Академический Документы
Профессиональный Документы
Культура Документы
ISBN : 978-81-8441-296-3
2010
DISCLAIMER:
The views expressed in the Technical Guide are those of author(s). The
Institute of Chartered Accountants of India may not necessary subscribe
to the views of the author(s).
Email : cia@icai.org
Website : www.icai.org
ii
FOREWORD
With the significant developments that have taken place in the capital, money
and foreign exchange markets in the recent years affecting volatility in
exchange rates and accentuating liquidity constraints, organisations have
started paying closer attention to the treasury management function. The
globalization of the economy with mobilization and deployment of funds
from/in other countries is also necessitating increased attention in the area of
treasury management. Banking industry has been all long focusing on
successful treasury management, which is extremely necessary for their
strong, viable and profitable existence.
In view of the complexity, volume and growth of treasury function in banks,
internal auditors have a dynamic role to play to support the banks in helping
to achieve the strategic goals. Internal auditors can strengthen the bank’s
treasury functions by reviewing critical control systems and risk management
processes and providing valuable suggestions.
I am happy to note that the Internal Audit Standards Board of the Institute is
issuing this publication “Technical Guide on Internal Audit of Treasury
Function in Banks” containing extensive knowledge on this complex subject.
I congratulate CA. Shanti Lal Daga, Chairman, Internal Audit Standards
Board and the members of the Board on issuance of this publication. I am
confident that this comprehensive publication would help the members as
well as other readers in acquiring good knowledge of products, practices and
regulations of treasury function in banks.
iii
iv
PREFACE
In this financially globalized volatile world, bank’s treasury groups which are
ultimately responsible for keeping their banks in business are witnessing
tremendous changes. The change is being forced with rapid economic
developments, globalizing industries and competition, new technologies and
revolutionary changes in the regulatory environment. Apart from responding to
these changes, treasury functions of banks are under pressure to add value to
the banks through their operations and contribute to achieve strategic goals.
Internal audit helps the organisations to achieve their stated objectives. Carrying
out an internal audit of treasury functions in banks requires an in-depth
understanding of the applicable statutes, systems and processes since it
operates under a very regulated and governed atmosphere. Specialist
knowledge in certain areas of banking is also of equal importance.
In the wake of these developments in the field of treasury management in banks,
the Internal Audit Standards Board of the Institute is issuing this publication
“Technical Guide on Internal Audit of Treasury Function in Banks” for the
members of the Institute as well as bankers. This publication is aimed to help the
readers in understanding the roles and responsibilities of the treasury function in
banks as well as in determining the nature of internal audit procedures to be
undertaken. The Technical Guide has been divided into various chapters
covering aspects such as treasury products and services, treasury dealing room,
organisational structure of a bank’s treasury, investment portfolio, asset liability
management, treasury risks. The guide also deals with the fundamental controls
and the internal audit procedures with special reference to treasury/ market risk
segments. It also contains detail checklist on internal audit of treasury operations,
foreign exchange operations and domestic operations of treasury. It also includes
a compilation of relevant circulars issued by the Reserve Bank of India applicable
to treasury operations of a bank. For better understanding of the readers, the
guide also contains an introduction section and also a glossary of some technical
terms used in the Guide.
At this juncture, I am grateful to CA. Rajkumar S. Adukia, Central Council
Member and convenor of the Group ably assisted by other members of the
Group, viz., CA. Pankaj Adukia, CA. Abhay Arolkar and CA. Vijay Joshi for
v
squeezing out time out of their professional and personal commitments and
preparing the basic draft of this Technical Guide. I would also take the
opportunity of placing on record my gratitude to CA. Akeel Master for reviewing
the draft and giving his valuable comments and suggestions.
I also wish to thank CA. Uttam Prakash Agarwal, President and CA. Amarjit
Chopra, Vice President for their continuous support and encouragement to the
initiatives of the Board. I must also thank my colleagues from the Council at the
Internal Audit Standards Board, viz., CA. Ved Jain, CA. Abhijit Bandyopadhyay,
CA. Bhavna G. Doshi, CA. Pankaj I. Jain, CA. Sanjeev K. Maheshwari, CA.
Mahesh P. Sarda, CA. S. Santhanakrishnan, CA. Vijay K. Garg, Shri Krishna
Kant, Shri Manoj K. Sarkar and Shri K. P. Sasidharan for their vision and support.
I also wish to place on record my gratitude for the coopted members on the
Board, viz., CA. N. K. Aneja, CA. Verendra Kalra, CA. M. Guruprasad, CA. Dilip
Kumar Vadilal Shah and CA. K. S. Sundara Raman as also special invitees on
the Board, viz., CA. K. P. Khandelwal, CA. S. Sundarraman, CA. Ravi H. Iyer,
CA. Rajiv Dave, CA. Pawan Chagti, CA. Ram Mohan Johri and CA. Arindam
Guha for their devotion in terms of time as well as views and opinions to the
cause of the professional development. I also wish to place on record the efforts
put in by CA. Jyoti Singh, Secretary, Internal Audit Standards Board and CA. Arti
Aggarwal, Senior Executive Officer, for their inputs in giving final shape to the
publication.
I am sure that the members of the Institute would find the Technical Guide
immensely useful in understanding the intricacies of the subject matter and in
carrying out their professional duties diligently.
vi
CONTENTS
Foreword................................................................................................... iii
Preface.......................................................................................................v
Glossary.................................................................................................... ix
Introduction ............................................................................................ xvii
CHAPTER :
1. Treasury- An Introduction .............................................................. 1 - 4
2. Treasury Products and Services ............................................. 1 - 7
3. The Treasury Dealing Room................................................... 1 - 3
4. Organisational Structure of A Bank’s Treasury........................ 1 - 6
5. Investment Portfolio..................................................................... 1 - 13
6. Asset Liability Management...........................................................1 – 6
7. Treasury Risks....................................................................... 1 - 6
8. Treasury Unit – Fundamental Controls........................................ 1 - 13
9. Internal Audit of Treasury Operations............................................ 1 - 6
ANNEXURES :
Annexure A- Specimen Checklist for Internal Audit of Treasury Operations ......
Annexure B - Specimen Checklist for Internal Audit of Foreign
Exchange Operations of Treasury.........................................
Annexure C- Specimen Checklist for Internal Audit of Domestic
Operations of Treasury ........................................................
Annexure D- Guidance Note on Market Risk Management ...................
Annexure E - Assets Liability Management (ALM) System....................
Annexure F- RBI Mc Guide primary dealers 2009.................................
Annexure G RBI Mc Capadeqrm 2009 .................................................
vii
Annexure H- RBI Mc Callmoney 2009..................................................
Annexure I - RBI Mc Cd 2009 ..............................................................
Annexure J - RBI Mc Comlpaper 2009 .................................................
Annexure K- RBI Mc Prunormsinvestt 2009 ........................................
viii
GLOSSARY
x
Glossary
xi
Technical Guide on Internal Audit of Treasury Function in Banks
xii
Glossary
xiii
Technical Guide on Internal Audit of Treasury Function in Banks
xiv
Glossary
xv
Technical Guide on Internal Audit of Treasury Function in Banks
xvi
INTRODUCTION
xviii
CHAPTER 1
TREASURY- AN INTRODUCTION
Meaning
1.1 A treasury is any place where currency or items of high monetary value
are kept. The term “treasury” was first used in classical times to describe the
votive buildings erected to house gifts to the gods, such as the Siphnian Treasury
in Delphi or other similar buildings erected in Olympia, Greece by competing city-
states, to impress others during the ancient Olympic Games.
1.2 A treasury can either be:
• The part of a government which manages all money and revenue;
• The funds of a government or institution or individual;
• The government department responsible for collecting, managing and
spending public revenues;
• A depository ( room or building) where wealth and precious objects can be
kept; or
• The center of financial operations within an organisation.
Treasury in Banks
1.3 Traditionally, the treasury function in banks was limited to Funds
management, i.e., maintaining adequate cash balances to meet day-to-day
requirements and deploying surplus funds from operations. The treasury in a
bank is also responsible for maintenance of reserve requirements (Cash Reserve
Ratio and Statutory Liquidity Ratio). Treasury was considered a service centre
and liquidity management was its main function.
The scope of treasury has now expanded beyond liquidity management and
treasury has now evolved as a profit centre with its own trading and investment
activity.
1.4 Presently, as per RBI circular on “Guidelines – Accounting Standard 17
(Segment Reporting) – Enhancement of Disclosures dated April 18, 2007, banks
Technical Guide on Internal Audit of Treasury Function in Banks
2
Treasury- An Introduction
categories about adopting the correct business strategy to ensure that the
funds are deployed optimally.
(f) Derivative products- Treasury can develop Interest rate swaps, and other
derivative products to hedge the bank’s exposure and also sell such
products to customers or other banks.
(g) Arbitrage- This involves simultaneous buying and selling of the same type of
assets in two different markets in order to make risk-less profits.
(h) Capital adequacy- This focuses on quality of assets and Return on
investments is key criteria for evaluating the efficiency of deployed funds.
(i) Canalizing and managing other asset instruments into investment
instruments e.g., instruments resulting out of Corporate Debt Restructuring,
Asset Reconstruction, Pass Thru certificates, Asset Backed Securitization
(ABS), Mortgage Backed Securitization(MBS), etc.
(j) To monitor the Rating Migrations on an on going basis and take timely
corrective action.
(k) To minimize the level of provisional requirements due to non-performing
investments.
1.6 Treasury operations play a pivotal role in not only improving the bottom
line of banks but also in Balance Sheet management by reducing risks by
hedging sensitive exposures. Treasury management would, normally, consist of
management of its cash flows, banking, money market and capital market
transactions; effective control of the risks associated with those activities; and the
pursuit of optimum performance consistent with those risks keeping in mind the
business objectives and in consonance with the regulatory framework.
Objectives of Treasury management
1.7 The objectives of treasury management can be stated as under:
(a) To plan, organize and manage funds profitably and to ensure compliance
with respect to regulatory requirements (SLR/CRR).
(b) Treasury services are also being utilized for Balance Sheet management
(CRAR-Capital Risk weighted Adequacy Ratio, Asset and Liability product
hedging, etc).
(c) To optimize return on surplus funds invested and to keep cost of funds to the
minimum.
3
Technical Guide on Internal Audit of Treasury Function in Banks
4
CHAPTER 2
Money Market
2.1 Money market desk is involved in management of assets and
liabilities of the bank. The main function involves the following:
(a) Management of statutory reserves viz., Cash Reserve Ratio (CRR)
and Statutory Liquidity Ratio (SLR) of the bank.
(b) Daily Funds Management for the bank.
(c) Balance Sheet Management.
(d) Debt Securities Trading.
Range of Products
2.2 The Money Market Desk trades in the following Instruments:
(i) Treasury-Bills
• Treasury Bills (T-bills) are short-term debt instruments issued by
the Central Government for maturities of 91, 182 and 364 days.
• Commercial banks, primary dealers, mutual funds, corporates,
institutions, provident or pension funds and insurance
companies can participate.
• RBI issues a calendar of T-bill auctions. Periodic auctions are
held for their issue and these are tradable in the secondary
market, which is quite active.
• T-bills are issued at a discount to face value and are
redeemable at par on maturity.
(ii) Commercial Paper (CP)
• A Commercial Paper (CP) is an unsecured money market
instrument through which corporate entities raise short-term
money.
Technical Guide on Internal Audit of Treasury Function in Banks
6
Treasury Products and Services
7
Technical Guide on Internal Audit of Treasury Function in Banks
8
Treasury Products and Services
Range of Products
2.4 The following are products traded in Foreign Exchange Market:
(i) Spot Contract
It is the simplest and most common foreign exchange transaction widely used
by corporates to cover their receivables and payables. The commitment by
the client is to buy and sell one currency against another at a fixed rate for
delivery two business days after the transaction. This eliminates the possible
risk due to exchange rate fluctuation for the client. Corporate can buy or sell
foreign currency for genuine transactional purposes only.
(ii) Forward Contract
It is a contract between the bank and its customers in which the
exchange/conversion of currencies would take place at future date at a rate
of exchange in advance under the contract. The essential idea of entering
into a forward contract is to peg the price and thereby avoid the price risk.
Forward Rates = spot rate +/- premium/discount
(iii) Currency Swaps
It is an agreement between two parties to exchange obligations in different
currencies at the beginning, during the tenure and at the end of the
transaction. At the start, initial principal is exchanged, though it is not
obligatory. Periodic interest payments (either fixed or floating) are exchanged
throughout the life of the contract. The principal is exchanged invariably on
termination at the exchange rate decided at the start of the transaction. By
means of currency swap, the associated currency and interest rate risks on
the underlying asset can be hedged.
(iv) Interest Rates Swaps(IRS)
It is a financial transaction in which two counterparties agree to exchange
streams of cash flows throughout the life of contract in which one party pays
a fixed interest rate on a notional principal and the other pays a floating rate
on the same sum. The basic purpose of IRS is to hedge the interest rate risk
of constituents and enable them to structure the asset/liability profile best
suited to their respective cash flows.
9
Technical Guide on Internal Audit of Treasury Function in Banks
(v) Options
It is a contract between the bank and its customers in which the customer has
the right to buy/sell a specified amount of underlying asset at fixed price within
a specific period of time, but has no obligation to do so. In this contract, the
customer has to pay specified amount upfront to the counterparty which is
known as premium. This is in contrast to the forward contract in which both
parties have a binding contract. This is a facility offered to customers to enable
them to book forward contracts in cross currencies at a target rate or price.
This facility helps the customers to encash the currency movements in late
European market, New York market and early Asian market
(vi) Forward Rate Agreement (FRA)
A Forward Rate Agreement (FRA) is an agreement between the bank and a
customer to pay or receive the difference (called settlement money) between an
agreed fixed rate (FRA rate) and the interest rate prevailing on stipulated future
date (the fixing date) based on a notional amount for an agreed period (the
contract period). In short, this is a contract whereby interest rate is fixed now for
a future period. The basic purpose of the FRA is to hedge the interest rate risk.
For example, if a borrower is going to borrow FC loan for 6 months at LIBOR rate
after 3 months, he can buy an FRA whereby he can fix interest rate for the loan.
Capital Market
2.4 Funds are also invested through:
a) Investment in units of Mutual fund- Mutual Fund is a trust that
pools the savings of a number of investors who share a common
financial goal. Each scheme of a mutual fund can have different
character and objectives. Mutual funds issue units to the investors,
which represent an equitable right in the assets of the mutual fund.
b) Investment in Equity IPO – These are securities which were not
previously available and are offered to the investing public for the
first time.
Regulatory Framework for Capital Markets in India
2.5 In India, the capital market is regulated by the Capital Markets
Division of the Department of Economic Affairs, Ministry of Finance. The
division is responsible for formulating the policies related to the orderly
growth and development of the securities markets (i.e., share, debt and
10
Treasury Products and Services
11
CHAPTER 3
3.1 The Treasury Dealing Room within a bank is, generally, the
clearinghouse for matching, managing and controlling market risks. It may
provide funding, liquidity and investment support for the assets and liabilities
generated by regular business of the bank. The Dealing Room is responsible
for the proper management and control of market risks in accordance with
the authorities granted to it by the bank's Risk Management Committee. The
Dealing Room is also responsible for meeting the needs of business units in
pricing market risks for application to its products and services. The Dealing
Room acts as the bank's interface to international and domestic financial
markets and, generally, bears responsibility for managing market risks in
accordance with the instructions received from the bank's Risk Management
Committee.
3.2 The Dealing Room may also have allocated to it by the Risk
Management Committee, a discretionary limit within which it may take market
risk on a proprietary basis. For these reasons, effective control and
supervision of bank's Dealing Room activities is critical to its effectiveness in
managing and controlling market risks.
3.3 It is critical to effective functioning of the Dealing Room that the
dealer has access to a comprehensive Dealing Room manual covering all
aspects of their day-to-day activities. All dealers active in day-to-day trading
activities must acknowledge familiarity with and provide an undertaking in
writing to adhere to the bank's dealing guidelines and procedures. The
Dealing Room procedures manual should be comprehensive in nature
covering operating procedures for all the bank’s trading activities in which the
Dealing Room is involved and, in particular, must cover the bank's
requirements in respect of:
a) Code of Conduct - All dealers active in day-to-day trading activities in
the lndian market must acknowledge familiarity with and provide an
undertaking to adhere to Foreign Exchange Dealers’ Association of India
(FEDAI) code of conduct (and Fixed Income Money Market and
Technical Guide on Internal Audit of Treasury Function in Banks
14
The Treasury Dealing Room
15
CHAPTER 4
ORGANISATIONAL STRUCTURE OF A
BANK’S TREASURY
Mid-office
4.4 The mid-office can be considered to be the conscience keeper of the
treasury. It is responsible for the critical functions of independent market risk
monitoring, measurement, analysis and reporting for the bank's Asset-
Liability Management Committee (ALCO). Ideally, this is a full time function of
reporting to, or encompassing the responsibility for, acting as Asset-Liability
Management Committee (ALCO)'s secretariat. An effective mid-office
provides independent risk assessment which is critical to Asset-Liability
Management Committee (ALCO)'s key function of controlling and managing
market risks in accordance with the mandate established by the Board/Risk
Management Committee. It is a highly specialised function and must include
trained and competent staff, and expert in market risk concepts.
4.5 The methodology of analysis and reporting will vary from bank to
bank depending on their degree of sophistication and exposure to market
risks. These same criteria will govern the reporting requirements demanded
of the mid-office, which may vary from simple gap analysis to computerized
VaR modeling. Mid-office staff may prepare forecasts (simulations) showing
the effects of various possible changes in market conditions related to risk
exposures. Banks using VaR or modeling methodologies should ensure that
its Asset-Liability Management Committee (ALCO) are aware of and
understand the nature of the output, how it is derived, assumptions and
variables used in generating the outcome and any shortcomings of the
methodology employed. Segregation of duties principles must be evident in
this function which must report to Asset-Liability Management Committee
(ALCO) independently of the treasury function.
4.6 The main functions of mid-office can be summarized as under:
(i) Management of risks:
(a) Market risk which arises on account of:
- Interest rate movement
- Foreign exchange rate movement
- Commodity prices
- Equity prices
18
Organisational Structure of a Bank’s Treasury
19
Technical Guide on Internal Audit of Treasury Function in Banks
20
Organisational Structure of a Bank’s Treasury
companies may not be available to the banks for determining the break-up
value.
The risk of using inappropriate or stale quotes for valuation has a direct
bearing not only on financial reporting but also on computing exposure limits.
Thus, the scope of the auditor should include an evaluation of the control
environment surrounding the valuation and marking-to-market of treasury
instruments. If the bank has an established and independent mid-office
function, the responsibility or soliciting quotes, rates, curves resides with the
mid-office. Another related risk to valuation and marking-to-market of
treasury investments is the timely monitoring of non-performing investments
(‘NPIs’). RBI has defined NPIs as investments where the interest/return or
principal has been in arrears for a period exceeding 90 days. The important
consideration for NPIs is that, banks should not reckon income on such
investments and should provide for depreciation on them appropriately, such
depreciation is further not allowed to be set-off against appreciation on other
performing investments. The back-office of a bank should have appropriate
procedures/controls instated for timely capturing of NPIs.
d) Monitoring and reporting of risk limits and usage: Reporting of usage
of risk against limits established by the Risk Management Committee (as
well as Credit Department for Counterparty risk limits) should be
maintained by the back-office independently of the dealing room.
Maintenance of all limit systems must also be undertaken by the back-
office and access to limit systems (such as counterparty limits, overnight
limits, etc.) must be secure from access and tampering by unauthorised
personnel. If the bank has an established and independent mid-office
function, this responsibility may properly pass on to the mid-office.
e) Control over payments systems: The procedures and systems for
making payments must be under, at least, dual control in the back-office
independent from the dealing function. Payment systems should be at all
times secure from access or tampering by unauthorised personnel.
f) Reconciliation of dealers profit or loss account: All dealers at the end
of day prepare their profit or loss account for the day and compute their
net open position. The back-office personnel who are independent of the
front-office dealer are responsible for recording and processing of the
deals/transactions into the general ledger system or the core banking
system. Banks should have in place a process of daily reconciliation of
21
Technical Guide on Internal Audit of Treasury Function in Banks
the dealers profit or loss vis-à-vis the profit or loss as per the general
ledger system to avoid instances of unrecorded transactions.
g) Controls in respect of financial reporting and MIS: A bank’s financial
statements include many exhaustive disclosures with treasury related
disclosures forming a significant portion thereof (such as, concentration
risk for swaps, PV01 disclosures for derivatives, maturity pattern for
investments, forex). The collation of information to be presented in these
disclosures is tedious and requires liaisoning with several treasury sub-
functions. Further, banks also have an exhaustive base of MIS (such as
ALM, concentration exposures, VAR or other measures capturing market
risk, net open positions) presented at the various senior management
committees (such as ALCO, Risk, Board, Investment, Credit).
Contents of an MIS pack or in a bank’s financials have a direct bearing on
the management decision making and users of financial statements. The
internal auditor should include within his scope the controls around
information flow and data integrity for collation and preparation of the
disclosures and MIS reports.
22
CHAPTER 5
INVESTMENT PORTFOLIO
5.1 The primary function of banks is to accept deposits and to lend money.
Earlier, the investments were made only to meet out the SLR requirements. By
the span of time the face of banking has changed. Due to the recessionary
conditions in the economy the credit demand decreased substantially. It forced
the banks to invest the surplus medium to long term funds in SLR/NSLR
securities and debts. The investments portfolio of a bank may have a number of
varieties of instruments. Keeping in view the return from lending and surplus
investments, dynamic decision making is required whereby return on deployment
is optimized.
5.2 The banks investment book may comprise the following:
(a) Central Government dated securities
(b) State Government developmental loans
(c) Treasury Bills
(d) Trust Securities
(e) Equity / Preference Shares
(f) Units of Mutual Funds
(g) Pass through Certificate/CDR/ARCIL
(h) Commercial Papers
(i) Corporate Bonds and Debentures
(j) Bonds and debentures of PSUs, Government / Semi-Government
autonomous bodies, etc.
(k) Venture capital investments
(l) Investment in subsidiaries and joint ventures(Indian/overseas)
(m) Other Asset backed/Mortgage backed securities.
Technical Guide on Internal Audit of Treasury Function in Banks
24
Investment Portfolio
(iv) 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.
(v) All brokerage deals have to be specifically approved by the delegated
authorities in the bank and a
(vi) separate account of brokerage paid, broker-wise, should be
maintained.For issue of Bank Receipts ( BRs), the banks should adopt
the format prescribed by the Indian Banks' Association (IBA) and strictly
follow the guidelines prescribed by them in this regard. The banks,
subject to the above, could issue BRs covering their own sale
transactions only and should not issue BRs on behalf of their
constituents, including brokers.
(vii) The banks should be circumspect while acting as agents of their broker
clients for carrying out transactions in securities on behalf of brokers.
(viii) Investment in equity shares and debentures must be undertaken after
considering the following:
• Build up adequate expertise in equity research by establishing a
dedicated equity research department, as warranted by their scale
of operations;
• Formulate a transparent policy and procedure for investment in
shares, etc., with the approval of the Board; and
• The decision in regard to direct investment in shares, convertible
bonds and debentures should be taken by the Investment
Committee set up by the bank's Board. The Investment Committee
should be held accountable for the investments made by the bank.
(ix) The bank’s Board of Directors should specify:
• the level of authority to put through deals,
• procedure to be followed for obtaining the sanction of the
appropriate authority,
• procedure to be followed while putting through deals,
• various prudential exposure limits, and
• the reporting system.
25
Technical Guide on Internal Audit of Treasury Function in Banks
26
Investment Portfolio
(f) The Accounts Section should independently write the books of account on
the basis of vouchers passed by the back office.
(g) Records of SGL and BR transactions should be maintained.
(h) Balances as per bank's books should be reconciled at quarterly intervals
with the balances in the books of the Public Debt office (PDOs).
(i) The investment transactions should be reported to the top management, on
a weekly basis covering the following:
• details of transactions in securities,
• details of bouncing of SGL transfer forms issued by other banks,
• BRs outstanding for more than one month, and
• a review of investment transactions undertaken during the period.
(j) Bankers' cheques/ pay orders should be issued for third party transactions,
including inter-bank transactions.
