IS DEFINED AS CAPABILITY TO SATISFY LIABILITY ON
DEMAND
 Mandatory:
 CRR
 SLR
 Transactional
 Cash
 Clearing
 Nostro
 Speculative & Pre-cautionary
 Possible Future Opportunity
 To avoid liquidity bottlenecks

• Trade of Between Liquidity and Profitability

• Cash Reserve Ratio Maintenance
- 5.5% of Total Local Currency Deposit less margin deposit to be maintained
in a current account with NRB.
- For maintaining the balance, banks need to use their own fund position. In
case of shortfall , they borrow from other banks or NRB through SLF
(Standing Liquidity Facility) process- by pledging T. Bills, Dev. Bonds,
 Nostro management
  There are various forms of depositors and their requirements are of different
nature, volume and cycles.
 Bank should have adequate liquid funds to meet the demand of depositors
and other creditors.
Commercial Banks should maintain cash reserve ratio of 5.5% of total deposit with
Nepal Rastra Bank
 The liquid assets consists of cash and bank balances, money at short notice
and investment in government securities.
 Having low volume of liquid assets increases the liquidity risk while having
unnecessary volumes of liquid asset compromises the profitability. Hence,
optimum balance needs to be achieved.
Banks need to monitor the maturity mismatches at regular intervals
 In order to manage the liquidity position effectively, banks normally set up
inter bank limits for lending and borrowing arrangements.
 When banks have long positions they lend it to other banks and borrow
when they have short positions.
 Maintaining long or short position is dependent on bank’s strategy and past
performance.

SWAP
in finance, a swap is a derivative in which counterparties exchange cash flows of
one party's financial instrument for those of the other party's financial instrument.
The benefits in question depend on the type of financial instruments involved. For
example, in the case of a swap involving two bonds, the benefits in question can be
the periodic interest (or coupon) payments associated with such bonds.
Specifically, two counterparties agree to exchange one stream of cash flows against
another stream. These streams are called the legs of the swap. The swap agreement
defines the dates when the cash flows are to be paid and the way they
are accrued and calculated. Usually at the time when the contract is initiated, at
least one of these series of cash flows is determined by a random or uncertain
variable such as an floating interest rate, foreign exchange rate, equity price, or
commodity price.
Interest rate swaps
The most common type of swap is a “plain Vanilla” interest rate swap. It is the
exchange of a fixed rate loan to a floating rate loan. The life of the swap can range
from 2 years to over 15 years. The reason for this exchange is to take benefit
from comparative advantage. Some companies may have comparative advantage in
fixed rate markets, while other companies have a comparative advantage in
floating rate markets. When companies want to borrow, they look for cheap
borrowing, i.e. from the market where they have comparative advantage. However,
this may lead to a company borrowing fixed when it wants floating or borrowing
floating when it wants fixed. This is where a swap comes in. A swap has the effect
of transforming a fixed rate loan into a floating rate loan or vice versa. For
example, party B makes periodic interest payments to party A based on
a variable interest rate of LIBOR +70 basis points. Party A in return makes
periodic interest payments based on a fixed rate of 8.65%. The payments are
calculated over the notional amount. The first rate is called variable because it is
reset at the beginning of each interest calculation period to the then
current reference rate, such as LIBOR. In reality, the actual rate received by A and
B is slightly lower due to a bank taking a spread.
Currency swaps
Main article: Currency swap
A currency swap involves exchanging principal and fixed rate interest payments on
a loan in one currency for principal and fixed rate interest payments on an equal
loan in another currency. Just like interest rate swaps, the currency swaps are also
motivated by comparative advantage. Currency swaps entail swapping both
principal and interest between the parties, with the cashflows in one direction being
in a different currency than those in the opposite direction. It is also a very crucial
uniform pattern in individuals and customers.
Commodity swaps
Main article: Commodity swap
A commodity swap is an agreement whereby a floating (or market or spot) price is
exchanged for a fixed price over a specified period. The vast majority of
commodity swaps involvecrude oil.
Credit default swaps
Main article: Credit default swap
A credit default swap (CDS) is a contract in which the buyer of the CDS makes a
series of payments to the seller and, in exchange, receives a payoff if an
instrument, typically abond or loan, goes into default (fails to pay). Less
commonly, the credit event that triggers the payoff can be a company
undergoing restructuring, bankruptcy or even just having its credit rating
downgraded. CDS contracts have been compared with insurance, because
the buyer pays a premium and, in return, receives a sum of money if one of the
events specified in the contract occur. Unlike an actual insurance contract the buyer
is allowed to profit from the contract and may also cover an asset to which the
buyer has no direct exposure.
Subordinated risk swaps
A subordinated risk swap (SRS), or equity risk swap, is a contract in which
the buyer (or equity holder) pays a premium to the seller (or silent holder) for the
option to transfer certain risks. These can include any form of equity, management
or legal risk of the underlying (for example a company). Through execution the
equity holder can (for example) transfer shares, management responsibilities or
else. Thus, general and special entrepreneurial risks can be managed, assigned or
prematurely hedged. Those instruments are traded over-the-counter (OTC) and
there are only a few specialized investors worldwide.