(k) In case of investment in shares, the surveillance and monitoring of
investment should be done by the Audit Committee of the Board. In each of
its meetings it shall review:
• the total exposure of the bank to capital market both fund based and
non-fund based, in different forms,
• ensure that the guidelines issued by RBI are complied with, and
• adequate risk management and internal control systems are in place.
(l) In order to avoid any possible conflict of interest, it should be ensured that
the stockbrokers as directors on the Boards of banks or in any other
capacity, do not involve themselves in any manner with the Investment
Committee or in the decisions in regard to making investments in shares,
etc., or advances against shares.
(m) An on-going internal audit system should be in place to report the
deficiencies directly to the management of the bank.
(n) The banks should get compliance in key areas certified by their statutory
auditors and furnish such audit certificate to the Regional Office of
Department of Banking Supervision of RBI under whose jurisdiction the HO
of the bank falls.
27
Technical Guide on Internal Audit of Treasury Function in Banks
Classification
5.6 The RBI’s Master Circular on “Prudential norms for clarification,
valuation and operation of investment portfolio by banks” lays down that the
entire investment portfolio of the banks (including SLR securities and non-SLR
securities) should be classified under three categories
(a) Held to Maturity
(b) Available for Sale and
(c) Held for Trading.
However, in the balance sheet, the investments will continue to be disclosed as
per the following existing six classifications:
(a) Government securities,
(b) Other approved securities,
(c) Shares,
(d) Debentures and Bonds,
(e) Subsidiaries/ joint ventures, and
(f) Others (CP, Mutual Fund Units, etc.).
Held to Maturity
5.7 The securities acquired by the banks with the intention to hold them up
to maturity will be classified under Held to Maturity (HTM).The investments
included under “Held to Maturity” should not exceed 25 per cent of the
bank’s total investments. The banks may include, at their discretion, under
Held to Maturity category securities less than 25 per cent of total
investment. The following investments will be classified under ‘Held to
Maturity’ but will not be accounted for the purpose of ceiling of 25%
specified for this category:
a) Re-capitalisation bonds received from the Government of India towards
their re-capitalisation requirement and held in their investment portfolio.
This will not include re-capitalisation bonds of other banks acquired for
investment purposes.
28
Investment Portfolio
29
Technical Guide on Internal Audit of Treasury Function in Banks
5.11 Shifting of investments from Held for Trading category to Available for
Sale category is generally not allowed. However, it will be permitted only under
exceptional circumstances with the approval of the Board of Directors/ ALCO/
Investment Committee. Transfer of scrips from one category to another, under all
circumstances, should be done at the acquisition cost/ book value/ market value
on the date of transfer, whichever is the least, and the depreciation, if any, on
such transfer should be fully provided for.
Valuation
5.12 RBI Guidelines for valuation for the three categories is as follows:
(a) Held to maturity
(i) Investments classified under Held to Maturity category need not be
marked to market and will be carried at acquisition cost, unless it is
more than the face value, in which case the premium should be
amortised over the period remaining to maturity.
(ii) Banks should recognise any diminution, other than temporary, in
the value of their investments in subsidiaries/ joint ventures which
are included under Held to Maturity category and provide therefore.
Such diminution should be determined and provided for each
investment individually.
(b) Available for sale
(i) The individual scrips in the Available for Sale category will be
marked to market at quarterly or at more frequent intervals.
(ii) While the net depreciation under each classification should be
recognised and fully provided for, the net appreciation under each
classification should be ignored.
(iii) The book value of the individual securities would not undergo any
change after the marking of market.
(iv) The provisions required to be created on account of depreciation in
the Available for Sale category in any year should be debited to the
Profit & Loss Account and an equivalent amount (net of tax benefit,
if any, and net of consequent reduction in the transfer to Statutory
Reserve) or the balance available in the Investment Fluctuation
Reserve Account, whichever is less, shall be transferred from the
Investment Fluctuation Reserve Account to the Profit & Loss
30
Investment Portfolio
31
Technical Guide on Internal Audit of Treasury Function in Banks
32
Investment Portfolio
investment portfolio under HFT and AFS with the approval of the Board of
Directors. The amount held under IFR arising out of gains on sale of investments
will be reckoned for the purpose of TIER –II capital.
Transactions through SGL Account
5.17 SGL or CSGL are a demat form of holding government securities with
the RBI. SGL stands for 'Subsidiary General Ledger' account. It is a facility
provided by RBI to large banks and financial institutions to hold their investments
in Government securities and Treasury bills in the electronic book-entry form.
Such institutions can settle their trades for securities held in SGL through a
Delivery-versus-Payments (DVP) mechanism which ensures movement of funds
and securities simultaneously.
5.18 As all investors in Government securities do not have an access to the
SGL accounting system, the RBI has permitted such investors to hold their
securities in physical stock certificate form. The RBI, being the R&T agent of all
Government securities issued by Central and State Governments, keeps the
records of holding of various investors in the securities issued. The SGL, in short
keeps the names of all investor in a particular security at any point of time. The
securities are held in electronic form in SGL accounts. They may also open a
Constituent SGL account with any entity authorised by the RBI for this purpose
and thus avail of the DVP settlement. Such client accounts are referred to as
Constituent SGL accounts.
5.19 Securities kept on behalf of customers by banks or PDs in Constituent
SGL account are kept in a segregated CSGL A/c with the RBI. Thus, if the bank
or the PD buys security for his client, it gets credited to the CSGL account of
bank or PD with the RBI. Successful bidders are allotted securities bid by them.
The RBI can debit their current accounts for amount payable and credit their SGL
account with the securities allotted to them. The amount debited to the current
account is placed to the credit of Government Account. In the same manner
secondary market operations are also handled by the RBI.
5.20 The following are to be noted with regard to transactions through SGL
Account:
• It is necessary for both the selling bank and the buying bank to maintain
current account with the RBI.
• All transactions in Govt. securities for which SGL facility is available should
be put through SGL A/c only.
33
Technical Guide on Internal Audit of Treasury Function in Banks
• A SGL transfer form issued by a bank in favour of another bank should not
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. If a
SGL transfer form bounces for want of sufficient balance in the SGL A/c, the
(selling) bank which has issued the form will be liable to the penal action
against it.
• 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.
• The SGL transfer form received by purchasing banks should be deposited in
their SGL A/c Immediately, i.e., the date of lodgment of the SGL Form with
the RBI shall be within one working day after the date of signing of the
Transfer Form.
• No sale should be effected by way of return of SGL form held by the bank.
• Participants must indicate the deal/trade/contract date in Part C of the SGL
Form under Sale date. Where this is not completed the SGL Form will not be
accepted by the RBI.
• SGL transfer forms should be signed by two authorised officials of the bank
whose signatures should be recorded with the respective PDOs of the
Reserve Bank and other banks.
Non-performing Investments
5.21 In respect of securities included in any of the three categories where
interest/ principal is in arrears, the banks should not reckon income on the
securities and should also make appropriate provisions for the depreciation in the
value of the investment. The banks should not set-off the depreciation
requirement in respect of these non-performing securities against the
appreciation in respect of other performing securities.
5.22 A non performing investment (NPI), similar to a non performing advance
(NPA), is one where:
(a) Interest/ instalment (including maturity proceeds) is due and remains
unpaid for more than 90 days.
(b) The above would apply mutatis-mutandis to preference shares where the
fixed dividend is not paid.
34
Investment Portfolio
(c) In the case of equity shares, in the event the investment in the shares of
any company is valued at Re.1 per company on account of the non-
availability of the latest balance sheet, those equity shares would also be
reckoned as NPI.
(d) If any credit facility availed by the issuer is NPA in the books of the bank,
investment in any of the securities issued by the same issuer would also
be treated as NPI and vice versa.
(e) The investments in debentures / bonds, which are deemed to be in the
nature of advance would also be subjected to NPI norms as applicable to
investments.
(f) In case of conversion of principal and / or interest into equity, debentures,
bonds, etc., such instruments should be treated as NPA abinitio in the
same asset classification category as the loan if the loan's classification is
substandard or doubtful on implementation of the restructuring package
and provision should be made as per the norms.
Income Recognition
5.23 Banks may book income on accrual basis on securities of corporate
bodies/ public sector undertakings in respect of which the payment of interest
and repayment of principal have been guaranteed by the Central Government or
a State Government, provided interest is serviced regularly and as such is not in
arrears. Banks may book income from dividend on shares of corporate bodies on
accrual basis provided dividend on the shares has been declared by the
corporate body in its Annual General Meeting and the owner's right to receive
payment is established. Banks may book income from Government securities
and bonds and debentures of corporate bodies on accrual basis, where interest
rates on these instruments are pre-determined and provided interest is serviced
regularly and is not in arrears. Banks should book income from units of mutual
funds on cash basis.
Broken Period Interest
5.24 Banks should not capitalise the Broken Period Interest paid to seller as
part of cost, but treat it as an item of expenditure under Profit and Loss
Account in respect of investments in Government and other approved
securities. However, the banks should comply with the requirements of
Income Tax Authorities in the manner prescribed by them.
35
CHAPTER 6
38
Asset Liability Management
* Saunders, 1997.
39
Technical Guide on Internal Audit of Treasury Function in Banks
6.11 The following equation describes the percentage fall in price of the bond
for a given increase in the required interest rates or yields:-
DP p = D ( dR /1+R)
The larger the value of the duration, the more sensitive is the price of that asset
or liability to changes in interest rates. As per the above equation, the bank will
be immunized from interest rate risk if the duration gap between assets and the
liabilities is zero. The one important benefit of duration model is that it uses the
market value of assets and liabilities.
6.12 Under this technique assumptions were made on various conditions, for
example: -
• Several interest rate scenarios were specified for the next 5 or 10 years.
These specified conditions like declining rates, rising rates, a gradual
decrease in rates followed by a sudden rise, etc. Ten or twenty scenarios
could be specified in all.
• Assumptions were made about the performance of assets and liabilities
under each scenario. They included prepayment rates on mortgages or
surrender rates on insurance products.
• Assumptions were also made about the firm's performance like, the rates at
which new business would be acquired for various products, demand for the
product, etc.
• Market conditions and economic factors like, inflation rates and industrial
cycles were also included.
6.13 Based upon these assumptions, the performance of the firm's balance
sheet could be projected under each scenario. If projected performance was poor
under specific scenarios, the ALM committee would adjust assets or liabilities to
address the indicated exposure. Let us consider the procedure for sanctioning a
commercial loan. The borrower, who approaches the bank, has to appraise the
banks credit department on various parameters like, industry prospects,
operational efficiency, financial efficiency, management qualities and other
things, which would influence the working of the company. On the basis of this
appraisal, the banks would then prepare a credit grading sheet after covering all
the aspects of the company and the business in which the company is in. Then
the borrower would then be charged a certain rate of interest which would cover
the risk of lending. The main shortcoming of scenario analysis was that it was
highly dependent on the choice of scenarios. It also required that many
40
Asset Liability Management
assumptions were to be made about how specific assets or liabilities will perform
under specific scenarios. Gradually, the firms recognized a potential for different
type of risks which was overlooked in ALM analysis.
Relationship between Treasury and ALM
6.14 The banking operations are confined to lending, accepting deposits and
miscellaneous services. It is the treasury which operates in financial markets
directly, establishing a link between core banking functions and market
operations. Thus, the market risk is identified and monitored through treasury.
Treasury uses derivatives and other means to bridge the liquidity and rate
sensitivity gaps. Treasury products are marketable and liquidity can be infused at
any point of time. Treasury monitors exchange rate and interest rate movements.
Hence, risk management is an integral part of treasury. In many banks, either
ALM desk is part of the dealing room or Asset Liability Management Committee
(ALCO) support group is part of the treasury team. The head of the treasury is an
important member of ALCO, thereby contributing not only to risk management
but also to product pricing and other policy issues.
RBI Guidelines on Asset Liability Management
6.15 The RBI had issued guidelines on ALM system vide Circular No. DBOD.
BP. BC. 8 / 21.04.098/ 99 dated February 10, 1999, which covered, among
others, interest rate risk and liquidity risk measurement, reporting framework and
prudential limits. The abovementioned guidelines are given in Annexure VII of
the Guide.
6.16 RBI reviewed the above guideline and made the following changes vide
Circular “Guidelines on Asset Liability Management (ALM) System –
amendments” (DBOD. No. BP. BC. 38 / 21.04.098/ 2007-08) dated October 24,
2007:
• As per the revised guidelines, banks must adopt a more granular approach
to measurement of liquidity risk by splitting the first time bucket of 1-14 days
in the Statement of Structural Liquidity into three time buckets – next day, 2-
7 days and 8-14 days.
• The net cumulative negative mismatches during the next day, 2-7 days, 8-14
days and 15-28 days buckets should not exceed 5 per cent, 10 per cent, 15
per cent and 20 per cent of the cumulative cash outflows in the respective
buckets in order to recognise the cumulative impact on liquidity,
41
Technical Guide on Internal Audit of Treasury Function in Banks
• Banks may undertake dynamic liquidity management and should prepare the
Statement of Structural Liquidity on daily basis. The Statement of Structural
Liquidity, may, however, be reported to RBI, once a month, as on the third
Wednesday of every month. However, the frequency of supervisory
reporting of the Structural Liquidity position shall be fortnightly, with effect
from the fortnight beginning April 1, 2008.
42
CHAPTER 7
TREASURY RISKS
7.1 Banks are highly sensitive to treasury risks, as the risks arrive out of
high leverage treasury business enjoys. The risks of losing capital are much
more than the credit business. Treasury faces broadly three types of risk, viz.,
market risk, credit risk, and operational risk.
Market Risk
7.2 Market risk may be defined as the possibility of loss to a bank caused
by changes in the market variables. The Bank for International Settlements (BIS)
defines market risk as “the risk that the value of on or off-balance sheet positions
will be adversely affected by movements in equity and interest rate markets,
currency exchange rates and commodity prices”. Thus, market risk is the risk to
the bank’s earnings and capital due to changes in the market level of interest
rates or prices of securities, foreign exchange and equities, as well as the
volatilities of those prices.
Market risk broadly covers liquidity risk, interest rate risk and foreign exchange
risk.
Liquidity Risk
7.3 Liquidity risk is the potential inability to meet the bank's liabilities as they
become due. It arises when the banks are unable to generate cash to cope with
a decline in deposits or increase in assets. It originates from the mismatches in
the maturity pattern of assets and liabilities. Measuring and managing liquidity
needs are vital for effective operation of commercial banks. By assuring a bank's
ability to meet its liabilities as they become due, liquidity management can
reduce the probability of an adverse situation developing.The liquidity risk in
banks manifest in different dimensions:
(a) Funding Risk - need to replace net outflows due to unanticipated
withdrawal/non-renewal of deposits (wholesale and retail);
(b) Time Risk - need to compensate for non-receipt of expected inflows of
funds, i.e., performing assets turning into non-performing assets; and
Technical Guide on Internal Audit of Treasury Function in Banks
44
Treasury Risks
45
Technical Guide on Internal Audit of Treasury Function in Banks
46
Treasury Risks
7.12 It is necessary that formal policies are in place with respect to trigger
limits; stop loss limits; prudential limits; well defined procedures and check lists;
effective internal controls and audit; insurance, wherever possible; business
process re-engineering to eliminate weak links in the process chain; prudential
limits on investments in banks; cap on unrated issues and private placements;
sub-limits for PSU bonds, corporate bonds and guaranteed bonds; same degree
of credit risk analysis in the case of any loan proposal; and more stringent
appraisal for non-borrower issuers.
Market Risk Limits
7.13 Market risk limits should be established at different levels of the entity,
i.e., the entity as a whole, various risk-taking units, trading desk heads and
individual traders. In determining how market risk limits are established and
allocated, management should take into account following factors:
(a) Past performance of the trading unit;
(b) Experience and expertise of the traders;
(c) Level of sophistication of the pricing, valuation and measurement
systems; quality of internal controls;
(d) Projected level of trading activity having regard to the liquidity of
particular products and markets; and
(e) Ability of the operating systems to settle the resultant trades.
Commonly Used Market Risk Limits
7.14 The following are some of the commonly used market limits:
(a) Notional or Volume Limits
Limits based on notional amount of derivatives contracts are the most basic and
simplest form of limits for controlling the risks of derivatives transactions. They
are useful in limiting transaction volume, liquidity and settlement risks. However,
these limits cannot take account of price sensitivity and volatility.
(b) Stop Loss Limits
These limits are established to avoid unrealized loss in a position from exceeding
a specified level. When these limits are reached, the position will either be
liquidated or hedged. Typical stop loss limits include those relating to
47
Technical Guide on Internal Audit of Treasury Function in Banks
48
Treasury Risks
49
CHAPTER 8
8.1 Every banking entity is different and the challenge lies in the integration
of effective controls into the correct area of risk, i.e., how well controls are
designed and executed. Thus, every entity has to identify its areas of risk and
decide how much control is required. Unfortunately, there is no standard
precedent for a treasury to simply follow. It is only with careful analysis and
understanding of the business and its risks that controls can be implemented in a
targeted and effective manner. In order to do this is real skill and expertise is
required. Proper controls not only save a bank from financial loss, but also assist
management in the running of the business more effectively.
Risk Appetite
8.2 It may be noted that before deciding on the control framework, it is
necessary to determine ‘risk appetite’. This depends on the type of business and
treasury operation. For instance, one would expect to see a tighter control
framework around a business that runs a profit centre treasury and trades to
make a return as opposed to a more simple transaction based (e.g., purely
hedging) treasury. Similarly, a different framework is also required for a treasury
that runs a more manual process as opposed to one that has a greater level of
straight through processing.
Governance
8.3 The bank’s board has the ultimate responsibility for ensuring that an
adequate system of internal controls is established and maintained. The
importance of the board and senior management understanding the risks the
business is facing, articulating its risk appetite and developing policies and
procedures that reflect that position hardly needs to be stressed. Every bank
should have a policy that covers the identification, measurement, management,
monitoring and control of financial risk. The policy should be approved by the
board. The board should also establish a Treasury Committee that meets every
Technical Guide on Internal Audit of Treasury Function in Banks
month or so. Members of this committee normally consist of the treasurer, chief
financial officer (CFO), representatives from areas such as, tax or corporate
finance, and perhaps a person from the business operations side.
8.4 The Treasury Committee should receive a report, along with minutes of
the previous meeting. The report should include a review of the past month's
treasury performance and also look into the future, to see what actions treasury
will need to take (e.g., replacing funding facilities). However, treasury reports are
often not particularly clear or meaningful and procedures should be adopted to
developing a clear, concise, timely and relevant reporting process. Treasury
Committee should also carry out a half yearly review of investment portfolio of
treasury to vouch safe adherence of investment policy laid down by the bank as
well as the applicable RBI guidelines.
Operating Controls
8.5 The first 'line of defense' is a set of operating controls around the
processes undertaken in the treasury function. Some of the operating controls
crucial to the functioning of a treasury are discussed in the following paragraphs.
Segregation of Duties
8.6 No two treasuries are the same. However, one thing is for sure, it is vital
that different individuals within the front, middle (if there is one) and back offices
are responsible for the different activities during the deal life cycle (such as,
dealing, recording, confirmation, settlement, reporting and monitoring).The front-
office should be responsible for the operation of the strategy approved by the
board or treasury committee, and designing and executing transactions to
manage the financial risks of the business. The back-office provides the
necessary checks to prevent unauthorised trading and minimise the potential for
error or fraud. The role of the back-office is to check, confirm, settle and reconcile
trades conducted by the front-office and possibly provide management
information.
8.7 It is ideal that the people who perform the respective duties of front-
office and back-office have different reporting lines.
If it is impossible to have total separation (as in the case of small treasuries) then
at least the responsibilities should be segregated such that no two sequential
steps are undertaken by the same person. These responsibilities include:
• identification of positions and dealing;
52
Treasury Unit – Fundamental Controls
• authorization of deals;
• confirmations;
• authorization of settlement;
• release of settlement; and
• accounting.
Dealing
8.8 It is market practice for dealers to select banks to be contacted on the
basis of known competitiveness in the relevant instrument, creditworthiness and
limit availability. Competitive quotes should always be sought, unless there is a
specific reason not to do so. Records should be maintained of banks contacted
and rates quoted, indicating those that have been accepted. This should ensure
that no one bank or broker is favoured over another and the best returns are
being achieved. Once the deal has been struck, the dealer should immediately
input the details into the deal recording system, either a specialist treasury
management system (TMS) or the bank's alternative to this. Normally, the
system will automatically number the trades using a sequence of numbers. The
TMS is the firm's official record of the trade, but the dealer may choose to have
either paper deal tickets or a 'blotter'. These can be useful when confirming that
all trades have been input into the system and that they are accurate. This would
typically be conducted by the back-office. The phones of dealers should be taped
to provide a record if there is a dispute with counterparty. These tapes should be
checked regularly to ensure that the tapes are working and there is room to
continue recording. Dealers should not have access to these tapes.
Access to the Front -office
8.9 There has been debate over the physical access to the dealing room
within a treasury environment. It is common within a banking environment to
have staff from the front and back offices physically separated. Otherwise, the
entity will need to rely more heavily on IT controls, e.g., computers locked with
password entry. House-keeping becomes extremely important with systems,
ensuring old users are deleted and current users have the correct access profile.
System Security
8.10 Irrespective of the physical set-up of the treasury, it is important that
systems have passwords that are regularly checked and that personal computers
53
Technical Guide on Internal Audit of Treasury Function in Banks
are locked if unattended. Timeout locks should assist this if a machine is not
touched for a period of time. Control procedures within treasury usually depend
to a great extent upon the correct usage of computer software packages. All
authorized users should be assigned a unique user identification (ID) and
personal password. Users should log out of the system when it is not being used
and, particularly, when leaving their desks. All computers should have screen
saver passwords that prevent access, other than by password, if the computer is
left unattended.
8.11 The following are some of the important system controls implemented
by banks in the present day treasury environment:
(a) In a treasury system with online deal entry (usually referred to as a
front-office dealing system), deals are entered directly in the system.
The back-office support function has only view rights to the deals
entered into such dealing system and every time they note a new deal
they confirm the particulars of the deal with the back-office of the
counterparty to the transaction. On confirmation, they approve the deal
through their security ID in the system and only then the deal finally gets
booked. In case of discrepancies, the back-office informs the front-office
dealer and then the deal is not booked in the system.
(b) In case of foreign exchange transactions, the treasury system is
configured to compare the rates at which the transactions are done by
the bank with the market rate range and generate an exception report.
This report is useful to note significant variations in rates which the
dealers would have transacted at.
(c) Front-office systems in banks may be configured to compute limits on a
real-time basis, such as, dealer limits, counterparty limits, broker limits,
currency limits, exposure limits, etc. When a transaction is entered into
the system these limits are automatically computed and flashed on the
screen to prompt the dealer of a potential limit breach if the deal is
executed.
(d) Systems may also be configured to perform automated nostro
reconciliations whereby the system extracts the bank’s nostro account
data from the general ledger and account statements of the
counterparty bank and then matches the similar trades and generates
an exception report for trade mismatches (or reconciling items). A
designated back-office team tracks the ageing of such reconciling items
54
Treasury Unit – Fundamental Controls
and follows up with the respective functions within the bank for resolving
the same.
(e) As noted above, all authorized users are assigned a unique user
identification (ID) and personal password. In any IT environment,
usually, the user rights and entitlements to the various IT systems is
clearly defined and documented and also subjected to a periodic review.
In an instance when a user ID that does not have access to a particular
set of information or command is trying to retrieve such information,
then a modification log automatically gets saved in the system which
gives details of the user ID trying to gain unauthorised access. Such
controls are referred to as ‘fraud risk controls’.
(f) Some bank’s IT system are interfaced to the financial accounting or
general ledger system. At the end of the day, usually, the balances and
positions in all the systems is uploaded in the financial accounting
system. At the time of such upload an exception report/log is
automatically generated which gives the details of the balances which
could not be uploaded correctly or completely. Banks have a dedicated
team in their back-office who are only responsible for resolving the open
items in such exception report on a timely basis.
8.12 IT creates opportunities but also calls for a new genre of risks, such as:
♦ Logical or processing errors caused by the underlying program code.
Systematic errors may be more difficult to detect.
♦ Unauthorised access to systems due to compromised controls over
access IDs and passwords or non-discontinuance of system access for
exit/transfer cases of staff members.
♦ Non-updation of master data fields leading to errors (such as, mailing
address, customer name, staff account status, dormant/unclaimed
account status).
♦ Loss of laptops, remote access control devices, blackberry, palmtops or
personal digital assistants (‘PDAs’) which may get misused for
authorising certain transactions or initiating certain communication.
8.13 The banking industry is one of the most significant users of technology
as compared to other industries. The bank’s management also enforces controls
such as, periodic reviews of access to the financial system resources and other
confidential/critical data, to confirm the appropriateness of these access rights
55
Technical Guide on Internal Audit of Treasury Function in Banks
56
Treasury Unit – Fundamental Controls
Document Security
8.18 All paper records should be filed in cabinets. Sensitive or valuable
documents should be kept in locked and preferably fire proof storage.
Oversight Controls
8.19 The treasurer should receive the following reports on a daily basis.
• breached credit limits;
• list of deals done for the day;
• off-market trades, with an explanation; and
• changes to standing data.
8.20 Back-office management should also ensure that their controls are
being conducted as they were designed. Some examples include a summary of
unreconciled items, suspense account items and outstanding confirmations that
have not been matched. It is very useful to see how numerous and large these
amounts are, and also how long they have been outstanding. Needless to say,
concurrent audit of treasury operations would ensure that these controls are in
operation.
Monitoring Controls and Treasury Reporting
8.21 Regular reporting to management is the most common form of
monitoring treasury activity. The purpose of treasury reporting is:
(a) To inform senior management of financial exposure;
(b ) To demonstrate to senior management that treasury activity is
within parameters authorised by the board; and
(c) To promote the analysis of activities and performance measurement
within treasury and so lead to improvements in efficiency and control.
8.22 The treasury report will include information on the major risks of the
business and the performance of the treasury function over the past month.
Examples of such information are:
• Economic update - based on market sources (e.g., relationship banks)
giving details on the current economic environment and likely future
scenarios and how these will impact the bank;
57
Technical Guide on Internal Audit of Treasury Function in Banks
58
CHAPTER 9
Functional Independence
9.3 The internal auditor should be independent from the internal control
process in order to avoid any conflict of interest. He should be given an
appropriate standing within the bank to carry out the assignments. He should not
be assigned the responsibility of performing other accounting or operational
functions. The internal audit staff should perform their duties with objectivity and
impartiality. The internal audit head should not report to any authority below the
level of the Board of Directors/Audit Committee.
Code of Ethics and Internal Auditors
9.4 A code of ethics is necessary and appropriate for the profession of
internal auditing, as it is founded on the trust placed in its objective assurance
about risk management, control, and governance. A member of the Institute of
Chartered Accountants of India, carrying out an internal audit activity, would
apart from other requirements, additionally be governed by:-
(i) the requirements of the Chartered Accountants Act, 1949;
(ii) the Code of Ethics issued by the Institute of Chartered Accountants of
India; and
(iii) other relevant pronouncements of the Institute of Chartered
Accountants of India.
Internal auditor has to uphold the golden principles of integrity, objectivity,
confidentiality and competence.
Stages of Internal Audit
9.5 The internal audit of treasury operations can be broadly divided into
following five stages:
60
Internal Audit of Treasury Operations
Pre-commencement Work
Audit Documentation
Audit Procedures
Pre-commencement Work
9.6 The following points have to be considered before commencing the
internal audit:
(a) Decision on whether the engagement should be accepted. This will be
based on:
• Consider whether capability, time and resources are available;
and
• Consider whether it satisfies ethical requirements.
(b) Internal auditor cannot be the statutory auditor for the same financial
year or the same bank.
61
Technical Guide on Internal Audit of Treasury Function in Banks
62
Internal Audit of Treasury Operations
• Risk tolerance
• Back-up system
(i) Reporting requirements
9.9 Knowledge of the entity’s business is a frame of reference within which
the internal auditor exercises professional judgment in reviewing the processes,
controls and risk management procedures of the entity. Understanding the
business and using this information appropriately assists the internal auditor in:
(a) Assessing the risks and identifying key focus area.
(b) Planning and performing the internal audit effectively and efficiently.
(c) Evaluating audit evidence.
(d) Providing better quality of services to the client.
Overall Internal Audit Plan
9.10 The success of any internal audit is dependent upon an appropriate
audit plan and its timely execution. The internal audit plan should be
comprehensive enough to ensure that it helps in achieving of the overall
objectives of an internal audit. The following are some of the important aspects in
this regard:
(a) The annual audit plan, approved by the Board, should include the
schedule and the rationale for audit work planned.
(b) The plan should include all risk areas and their prioritization based on
the level of risk.
9.11 Internal audit plan should cover areas such as:
• Obtaining the knowledge of the legal and regulatory framework within
which the entity operates.
• Obtaining the knowledge of the entity’s accounting and internal control
systems and policies.
• Determining the effectiveness of the internal control procedures adopted
by the entity.
• Determining the nature, timing and extent of procedures to be
performed.
63
Technical Guide on Internal Audit of Treasury Function in Banks
64
Internal Audit of Treasury Operations
65
Technical Guide on Internal Audit of Treasury Function in Banks
(b) Evaluation of the effectiveness of the control systems for monitoring the
inherent risks of the business activities.
(c) Drawing up a risk matrix for taking into account both the factors, viz.,
inherent business risks and control risks.
(d) The basis for determination of the level (high, medium, low) and trend
(increasing, stable, decreasing) of inherent business risks and control
risks should be clearly spelt out. The risk assessment may make use of
both quantitative and qualitative approaches. While the quantum of
credit, market, and operational risks could largely be determined by
quantitative assessment, the qualitative approach may be adopted for
assessing the quality of controls in various business activities. In order
to focus attention on areas of greater risk to the bank, identification of
activity-wise and location-wise risks should be undertaken.
(e) The risk assessment methodology should include, inter alia, the
following parameters:
• Previous internal audit reports and compliance;
• Proposed changes in business lines or change in focus;
• Significant change in management/key personnel;
• Results of latest regulatory examination report;
• Reports of external auditor;
• Industry trends and other environmental factors;
• Time lapsed since last audit;
• Volume of business and complexity of activities; and
• Substantial performance variations from the budget.
9.16 For the risk assessment to be accurate, it will be necessary to have in
place proper MIS and data integrity. The internal audit function should be kept
informed of all developments such as introduction of new products, changes in
reporting lines, changes in accounting practices/policies, etc. The risk
assessment should invariably be undertaken on a yearly basis. The assessment
should also be periodically updated to take into account changes in business
environment, activities and work processes, etc.
66
Internal Audit of Treasury Operations
Risk Perspectives
9.17 Inherent business risks indicate the intrinsic risk in a particular
area/activity of the bank and could be grouped into low, medium and high
categories depending on the severity of risk. Control risks arise out of inadequate
control systems, deficiencies, gaps and/or likely failures in the existing control
processes. The control risks could also be classified into low, medium and high
categories.
Risk and Audit Matrix
9.18 In the overall risk assessment both the inherent business risks and
control risks should be factored in. The overall risk assessment as reflected in
each cell of the risk matrix is explained below:
RISK MATRIX
High A B C
High Risk Very High Extremely
Inherent Business Risks
Risk Assessment
A. High Risk: Even though the control risk is low, this is a high risk area
due to high inherent business risks.
B. Very High Risk: The high inherent business risk coupled with medium
control risk makes this a Very High Risk area
67
Technical Guide on Internal Audit of Treasury Function in Banks
C. Extremely High Risk: Both the inherent business risk and control risk
are high which makes this an Extremely High Risk area. This area
would require immediate audit attention, maximum allocation of audit
resources besides ongoing monitoring by the bank’s top management.
D. Medium Risk: Although the control risk is low this is a Medium Risk area
due to medium inherent business risks.
E. High Risk: Although the inherent business risk is medium this is a High
Risk area because of control risk also being medium.
F. Very High Risk: Although the inherent business risk is medium, this is a
Very High Risk area due to high control risk.
G. Low Risk: Both the inherent business risk and control risk are low.
H. Medium Risk: The inherent business risk is low and the control risk is
medium.
I. High Risk: Although the inherent business risk is low, due to high control
risk this becomes a High Risk area.
9.19 The banks should also analyse the inherent business risks and control
risks with a view to assess whether these are showing a stable, increasing or
decreasing trend. Illustratively, if an area falls within cell ‘B’ or ‘F’ of the Risk
Matrix and the risks are showing an increasing trend, these areas would also
require immediate audit attention, maximum allocation of audit resources besides
ongoing monitoring by the bank’s top management (as applicable for cell ‘C’).
The Risk Matrix should be prepared for each business activity/location.
Internal Audit Documentation
9.20 Internal auditor should have proper working papers that will enable him
to substantiate his results. The internal auditor’s work papers serve as the
connecting link between the audit assignment, the auditor's fieldwork, and the
final report. Work papers contain the records of planning and preliminary
surveys, audit procedures, fieldwork, and other documents relating to the internal
audit. Most importantly, the work papers document the internal auditor's
conclusions and the reasons those conclusions were reached. As each audit
step in the audit procedures is satisfied, the internal audit supervisor should
request review of the related work papers.
68
Internal Audit of Treasury Operations
69
Technical Guide on Internal Audit of Treasury Function in Banks
70
Internal Audit of Treasury Operations
71
Annexures
ANNEXURE – A
The internal auditor’s procedures with respect to the following specific areas of
treasury operations are as follows:
76
Annexure – A
77
Technical Guide on Internal Audit of Treasury Function in Banks
78
Annexure – A
79
Technical Guide on Internal Audit of Treasury Function in Banks
80
ANNEXURE – B
The internal auditor’s procedures with respect to the following specific areas of
foreign exchange operations are as follows:
Sr.
Particulars Remarks
No.
I Interbank Deal
a Whether the bank has specified the dealing hours for the
dealers operating in foreign exchange market.
b Whether adequate care is exercised in selecting and
grooming the dealers.
c1.3 Whether dealers operate in the interbank market
according to the guidelines lay down by the
management
d Whether there is a system of rotation of duties of
dealers.
e1.5 Whether dealers have furnished an undertaking to
conform to the code of conduct prescribed by Foreign
Exchange Dealer’s Association of India (FEDAI).
f Whether the trading date, time and the transaction serial
number are entered automatically in the system and the
same can not be altered by the dealer after a contract is
finalised.
Technical Guide on Internal Audit of Treasury Function in Banks
82
Annexure – B
83
Technical Guide on Internal Audit of Treasury Function in Banks
III Brokerage
a Whether branch is maintaining panel of brokers
approved by the management .
b Whether substitution of one bank by another in inter-
bank contract by brokers is noticed.
c Whether provisions of Income Tax Act regarding the tax
deducted at source (TDS) on brokerage have been
complied with.
d Whether all brokerage claims are being verified from the
above broker-wise register.
e Whether the back office is preparing a monthly summary
of brokerage paid to each broker in the abovementioned
register and the contents thereof are being submitted to
head office.
f Whether back office department ensures that all broker
notes have been received expeditiously and particulars
therein including the dates thereof agree with relative
deal slips.
g In case of discrepancies in the brokers note, whether the
84
Annexure – B
IV Limits
a Whether limit is fixed for the exposure to other banks in
respect of interbank dealings. If so, whether the dealings
are within the limits. If not, verify the procedure followed
for regularisingit.
b Whether day light limits have been exceeded and if so,
check the extent. Ascertain and indicate the reasons for
same and verify whether higher authorities ratified the
same.
c Whether the overnight open position limits in various
currencies, as fixed by the management, have been
exceeded at any time and if so,verify the time and extent.
Indicate the action taken to regularize the position.
d Whether the gap limits are adhered to. If not, indicate the
details and the steps taken to comply with the
requirements in this regard.
e Whether statements of maturities are being submitted to
higher authorities / RBI by accounting department and
check the intervals of the submission also.
f Whether particulars reported in Gap statements are
85
Technical Guide on Internal Audit of Treasury Function in Banks
V POS Register
a Whether daily currency position report (Form IC-5 of
guidelines) is being submitted to higher authorities.
b Whether statement of currency positions in each
currency as on the last Friday of each month computed
after taking into account the effect of all pipeline
transactions, is submitted to the management indicating
the steps to be taken for reducing the distortions, if any.
c Whether the particulars reported in the last statement of
true currency positions prepared and submitted to the
management are correct as per records maintained.
d Whether there is any alteration / correction at the dates
of the contracts in order to manipulate currency position.
e Whether dealers have maintained position pads, funds
chart and maturity pattern of the contracts.
f Whether currency wise position and funds position is
communicated and / or updated in the system frequently
to enable the dealer to have updated position.
g Whether positions are taken purely for covering
positions.
h Whether positions are also taken in advance.
86
Annexure – B
VI Nostro Reconciliation
a Whether accounting entries are promptly booked and
payments committed under the deals are promptly
advised and effected. Whether receipts are suitably
recorded in the “Nostro” account.
b Whether a separate department / section, under the
charge of a separate official, is there forreconciliation
work.
c Whether the officials attached to the reconciliation
department have been entrusted with the operation of
Nostro Accounts or passing of entries in the Mirror
Account.
d Whether statement of accounts are received at least
once in month by the reconciliation department and the
department is:
(a) Watching the receipt of statement
(b) Ensuring that there are no unauthenticated
alterations, erasures, etc.
e Whether the reconciliation work is undertaken
expeditiously and is upto date.
f Whether the credits are advised to the concerned
branches immediately.
g Whether the follow up action on the entries, especially
debit items appearing in the statements and/or mirror
account is promptly initiated / taken.
h Whether the department is submitting a report once a
month to the higher authorities indicating the progress of
reconciliation work and the special features, such as
large non reconciled items etc., and if so, what action has
been taken on such reports by the branch?
i Whether large balance has been held in an inoperative
account, for a long period and if so, the reasons thereof.
87
Technical Guide on Internal Audit of Treasury Function in Banks
VII R- Returns
a Whether timely, accurate and comprehensive
management information system is in place,
b Whether monitoring and reporting is undertaken by
officials who are not directly concerned with trading
activities.
c Whether R-Returns are submitted to RBI within the
stipulated due-date.
VIII Forex Profits/ Losses
a Whether dealer-wise profit targets are fixed.
b Whether the bank is reckoning only the Nostro balances
for adjustment of the profits / losses revealed in the
88
Annexure – B
89
Technical Guide on Internal Audit of Treasury Function in Banks
XI Internal Control
a Whether data processing system is adequate to the
nature / volume of activities and is designed to functional
separation.
b Whether back up facilities are available for deployment in
case of system failure and other emergencies.
c Whether job rotation is provided to the dealers as well as
back office personnel.
d Whether clear functional separation of dealing, back
office, settlement / accounting / reconciliation is being
observed.
e Whether the bank has the system of internal audit of the
Forex Department.
f Whether the bank has proper system of receiving,
distributing and filing all relevant RBI circulars.
g Whether the bank has sufficient number of Exchange
Control Manuals with all the amendments.
XII Overnight Placement of Orders in Trading
a Whether there are any instances that the bank has
invested funds in overseas markets above $10 million (or
25% of Unimpaired Tier 1 capital) or borrowed above $
10 million (or 25% of Unimpaired Tier 1 Capital)
whichever is higher, from the correspondents.
90
Annexure – B
91
ANNEXURE – C
Sr.
Particulars Remarks
No
I Investment Policy
a Whether bank has framed an investment policy.
b Whether the policy is revised periodically and is in
accordance with the RBI guidelines/
c Whether the policy after approval by Board is sent to
RBI.
d Whether the investment activity of the bank is in
consonance with the policy
93
Technical Guide on Internal Audit of Treasury Function in Banks
94
Annexure – C
95
Technical Guide on Internal Audit of Treasury Function in Banks
96
Annexure – C
97
Technical Guide on Internal Audit of Treasury Function in Banks
98
Annexure – C
99
Technical Guide on Internal Audit of Treasury Function in Banks
100
Annexure – C
101
Technical Guide on Internal Audit of Treasury Function in Banks
102
Annexure – C
103
Technical Guide on Internal Audit of Treasury Function in Banks
104
Annexure – C
105
Technical Guide on Internal Audit of Treasury Function in Banks
106
Annexure – C
107
Technical Guide on Internal Audit of Treasury Function in Banks
108
ANNEXURE – D
INDEX
Chapter
Subject Page No.
No.
1. Policy Framework
2. Organizational set up
3. Liquidity Risk Management
4. Interest Rate Risk Management
5. Foreign Exchange Risk Management
6. The Treatment of Market Risk in the
Proposed Basel Capital Accord:
Annexures
Annexure I BCBS Principles for the Assessment of
Liquidity Management in Banks
Annexure II BCBS Principles for Interest Rate Risk
Management
Annexure III Sources, effects and measurement of
interest rate risk
Annexure IV Value at Risk
Annexure V Stress Testing
Technical Guide on Internal Audit of Treasury Function in Banks
110
Annexure – D
Sensitivity and Value at Risk limits for trading portfolios and limits for
accrual portfolios (as prescribed for ALM) must be measured daily.
Where market risk is not measured daily, Risk Taking Units must
have procedures that monitor activity to ensure that they remain
within approved limits at all times.
• Mandatory market risk limits are required for Factor Sensitivities and
Value at Risk for mark to market trading and appropriate limits for
accrual positions including Available-for-Sale portfolios. Requests for
limits should be submitted annually for approval by the Risk Policy
Committee. The approval will take into consideration the Risk Taking
Unit's capacity and capability to perform within those limits evidenced
by the experience of the Traders, controls and risk management,
audit ratings and trading revenues.
• Approved Management Action Triggers or Stop-loss are required for
all mark to market risk taking activities.
• Risk Taking Units are expected to apply additional, appropriate
market risk limits, including limits for basis risk, to the products
involved; these should be detailed in the Market Risk Product
Programme.
1.2.3 Risk Monitoring
• A rate reasonability process is required to ensure that all transactions
are executed and revalued at prevailing market rates; rates used at
inception or for periodic marking to market for risk management or
accounting purposes must be independently verified.
• Financial Models used for revaluations for income recognition
purposes or to measure or monitor Price Risk must be independently
tested and certified.
• Stress tests must be performed preferably quarterly for both trading
and accrual portfolios. This may be done when the underlying
assumptions of the model/ market conditions significantly change as
decided by the Asset Liability Committee.
1.2.4 Models of analysis
• Line Management must ensure that the software used in Financial
Models that value positions or measure market risk is performing
111
Technical Guide on Internal Audit of Treasury Function in Banks
112
Annexure – D
113
Technical Guide on Internal Audit of Treasury Function in Banks
114
Annexure – D
115
Technical Guide on Internal Audit of Treasury Function in Banks
116
Annexure – D
117
Technical Guide on Internal Audit of Treasury Function in Banks
118
Annexure – D
activity.
• Dealing with Brokers - All dealers should be aware of, acknowledge
and provide an undertaking to remain within the guidelines governing
the bank's activities with brokers including conducting business only
with brokers authorised by bank's Risk Management Committee on the
bank's Brokers Panel.
• Ensuring their activities with brokers do not allow for the brokers to act
as principals in transactions, but remain strictly in their authorised role
as market intermediaries.
• Requiring brokers to provide all broker notes and confirmations of
transactions before close of business each day (or exceptionally by the
beginning of the next business day, in which case the note must be
prominently marked by the broker as having been transacted the
previous day, and the Back Office must recast the previous night's
position against limits reports) to the bank's Back Office for
reconciliation with transaction data.
• Ensuring all brokerage payments and statements are received,
reconciled and paid by the bank's Back Office department and under no
circumstances authorised or any payment released by dealers.
• Prohibiting the acceptance by dealers of gifts, gratifications or other
favours from brokers, instances of which should be reported in detail to
RBI’s Department of Banking Supervision indicating the nature of the
case
• Prohibiting dealers from nominating a broker in transactions not done
through that broker.
• Rules for the prompt investigation of complaints against dealers and
malpractices by brokers and reporting to FEDAI and RBI’s Department
of Banking Supervision.
• Dealing Hours - All Dealers should be aware of the bank's normal
trading hours, cut off time for overnight positions and rules governing
after hours and off-site trading (if allowed by the bank)
• Security and Confidentiality - All dealers should be aware of the
bank's requirements in respect of maintaining confidentiality over its
own and its customers' trading activities as well as the responsibility for
119
Technical Guide on Internal Audit of Treasury Function in Banks
120
Annexure – D
121
Technical Guide on Internal Audit of Treasury Function in Banks
3.1 Liquidity risk is the potential inability to meet the bank’s liabilities
as they become due. It arises when the banks are unable to generate
cash to cope with a decline in deposits or increase in assets. It
originates from the mismatches in the maturity pattern of assets and
liabilities. Measuring and managing liquidity needs are vital for effective
operation of commercial banks. By assuring a bank’s ability to meet its
liabilities as they become due, liquidity management can reduce the
probability of an adverse situation developing.
3.2 Analysis of liquidity risk involves the measurement of not only
the liquidity position of the bank on an ongoing basis but also
examining how funding requirements are likely to be affected under
crisis scenarios. Net funding requirements are determined by analysing
the bank’s future cash flows based on assumptions of the future
behaviour of assets and liabilities that are classified into specified time
buckets and then calculating the cumulative net flows over the time
frame for liquidity assessment.
3.3 Future cash flows are to be analysed under “what if” scenarios
so as to assess any significant positive / negative liquidity swings that
could occur on a day-to-day basis and under bank specific and general
market crisis scenarios. Factors to be taken into consideration while
determining liquidity of the bank’s future stock of assets and liabilities
include their potential marketability, the extent to which maturing
assets /liability will be renewed, the acquisition of new assets / liability
and the normal growth in asset / liability accounts.
3.4 Factors affecting the liquidity of assets and liabilities of the bank
cannot always be forecast with precision. Hence they need to be
reviewed frequently to determine their continuing validity, especially
given the rapidity of change in financial markets.
3.5 The liquidity risk in banks manifest in different dimensions:
i) Funding Risk – need to replace net outflows due to
unanticipated withdrawal/non-renewal of deposits (wholesale
and retail);
ii) Time Risk – need to compensate for non-receipt of expected
122
Annexure – D
123
Technical Guide on Internal Audit of Treasury Function in Banks
124
Annexure – D
environment are duly accounted for. The banks can also estimate the
liquidity profile on a dynamic way by giving due importance to:
1) Seasonal pattern of deposits/loans;
2) Potential liquidity needs for meeting new loan demands,
unavailed credit limits, potential deposit losses, investment
obligations, statutory obligations, etc.
3.11 Contingency Funding Plan
• All banks are required to produce a Contingency Funding Plan.
These plans are to be approved by ALCO, submitted annually as
part of the Liquidity and Capital Plan, and reviewed quarterly. The
preparation and the implementation of the plan may be entrusted
to the treasury.
• Contingency Funding Plans are liquidity stress tests designed to
quantify the likely impact of an event on the balance sheet and the
net potential cumulative gap over a 3-month period. The plan also
evaluates the ability of the bank to withstand a prolonged adverse
liquidity environment. At least two scenarios require testing:
Scenario A, a local liquidity crisis, and Scenario B, where there is
a nationwide name problem or a downgrade in the credit rating if
the bank is publicly rated.
• The bank’s contingency funding plans should reflect the funding
needs of any bank managed mutual fund whose own Contingency
Funding Plan indicates a need for funding from the bank.
• Reports of Contingency Funding plans should be performed at
least quarterly and reported to ALCO.
• If a Contingency Funding plan results in a funding gap within a 3-
month time frame, the ALCO must establish an action plan to
address this situation. The Risk Management Committee should
approve the action plan.
• At a minimum, Contingency Funding plans under each scenario
must consider the impact of accelerated runoff of Large Funds
Providers.
• The plans must consider the impact of a progressive, tiered
deterioration, as well as sudden, drastic events.
125
Technical Guide on Internal Audit of Treasury Function in Banks
126
Annexure – D
127
Technical Guide on Internal Audit of Treasury Function in Banks
4.1 Interest rate risk is the risk where changes in market interest rates
might adversely affect a bank’s financial condition. The immediate impact of
changes in interest rates is on the Net Interest Income (NII). A long term
impact of changing interest rates is on the bank’s networth since the
economic value of a bank’s assets, liabilities and off-balance sheet positions
get affected due to variation in market interest rates. The interest rate risk
when viewed from these two perspectives is known as ‘earnings perspective’
and ‘economic value’ perspective, respectively.
4.2 Management of interest rate risk aims at capturing the risks arising
from the maturity and repricing mismatches and is measured both from the
earnings and economic value perspective.