Advantages/ Benefits/Merits/Functions of Derivatives:

1. Enable Price Discovery: In the first place, derivatives encourage more and
more people with objectives of hedging, speculation, arbitrage to take part in the
market and hence increase competition. Hence there are more and more people
who keep track of prices and trade on slightest of reasons. Individuals with better
information and judgment are inclined to participate in the markets to take
advantage of such situation. A small change in price and it attracts some action on
the part of speculators. Active participation in the market in large no.s of both
buyers and sellers ensures a fair price. The increased no. of participants, more
trades, more volumes, and greater sensitivity to smallest of price changes
facilitates correct and efficient pricediscovery of assets.
2. Facilitates Transfer of Risk: By their very nature, the derivatives instruments
do not involve risk. Instead, they redistribute risk between the various market
participants. In this sense, derivatives can be compared to insurance: provides
means to hedge against unfavorable market movements in return for a premium,
and provides opportunities to those who are willing to take risks and make profits
in the process.
3. Provide Leveraging: In order to take position in derivatives, you require very
small initial outlay of capital in comparison to taking position in the spot market.
Assume that Mr. A believes that price of rice shall be Rs. 50/kg in 3 months from
now and that a farmer has agreed to sell it at Rs. 49/kg. To take this benefit, Mr. A
has to pay full amount of Rs. 49/kg today and he will realize Rs. 50/kg 3
months later. Instead, if there is a way through which he can escape making a full
payment, he shall be really glad to enter into such contract and Derivatives
provide those exit routes by letting one enter into a contract and can neutralize
their position by booking opposite position on a future date.
4. Completion of Market/Efficient Market: A market is efficient or said to be
complete market (theoretically possible) when the available instruments can by
itself or jointly provide cover against any possible adverse outcomes. It is a
theoretical concept, which is not seen in practice. Though with the presence of
derivatives, there is a greater degree of market completeness.
5. Lower Transaction costs: It translates into low transaction costs due to the
high no. of participants that take part in the market.
Derivatives behave like a two edged sword. If put to use wisely they work very
effectively but when used recklessly can cause you severe agonies. Sadly there is
no realistic way in which one could demarcate between the two. There is a very
thin line that distinguishes gambling with a calculated taken risk.
Below mentioned are disadvantages/ demerits of Derivatives:
1. Raises Volatility: As a large no. of market participants can take part in
derivatives with a small initial capital due to leveraging derivatives provide, it
leads to speculation and raises volatility in the markets.
2. Higher no. of Bankruptcies: Due to leveraged nature of derivatives,
participants assumepositions which do not match their financial capabilities and
eventually lead to bankruptcies.
3. Increased need of regulation: Large no. of participants take positions in
derivatives and take speculative positions. It is necessary to stop these activities
and prevent people from getting bankrupt and to stop the chain of defaults