Earnings perspective involves analysing the impact of changes in
interest rates on accrual or reported earnings in the near term. This is
measured by measuring the changes in the Net Interest Income (NII)
or Net Interest Margin (NIM) i.e. the difference between the total
interest income and the total interest expense.
Economic Value perspective involves analysing the changes of
impact og interest on the expected cash flows on assets minus the
expected cash flows on liabilities plus the net cash flows on off-
balance sheet items. It focuses on the risk to networth arising from all
repricing mismatches and other interest rate sensitive positions. The
economic value perspective identifies risk arising from long- term
interest rate gaps.
4.3 The management of Interest Rate Risk should be one of the critical
components of market risk management in banks. The regulatory restrictions
in the past had greatly reduced many of the risks in the banking system.
Deregulation of interest rates has, however, exposed them to the adverse
impacts of interest rate risk. The Net Interest Income (NII) or Net Interest
Margin (NIM) of banks is dependent on the movements of interest rates. Any
mismatches in the cash flows (fixed assets or liabilities) or repricing dates
(floating assets or liabilities), expose bank’s NII or NIM to variations. The
earning of assets and the cost of liabilities are now closely related to market
interest rate volatility.
128
Annexure – D
129
Technical Guide on Internal Audit of Treasury Function in Banks
‘tails’ of the loss distribution. Banks may also undertake scenario analysis
with specific possible stress situations (recently experienced in some
countries) by linking hypothetical, simultaneous and related changes in
multiple risk factors present in the trading portfolio to determine the impact of
moves on the rest of the portfolio. VaR models could also be modified to
reflect liquidity risk differences observed across assets over time.
International banks are now estimating Liquidity adjusted Value at Risk
(LaVaR) by assuming variable time horizons based on position size and
relative turnover. In an environment where VaR is difficult to estimate for lack
of data, non- statistical concepts such as stop loss and gross/net positions
can be used.
4.6 Banking Book
The changes in market interest rates have earnings and economic value
impacts on the bank’s banking book. Thus, given the complexity and range of
balance sheet products, banks should have IRR measurement systems that
assess the effects of the rate changes on both earnings and economic value.
The variety of techniques ranges from simple maturity (fixed rate) and
repricing (floating rate) gaps and duration gaps to static simulation, based on
current on-and-off-balance sheet positions, to highly sophisticated dynamic
modelling techniques that incorporate assumptions on behavioural pattern of
assets, liabilities and off-balance sheet items and can easily capture the full
range of exposures against basis risk, embedded option risk, yield curve risk,
etc.
4.7 Rigidities and the remedial measures:
4.7.1 However, there are certain rigidities at micro level of banks and also at
the systemic level, which the banks have to address. At the micro level, the
banks have to strengthen their Management Information System (MIS) and
computer processing capabilities for accurate measurement of interest rate
risk in their banking books, which impact, in the short-term, their net interest
income (NII) or net interest margin (NIM) or “spread” and in the long-term, the
economic value of the bank.
4.7.2 At the systemic level, the rigidities are the following:
• Most of the liabilities of banks, like deposits and borrowings are on fixed
interest rate basis while their assets like loans and advances are on
floating rate basis.
130
Annexure – D
131
Technical Guide on Internal Audit of Treasury Function in Banks
positions in the trading book and gold and forex position in both trading and
banking books. The banks in India are required to apply the 2.5% risk-weight
for capital charge for market risk for the whole investment portfolio and 100%
risk- weight on open gold and forex position limits. In the “New Capital
Adequacy Framework” consultative paper, the BCBS recognises the
significance of interest rate risk in some banking books and proposes to
develop a capital charge for interest rate risk in the banking book for banks
where interest rate risks are significantly above average (“outliers”). (The
proposed Basel Capital Accord is separately covered in Chapter 7 and
annexure)
4.9 Equity Position Risk Management
Internationally banks use VAR models for management of equity position
risk. The banks should devise specific price risk structure (like sensitivity
limits, VAR, stop-loss limits) and the methods to measure liquidity of shares
to mitigate equity position risk.
132
Annexure – D
5.1 The risk inherent in running open foreign exchange positions have
been heightened in recent years by the pronounced volatility in forex rates,
thereby adding a new dimension to the risk profile of banks’ balance sheets.
Foreign Exchange Risk maybe defined as the risk that a bank may
suffer losses as a result of adverse exchange rate movements during a
period in which it has an open position, either spot or forward, or a
combination of the two, in an individual foreign currency. The banks are
also exposed to interest rate risk, which arises from the maturity mismatching
of foreign currency positions. Even in cases where spot and forward positions
in individual currencies are balanced, the maturity pattern of forward
transactions may produce mismatches. As a result, banks may suffer losses
as a result of changes in premia/discounts of the currencies concerned.
5.2 In the forex business, banks also face the risk of default of the
counterparties or settlement risk. While such type of risk crystallisation does
not cause principal loss, banks may have to undertake fresh transactions in
the cash/spot market for replacing the failed transactions. Thus, banks may
incur replacement cost, which depends upon the currency rate movements.
Banks also face another risk called time-zone risk or Herstatt risk which
arises out of time-lags in settlement of one currency in one centre and the
settlement of another currency in another time-zone. The forex transactions
with counterparties from another country also trigger sovereign or country
risk (dealt with in details in the guidance note on credit risk).
5.3 The three important issues that need to be addressed in this regard
are:
• Nature and magnitude of exchange risk
• The strategy to be adopted for hedging or managing exchange risk.
• The tools of managing exchange risk.
5.4 Nature and Magnitude of Risk
5.4.1 The first aspect of management of foreign exchange risk is to
acknowledge that such risk does exist and that it must be managed to avoid
adverse financial consequences. Many banks refrain from active
management of their foreign exchange exposure because they feel that
133
Technical Guide on Internal Audit of Treasury Function in Banks
134
Annexure – D
convertible, this relationship does not hold exactly. Although interest rate
differentials are the driving factor for the Dollar premium against the Rupee, it
also is a factor of forward demand / supply factors. This brings in typical
complications to forward hedging which must be taken into account.
5.4.6 From the above it can easily be determined that a currency with a
lower interest rate will be at a premium to a currency with a higher interest
rate. The other relationships in the forex market are not as deterministic as
the covered interest parity, but needs to be recognised to manage forex
exposure because they are the theoretical tools used for predicting exchange
rate movements, essential to any hedging strategy particularly to economic
risk as opposed to accounting risk. The most important of these is the
Purchasing Power Parity relationship which says exchange rate changes are
determined by inflation differentials. The Uncovered Interest Parity theory
says that the forward exchange rate is the best and unbiased predictor of
future spot rates under risk neutrality. These relationships have to be clearly
understood for any meaningful forex risk management process.
5.5 Managing Foreign Exchange Risk
5.5.1 For a bank therefore the first major decision on forex risk management
is for the management to fix its open foreign exchange position limits.
Although typically this is a management decision, it could also be subject to
regulatory capital and could also be required to be in tune with the regulatory
environment that prevails. These open position limits have two aspects, the
Daylight limit and the Overnight limit. The daylight limit could typically be
substantially higher for two reasons, (a) It is easier to manage exchange risk
when the market is open and the bank is actively present in the market and
(b) the bank needs a higher limit to accommodate client flows during
business hours. Overnight position, being subject to more uncertainty and
therefore being more risky should be much lower.
5.5.2 Having decided on the overall open position limits, the next step is to
allocate these limits among different operating centres of the bank (in the
case of banks which hold positions at multiple centres). Within a centre there
could be a further allocation among different dealers. It must however be
ensured that the bank has a system to monitor the overall open position limit
for the bank on a real time basis.
5.6 Tools and Techniques for managing forex risk
5.6.1 There are various tools, often substitutes, available for hedging of
135
Technical Guide on Internal Audit of Treasury Function in Banks
foreign exchange risk like over the counter forwards, futures, money market
instruments, options and the like. Most currency management instruments
enable the bank to take a long or a short position to hedge an opposite short
or long position. In equilibrium and in an efficient market the cost of all will be
the same, according to the fundamental relationships. The tools differ to the
extent that they hedge different risks. In particular, symmetric hedging tools
like futures cannot easily hedge contingent cash flows where risk is non-
linear: options may be better suited to the latter.
5.6.2 Foreign exchange forward contracts are the most common means
of hedging transactions in foreign currencies. However since they require
future performance, and if one party is unable to perform on the contract, the
hedge disappears, bringing in replacement risk which could be high. This
default risk also means that many banks may not have access to the forward
market to adequately hedge their exchange exposure. For such situations,
futures may be more suitable, where available, since they are exchange
traded and effectively minimise default risk. However, futures are
standardised and therefore may not be as versatile in terms of quantity and
tenor as over the counter forward contracts. This in turn gives rise to
assumption of basis risk.
5.6.3 Money market borrowing to invest in interest-bearing assets to offset a
foreign currency payment – also serves the same purpose as forward
contracts. This follows from the covered interest parity principle. Since the
carrying cost of a position is the same in both, the forex or the money market
hedging can also be done in either market. For instance, let us say a bank
has a short forward Dollar position. It can of course hedge the position by
buying forward Dollars. Alternatively it can borrow Rupees now, buy Dollar
with the proceeds, and place the Dollars in a forward deposit to meet the
short Dollar position on maturity. The Rupees received on the sale on
maturity are used to pay off the Rupee borrowing. The cost of this money
market hedge is the difference between the Rupee interest rate paid and the
US dollar interest rate earned. According to the interest rate parity theorem,
the interest differential equals the forward exchange premium, the
percentage by which the forward rate differs from the spot exchange rate. So
the cost of the money market hedge should be the same as the forward or
futures market hedge.
5.6.4 Currency options are another tool for managing forex risk. A foreign
exchange option is a contract for future delivery of a currency in exchange for
136
Annexure – D
another, where the holder of the option has the right to buy (or sell) the
currency at an agreed price, the strike or exercise price, but is not required to
do so. The right to buy is a call; the right to sell, a put. For such a right he
pays a price called the option premium. The option seller receives the
premium and is obliged to make (or take) delivery at the agreed-upon price if
the buyer exercises his option. In some options, the instrument being
delivered is the currency itself; in others, a futures contract on the currency.
American options permit the holder to exercise at any time before the
expiration date; European options, only on the expiration date.
5.6.5 Futures and forwards are contracts in which two parties oblige
themselves to exchange something in the future. They are thus useful to
hedge or convert known currency or interest rate exposures. An option, in
contrast, gives one party the right but not the obligation to buy or sell an
asset under specified conditions while the other party assumes an obligation
to sell or buy that asset if that option is exercised. Options being non-linear
instruments are more difficult to price and therefore their risk profiles need to
be well understood before they can be used. For example it needs to be
understood that the value of a currency changes not just when exchange rate
changes (the event for which the bank usually hedges using forwards/futures)
but also if the underlying volatility of the currency pair changes, a risk which
banks are not directly concerned with while hedging.
5.7 Treasury operations.
5.7.1 The primary treasury operation of a bank is that of catering to
customer needs, both in the spot as well as forward market. This lands the
bank with net foreign exchange positions which it needs to manage on a real
time basis. If the bank needs to sell Dollars forward to an importer, the bank
has a short Dollar position. It can offset the position by buying matching
forward Dollars in the market in which case all risks apart from the profit
element are covered for the bank. However, it may be easier for the bank to
immediately cover the forex risk with a purchase of Dollars in the spot
market. Here again the exchange risk is fully covered except for the profit
element. However the bank now has a swap position. This is called a gap.
The bank has a gap risk which affects it if interest rates change affecting the
forward premia for Dollar. In the case of our domestic markets, in addition,
premia could also change due to forward demand/supply factors. However,
gap risks are easier to manage than exchange risks. So the bank can build
up gaps, subject to the management mandated gap limits, and do offsetting
137
Technical Guide on Internal Audit of Treasury Function in Banks
138
Annexure – D
139
Technical Guide on Internal Audit of Treasury Function in Banks
140
Annexure – D
141
Technical Guide on Internal Audit of Treasury Function in Banks
Annexure-I
BCBS Principles for the Assessment of Liquidity
Management in Banks*
Developing a Structure for Managing Liquidity
Principle 1: Each bank should have an agreed strategy for the day-to-day
management of liquidity. This strategy should be communicated
throughout the organisation.
Principle 2: A bank’s board of directors should approve the strategy and
significant policies related to the management of liquidity. The board
should also ensure that senior management takes the steps necessary to
monitor and control liquidity risk. The board should be informed regularly
of the liquidity situation of the bank and immediately if there are any
material changes in the bank’s current or prospective liquidity position.
Principle 3: Each bank should have a management structure in place to
execute effectively the liquidity strategy. This structure should include the
ongoing involvement of members of senior management. Senior
management must ensure that liquidity is effectively managed, and that
appropriate policies and procedures are established to control and limit
liquidity risk. Banks should set and regularly review limits on the size of
their liquidity positions over particular time horizons.
Principle 4: A bank must have adequate information systems for
measuring, monitoring, controlling and reporting liquidity risk. Reports
should be provided on a timely basis to the bank’s board of directors,
senior management and other appropriate personnel.
Measuring and Monitoring Net Funding Requirements
Principle 5: Each bank should establish a process for the ongoing
measurement and monitoring of net funding requirements.
Principle 6: A bank should analyse liquidity utilising a variety of “what if”
scenarios.
Principle 7: A bank should review frequently the assumptions utilised in
managing liquidity to determine that they continue to be valid.
142
Annexure – D
143
Technical Guide on Internal Audit of Treasury Function in Banks
Annexure II
BCBS Principles for Interest Rate Risk Management*
144
Annexure – D
145
Technical Guide on Internal Audit of Treasury Function in Banks
146
Annexure – D
Annexure-III
Sources, effects and measurement of interest rate risk*
Interest rate risk is the exposure of a bank's financial condition to adverse
movements in interest rates. Accepting this risk is a normal part of banking
and can be an important source of profitability and shareholder value.
However, excessive interest rate risk can pose a significant threat to a
bank's earnings and capital base. Changes in interest rates affect a bank's
earnings by changing its net interest income and the level of other
interest-sensitive income and operating expenses. Changes in interest
rates also affect the underlying value of the bank's assets, liabilities and
off-balance sheet instruments because the present value of future cash
flows (and in some cases, the cash flows themselves) change when
interest rates change.
A. Sources of Interest Rate Risk
Repricing risk: As financial intermediaries, banks encounter interest rate
risk in several ways. The primary and most often discussed form of
interest rate risk arises from timing differences in the maturity (for fixed
rate) and repricing (for floating rate) of bank assets, liabilities and off-
balance-sheet (OBS) positions. While such repricing mismatches are
fundamental to the business of banking, they can expose a bank's income
and underlying economic value to unanticipated fluctuations as interest
rates vary. For instance, a bank that funded a long-term fixed rate loan
with a short-term deposit could face a decline in both the future income
arising from the position and its underlying value if interest rates increase.
These declines arise because the cash flows on the loan are fixed over its
lifetime, while the interest paid on the funding is variable, and increases
after the short-term deposit matures.
Yield curve risk: Repricing mismatches can also expose a bank to
changes in the slope and shape of the yield curve. Yield curve risk arises
when unanticipated shifts of the yield curve have adverse effects on a
bank's income or underlying economic value. For instance, the underlying
economic value of a long position in 10-year government bonds hedged
by a short position in 5-year government notes could decline sharply if the
*Principles for the Management and Supervision of Interest Rate Risk, Supporting Document to the
New Basel Capital Accord, BCBS, January, 2001
147
Technical Guide on Internal Audit of Treasury Function in Banks
148
Annexure – D
149
Technical Guide on Internal Audit of Treasury Function in Banks
positions. In this sense, the economic value perspective reflects one view
of the sensitivity of the net worth of the bank to fluctuations in interest
rates. Since the economic value perspective considers the potential
impact of interest rate changes on the present value of all future cash
flows, it provides a more comprehensive view of the potential long-term
effects of changes in interest rates than is offered by the earnings
perspective. This comprehensive view is important since changes in near-
term earnings – the typical focus of the earnings perspective - may not
provide an accurate indication of the impact of interest rate movements on
the bank's overall positions.
Embedded losses: The earnings and economic value perspectives
discussed thus far focus on how future changes in interest rates may
affect a bank's financial performance. When evaluating the level of interest
rate risk it is willing and able to assume, a bank should also consider the
impact that past interest rates may have on future performance. In
particular, instruments that are not marked to market may already contain
embedded gains or losses due to past rate movements. These gains or
losses may be reflected over time in the bank's earnings. For example, a
long term fixed rate loan entered into when interest rates were low and
refunded more recently with liabilities bearing a higher rate of interest will,
over its remaining life, represent a drain on the bank's resources.
C. Measuring Interest Rate Risk
The techniques available for measuring interest rate risk range from
calculations that rely on simple maturity and repricing tables, to static
simulations based on current on- and off-balance sheet positions, to highly
sophisticated dynamic modelling techniques that incorporate assumptions
about the behaviour of the bank and its customers in response to changes
in the interest rate environment. Some of these general approaches can
be used to measure interest rate risk exposure from both an earnings and
an economic value perspective, while others are more typically associated
with only one of these two perspectives. In addition, the methods vary in
their ability to capture the different forms of interest rate exposure: the
simplest methods are intended primarily to capture the risks arising from
maturity and repricing mismatches, while the more sophisticated methods
can more easily capture the full range of risk exposures.
150
Annexure – D
151
Technical Guide on Internal Audit of Treasury Function in Banks
∗
Timothy Koch (1995): Bank Management (Dryden, New York)
152
Annexure – D
absolute value). Higher duration implies that a given change in the level of
interest rates will have a larger impact on economic value.
Duration-based weights can be used in combination with a maturity/
repricing schedule to provide a rough approximation of the change in a
bank's economic value that would occur given a particular change in the
level of market interest rates. Specifically, an "average" duration is
assumed for the positions that fall into each time band. The average
durations are then multiplied by an assumed change in interest rates to
construct a weight for each time band. In some cases, different weights
are used for different positions that fall within a time band, reflecting broad
differences in the coupon rates and maturities (for instance, one weight for
assets, and another for liabilities). In addition, different interest rate
changes are sometimes used for different time bands, generally to reflect
differences in the volatility of interest rates along the yield curve. The
weighted gaps are aggregated across time bands to produce an estimate
of the change in economic value of the bank that would result from the
assumed changes in interest rates.
Alternatively, a bank could estimate the effect of changing market rates by
calculating the precise duration of each asset, liability and off-balance
sheet position and then deriving the net position for the bank based on
these more accurate measures, rather than by applying an estimated
average duration weight to all positions in a given time band. This would
eliminate potential errors occurring when aggregating positions/cash
flows. As another variation, risk weights could also be designed for each
time band on the basis of actual percent changes in market values of
hypothetical instruments that would result from a specific scenario of
changing market rates. That approach - which is sometimes referred to as
effective duration - would better capture the non-linearity of price
movements arising from significant changes in market interest rates and,
thereby, would avoid an important limitation of duration.
Estimates derived from a standard duration approach may provide an
acceptable approximation of a bank's exposure to changes in economic
value for relatively non-complex banks. Such estimates, however,
generally focus on just one form of interest rate risk exposure - repricing
risk. As a result, they may not reflect interest rate risk arising – for
instance - from changes in the relationship among interest rates within a
time band (basis risk). In addition, because such approaches typically use
153
Technical Guide on Internal Audit of Treasury Function in Banks
an average duration for each time band, the estimates will not reflect
differences in the actual sensitivity of positions that can arise from
differences in coupon rates and the timing of payments. Finally, the
simplifying assumptions that underlie the calculation of standard duration
means that the risk of options may not be well-captured.
The other methods of measurement of market risk, viz., Value at Risk
(VaR) and Stress Testing Techniques are elaborately discussed in the
subsequent chapters.
154
Annexure – D
Annexure-IV
Value at Risk (VaR)
Definition: VaR is defined as an estimate of potential loss in a position or
asset/liability or portfolio of assets/liabilities over a given holding period
at a given level of certainty.
VaR measures risk. Risk is defined as the probability of the unexpected
happening - the probability of suffering a loss. VaR is an estimate of the
loss likely to suffer, not the actual loss. The actual loss may be different
from the estimate. It measures potential loss, not potential gain. Risk
management tools measure potential loss as risk has been defined as the
probability of suffering a loss. VaR measures the probability of loss for a
given time period over which the position is held. The given time period
could be one day or a few days or a few weeks or a year. VaR will change
if the holding period of the position changes. The holding period for an
instrument/position will depend on liquidity of the instrument/ market. With
the help of VaR, we can say with varying degrees of certainty that the
potential loss will not exceed a certain amount. This means that VaR will
change with different levels of certainty.
The Bank for International Settlements (BIS) has accepted VaR as a
measurement of market risks and provision of capital adequacy for
market risks, subject to approval by banks' supervisory authorities.
VaR Methodologies
VAR can be arrived as the expected loss on a position from an
adverse movement in identified market risk parameter(s) with a
specified probability over a nominated period of time.
Volatility in financial markets is usually calculated as the standard
deviation of the percentage changes in the relevant asset price over
a specified asset period. The volatility for calculation of VaR is usually
specified as the standard deviation of the percentage change in the risk
factor over the relevant risk horizon.
The following table describes the three main methodologies to calculate
VaR∗
∗
Risk Management: A Practical Guide, RiskMetrics Group, J.P. Morgan, August, 1999
155
Technical Guide on Internal Audit of Treasury Function in Banks
156
Annexure – D
Why Backtest
Backtests compare realized trading results with model generated risk
measures, both to evaluate a new model and to reassess the
accuracy of existing models. Although no single methodology for
backtesting has been established, banks using internal VaR models for
market risk capital requirements must backtest their models on a
regular basis. Banks should generally backtest risk models on a
monthly or quarterly basis to verify accuracy. In these tests, they
should observe whether trading results fall within pre-specified
confidence bands as predicted by the VaR models. If the models
perform poorly, they should probe further to find the cause (e.g., check
integrity of position and market data, model parameters, methodology).
The BIS outlines backtesting best practices in its January 1996
publication “Supervisory framework for the use of ‘backtestin’ in
conjunction with the internal models approach to market risk capital
requirements
157
Technical Guide on Internal Audit of Treasury Function in Banks
Annexure-V
Stress Testing
“Stress testing” has been adopted as a generic term describing various
techniques used by banks to gauge their potential vulnerability to
exceptional, but plausible, events. Stress testing addresses the large
moves in key market variables of that kind that lie beyond day to day risk
monitoring but that could potentially occur. The process of stress testing,
therefore, involves first identifying these potential movements,
including which market variables to stress, how much to stress them by,
and what time frame to run the stress analysis over. Once these market
movements and underlying assumptions are decided upon, shocks are
applied to the portfolio. Revaluing the portfolios allows one to see what
the effect of a particular market movement has on the value of the
portfolio and the overall Profit and Loss.
Stress test reports can be constructed that summarise the effects of
different shocks of different magnitudes. Normally, then there is some kind
of reporting procedure and follow up with traders and management to
determine whether any action need to be taken in response.
∗
Philip Best: “Stress Testing”, Marc Lore & Lev Borodovsky (ed)-The Professional’s Handbook
of Financial Risk Management, Global Association of Risk Professionals (GARP), 2001
158
Annexure – D
159
Technical Guide on Internal Audit of Treasury Function in Banks
160
Annexure – D
161
ANNEXURE – E
more sophisticated systems may continue their existing systems but they
should ensure to fine-tune their current information and reporting system so
as to be in line with the ALM System suggested in the Guidelines. Other
banks should examine their existing MIS and arrange to have an information
system to meet the prescriptions of the new ALM System. To begin with,
banks should ensure coverage of at least 60% of their liabilities and assets.
As for the remaining 40% of their assets and liabilities, banks may include the
position based on their estimates. It is necessary that banks set targets in the
interim, for covering 100 per cent of their business by April 1, 2000. The MIS
would need to ensure that such minimum information/data consistent in
quality and coverage is captured and once the ALM System stabilises and
banks gain experience, they must be in a position to switch over to more
sophisticated techniques like Duration Gap Analysis, Simulation and Value at
Risk for interest rate risk management.
4. In order to capture the maturity structure of the cash inflows and outflows,
the Statement of Structural Liquidity (Annexure-I) should be prepared, to start
with, as on the last reporting Friday of March/June/ September/December
and put up to ALCO/Top Management within a month from the close of the
last reporting Friday. It is the intention to make the reporting system on a
fortnightly basis by April 1, 2000. The Statement of Structural Liquidity should
be placed before the bank s Board in the next meeting. It would also be
necessary to take into account the rupee inflows and outflows on account of
previously contracted forex transactions (swaps, forwards, etc). Tolerance
levels for various maturities may be fixed by the bank s Top Management
depending on the bank s asset - liability profile, extent of stable deposit base,
the nature of cash flows, etc. In respect of mismatches in cash flows for the
1-14 days bucket and 15-28 days bucket, it should be the endeavour of the
bank s management to keep the cash flow mismatches at the minimum
levels. To start with, the mismatches (negative gap) during 1-14 days and 15-
28 days in normal course may not exceed 20% each of the cash outflows
during these time buckets. If a bank in view of its structural mismatches
needs higher limit, it could operate with higher limit with the approval of its
Board/Management Committee, giving specific reasons on the need for such
higher limit. The objective of RBI is to enforce the tolerance levels strictly
by April 1, 2000.
5. In order to enable the banks to monitor their liquidity on a dynamic basis
over a time horizon spanning from 1-90 days, an indicative format (Annexure
163
Technical Guide on Internal Audit of Treasury Function in Banks
Yours faithfully,
(A . Ghosh)
Chief General Manager
Encl: As above
164
Annexure – E
In the normal course, banks are exposed to credit and market risks in view of
the asset-liability transformation. With liberalisation in Indian financial
markets over the last few years and growing integration of domestic markets
and with external markets, the risks associated with banks operations have
become complex and large, requiring strategic management. Banks are now
operating in a fairly deregulated environment and are required to determine
on their own, interest rates on deposits and advance in both domestic and
foreign currencies on a dynamic basis. The interest rates on banks
investments in government and other securities are also now market related.
Intense competition for business involving both the assets and liabilities,
together with increasing volatility in the domestic interest rates as well as
foreign exchange rates, has brought pressure on the management of banks
to maintain a good balance among spreads, profitability and long-term
viability. Imprudent liquidity management can put banks earnings and
reputation at great risk. These pressures call for structured and
comprehensive measures and not just ad hoc action. The Management of
banks has to base their business decisions on a dynamic and integrated risk
management system and process, driven by corporate strategy. Banks are
exposed to several major risks in the course of their business - credit risk,
interest rate risk, foreign exchange risk, equity / commodity price risk ,
liquidity risk and operational risk. It is, therefore, important that banks
introduce effective risk management systems that address the issues related
to interest rate, currency and liquidity risks.
Banks need to address these risks in a structured manner by upgrading their
risk management and adopting more comprehensive Asset-Liability
Management (ALM) practices than has been done hitherto. ALM, among
other functions, is also concerned with risk management and provides a
comprehensive and dynamic framework for measuring, monitoring and
managing liquidity, interest rate, foreign exchange and equity and commodity
price risks of a bank that needs to be closely integrated with the banks
business strategy. It involves assessment of various types of risks and
165
Technical Guide on Internal Audit of Treasury Function in Banks
166
Annexure – E
for all banks feasible. There are various methods prevalent world-wide for
measuring risks. These range from the simple Gap Statement to extremely
sophisticated and data intensive Risk Adjusted Profitability Measurement
methods. However, the central element for the entire ALM exercise is the
availability of adequate and accurate information with expedience and the
existing systems in many Indian banks do not generate information in the
manner required for ALM. Collecting accurate data in a timely manner will be
the biggest challenge before the banks, particularly those having wide
network of branches but lacking full scale computerisation. However, the
introduction of base information system for risk measurement and monitoring
has to be addressed urgently. As banks are aware, internationally, regulators
have prescribed or are in the process of prescribing capital adequacy for
market risks. A pre-requisite for this is that banks must have in place an
efficient information system.
Considering the large network of branches and the lack of (an adequate)
support system to collect information required for ALM which analyses
information on the basis of residual maturity and behavioural pattern, it will
take time for banks in the present state to get the requisite information. The
problem of ALM needs to be addressed by following an ABC approach i.e.
analysing the behaviour of asset and liability products in the sample
branches accounting for significant business and then making rational
assumptions about the way in which assets and liabilities would behave in
other branches. In respect of foreign exchange, investment portfolio and
money market operations, in view of the centralised nature of the functions, it
would be much easier to collect reliable information. The data and
assumptions can then be refined over time as the bank management gain
experience of conducting business within an ALM framework. The spread of
computerisation will also help banks in accessing data.
5. ALM Organisation
5.1 a) Successful implementation of the risk management process would
require strong commitment on the part of the senior management in
the bank, to integrate basic operations and strategic decision making
with risk management. The Board should have overall responsibility
167
Technical Guide on Internal Audit of Treasury Function in Banks
168
Annexure – E
meetings.
5.3 Composition of ALCO
The size (number of members) of ALCO would depend on the size of each
institution, business mix and organisational complexity. To ensure
commitment of the Top Management and timely response to market
dynamics, the CEO/CMD or the ED should head the Committee. The Chiefs
of Investment, Credit, Resources Management or Planning, Funds
Management / Treasury (forex and domestic), International Banking and
Economic Research can be members of the Committee. In addition, the Head
of the Technology Division should also be an invitee for building up of MIS
and related computerisation. Some banks may even have Sub-committees
and Support Groups.
5.4 Committee of Directors
The Management Committee of the Board or any other Specific Committee
constituted by the Board should oversee the implementation of the system
and review its functioning periodically.
5.5 ALM Process:
The scope of ALM function can be described as follows:
• Liquidity risk management
• Management of market risks
• Trading risk management
• Funding and capital planning
• Profit planning and growth projection
The guidelines given in this note mainly address Liquidity and Interest Rate
risks.
6. Liquidity Risk Management
6.1 Measuring and managing liquidity needs are vital for effective operation
of commercial banks. By assuring a bank s ability to meet its liabilities as
they become due, liquidity management can reduce the probability of an
169
Technical Guide on Internal Audit of Treasury Function in Banks
170
Annexure – E
relationship with customers. Securities held in the Trading Book are subject
to certain preconditions like :
i) The composition and volume are clearly defined;
ii) Maximum maturity/duration of the portfolio is restricted;
iii) The holding period not to exceed 90 days;
iv) Cut-loss limit prescribed;
v) Defeasance periods (product-wise) i.e. times taken to liquidate the position
on the basis of liquidity in the secondary market are prescribed;
vi) Marking to market on a daily/weekly basis and the revaluation gain/loss
charged to the profit and loss account; etc.
Banks which maintain such Trading Books and complying with the above
standards are permitted to show the trading securities under 1-14 days, 15-
28 days and 29-90 days buckets on the basis of the defeasance periods. The
Board/ALCO of the banks should approve the volume, composition,
holding/defeasance period, cut loss, etc. of the Trading Book and copy of the
policy note thereon should be forwarded to the Department of Banking
Supervision, RBI.
6.4 Within each time bucket there could be mismatches depending on cash
inflows and outflows. While the mismatches upto one year would be relevant
since these provide early warning signals of impending liquidity problems, the
main focus should be on the short-term mismatches viz., 1- 14 days and 15-
28 days. Banks, however, are expected to monitor their cumulative
mismatches (running total) across all time buckets by establishing internal
prudential limits with the approval of the Board / Management Committee.
The mismatches (negative gap) during 1-14 days and 15-28 days in normal
course may not exceed 20% of the cash outflows in each time bucket. If a
bank in view of its current asset -liability profile and the consequential
structural mismatches needs higher tolerance level, it could operate with
higher limit sanctioned by its Board / Management Committee giving specific
reasons on the need for such higher limit. The discretion to allow a higher
tolerance level is intended for a temporary period, i.e. till March 31, 2000.
171
Technical Guide on Internal Audit of Treasury Function in Banks
172
Annexure – E
loans and advances and quoting prices for foreign exchange transactions.
Irrespective of the strategies adopted, it may not be possible to eliminate
currency mismatches altogether. Besides, some of the institutions may take
proprietary trading positions as a conscious business strategy.
7.3 Managing Currency Risk is one more dimension of Asset- Liability
Management. Mismatched currency position besides exposing the balance
sheet to movements in exchange rate also exposes it to country risk and
settlement risk. Ever since the RBI (Exchange Control Department)
introduced the concept of end of the day near square position in 1978, banks
have been setting up overnight limits and selectively undertaking active day
time trading. Following the introduction of Guidelines for Internal Control over
Foreign Exchange Business in 1981, maturity mismatches (gaps) are also
subject to control. Following the recommendations of Expert Group on
Foreign Exchange Markets in India (Sodhani Committee) the calculation of
exchange position has been redefined and banks have been given the
discretion to set up overnight limits linked to maintenance of capital to Risk-
Weighted Assets Ratio of 8% of open position limit.
7.4 Presently, the banks are also free to set gap limits with RBI s approval
but are required to adopt Value at Risk (VaR) approach to measure the risk
associated with forward exposures. Thus the open position limits together
with the gap limits form the risk management approach to forex operations.
For monitoring such risks banks should follow the instructions contained in
Circular A.D (M. A. Series) No.52 dated December 27, 1997 issued by the
Exchange Control Department.
8. Interest Rate Risk (IRR)
8.1 The phased deregulation of interest rates and the operational flexibility
given to banks in pricing most of the assets and liabilities imply the need for
the banking system to hedge the Interest Rate Risk. Interest rate risk is the
risk where changes in market interest rates might adversely affect a bank s
financial condition. The changes in interest rates affect banks in a larger way.
The immediate impact of changes in interest rates is on bank s earnings (i.e.
reported profits) by changing its Net Interest Income (NII). A long-term impact
of changing interest rates is on bank s Market Value of Equity (MVE) or Net
173
Technical Guide on Internal Audit of Treasury Function in Banks
174
Annexure – E
receive it within the time horizon. This includes final principal payment and
interim instalments. Certain assets and liabilities receive/pay rates that vary
with a reference rate. These assets and liabilities are repriced at pre-
determined intervals and are rate sensitive at the time of repricing. While the
interest rates on term deposits are fixed during their currency, the advances
portfolio of the banking system is basically floating. The interest rates on
advances could be repriced any number of occasions, corresponding to the
changes in PLR.
The Gaps may be identified in the following time buckets:
i) 1-28 days
ii 29 days and upto 3 months
iii) Over 3 months and upto 6 months
iv) Over 6 months and upto 1 year
v) Over 1 year and upto 3 years
vi) Over 3 years and upto 5 years
vii) Over 5 years
viii) Non-sensitive
The various items of rate sensitive assets and liabilities and off-balance
sheet items may be classified as explained in Appendix - II and the Reporting
Format for interest rate sensitive assets and liabilities is given in Annexure II.
8.3 The Gap is the difference between Rate Sensitive Assets (RSA) and Rate
Sensitive Liabilities (RSL) for each time bucket. The positive Gap indicates
that it has more RSAs than RSLs whereas the negative Gap indicates that it
has more RSLs. The Gap reports indicate whether the institution is in a
position to benefit from rising interest rates by having a positive Gap (RSA >
RSL) or whether it is in a position to benefit from declining interest rates by a
negative Gap (RSL > RSA). The Gap can, therefore, be used as a measure
of interest rate sensitivity.
8.4 Each bank should set prudential limits on individual Gaps with the
approval of the Board/Management Committee. The prudential limits should
175
Technical Guide on Internal Audit of Treasury Function in Banks
have a bearing on the Total Assets, Earning Assets or Equity. The banks
may work out Earnings at Risk (EaR) or Net Interest Margin (NIM) based
on their views on interest rate movements and fix a prudent level with the
approval of the Board/Management Committee.
8.5 RBI will also introduce capital adequacy for market risks in due course.
9. General
9.1 The classification of various components of assets and liabilities into
different time buckets for preparation of Gap reports (Liquidity and Interest
Rate Sensitivity) as indicated in Appendices I & II is the benchmark. Banks
which are better equipped to reasonably estimate the behavioural pattern,
embedded options, rolls-in and rolls-out, etc of various components of assets
and liabilities on the basis of past data / empirical studies could classify them
in the appropriate time buckets, subject to approval from the ALCO / Board.
A copy of the note approved by the ALCO / Board may be sent to the
Department of Banking Supervision.
9.2 The present framework does not capture the impact of embedded
options, i.e. the customers exercising their options (premature closure of
deposits and prepayment of loans and advances) on the liquidity and interest
rate risks profile of banks. The magnitude of embedded option risk at times of
volatility in market interest rates is quite substantial. Banks should therefore
evolve suitable mechanism, supported by empirical studies and behavioural
analysis to estimate the future behaviour of assets, liabilities and off-balance
sheet items to changes in market variables and estimate the embedded
options.
9.3 A scientifically evolved internal transfer pricing model by assigning values
on the basis of current market rates to funds provided and funds used is an
important component for effective implementation of ALM System. The transfer
price mechanism can enhance the management of margin i.e. lending or credit
spread, the funding or liability spread and mismatch spread. It also helps
centralising interest rate risk at one place which facilitates effective control and
management of interest rate risk. A well defined transfer pricing system also
provides a rational framework for pricing of assets and liabilities.
176
Annexure – E
APPENDIX I
177
Technical Guide on Internal Audit of Treasury Function in Banks
178
Annexure – E
179
Technical Guide on Internal Audit of Treasury Function in Banks
(v) Securities in the Trading (v) 1-14 days, 15-28 days and 29-90
Book days according to defeasance periods.
5. Advances (Performing)
(i) Bills Purchased and (i) Respective maturity buckets.
Discounted (including bills
under DUPN)
(ii) Cash Credit / Overdraft (ii) Banks should undertake a study
(including TOD) and behavioural and seasonal pattern of
Demand Loan component of availments based on outstandings and
Working Capital. the core and volatile portion should be
identified. While the volatile portion
could be shown in the near-term
maturity buckets, the core portion may
be shown under over 1-3 years bucket.
(iii) Term Loans (iii) Interim cash flows may be shown
under respective maturity buckets.
6. NPAs (Net of provisions, interest suspense and claims received from
ECGC/DICGC )
(i) Sub-standard (i) Over 3-5 years bucket.
(ii) Doubtful and Loss (ii) Over 5 years bucket.
7. Fixed Assets Over 5 years bucket
8. Other Assets
(i) Inter-office Adjustment The net debit balance may be shown in
1-14 days bucket. Intangible assets and
assets not representing cash
receivables may be shown in over 5
years bucket.
(ii) Leased Assets Interim cash flows may be shown under
respective maturity buckets.
C. Contingent Liabilities / Lines of Credit committed / available and
other Inflows / Outflows
1. (i) Lines of Credit (i) 1-14 days bucket.
committed to/ from
Institutions
180
Annexure – E
181
Technical Guide on Internal Audit of Treasury Function in Banks
ii. All overdue liabilities may be placed in the 1-14 days bucket.
iii. Interest and instalments from advances and investments, which are
overdue for less than one month may be placed in over 3-6 months,
bucket. Further, interest and instalments due (before classification as
NPAs) may be placed in over 6-12 months bucket without the grace
period of one month if the earlier receivables remain uncollected.
D. Financing of Gap :
In case the negative gap exceeds the prudential limit of 20% of outflows, (1-
14 days and 15-28 days) the bank may show by way of a foot note as to how
it proposes to finance the gap to bring the mismatch within the prescribed
limits. The gap can be financed from market borrowings (call / term), Bills
Rediscounting, Repos and deployment of foreign currency resources after
conversion into rupees ( unswapped foreign currency funds ), etc.
182
Annexure – E
183
Technical Guide on Internal Audit of Treasury Function in Banks
184
Annexure – E
185
Technical Guide on Internal Audit of Treasury Function in Banks
ANNEXURE - I
RESIDUAL MATURITY
29 Over 3 Over 6 Over 1 Over 3
1 to 15 to days months Months year years Over
OUTFLOWS 14 28 and and and and and 5 Total
days days upto 3 upto 6 upto 1 upto 3 upto 5 years
months onths year years years
1.Capital
2.Reserves & Surplus
3.Deposits XXX XXX XXX XXX XXX XXX XXX XXX XXX
(i) Current Deposits
(ii) Savings Bank
Deposits
(iii) Term Deposits
(iv) Certificates of
Deposit
4.Borrowings XXX XXX XXX XXX XXX XXX XXX XXX XXX
(i) Call and Short
Notice
(ii) Inter-Bank (Term)
(iii) Refinances
(iv) Others (specify)
5.Other Liabilities & XXX XXX XXX XXX XXX XXX XXX XXX XXX
Provisions
(i) Bills Payable
(ii) Inter-office
Adjustment
(iii) Provisions
186
Annexure – E
(iv) Others
6.Lines of Credit XXX XXX XXX XXX XXX XXX XXX XXX XXX
committed to
(i) Institutions
(ii) Customers
7. Unavailed portion
of Cash Credit /
Overdraft / Demand
Loan component of
Working Capital
8. Letters of Credit /
Guarantees
9.Repos
11.Swaps (Buy/Sell) /
maturing forwards
13.Others (specify)
A. TOTAL
OUTFLOWS
INFLOWS
1.Cash
3.Balances with other XXX XXX XXX XXX XXX XXX XXX XXX XXX
Banks
187
Technical Guide on Internal Audit of Treasury Function in Banks
4.Investments
(including those under
Repos but excluding
Reverse Repos)
5.Advances XXX XXX XXX XXX XXX XXX XXX XXX XXX
(Performing)
6. NPAs (Advances
and Investments)*
7. Fixed Assets
8. Other Assets XXX XXX XXX XXX XXX XXX XXX XXX XXX
(i) Inter-office
Adjustment
(iii) Others
9. Reverse Repos
188
Annexure – E
B. TOTAL INFLOWS
C. MISMATCH (B-A)
D. CUMULATIVE
MISMATCH
E. C as % To A
189
Technical Guide on Internal Audit of Treasury Function in Banks
ANNEXURE - II
1. Capital
2. Reserves &
Surplus
3. Deposits XXX XXX XXX XXX XXX XXX XXX XXX XXX
(iv) Certificates of
Deposit
4. Borrowings XXX XXX XXX XXX XXX XXX XXX XXX XXX
(ii) Inter-Bank(Term)
(iii) Refinances
5. Other Liabilities & XXX XXX XXX XXX XXX XXX XXX XXX XXX
Provisions
(ii) Inter-office
190
Annexure – E
Adjustment
(iii) Provisions *
(iv) Others
6. Repos
7. Bills Re
discounted (DUPN)
8. Swaps (Buy/Sell)
9. Others (specify)
A. TOTAL
LIABILITIES
ASSETS
1.Cash
2.Balances with RBI
3.Balances with other XXX XXX XXX XXX XXX XXX XXX XXX XXX
Banks
(i) Current Account
(ii) Money at Call and
Short Notice, Term
Deposits and other
placements.
4.Investments
(including those under
Repos but excluding
Reverse Repos)
5.Advances XXX XXX XXX XXX XXX XXX XXX XXX XXX
(Performing)
(i) Bills Purchased
and Discounted
(including bills under
DUPN)
(ii) Cash Credits,
Overdrafts and Loans
191
Technical Guide on Internal Audit of Treasury Function in Banks
repayable on demand
(iii) Term Loans
6. NPAs (Advances
and Investments) *
7. Fixed Assets
8. Other Assets XXX XXX XXX XXX XXX XXX XXX XXX XXX
(i)Inter-office
Adjustment
(ii) Leased Assets
(iii) Others
9. Reverse Repos
10. Swaps (Sell/ Buy)
11.Bills Rediscounted
(DUPN)
12. Others (specify)
B. TOTAL ASSETS
C. GAP ( B-A )
OTHER PRODUCTS XXX XXX XXX XXX XXX XXX XXX XXX XXX
(INTEREST RATE)
(i) FRAs
(ii) Swaps
(iii) Futures
(iv) Options
(v) Others
D. TOTAL OTHER
PRODUCTS
E.NET GAP (C-D)
F.CUMULATIVE GAP
G. E AS % TO B
192
Annexure – E
ANNEXURE - III
193
Technical Guide on Internal Audit of Treasury Function in Banks
RBI/2007-2008/165
DBOD. No. BP. BC. 38 / 21.04.098/ 2007-08 October 24, 2007
Reserve Bank had issued guidelines on ALM system vide Circular No. DBOD.
BP. BC. 8 / 21.04.098/ 99 dated February 10, 1999, which covered, among
others, interest rate risk and liquidity risk measurement / reporting framework and
prudential limits. As a measure of liquidity management, banks are required to
monitor their cumulative mismatches across all time buckets in their Statement of
Structural Liquidity by establishing internal prudential limits with the approval of
the Board / Management Committee. As per the guidelines, the mismatches
(negative gap) during the time buckets of 1-14 days and 15-28 days in the
normal course, are not to exceed 20 per cent of the cash outflows in the
respective time buckets.
2. Having regard to the international practices, the level of sophistication of banks
in India and the need for a sharper assessment of the efficacy of liquidity
management, these guidelines have been reviewed and it has been decided that:
(a) the banks may adopt a more granular approach to measurement of liquidity
risk by splitting the first time bucket (1-14 days at present) in the
Statement of Structural Liquidity into three time buckets viz. Next day , 2-7
days and 8-14 days.
(b) the Statement of Structural Liquidity may be compiled on best available data
coverage, in due consideration of non-availability of a fully networked
environment. Banks may, however, make concerted and requisite efforts
to ensure coverage of 100 per cent data in a timely manner.
(c) the net cumulative negative mismatches during the Next day, 2-7 days, 8-14
days and 15-28 days buckets should not exceed 5 % ,10%, 15 % and 20
194
Annexure – E
Yours faithfully,
(Prashant Saran)
Chief General Manager-in-Charge
195
Technical Guide on Internal Audit of Treasury Function in Banks
Annex - I
OUTFLOWS Day 2-7 8-14 15 -28 29 Over 3 Over 6 Over 1 Over 3 Over Total
1 day s day s days days months Month year years 5
and and and and and years
upto 3 upto 6 upto 1 upto 3 upto 5
months months year years years
1. Capital
2. Reserves &
Surplus
3. Deposits XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX
(iv) Certificates of
Deposit
4. Borrowings XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX
(iii) Refinances
5.Other Liabilities & XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX
Provisions
196
Annexure – E
(ii) Provisions
(iii) Others
6. Lines of Credit XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX
committed to
(i) Institutions
(ii) Customers
7. Unavailed portion
of Cash Credit /
Overdraft / Demand
Loan component of
Working Capital
8. Letters of Credit /
Guarantees
9. Repos
11.Swaps (Buy/Sell) /
maturing forwards
A. TOTAL
OUTFLOWS
B. CUMULATIVE
OUTFLOWS
197
Technical Guide on Internal Audit of Treasury Function in Banks
Residual Maturity
1. Cash
3.Balances with other XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX
Banks
4.Investments
(including those
under Repos but
excluding Reverse
Repos)
5. Advances XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX
(Performing)
6. NPAs (Advances
198
Annexure – E
and Investments) *
7. Fixed Assets
8. Other Assets XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX
(ii) Others
9. Reverse Repos
11.Bills Rediscounted
(DUPN)
12. Interest
receivable
C. TOTAL INFLOWS
D. MISMATCH( C-A )
E. MISMATCH as %
to OUTFLOWS
(D as % to A)
F. CUMULATIVE
MISMATCH
G. CUMULATIVE
MISMATCH as a %
to CUMULATIVE
OUTFLOWS ( F as a
% to B)
199
Technical Guide on Internal Audit of Treasury Function in Banks
Annex - II
Guidance for slotting the future cash flows of banks in the revised
time buckets
A. Outflows
2. Demand Deposits Savings Bank and Current Deposits may be classified into volatile
(Current and Savings Bank and core portions. Savings Bank (10%) and Current (15%) Deposits
Deposits) are generally withdrawable on demand. This portion may be treated
as volatile. While volatile portion can be placed in the Day 1, 2-7
days and 8-14 days time buckets, depending upon the experience
and estimates of banks and the core portion may be placed in over
1- 3 years bucket.
3. Term Deposits Respective maturity buckets. Banks which are better equipped to
estimate the behavioural pattern, roll-in and roll-out, embedded
options, etc. on the basis of past data/empirical studies could
classify the retail deposits in the appropriate buckets on the basis
of behavioural maturity rather than residual maturity. However, the
wholesale deposits should be shown under respective maturity
buckets.
4. Certificates of Deposit, Respective maturity buckets. Where call/put options are built into the
Borrowings and Bonds issue structure of any instrument/s, the call/put date/s should be
(including Sub-ordinated reckoned as the maturity date/s and the amount should be shown in
Debt) the respective time buckets.
200
Annexure – E
B. Inflows
Heads of Accounts Classification into time buckets
1. Cash Day 1 bucket.
2. Balances with RBI While the excess balance over the required CRR/SLR may be
shown under Day 1 bucket, the Statutory Balances may be
distributed amongst various time buckets corresponding to the
maturity profile of DTL with a time-lag of 14 days.
3. Balances with other
banks
(i) Current Account (i) Non-withdrawable portion on account of stipulations of minimum
balances may be shown under ‘Over 1-3 years’ bucket and the
remaining balances may be shown under Day 1 bucket.
(ii) Money at Call and Short (ii) Respective maturity buckets.
Notice, Term Deposits and
other placements
4. Investments (Net of
#
provisions)
(i) Approved securities (i) Respective maturity buckets, excluding the amount required to be
reinvested to maintain SLR corresponding to the DTL profile in
various time buckets.
(ii) Corporate debentures (ii) Respective maturity buckets. Investments classified as NPIs
201
Technical Guide on Internal Audit of Treasury Function in Banks
202
Annexure – E
203
Technical Guide on Internal Audit of Treasury Function in Banks
Note:
(i) Liability on account of event cash flows i.e. short fall in CRR balance on
reporting Fridays, wage settlement, capital expenditure, etc. which are
known to the banks and any other contingency may be shown under
respective maturity buckets. The event cash outflows, including
incremental SLR requirement should be reported against “Outflows –
Others”.
(ii) All overdue liabilities may be placed in the Day 1, 2-7 days and 8-14 days
buckets, based on behavioural estimates.
(iii) Interest and instalments from advances and investments, which are
overdue for less than one month may be placed in Day 1, 2-7 days and 8-
14 days buckets, based on behavioural estimates. Further, interest and
instalments due (before classification as NPAs) may be placed in ‘29 days
to 3 months bucket’ if the earlier receivables remain uncollected.
204
Annexure – E
D. Financing of Gap:
In case the net cumulative negative mismatches during the Day 1, 2-7 days, 8-14
days and 15-28 days buckets exceed the prudential limit of 5 % ,10%, 15 % and
20% of the cumulative cash outflows in the respective time buckets, the bank
may show by way of a foot note as to how it proposes to finance the gap to bring
the mismatch within the prescribed limits. The gap can be financed from market
borrowings (call / term), Bills Rediscounting, Repos, LAF and deployment of
foreign currency resources after conversion into rupees (unswapped foreign
currency funds ), etc.
205
Technical Guide on Internal Audit of Treasury Function in Banks
RBI/2007-08/278
DBOD. No. BP. BC. 68 / 21.04.098/ 2007-08 April 9, 2008
Yours faithfully,
206
ANNEXURE – F
Yours faithfully
(K.V.Rajan)
Chief General Manager
Encl: As above
208
Annexure – F
Table of Contents
209
Technical Guide on Internal Audit of Treasury Function in Banks
Annexes:
I. Form of Undertaking 34
II. Statements/Returns required to be submitted by PDs 37
II A. Statements/Returns required to be submitted by banks on their PD
business 39
III. Illustration showing the underwriting scheme 40
IV. Illustration showing PDs commitment to T-Bill auctions 43
V. Format PDR–I 44
VI. Format PDR-II 46
VII. Format PDR-IV 48
VIII. Publication of Financial Results 52
IX. Interest Rate Risk of Rupee Derivatives 53
X. List of circulars consolidated 54
210
Annexure – F
211
Technical Guide on Internal Audit of Treasury Function in Banks
212
Annexure – F
Note: The decision to enlist Primary Dealers will be taken by Reserve Bank of
India based on its perception of market needs, suitability of the applicant and the
likely value addition to the system.
1.5 PDs’ role and obligations
PDs are expected to play an active role in the government securities market,
both in its primary and secondary market segments. A Primary Dealer will be
required to have a standing arrangement with RBI based on the execution of an
undertaking (Annex I) and the authorisation letter issued by RBI each year. The
major roles and obligations of PDs are as below:
i. Support to Primary Market: PDs are required to support auctions for
issue of Government dated securities and Treasury Bills as per the
minimum norms for underwriting commitment, bidding commitment and
success ratio as prescribed by RBI from time to time.
ii. Market making in Government securities: PDs should offer two-way
prices in Government securities, through the Negotiated Dealing System-
Order Matching (NDSOM), over-the-counter market and recognised Stock
Exchanges in India and take principal positions in the secondary market
for Government securities.
iii. PDs should maintain adequate physical infrastructure and skilled
manpower for efficient participation in primary issues, trading in the
secondary market, and to advise and educate investors.
iv. A Primary Dealer shall have an efficient internal control system for fair
conduct of business, settlement of trades and maintenance of accounts.
v. A Primary Dealer will provide access to RBI to all records, books,
information and documents as and when required.
vi. PDs’ investment in Government Securities and Treasury Bills on a daily
basis should be at least equal to its net call/notice/repo (including CBLO)
borrowing plus net RBI borrowing (through LAF/ Intra-Day Liquidity/
Liquidity Support) plus the minimum prescribed NOF.
vii. PDs should annually achieve a minimum turnover ratio of 5 times for
Government dated securities and 10 times for Treasury Bills of the
average month-end stocks. The turnover ratio in respect of outright
transactions should not be less than 3 times in government dated
securities and 6 times in Treasury Bills (Turnover ratio is computed as the
213
Technical Guide on Internal Audit of Treasury Function in Banks
ratio of total purchase and sales during the year in the secondary market
to average month-end stocks).
viii. A PD should submit periodic returns as prescribed by RBI from time to
time.
ix. PDs’ operations are subject to prudential and regulatory guidelines issued
by RBI from time to time.
1.6 Facilities from RBI to PDs
The Reserve Bank currently extends the following facilities to PDs to enable
them to effectively fulfill their obligations:
i. Access to Current Account facility with RBI.
ii. Access to Subsidiary General Ledger (SGL) Account facility (for
Government securities) with RBI.
iii. Permission to borrow and lend in the money market including call money
market and to trade in all money market instruments.
iv. Memberships of electronic dealing, trading and settlement systems (NDS
platforms/INFINET/RTGS/CCIL).
v. Access to the Liquidity Adjustment Facility (LAF) of RBI.
vi. Access to liquidity support from RBI under a scheme separately notified
for standalone PDs.
vii. Favoured access to open market operations by Reserve Bank of India.
The facilities are, however, subject to review, depending upon the market
conditions and requirement.
1.7 Regulation
i. PDs are required to meet registration and such other requirements as
stipulated by the Securities and Exchange Board of India (SEBI) including
operations on the Stock Exchanges, if they undertake any activity
regulated by SEBI.
ii. PDs are expected to join Primary Dealers Association of India (PDAI) and
Fixed Income Money Market and Derivatives Association (FIMMDA) and
abide by the code of conduct framed by them and such other actions as
initiated by them in the interest of the securities markets.
214
Annexure – F
215
Technical Guide on Internal Audit of Treasury Function in Banks
ii. The MUC of each PD will be computed to ensure that at least 50 percent
of the notified amount of each issue is mandatorily underwritten equally by
all PDs. The share under MUC will be uniform for all PDs, irrespective of
their capital or balance sheet size. The remaining portion of the notified
amount will be underwritten through an Additional Competitive
Underwriting (ACU) auction.
iii. RBI will announce the MUC of each PD and the balance amount which
will be underwritten under the ACU auction. In the ACU auction, each PD
would be required to bid for an amount at least equal to its share of MUC.
A PD cannot bid for more than 30 per cent of the notified amount in the
ACU auction.
iv. The auction could be either uniform price-based or multiple price-based
depending upon the market conditions and other relevant factors, which
will be announced before the underwriting auction for each issue.
v. Bids will be tendered by PDs within the stipulated time, indicating both the
amount of the underwriting commitment and underwriting commission
rates. A PD can submit multiple bids for underwriting. Depending upon the
bids submitted for underwriting, RBI will decide the cut-off rate of
commission and inform the PDs.
vi. Underwriting commission: All successful bidders in the ACU auction will
be paid underwriting commission on the ACU segment as per the auction
rules. Those PDs who succeed in the ACU for 4 per cent and above of the
notified amount of the issue, will be paid commission on the MUC at the
weighted average of all the accepted bids in the ACU. Others will get
commission on the MUC at the weighted average rate of the three lowest
bids in the ACU.
vii. In the GOI securities auction, a PD should bid for an amount not less than
their total underwriting obligation. If two or more issues are floated on the
same day, the minimum bid amount will be applied to each issue
separately.
viii. Underwriting commission will be paid on the amount accepted for
underwriting by the RBI, irrespective of the actual amount of devolvement,
by credit to the current account of the respective PDs at the RBI, Fort,
Mumbai, on the date of issue of security.
ix. In case of devolvement, PDs would be allowed to set-off the accepted
216
Annexure – F
217
Technical Guide on Internal Audit of Treasury Function in Banks
218
Annexure – F
219
Technical Guide on Internal Audit of Treasury Function in Banks
among all the stand-alone PDs. The remaining half (i.e. 50%) will be
divided in the ratio of 1:1 based on market performance in primary market
and secondary market. Performance in primary market will be computed
on the basis of bids accepted in the T-Bill auction and G-sec auction in
the proportionate weights of 1 and 3. Similarly, the secondary market
performance will be judged on the basis of outright turnover in T-Bills and
dated Government securities in the proportionate weights of 1 and 3.
ii. The PD-wise limit of liquidity support will be revised every half-year (April-
September and October-March) based on the market performance of the
PDs in the preceding six months.
iii. The liquidity support to PDs will be made available at the ‘Repo rate’
announced by the Reserve Bank.
iv. The liquidity support availed by a PD will be repayable within a period of
90 days. The penal rate of interest payable by PDs if liquidity support is
repaid after 90 days is Bank rate plus 5 percentage points for the period
beyond 90 days.
3.6 Inter-Corporate Deposits
3.6.1 Inter-Corporate Deposits (ICD) may be raised by Primary Dealers
sparingly and should not be used as a continuous source of funds. After proper
and due consideration of the risks involved, the Board of Directors of the PD
should lay down the policy in this regard, which among others, should include the
following general principles:
i. While the ceiling fixed on ICD borrowings should in no case exceed 50%
of the NOF as at the end of March of the preceding financial year, it is
expected that actual dependence on ICDs would be much below this
ceiling.
ii. ICDs accepted by PDs should be for a minimum period of one week.
iii. ICDs accepted from parent/promoter/group companies or any other
related party should be on "arms length basis" and disclosed in financial
statements as "related party transactions".
iv. Funds raised through ICDs are subject to ALM discipline.
3.6.2 PDs are prohibited from placing funds in ICD market.
3.7 FCNR (B) loans / External Commercial Borrowings
220
Annexure – F
3.7.1 PDs may avail of FCNR(B) loans up to a maximum of 25% of the NOF as
at the end of March of the preceding financial year and subject to the foreign
exchange risk of such loans being hedged at all times at least to the extent of 50
per cent of the exposure.
3.7.2 PDs are not permitted to raise funds through External Commercial
Borrowings.
3.8 Reporting Requirements
3.8.1 PDs are required to report the sources and application of funds
maintained on daily basis and reported to RBI on fortnightly basis. The format of
return (PDR-I) is enclosed in Annex V.
3.8.2 PDs are required to report the securities market turnover on monthly
basis. The format of return (PDR-II) is enclosed in Annex VI.
3.8.3 PDs are required to submit a quarterly statement on capital adequacy in
the prescribed format (PDR-III).
3.8.4 PDs are required to report select financial and Balance Sheet indicators
on quarterly basis. The format of return (PDR-IV) is enclosed in Annex VII.
4. Diversification of activities by stand-alone Primary Dealers
4.1 Stand-alone Primary Dealers (PDs) are permitted to diversify their
activities, as considered appropriate, in addition to their existing business of
Government securities, subject to limits.
4.2 PDs may bifurcate their operations into core and non-core activities.
4.2.1 The following activities are permitted under core activities:
i. Dealing and underwriting in Government securities
ii. Dealing in Interest Rate Derivatives
iii. Providing broking services in Government securities
iv. Dealing and underwriting in Corporate / PSU / FI bonds/ debentures
v. Lending in Call/ Notice/ Term/ Repo/ CBLO market
vi. Investment in Commercial Papers
vii. Investment in Certificates of Deposit
viii. Investment in Security Receipts issued by Securitization Companies/
221
Technical Guide on Internal Audit of Treasury Function in Banks
222
Annexure – F
223
Technical Guide on Internal Audit of Treasury Function in Banks
those segments in the investment policy with the approval of their Board.
5. Investment Guidelines
5.1 Investment policy – PDs should frame and implement investment and
operational policy guidelines on securities transactions which should be
approved by their Boards. The guidelines should contain the broad objectives to
be followed while undertaking transactions in securities on their own account and
on behalf of clients, clearly define the authority to put through deals, and lay
down procedure to be followed while putting through deals, various prudential
exposure limits, policy regarding dealings through brokers, systems for
management of various risks, guidelines for valuation of the portfolio and the
reporting systems etc. Operational procedures and controls in relation to the day-
to-day business operations should also be worked out and put in place to ensure
that operations in securities are conducted in accordance with sound and
acceptable business practices. While laying down these guidelines, the PDs
should strictly adhere to Reserve Bank’s instructions, issued from time to time.
The effectiveness of the policy and operational guidelines should be periodically
evaluated.
5.2 PDs should necessarily hold their investments in Government securities
portfolio in SGL with RBI. They may also have a dematerialised account with
depositories (NSDL/CDSL). All purchase/sale transactions in Government
securities by PDs should be compulsorily through SGL/CSGL/Demat accounts.
5.3 PDs should hold all other investments such as commercial papers, bonds
and debentures, privately placed or otherwise, and equity instruments, only in
dematerialized form.
5.4 All problem exposures, which are not backed by any security or backed
by security of doubtful value, should be fully provided for. Where a PD has filed
suit against another party for recovery, such exposures should be evaluated and
provisions made to the satisfaction of auditors. Any claim against the PD should
also be taken note of and provisions made to the satisfaction of auditors.
5.5 The profit and loss account should reflect the problem exposures if any,
and also the effect of valuation of portfolio, as per the instructions issued by the
Reserve Bank, from time to time. The report of the statutory auditors should
contain a certification to this effect.
5.6 PDs should formulate, within the above parameters, their own internal
guidelines on securities transactions in both primary and secondary markets, with
224
Annexure – F
225
Technical Guide on Internal Audit of Treasury Function in Banks
5.7.8 PDs should ensure that their investment policies duly approved by the
Board of Directors are formulated after taking into account all the relevant issues
specified in these guidelines on investment in non-Government securities. PDs
should put in place proper risk management systems for capturing and analysing
the risk in respect of non-Government securities before making investments and
taking remedial measures in time. PDs should also put in place appropriate
systems to ensure that investment in privately placed instruments is made in
accordance with the systems and procedures prescribed under respective PDs’
investment policy.
5.7.9 Boards of PDs should review the following aspects of investment in non-
Government Securities at least at quarterly intervals:
i. Total business (investment and divestment) during the reporting period.
ii. Compliance with the prudential limits prescribed by the Board for
investment in non-Government securities.
iii. Compliance with the prudential guidelines on non-Government securities
prescribed above.
iv. Rating migration of the issuers/ issues held in the PDs’ books.
5.7.10 In order to help the creation of a central database on private placement of
debt, a copy of all offer documents should be filed with the Credit Information
Bureau (India) Ltd. (CIBIL) by the PDs. Further, any default relating to interest/
installment in respect of any privately placed debt should also be reported to
CIBIL by the investing PDs along with a copy of the offer document.
5.7.11 As per the SEBI guidelines, all trades with the exception of the spot
transactions, in a listed debt security, shall be executed only on the trading
platform of a stock exchange. In addition to complying with these SEBI
guidelines, (as and when applicable) PDs should ensure that all spot transactions
in listed and unlisted debt securities are reported on the NDS and settled through
the CCIL.
6. Prudential systems/controls
6.1 Internal Control System in respect of securities transactions
i. PDs should have an Audit Committee of the Board (ACB) which should
meet at least at quarterly intervals. The ACB should peruse the findings of
the various audits. ACB should ensure efficacy and adequacy of the audit
function.
226
Annexure – F
227
Technical Guide on Internal Audit of Treasury Function in Banks
228
Annexure – F
229
Technical Guide on Internal Audit of Treasury Function in Banks
230
Annexure – F
231
Technical Guide on Internal Audit of Treasury Function in Banks
Accounts (DGBA).
7.3 Operational Guidelines
i. PDs should take specific approval from their Board to enable them to
trade in the Stock Exchanges.
ii. PDs may undertake transactions only on the basis of giving and taking
delivery of securities.
iii. Brokers/trading members shall not be involved in the settlement process;
all trades have to be settled either directly with clearing
corporation/clearing house (in case they are clearing members) or else
through clearing member custodians.
iv. The trades done through any single broker will also be subject to the
current regulations on transactions done through brokers.
v. A standardized settlement on T+1 basis of all outright secondary market
transactions in Government Securities has been adopted to provide the
participants more processing time for transactions and to help in better
funds as well as risk management.
vi. In the case of repo transactions in Government Securities, however,
market participants will have the choice of settling the first leg on either
T+0 basis or T+1 basis, as per their requirements.
vii. Any settlement failure on account of non-delivery of securities/ non-
availability of clear funds will be treated as SGL bouncing and the current
penalties in respect of SGL transactions will be applicable. Stock
Exchanges will report such failures to the respective Public Debt Offices.
viii. PDs who are trading members of the Stock Exchanges may have to put
up margins on behalf of their non-institutional client trades. Such margins
are required to be collected from the respective clients. PDs are not
permitted to pay up margins on behalf of their client trades and incur
overnight credit exposure to their clients. In so far as the intra day
exposures on clients for margins are concerned, the PDs should be
conscious of the underlying risks in such exposures.
ix. PDs who intend to offer clearing /custodial services should take specific
approval from SEBI in this regard. Similarly, PDs who intend to take
trading membership of the Stock Exchanges should satisfy the criteria laid
down by SEBI and the Stock Exchanges.
232
Annexure – F
233
Technical Guide on Internal Audit of Treasury Function in Banks
234
Annexure – F
235
Technical Guide on Internal Audit of Treasury Function in Banks
between the PD and any PMS client or between two PMS clients should
be strictly at market rates.
11. Guidelines on interest rate derivatives
11.1 PDs shall adhere to the guidelines laid down in circular
DBOD.No.BP.BC.86 /21.04.157 /2006-07 dated April 20, 2007 as applicable to
interest rate derivatives.
11.2 PDs are required to report all their IRS/FRA trades on the CCIL reporting
platform within 30 minutes from the deal time in terms of circular
IDMD/11.08.15/809/2007-08 dated August 23, 2007.
11.3 PDs are required to report to IDMD, as per the pro forma indicated in
Annex IX, their FRAs/ IRS operations on a monthly basis.
12. Guidelines on declaration of dividends
PDs should follow the following guidelines while declaring dividend distribution:
i. The PD should have complied with the regulations on transfer of profits to
statutory reserves and the regulatory guidelines relating to provisioning
and valuation of securities, etc.
ii. PDs having Capital to Risk Weighted Assets Ratio (CRAR) below the
regulatory minimum of 15 per cent in any of the previous four quarters
cannot declare any dividend. For PDs having CRAR between the
regulatory minimum of 15 per cent during all the four quarters of the
previous year, but lower than 20 per cent in any of the four quarters, the
dividend payout ratio should not exceed 33.3 per cent. For PDs having
CRAR above 20 per cent during all the four quarters of the previous year,
the dividend payout ratio should not exceed 50 per cent. Dividend payout
ratio should be calculated as a percentage of dividend payable in a year
(excluding dividend tax) to net profit during the year.
iii. The proposed dividend should be payable out of the current year’s profits.
In case the profit for the relevant period includes any extraordinary profit
income, the payout ratio should be computed after excluding such
extraordinary items for reckoning compliance with the prudential payout
ratio ceiling of 33.3 per cent or 50 per cent, as the case may be.
iv. The financial statements pertaining to the financial year for which the PD
is declaring dividend should be free of any qualifications by the statutory
auditors, which have an adverse bearing on the profit during that year. In
236
Annexure – F
case of any qualification to that effect, the net profit should be suitably
adjusted downward while computing the dividend payout ratio.
v. In case there are special reasons or difficulties for any PD in strictly
adhering to the guidelines, it may approach Reserve Bank in advance for
an appropriate ad hoc dispensation in this regard.
vi. All the PDs declaring dividend should report details of dividend declared
during the accounting year as per the prescribed pro forma. The report
should be furnished within a fortnight of payment of dividend.
13. Guidelines on Corporate Governance
PDs may adhere to circular DNBS.PD/CC 94/03.10.042/2006-07 dated May 8,
2007 on guidelines on corporate governance.
14. Prevention of Money Laundering Act, 2002 - Obligations of NBFCs
PDs shall adhere to the guidelines contained in circular DNBS(PD).CC.68
/03.10.042/2005-06 dated April 5, 2006.
15. Violation/Circumvention of Instructions
Any violation/circumvention of the above guidelines or the terms and conditions
of the undertaking executed by a Primary Dealer with the Reserve Bank of India
(Annex I) would be viewed seriously and such violation would attract penal
action including the withdrawal of liquidity support, denial of access to the money
market, withdrawal of authorisation for carrying on the business as a Primary
Dealer, and/or imposition of monetary penalty or liquidated damages, as the
Reserve Bank may deem fit.
Section II: Additional Guidelines applicable to banks undertaking PD
business departmentally
1. Introduction
Scheduled commercial banks (except Regional Rural Banks) have been
permitted to undertake Primary Dealership business departmentally from 2006-
07.
2. Procedure for Authorisation of bank-PDs
2.1 Banks eligible to apply for Primary Dealership, for undertaking PD
business, (please see eligibility conditions at (iv) of paragraph 1.3.1 above) may
approach the Chief General Manager, Department of Banking Operations &
Development (DBOD), Reserve Bank of India, Central Office, Centre I, World
237
Technical Guide on Internal Audit of Treasury Function in Banks
238
Annexure – F
PDs.
3.5 It is clarified that for the purpose of "when-issued trades" issued vide
circular IDMD.No/2130/11.01.01 (D)/2006-07 dated November 16, 2006, bank-
PDs will be treated as Primary Dealers.
3.6 Bank-PDs shall be guided by the extant guidelines applicable to banks as
regards borrowing in call/notice/term money market, Inter-Corporate Deposits,
FCNR (B) loans /External Commercial Borrowings and other sources of funds.
3.7 The investment policy of the bank may be suitably amended to include PD
activities also. Within the overall framework of the investment policy, the PD
business undertaken by the bank will be limited to dealing, underwriting
and market-making in Government Securities. Investments in Corporate/
PSU/ FIs bonds, Commercial Papers, Certificate of
deposits, debt mutual funds and other fixed income securities will not be deemed
to be a part of PD business.
3.8 The classification, valuation and operation of investment portfolio
guidelines as applicable to banks in regard to "Held for Trading" portfolio will also
apply to the portfolio of Government Dated Securities and Treasury Bills
earmarked for PD business.
3.9 The Government Dated Securities and Treasury Bills under PD business
will count for SLR.
3.10 Bank-PDs shall be guided by the extant guidelines applicable to banks as
regards business through brokers, ready forward transactions, interest rate
derivatives (OTC & exchange traded derivatives), investment in non-Government
Securities, Issue of Subordinated Debt Instruments and declaration of dividends.
4. Maintenance of books and accounts
4.1 The transactions related to Primary Dealership business, undertaken by a
bank departmentally, should be executed through the existing Subsidiary
General Ledger (SGL) account of the bank. However, such banks will have to
maintain separate books of accounts for transactions relating to PD business (as
distinct from normal banking business) with necessary audit trails. It should be
ensured that, at any point of time, there is a minimum balance of Rs. 100 crore of
Government Securities earmarked for PD business.
4.2 Bank-PDs should subject 100 per cent of the transactions and regulatory
returns submitted by PD department to concurrent audit. An auditors' certificate
239
Technical Guide on Internal Audit of Treasury Function in Banks
for having maintained the minimum stipulated balance of Rs. 100 crore of
Government Securities in the PD-book on an ongoing basis and having adhered
to the guidelines/ instructions issued by RBI, should be forwarded to IDMD, RBI
on a quarterly basis.
5. Capital Adequacy and Risk Management
5.1 The capital adequacy and risk management guidelines applicable to a
bank undertaking PD activity departmentally, will be as per the extant guidelines
applicable to banks. In other words, for the purpose of assessing the bank's
capital adequacy requirement and coverage under risk management framework,
the PD activity should also be taken into account.
5.2 The bank undertaking PD activity may put in place adequate risk
management systems to measure and provide for the risks emanating from the
PD activity.
6. Supervision by RBI
6.1 The banks authorized to undertake PD business departmentally are
required to submit prescribed periodic returns to RBI promptly. The current list of
such returns and their periodicity, etc. is furnished in Annex II A.
6.2 Reserve Bank of India reserves its right to amend or modify the above
guidelines from time to time, as may be considered necessary.
240
Annexure – F
Annex I
UNDERTAKING
To
The Chief General Manager,
Internal Debt Management Department,
Reserve Bank of India,
Central Office Building,
Mumbai-400 001.
By
……………………………………………………………….
Registered Office …………………………………………
………………………………………………………………
……………………………………………………………….
WHEREAS the Reserve Bank of India (RBI) has offered in principle to permit us
to undertake Primary Dealer activity in Government securities in accordance with
the Guidelines issued thereon from time to time.
AND WHEREAS as a precondition to our being authorised to undertake Primary
Dealership activity we are required to furnish an undertaking covering the relative
terms and conditions.
AND WHEREAS at the duly convened Board of Directors meeting of
________________ on __________, the Board has authorised Shri/Smt./Kum.
_________________ and Shri/Smt./Kum. __________________ to execute and
furnish an UNDERTAKING to the Reserve Bank of India jointly and severally as
set out below:
NOW, THEREFORE, in consideration of the RBI agreeing to permit us to
undertake Primary Dealer activity, we hereby undertake and agree:
1. To commit to aggregatively bid in the auction of Treasury Bills and
Government of India Dated Securities, to the extent of …….per cent of
each issue of auction Treasury Bills and for a minimum amount equal to
the underwriting commitment (allotted under Minimum Underwriting
Commitment and Additional Competitive Underwriting) for Government of
India Dated Securities and to maintain the success ratio in aggregate
winning bids at not less than 40 per cent for Treasury Bills.
241
Technical Guide on Internal Audit of Treasury Function in Banks
242
Annexure – F
/99-2000 dated December 31, 1999 and Master Circulars issued from
time to time and put in place necessary internal control systems for fair
conduct of business and settlement of trades and maintenance of
accounts.
10. To comply with all applicable Reserve Bank of India/Securities and
Exchange Board of India (SEBI) requirements under the existing
guidelines and which may be laid down from time to time in this behalf,
failing which RBI would be at liberty to cancel the authorisation as a
Primary Dealer.
11. To abide by the code of conduct as laid down by RBI/SEBI, the Primary
Dealers’ Association of India (PDAI) and the Fixed Income, Money
Markets and Derivatives Association of India (FIMMDA).
12. To maintain separate books of account for transactions relating to PD
business (distinct from the normal banking business) with necessary audit
trails and to ensure that, at any point of time, there is a minimum balance
of Rs. 100 crore of Government securities earmarked for PD business.
(applicable to bank-PDs only)
13. To maintain and preserve such information, records, books and
documents pertaining to our working as a Primary Dealer as may be
specified by the RBI from time to time.
14. To permit the RBI to inspect all records, books, information, documents
and make available the records to the officers deputed by the RBI for
inspection/scrutiny and render all necessary assistance.
15. To maintain at all times a minimum net owned funds of Rs. 50 crore /
Rs.100 crore in Government securities and to deploy the liquidity support
from the RBI, net borrowings from call money market and net repo
borrowings exclusively in Government securities. (applicable to
standalone PDs only)
16. To maintain an arms length relationship in transactions with group and
related entities.
17. To obtain prior approval of Reserve Bank of India for any change in the
shareholding pattern of the company. (applicable to standalone PDs only)
18. To submit in prescribed formats periodic reports including daily
transactions and market information, monthly report of details of
243
Technical Guide on Internal Audit of Treasury Function in Banks
244
Annexure – F
Annex II
A. Statements / Returns required to be submitted by Primary Dealers to
IDMD
Sr. Last date for Reference under
Return/Report Periodicity
No. submission which required
1. PDR-I* Fortnightly Next working day of
the reporting fortnight
2. PDR-II* Monthly 10th of the following
month
3. PDR-III* Quarterly 15 of the month
following the reporting
quarter
4. PDR IV* Quarterly th
15 of the month of
the month following PD Guidelines
the reporting quarter
5. Return on FRAs / IRS Monthly 10th of the following
month
6. Annual Report & Annual Annual As soon as annual
Audited A/cs accounts audited and
finalised
7. Auditor's Certificate on Net Yearly 30th June
Owned Funds
8. Reconciliation of holdings One month from the IDMC.No.PDRS/2049A
of Govt. Securities in own close of accounting /03.64.00/99-2000
A/c and constituent A/c year dated December 31,
1999
Yearly
9. Investments in non- Yearly Disclosures in the IDMD.PDRS.No.3/03.6
Government securities ‘Notes on Accounts’ 4.00/2003-04 March
of the balance sheet, 08, 2004
with effect from the
financial year ending
31 March 2004.
10 Details of dividend Yearly Within a fortnight from IDMD.PDRS.No
declared during the the payment of 6/03.64.00/2003-04
accounting year dividend June 03, 2004
245
Technical Guide on Internal Audit of Treasury Function in Banks
Note: The last date prescribed for submission of these statements by the
departments concerned and/or IDMD should be adhered to.
246
Annexure – F
Annex II A
Statements / Returns required to be submitted by banks on their Primary
Dealership business to IDMD*:
Sr.
Return/Report Periodicity Last date for submission
No.
11. PDR-II** (format enclosed as Appendix Monthly 10th of the following month
III)
12. Concurrent auditor certificate for having Quarterly 15th of the month following the
maintained the minimum stipulated reporting month
balance of Rs. 100crore of Government
Securities in the PD book on an
ongoing basis.
13. Annual Report on PD activity of the Annual Within 30 days of the finalization of
bank. audited accounts.
247
Technical Guide on Internal Audit of Treasury Function in Banks
Annex III
Illustration showing the underwriting amount, cut off rate of underwriting
fee accepted by Reserve Bank of India
Illustration showing the underwriting amount, cut-off of fee quoted,
commission payable to PDs
248
Annexure – F
Amount Weighted
PDs
of bid in Cumulative Underwriting Amount Average
S. participated
ACU Amount fee (in paise / of bid * Remarks underwriting
No in U/W
(Rs. (Rs. Cr) Rs.100) U/w fee fee (paise /
auction
Crore) Rs.100)
Three
249
Technical Guide on Internal Audit of Treasury Function in Banks
250
Annexure – F
251
Technical Guide on Internal Audit of Treasury Function in Banks
Commission on ACU
Total Commission
Commn on MUC
ACU average fee
accepted taken for
is >= 4% MUC
NA commission
calculation
(in (in (in (paise per (Rs.)
crore) crore) crore) Rs.100)
A 106 210 316 YES 4.20 445,200 438,000 883,200
B 106 380 486 YES 4.20 445,200 1,284,800 1,730,000
C 106 185 291 YES 4.20 445,200 796,100 1,241,300
D 106 120 226 NO 2.29 242,740 480,000 722,740
E 106 210 316 YES 4.20 445,200 990,050 1,435,250
F 106 290 396 YES 4.20 445,200 1,404,000 1,849,200
G 106 250 356 YES 4.20 445,200 1,237,500 1,682,700
H 106 120 226 NO 2.29 242,740 600,000 842,740
I 106 221 327 YES 4.20 445,200 1,105,000 1,550,200
J 106 0 106 NO 2.29 242,740 0 242,740
K 106 0 106 NO 2.29 242,740 0 242,740
L 106 0 106 NO 2.29 242,740 0 242,740
M 106 0 106 NO 2.29 242,740 0 242,740
N 106 0 106 NO 2.29 242,740 0 242,740
O 106 0 106 NO 2.29 242,740 0 242,740
P 106 0 106 NO 2.29 242,740 0 242,740
Q 106 0 106 NO 2.29 242,740 0 242,740
R 106 0 106 NO 2.29 242,740 0 242,740
S 106 0 106 NO 2.29 242,740 0 242,740
TOTAL 2014 1986 4000 6,029,280 8,335,450 14,364,730
252
Annexure – F
Annex IV
Illustrations showing adherence by PDs to Commitments on aggregative
bidding in auction of Treasury Bills and success ratio
1. A PD has committed to bid aggregatively Rs. 500 crore GOI Treasury Bills
as shown below. The success ratio to be maintained by the PD is 40 per
cent in respect of Treasury Bills. Various scenarios in respect of fulfillment
of the bidding commitment and the success ratio assuming that the bids
tendered and the bids accepted will be as under:
(1) Treasury Bills: (Rs. crore)
SCENARIOS (I) (II) (III)
Success ratio in Treasury Bills is the ratio of bids accepted and bidding commitment.
253
Technical Guide on Internal Audit of Treasury Function in Banks
Annex V
PDR I Return
Name of PD:
Net Owned Funds(as per last b/s):
Return for fortnight ending:
date wise fortnightly statement
1
A Outright purchases (Face Value)
(i) Government Securities and Treasury bills
(ii) Other securities
B Outright sales (Face Value)
(i) Government Securities and Treasury bills
(ii) Other securities
C Repo transactions
(i) Borrowing (amount)
- from Reserve Bank of India
- from the market
(ii) Lending (amount)
- to Reserve Bank of India
- to the market
D Call Money transactions
- Borrowing
- Lending
2 Outstanding balances (Settled position
figures)
A Sources of Funds
a) Net Owned funds (as per last audited
balance sheet)
b) Current years accruals under profit /loss
account
254
Annexure – F
255
Technical Guide on Internal Audit of Treasury Function in Banks
256
Annexure – F
257
Technical Guide on Internal Audit of Treasury Function in Banks
258
Annexure – F
REPURCHASE AGREEMENTS
i) Repo (both legs)
ii) Reverse Repo (both legs)
TOTAL REPOS TURNOVER (B)
V. Total Turnover - OTC (IV(A)+IV(B))
VI. SECONDARY MARKET TURNOVER –
STOCK EXCHANGES
i) Purchases N.A. N.A.
ii) Sales N.A. N.A.
259
Technical Guide on Internal Audit of Treasury Function in Banks
260
Annexure – F
Annex VII
Name of the Primary Dealer : PDR – IV
Quarterly return on select Financial & Balance Sheet indicators for quarter
ended
(Rs. in crore)
Quarter ended Previous
I. BALANCE SHEET INDICATORS
(cumulative) Quarter
SOURCES OF FUNDS
Share Capital
Reserves & Surplus
Deposits, if any
Secured loans
Unsecured loans
TOTAL
APPLICATION OF FUNDS
Fixed Assets
Gross Block
less Depreciation
Net block
Add Capital work in progress
Investments
a. Govt. Securities
1. Dated GOI securities
2. State Govt. Securities
3. T-bills
b. Others (Specify)
Current Assets, Loans and Advances
(A) Current Assets Accrued Interest
Stock – in – Trade Cash & Bank
balance
261
Technical Guide on Internal Audit of Treasury Function in Banks
EXPENDITURE
262
Annexure – F
Interest Expenses
1. Call/Term
2. Repo
3. Borrowing from RBI
4. Others
Operating Expenses
Establishment & Administrative Expenses
Provisions against doubtful assets
Depreciation on Fixed Assets
Other expenses (specify)
TOTAL EXPENDITURE
PROFIT BEFORE TAX
Less provision for taxation and deferred tax
PROFIT AFTER TAX
III. FINANCIAL INDICATORS
Certain Key Figures
Dividend paid/proposed
Retained earnings
Average Earning assets
Average Non-earning assets
*** Average total assets
1. Average dated G-secs (Central and
State)
2. Average T-Bills
3. Other average assets
**** Average Interest bearing liabilities
1. Call borrowing
2. Repo
3. Borrowing from RBI
4. Others
263
Technical Guide on Internal Audit of Treasury Function in Banks
Measures of Return
Return on Assets
Before
tax (PBT/Ave.Total Assets)
After
tax (PAT/Ave.Total Assets)
Return on average Equity
Before tax (PBT/Ave.Equity) After
tax (PAT/Ave.Equity)
Return on Capital Employed
Before tax (PBT/(Owners' Equity+Total
Debt))
After Tax (PAT/(Owners' Equity+Total Debt))
Net Margin Analysis
Net Margin (PAT/Total Income)
Interest expenses/Total income
IV. PERFORMANCE INDICATORS Quarter ended Previous
(cumulative) Quarter
NOF (Rs. In crore)
CRAR (as %)
264
Annexure – F
*** Average assets refers to the simple average of month end book balance.
**** Average liabilities refers to the simple average of month end book
balance.
***** Before adjusting Repo transactions and MTM depreciation on IRS
transactions.
Signature
265
Technical Guide on Internal Audit of Treasury Function in Banks
Annex VIII
Publication of Financial Results
Name of Primary Dealer
Audited Financial Results for the year ended 31st March ………
Sources of Funds
Capital
Reserves and Surplus
Loans
Secured
Unsecured
(of which call money borrowings)
Application of Funds
Fixed Assets
Investments
Government Securities (inclusive of T. Bills)
Commercial Papers
Corporate Bonds
Loans and Advances
(of which call money lendings)
Non Current Assets
Others
Profits and Loss account
Income (business segment wise)
Interest
Discount
Trading Profit
266
Annexure – F
Expenses
Interest
Administrative Costs
Profit before tax
Net Profit
Regulatory Capital required (as per Capital Adequacy Guidelines)
Actual Capital
Return on Net Worth
267
Technical Guide on Internal Audit of Treasury Function in Banks
Annex IX
Monthly Return on Interest Rate Risk of Rupee Derivatives
As at end-month
Name of the Bank/Institution:
1. Cash Bonds Market Value (Rs. PV01(Rs. In
in Crore) Crore)
(a) (b) (c)
(a) HFT (See Note 1)
(b) AFS (See Note 1)
(c) HTM (See Note 1)
Total [(a) to (c) above]
2. Rupee Interest Rate Derivatives Notional Amount PV01(Rs. In
(Rs. In Crore) Crore)
(a) Bond Futures (See Note 1)
(b) MIBOR (OIS) (See Note 2)
(c) MIFOR (See Note 2)
(d) G-Sec benchmarks (See Note2)
(e) Other benchmarks (Please report (See Note
separately) 2&4)
(f) Forward Rate Agreements (See Note 3)
Total [(a) to (f) above]
268
Annexure – F
Annex X
List of circulars consolidated
269
Technical Guide on Internal Audit of Treasury Function in Banks
270
Annexure – F
271
Technical Guide on Internal Audit of Treasury Function in Banks
272
ANNEXURE – G
Yours faithfully
(K.V.Rajan)
Chief General Manager
Encl : As above
Technical Guide on Internal Audit of Treasury Function in Banks
APPENDIX
RESERVE BANK OF INDIA
INTERNAL DEBT MANAGEMENT DEPARTMENT
CENTRAL OFFICE BUILDING
MUMBAI 400 001
(Ref: RBI/2009-10/ IDMD.PDRD.02 /03.64.00/2009-10 dated July 1, 2009)
CAPITAL FUNDS & CAPITAL REQUIREMENTS
General Guidelines
1 General
1.1 Capital adequacy standards for Primary Dealers in Government Securities
market have been in vogue since December 2000. The guidelines were revised
keeping in view the developments in the market, experience gained over time
and introduction of new products like exchange traded derivatives. The revised
guidelines were issued vide circular IDMD.1/(PDRS)03.64.00/2003-04 dated
January 07, 2004. The present circular has been updated with the guidelines on
capital requirements issued subsequent to the aforesaid circular.
2 Capital Funds
Capital Funds would include the following elements:
2.1 Tier-I Capital
Tier-I Capital would mean paid-up capital, statutory reserves and other disclosed
free reserves. Investment in subsidiaries where applicable, intangible assets,
losses in current accounting period, deferred tax asset (DTA) and losses brought
forward from previous accounting periods will be deducted from the Tier I capital.
In case any PD is having substantial interest/ (as defined for NBFCs) exposure
by way of loans and advances not related to business relationship in other Group
companies, such amounts will be deducted from its Tier I capital.
2.2 Tier-II capital
Tier II capital includes the following:-
(i) Undisclosed reserves and cumulative preference shares other than those
which are compulsorily convertible into equity. Cumulative Preferential
shares should be fully paid-up and should not contain clauses which
274
Annexure – G
275
Technical Guide on Internal Audit of Treasury Function in Banks
276
Annexure – G
30/09 dated September 30, 2003 as amended from time to time, wherever
applicable.
vi. In case of unlisted issues of Subordinated Debt, the disclosure
requirements as prescribed by the SEBI for listed companies in terms of
the above guidelines should be complied with.
vii. Necessary permission from the Foreign Exchange Department of the
Reserve Bank of India should be obtained for issuing the instruments to
NRIs/FIIs. PDs should comply with the terms and conditions, if any,
prescribed by SEBI/other regulatory authorities in regard to issue of the
instruments.
viii. Investments by PDs in Subordinated Debt of other PDs/banks will be
assigned 100% risk weight for capital adequacy purpose. Further, the
PD’s aggregate investments in Tiers II and III bonds issued by other PDs,
banks and financial institutions shall be restricted up to 5 percent of the
investing PD's total capital. The capital for this purpose will be the same
as that reckoned for the purpose of capital adequacy.
ix. The PDs should submit a report to the Internal Debt Management
Department, Reserve Bank of India giving details of the capital raised,
such as, amount raised, maturity of the instrument, rate of interest
together with a copy of the offer document, soon after the issue is
completed.
2.5 Minimum Requirement of Capital Funds
PDs are required to maintain a minimum Capital to Risk-weighted Assets Ratio
(CRAR) norm of 15 percent on an ongoing basis.
In calculating eligible capital, it will be necessary first to calculate the PDs’
minimum capital requirement for credit risk, and thereafter its market risk
requirement, to establish how much Tier I and Tier II capital is available to
support market risk. Eligible capital will be the sum of the whole of the PDs’ Tier I
capital, plus all of its Tier II capital under the limits imposed as summarized in
Annex C. Tier III capital will be regarded as eligible only if it meets the criteria set
out in para 2.3 above.
3 Measurement of Risk Weighted Assets:
The details of credit risk weights for the various on-balance sheet items and
offbalance sheet items based on the degree of credit risk and methodology of
277
Technical Guide on Internal Audit of Treasury Function in Banks
computing the risk weighted assets for the credit risk are listed in Annex A. The
procedure for calculating capital charge for market risk is detailed in Annex B. In
order to ensure consistency in the calculation of the capital requirements for
credit and market risks, an explicit numerical link will be created by multiplying
the measure of market risk by 6.67 (i.e., the reciprocal of the credit risk ratio of
15%) and adding the resulting figure to the sum of risk-weighted assets compiled
for credit risk purposes. The ratio will then be calculated in relation to the sum of
the two, using as the numerator only eligible capital as given in Annex C.
4 Regulatory reporting of Capital adequacy:
All PDs should report the position of their capital adequacy in PDR III return on a
quarterly basis. The PDR III statement is given in Annex D. Apart from the
Appendices I to V which are to be submitted alongwith PDR III, PDs should also
take into consideration the criteria for use of internal model to measure market
risk capital charge (as given in Annex E) alongwith the "Back Testing"
mechanism (detailed in Annex F)
5 Diversification of PD Activities
5.1 The guidelines on diversification of activities by stand-alone Primary
Dealers have been issued vide circular IDMD. PDRS.26/03.64.00/2006-07 dated
July 4, 2006.
5.2 The capital charge for market risk (Value-at-Risk calculated at 99 per cent
confidence interval, 15-day holding period, with multiplier of 3.3) for the activities
defined below should not be more than 20 per cent of the NOF as per the last
audited balance sheet:
1. Investment / trading in equity and equity derivatives
2. Investment in units of equity oriented mutual funds
3. Underwriting public issues of equity
5.3 PDs may calculate the capital charge for market risk on the stock
positions / underlying stock positions/ units of equity oriented mutual funds using
Internal Models (Value-at-Risk based) based on the guidelines prescribed in
Appendix III of Annex D. PDs may continue to provide for credit risk arising out
of equity, equity derivatives and equity oriented mutual funds as prescribed
Annex A.
278
Annexure – G
279
Technical Guide on Internal Audit of Treasury Function in Banks
Annex A
CAPITAL ADEQUACY FOR CREDIT RISK
Risk weights for calculation of CRAR
(a) On-Balance Sheet assets
All the on-balance sheet items are assigned percentage weights as per degree of
credit risk. The value of each asset/item is to be multiplied by the relevant risk
weight to arrive at risk adjusted value of the asset, as detailed below. The
aggregate of the Risk Weighted Assets will be taken into account for reckoning
the minimum capital ratio.
Nature of asset/item Percentage weight
(i) Cash balances and balances in Current 0
Account with RBI
(ii) Amounts lent in call/notice money market/ 20
Other money market instruments of banks/
FIs including CDs and balances in Current
account with banks
(iii) Investments
(a) `Government’securities/‘Approved’securities 0
guaranteed by Central/State Governments
[other than at (e) below]
(b) Fixed Deposits, Bonds of banks and FIs 20
(as specified by DBOD)
(c) Bonds issued by banks/Financial Institutions 100
as Tier II capital
(d) Shares of all Companies and 100
debentures/bonds/Commercial
Paper of Companies other than in (b)
above/units of mutual funds
(e) Securities of Public Sector Undertakings 20
guaranteed by Government but issued
outside the market borrowing programme
(f) Securities of and other claims on 100
280
Annexure – G
281
Technical Guide on Internal Audit of Treasury Function in Banks
282
Annexure – G
283
Technical Guide on Internal Audit of Treasury Function in Banks
Annex B
MEASUREMENT OF MARKET RISK
Market risk may be defined as the possibility of loss caused by change in
market variables. The objective in introducing the capital adequacy for
market risk is to provide an explicit capital cushion for the price risk to which
the PDs are especially exposed in their portfolio.
The methods for working out the capital charge for market risks are the
standardised model and the internal risk management framework based
model. PDs would continue to calculate capital charges based on the
standardised method as also under the internal risk management framework
based (VaR) model and maintain the higher of the two requirements.
However, where price data is not available for specific category of assets,
then PDs may follow the standardized method for computation of market risk.
In such a situation, PDs shall disclose to Reserve Bank of India, details of
such assets and ensure that consistency of approach is followed. PDs should
obtain Reserve Bank of India’s permission before excluding any category of
asset for calculations of market risk. The Bank would normally consider the
instruments of the nature of fixed deposits, commercial bills etc., for this
purpose. Such items will be held in the books till maturity and any diminution
in the value will have to be provided for in the books.
Note: In case of underwriting commitments, following points should be
adhered to:
a) In case of devolvement of underwriting commitment for government
securities, 100% of the devolved amount would qualify for the
measurement of market risk.
b) In case of underwriting under merchant banking issues (other than
Gsecs), where price has been committed/frozen at the time of
underwriting, the commitment is to be treated as a contingent liability
and 50% of the commitment should be included in the position for
market risk. However, 100% of devolved position should be subjected
to market risk measurement. The methodology for working out the
capital charges for market risk on the portfolio is explained below:
A: Standardised Method: Capital charge under standardized method
will be the measures of risk arrived at in terms of paragraphs A.1-3 below
summed arithmetically.
284
Annexure – G
285
Technical Guide on Internal Audit of Treasury Function in Banks
iii. Subject the lower of the long and short positions in each time-band to
a 5% capital charge towards vertical disallowance designed to capture
basis risk;
iv. Carry forward the net positions in each time-band for horizontal
offsetting across the zones subject to the disallowances set out in
Table 2.
Note : Points iii and iv above are applicable only where opposite positions
exist as explained at Note above.
Table 1
Duration time-bands and assumed changes in yield
Assumed change in yield (%) Assumed change in yield (%)
Zone 1 Zone 3
0 to 1month 1.00 4 to 5 years 0.85
1 to 3 months 1.00 5 to 7 years 0.80
3 to 6 months 1.00 7 to 10 years 0.75
6 to 12 months 1.00 10 to 15 years 0.70
15 to 20 years 0.65
Over 20 years 0.60
Zone 2
1to2 years 0.95
2 to 3 years 0.90
3 to 4 years 0.85
286
Annexure – G
Table 2
Horizontal disallowances
Zones Time-band Within the Between Between
zone adjacent zones 1
zones and 3
0 – month
1 – 3 months
Zone 1 40%
3 – 6 months
6 – 12 months
1 – 2 years
Zone 2 2 – 3 years 30%
3 – 4 years 40% 100%
4 – 5 years
5 – 7 years
7 – 10 years
Zone 3 30%
10 – 15 years
15 – 20 years
Over 20 years
The gross positions in each time-band will be subject to risk weighting as per
the assumed change in yield set out in Table 1, with no further offsets.
A1.1. Capital charge for interest rate derivatives:
The measurement system should include all interest rate derivatives and off
balance-sheet instruments in the trading book which react to changes in
interest rates, (e.g. forward rate agreements (FRAs), other forward contracts,
bond futures, interest rate positions).
A1.2. Calculation of positions
The derivatives should be converted into positions in the relevant underlying
and become subject to market risk charges as described above. In order to
calculate the market risk as per the standardized method described above,
the amounts reported should be the market value of the principal amount of
the underlying or of the notional underlying.
287
Technical Guide on Internal Audit of Treasury Function in Banks
288
Annexure – G
with a short position to deliver. The leg representing the time to expiry of the
future should, however, be reported. Security, sometimes called the
"cheapest-to-deliver", and the price of the future or forward contract should in
such cases move in close alignment. In addition, opposite positions in the
same category of instruments can in certain circumstances be regarded as
matched and allowed to offset fully. To qualify for this treatment the positions
must relate to the same underlying instruments can be of the same nominal
value. In addition:
(i) for futures: offsetting positions in the notional or underlying
instruments to which the futures contract relates must be for identical
products and mature within seven days of each other;
(ii) for swaps and FRAs: the reference rate (for floating rate positions)
must be identical and the coupon closely matched (i.e. within 15 basis
points); and
(iii) for swaps, FRAs and forwards: the next interest fixing date or, for
fixed coupon positions or forwards, the residual maturity must
correspond within the following limits:
• less than one month hence: same day;
• between one month and one year hence: within seven days;
• over one year hence: within thirty days.
PDs with large swap books may use alternative formulae for these swaps to
calculate the positions to be included in the duration ladder. One method
would be to first convert the payments required by the swap into their present
values. For that purpose, each payment should be discounted using zero
coupon yields, and a single net figure for the present value of the cash flows
entered into the appropriate time-band using procedures that apply to zero
(or low) coupon bonds; these figures should be slotted into the general
market risk framework as set out earlier. An alternative method would be to
calculate the sensitivity of the net present value implied by the change in
yield used in the duration method and allocate these sensitivities into the
time-bands set out in Table 1. Other methods which produce similar results
could also be used. Such alternative treatments will, however, only be
allowed if:
• the supervisory authority is fully satisfied with the accuracy of the
systems being used;
289
Technical Guide on Internal Audit of Treasury Function in Banks
• the positions calculated fully reflect the sensitivity of the cash flows to
interest rate changes and are entered into the appropriate time-bands;
General market risk applies to positions in all derivative products in the same
manner as for cash positions, subject only to an exemption for fully or very
closely-matched positions in identical instruments as defined in above
paragraphs. The various categories of instruments should be slotted into the
maturity ladder and treated according to the rules identified earlier.
A 2. Capital charge for equity positions:
A2.1. Equity positions
This section sets out a minimum capital standard to cover the risk of holding
or taking positions in equities by the PDs. It applies to long and short
positions in all instruments that exhibit market behavior similar to equities,
but not to nonconvertible preference shares (which will be covered by the
interest rate risk requirements). Long and short positions in the same issue
may be reported on a net basis. The instruments covered include equity
shares, convertible securities that behave like equities, i.e., units of MF and
commitments to buy or sell equity securities. The equity or equity like
positions including those arrived out in relation to equity /index derivatives as
described below may be included in the duration ladder below one month.
A2.2. Equity derivatives
Equity derivatives and off balance-sheet positions which are affected by
changes in equity prices should be included in the measurement system.
This includes futures and swaps on both individual equities and on stock
indices. The derivatives are to be converted into positions in the relevant
underlying.
A2.3. Calculation of positions
In order to calculate the market risk as per the standardized method for credit
and market risk, positions in derivatives should be converted into notional
equity positions:
• futures and forward contracts relating to individual equities should in
principle be reported at current market prices;
• futures relating to stock indices should be reported as the marked-
tomarket value of the notional underlying equity portfolio;
290
Annexure – G
291
Technical Guide on Internal Audit of Treasury Function in Banks
292
Annexure – G
Annex C
SUMMATION OF CAPITAL ADEQUACY REQUIREMENTS
The capital adequacy requirements for the PDs will comprise
• the capital charge for credit risk requirements as indicated in Annex A,
plus
• the capital charge for market risk requirements as indicated in Annex B
• In working out the eligible capital, the PDs are required to first calculate
their minimum capital requirements for credit risk and only afterwards
the capital charge towards market risk requirements. The total capital
funds will represent the capital available to meet both the credit as also
the market risks.
• Of the 15% capital charge for credit risk, at least 50% should be met by
Tier I capital, that is the total of Tier II Capital, if any, shall not exceed
one hundred per cent of Tier I Capital, at any point of time, for meeting
the capital charge for credit risk.
• Subordinated debt as capital should not exceed 50% of tier II capital.
• The total of Tier III Capital, if any, shall not exceed two hundred and fifty
per cent of the Tier I Capital that is available for meeting market risk
capital charge i.e. excess over the credit risk capital requirements.
• The total of Tier II and Tier III capital eligible for working out the total
capital funds should not exceed 100% of Tier I capital.
• The overall capital adequacy ratio will be calculated by establishing an
explicit numerical link between the credit risk and the market risk
factors, by multiplying the market risk capital charge with 6.67 i.e. the
reciprocal of the minimum credit risk capital charge of 15 %. The
resultant figure is added to the sum of risk weighted assets worked out
for credit risk purpose. The numerator for calculating the overall ratio
will be the PD’s Tier I, Tier II and the Tier III Capital after head room
deductions, if any. The calculation of capital charge is illustrated in PDR
III format, which is enclosed as Annex D.
293
Technical Guide on Internal Audit of Treasury Function in Banks
Annex D
PDR III Return
Statement of Capital Adequacy - Quarter ended -
Name of the Primary Dealer :
Statement - 1 ( Summary) Rupees
(i) Total of Risk Weighted Assets for Credit Risk (Annex I) Rs.
(ii) (a) Tier I Capital funds (after deductions) Rs.
(b) Tier II Capital funds eligible Rs.
(c) Total of available Tier I & II capital funds Rs.
(iii) Minimum credit risk capital required Rs.
i.e. (i) x 15 per cent
(iv) Excess of Tier I & II capital funds available Rs.
For market risk capital charge i.e. (ii) (c) – (iii)
(v) The Market Risk capital charge worked Rs.
out as the higher of the amounts under the
Standardised method and the one as per
Internal Risk Management (VaR) Model
(Appendices II and III)
(vi) Capital funds available to meet (v) Rs.
i.e: excess of Tier I and Tier II as at (iv) above,
Plus
eligible Tier III capital funds [maximum
up to 250 % of surplus Tier I capital]
(vii) Over all Capital Adequacy
(a) Total RWA for credit risk i.e. (i) Rs.
(b) Capital charge for market risk i.e. (v) Rs.
(c) Numerical Link for (b) = 6.67
i.e.(reciprocal of credit risk capital ratio of 15%)
(d) Risk Weighted Assets relating to
Market Risk i.e. (b) x (c) Rs.
(e) Total Risk Weighted Assets i.e. (a) + (d) Rs.
(f) Minimum capital required i.e. (e) x 15% Rs.
(g) Total Capital funds available i.e. (ii) + (vi) Rs.
294
Annexure – G
295
Technical Guide on Internal Audit of Treasury Function in Banks
Appendix I
CREDIT RISK
A. ALANCE SHEET
TEMS
296
Annexure – G
297
Technical Guide on Internal Audit of Treasury Function in Banks
298
Annexure – G
CREDIT
BOOK RISK RISK
CONV
FUNDED RISK ASSET VALUE WEIGHT ADJ
FACTOR
Rupees % VALUE
%
Banks/ Financial Institutions (as specified 100% 20%
by DBOD)
Primary Dealers in the Government 100% 100%
securities market
All others 100% 100%
V. Notional Equity/Index Positions underlying 100% 100%
the equity derivative
VI. Bills discounted/ rediscounted
Government/ any exposure guaranteed by 100% 0%
Government
Banks/ Financial Institutions (as specified 100% 20%
by DBOD)
Primary Dealers in the Government 100% 100%
securities market
All others 100% 100%
VII. Repurchase agreements where the credit
risk remains with the PD
Government/ any exposure guaranteed by 100% 0%
Government
Banks/ Financial Institutions (as specified 100% 20%
by DBOD)
Primary Dealers in the Government 100% 100%
securities market
All others 100% 100%
VIII. Other contingent liabilities/ commitments like
standby
Government/ any exposure guaranteed by 50% 0%
Government
Banks/ Financial Institutions (as specified 50% 20%
by DBOD)
Primary Dealers in the Government 50% 100%
securities market
299
Technical Guide on Internal Audit of Treasury Function in Banks
CREDIT
BOOK RISK RISK
CONV
FUNDED RISK ASSET VALUE WEIGHT ADJ
FACTOR
Rupees % VALUE
%
All others 50% 100%
IX. Interest Rate swaps
Original maturity of less than 1 year 0.5% 100%
Original maturity of 1 year and above but 1% 100%
less than 2 years
Original maturity of 2 years and above but 2% 100%
less than 3 years
Original maturity of 3 years and above but 3% 100%
less than 4 years
Original maturity of 4 years and above but 4% 100%
less than 5 years
Original maturity of 5 years and above but 5% 100%
less than 6 years
Original maturity of 6 years and above but 6% 100%
less than 7 years
( Every additional year - CCF increases by
1%)
X. Foreign Exchange Forward Contract
Original maturity of less than 1 year$ 2% 20 -
100%
Original maturity of more than 1 year and 5% 20 -
less than 2 years$ 100%
(Every additional year – CCF increases by
3%)
$ Risk depends on the counter party
Note: Cash margins/ deposits should be deducted before applying the credit conversion
factor
300
Appendix II
PDR-III
Statement 3 Quarterly
Return
MARKET RISK CAPITAL STATEMENT(Correlations i.e. appreciation not recognised)
(i) Standardised Method
A. Interest rate Instruments & Equity /Equity like instruments
ASSUMED
CHANGE MARKET
CHANGE
INSTRUMENT IN RISK
(FV)
ZONE
BOOK
BOOK
YIELD
YIELD
PRICE
PRICE
VALUE
IN YIELD
BUCKET
POSITION
MODIFIED
CHANGED
CHANGED
DURATION
DURATION
PRICE CHARGE
Maturity Date
(bps)
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) (13)
(Including equity
positions)
Total of A
B. Unhedged Foreign Exchange Position 15%
Total (A+B)
C. Asset items subjected to flat charge of 15% for market risk measurement
Memo items:
Items of assets which, with the approval of RBI, have been classified as investment items and not subjected to market risk measure:
Asset Book Value MTM/NAV
1.
2.
3.
302
Annexure – G
Appendix III
Details of the VaR calculation - for the last 60 days
Total
Date Portfolio Value (Rs.) VaR (Rs.) one day VaR with holding VaR with holding period as a
period Percentage of portfolio
303
Technical Guide on Internal Audit of Treasury Function in Banks
Appendix IV
Back Testing of VaR Model
For the last 250 trading days
Back testing Report as part of PDR III for Quarter ended __________________
Actual Hypothetical
No of observations (excluding holidays) 250 250
No of failures ie no of times VaR underpredicted the actual trading/ hypothetical MTM losse 0 0
Mkt Value Next Difference
Sr. 1 day VaR Entire Mkt Value Entire Failure Actual P/(L)
Date Day Same Failure (Y/N)
No. Portfolio Rs. crs Portfolio (Y/N) Rs. crs
Portfolio Rs. crs
1
2
3
4
.
.
.
.
.
250
The daily VaR preceding holidays should be upscaled by the square root of number of intervening holidays. For example if the
Friday is followed by 2 holidays, then the one VaR figure for Friday should be multiplied by square root of 2.
304
Appendix V
Details of stress testing
STRESS TEST AS
ON:
Name of the PD:
Other details:
Net interest income in the current year so far
Trading profits/loss in the current year so far
Unrealised MTM (Net gain/loss on cash
positions)
Unrealised MTM (Net gain/loss on derivative
positions)
Other income, if any (Details to be specified) ***
NOF deployed in fixed income and related
instruments
Total NOF (Break-up to be furnished)
306
Annexure – G
Capital funds of the firm as on the date of stress test (Rs.in crore)
i. Tier I captial
ii. Tier II Capital
iii. Tier III Capital
iv. Details of Deductions
investment in subsidiaries
intangible assets
losses in current accounting period
deferred tax assets
losses brought forward from previous accounting periods
Capital funds prescribed by other regulator
v. Net total capital funds
Less
vi. change in NOF due to one percent increase in yields
vii. Net capital funds available after providing for change
in NOF
viii. Risk-weighted assets for the credit risk of the firm
ix. Risk-weighted assets for the market risk of the firm
x. Total risk-weighted assets
xi. Capital adequacy ratio as on the date of stress test
(vii/x)
307
Technical Guide on Internal Audit of Treasury Function in Banks
Annex E
Criteria for use of internal model to
measure market risk capital charge
A. General criteria
1. In order that the internal model is effective, it should be ensured that :
- the PD's risk management system is conceptually sound and its
implementation is certified by external auditors;
- the PD has sufficient numbers of staff skilled in the use of
sophisticated models not only in the trading area but also in the risk
control, audit, and back office areas;
- the PD has a proven track record of reasonable accuracy in
measuring risk (back testing);
- the PD regularly conducted stress tests along the lines discussed in
Para B.4 below
2. In addition to these general criteria, PDs using internal models for
capital purposes will be subject to the requirements detailed in
Sections B.1 to B.5 below.
B.1 Qualitative standards
The extent to which PDs meet the qualitative criteria contained herein will
influence the level at which the RBI will ultimately set the multiplication factor
referred to in Section B.3 (b) below, for the PD. Only those PDs, whose
models are in full compliance with the qualitative criteria, will be eligible for
use of the minimum multiplication factor. The qualitative criteria include:
a) The PD should have an independent risk control unit that is
responsible for the design and implementation of the system. The unit
should produce and analyse daily reports on the output of the PD's
risk measurement model, including an evaluation of the relationship
between measures of risk exposure and trading limits. This unit must
be independent from trading desks and should report directly to senior
management of the PD.
b) The unit should conduct a regular back testing programme, i.e. an ex-
post comparison of the risk measure generated by the model against
308
Annexure – G
309
Technical Guide on Internal Audit of Treasury Function in Banks
review should include both the activities of the trading desks and of
the risk control unit. A review of the overall risk management process
should take place at regular intervals (ideally not less than once a
year) and should specifically address, at a minimum:
• the adequacy of the documentation of the risk management system
and process;
• the organisation of the risk control unit ;
• the integration of market risk measures into daily risk
management;
• the approval process for risk pricing models and valuation systems
used by front and back-office personnel;
• the validation of any significant change in the risk measurement
process;
• the scope of market risks captured by the risk measurement
model;
• the integrity of the management information system;
• the accuracy and completeness of position data;
• the verification of the consistency, timeliness and reliability of data
sources used to run internal models, including the independence of
such data sources;
• the accuracy and appropriateness of volatility and other
assumptions;
• the accuracy of valuation and risk transformation calculations;
• the verification of the model's accuracy through frequent back
testing as described in (b) above and in the Annex G.
i) The integrity and implementation of the risk management system in
accordance with the system policies/procedures laid down by the
Board of Directors should be certified by the external auditors as
outlined at Para B.5.
j) A copy of the back testing result should be furnished to Reserve Bank
of India.
310
Annexure – G
311
Technical Guide on Internal Audit of Treasury Function in Banks
312
Annexure – G
313
Technical Guide on Internal Audit of Treasury Function in Banks
used to identify and carry out stress testing under the scenarios, as well as
with a description of the results derived from these scenarios.
The results should be reviewed periodically by senior management and
should be reflected in the policies and limits set by management and the
Board of Directors. Moreover, if the testing reveals particular vulnerability to
a given set of circumstances, Reserve Bank of India would expect the PD to
take prompt steps to manage those risks appropriately (e.g. by reducing the
size of its exposures).
B.5 External Validation
PDs should get the internal model’s accuracy validated by external auditors,
including at a minimum, the following:
(a) verifying that the internal validation processes described in B.1(h) are
operating in a satisfactory manner;
(b) ensuring that the formulae used in the calculation process as well as
for the pricing of complex instruments are validated by a qualified unit,
which in all cases should be independent from the trading desks;
(c) Checking that the structure of internal models is adequate with respect
to the PD’s activities and geographical coverage;
(d) Checking the results of the PD’s back testing of its internal
measurement system (i.e. comparing Value-at-Risk estimates with
actual profits and losses) to ensure that the model provides a reliable
measure of potential losses over time. PDs should make the results as
well as the underlying inputs to their value-at-risk calculations
available to the external auditors;
(e) Making sure that data flows and processes associated with the risk
measurement system are transparent and accessible. In particular, it
is necessary that auditors are in a position to have easy access,
wherever they judge it necessary and under appropriate procedures,
to the models’ specifications and parameters.
314
Annexure – G
Annex F
“BACK TESTING” mechanism to be used in conjunction with the
internal risk based model for market risk capital charge
The following are the parameters of the back testing framework for
incorporating into the internal models approach to market risk capital
requirements.
Primary Dealers that have adopted an internal model-based approach to
market risk measurement are required routinely to compare daily profits and
losses with modelgenerated risk measures to gauge the quality and accuracy
of their risk measurement systems. This process is known as "back testing".
The objective of the back testing efforts is the comparison of actual trading
results with model-generated risk measures. If the comparison uncovers
sufficient differences, problems almost certainly must exist, either with the
model or with the assumptions of the back test.
Description of the back testing framework
The back testing program consists of a periodic comparison of the Primary
Dealer’s daily Value-at-Risk measures with the subsequent daily profit or loss
(“trading outcome”). The Value-at-Risk measures are intended to be larger
than all but a certain fraction of the trading outcomes, where that fraction is
determined by the confidence level of the Value-at-Risk measure. Comparing
the risk measures with the trading outcomes simply means that the Primary
Dealer counts the number of times that the risk measures were larger than
the trading outcome. The fraction actually covered can then be compared
with the intended level of coverage to gauge the performance of the Primary
Dealer’s risk model.
Under the Value-at-Risk framework, the risk measure is an estimate of the
amount that could be lost on a set of positions due to general market
movements over a given holding period, measured using a specified
confidence level.
The back tests to be applied compare whether the observed percentage of
outcomes covered by the risk measure is consistent with a 99% level of
confidence.
That is, they attempt to determine if a PD’s 99th percentile risk measures
truly cover 99% of the firm’s trading outcomes.
315
Technical Guide on Internal Audit of Treasury Function in Banks
316
Annexure – G
In case large number of exceptions are being noticed, it may be useful for the
PDs to dis-aggregate their activities into sub sectors in order to identify the
large exceptions on their own. The reasons could be of the following
categories:
Basic integrity of the model
1) The PD’s systems simply are not capturing the risk of the positions
themselves (e.g. the positions of an office are being reported
incorrectly).
2) Model volatilities and/or correlations were calculated incorrectly (e.g.
the computer is dividing by 250 when it should be dividing by 225).
Model’s accuracy could be improved
3) The risk measurement model is not assessing the risk of some
instruments with sufficient precision (e.g. too few maturity buckets or
an omitted spread).
Bad luck or markets moved in fashion unanticipated by the model
4) Random chance (a very low probability event).
5) Markets moved by more than the model predicted was likely (i.e.
volatility was significantly higher than expected).
6) Markets did not move together as expected (i.e. correlations were
significantly different than what was assumed by the model).
Intra-day trading
7) There was a large (and money-losing) change in the PD’s positions or
some other income event between the end of the first day (when the risk
estimate was calculated) and the end of the second day (when trading results
were tabulated).
317
Technical Guide on Internal Audit of Treasury Function in Banks
Annex G
Annex
Monthly Return on Interest Rate Risk of Rupee Derivatives
As at end-month
Name of the Bank/Institution:
1. Cash Bonds Market Value (Rs. In PV01 (Rs. In Crore)
Crore)
(a) (b) (c)
(a) HFT (See Note 1)
(b) AFS (See Note 1)
(c) HTM (See Note 1)
Total [(a) to (c) above]
2. Rupee Interest Rate Derivatives Notional Amount (Rs. PV01(Rs. in
in Crore) Crore)
(a) Bond Futures (See Note 1)
(b) MIBOR (OIS) (See Note 2)
(c) MIFOR (See Note 2)
(d) G-Sec benchmarks (See Note2)
(e) Other benchmarks (Please report separately) (See Note 2&4)
(f) Forward Rate Agreements (See Note 3)
Total [(a) to (f) above]
Note 1. PV01 may be taken as POSITIVE for long positions and NEGATIVE for short
positions.
Note 2. PV01 may be taken as POSITIVE if receiving a swap and NEGATIVE if paying a
swap.
Note 3. For FRAs, use the PVO1 of the underlying deposit/instrument.
Note 4. In 2 (e) above, swaps on other benchmarks such as LIBOR may be reported
separately for each benchmark
318
Annexure – G
Annex H
List of circulars Consolidated
1 IDMD.1 / (PDRS) 03.64.00 / January 07, Capital Adequacy Standards and Risk
5 RBI / 2008-09 / 424 April 1, 2009 Issue of Tier II and Tier III Capital
IDMD.PDRD.No. 4878 /
03.64.00 /2008-09
319
ANNEXURE – H
RBI/2009-10/46
FMD. MSRG. No. 36/02.08.003/2009-10 July 1, 2009
Aashadha 9, 1931 (S)
The Chairmen/Chief Executives of
all Scheduled Commercial Banks (excluding RRBs) /
Co-operative Banks / Primary Dealers
Dear Sirs,
As you are aware, the Reserve Bank of India has, from time to time, issued a
number of guidelines/instructions/directives to banks in regard to matters relating
to call/notice money market. To enable eligible institutions to have current
instructions at one place, a Master Circular incorporating all the existing
guidelines/instructions/directives on the subject has been prepared. It may be
noted that this Master Circular consolidates and updates all the
instructions/guidelines contained in the circulars issued up to June 30, 2009, in
so far as they relate to operations of eligible institutions in the call/notice money
markets. This Master Circular has been placed on the RBI website at
www.mastercirculars.rbi.org.in.
Yours faithfully,
(Chandan Sinha)
Chief General Manager
Encls.: As above
Annexure – H
Master Circular
Call/Notice Money Market Operations
Table of Contents
1. Introduction
2. Participants
3. Prudential Limits
4. Interest Rate
5. Dealing Session
6. Documentation
7. Reporting requirement
8. Annexes
I. List of institutions permitted in Call/Notice Money Market
II. Reporting Format
III. Definitions
9. Appendix: List of Circulars
321
Technical Guide on Internal Audit of Treasury Function in Banks
322
Annexure – H
3. Primary Dealers PDs are allowed to borrow, on PDs are allowed to lend in
(PDs) average in a reporting fortnight, up to call/notice money market, on
200 per cent of their net owned funds average in a reporting
(NOF) as at end- March of the fortnight, up to 25 per cent of
previous financial year. their NOF.
3.2 Non-bank institutions are not permitted in the call/notice money market
with effect from August 6, 2005.
4. Interest Rate
4.1 Eligible participants are free to decide on interest rates in call/notice
money market.
4.2 Calculation of interest payable would be based on FIMMDA’s (Fixed
Income Money Market and Derivatives Association of India) Handbook of Market
Practices.
5. Dealing Session
5.1 Deals in the call/notice money market can be done upto 5.00 pm on
weekdays and 2.30 pm on Saturdays or as specified by RBI from time to time.
6. Documentation
6.1 Eligible participants may adopt the documentation suggested by FIMMDA
from time to time.
7. Reporting Requirement
7.1 All dealings in call/notice money on screen-based negotiated quote-driven
system (NDS-CALL) launched since September 18, 2006 do not require separate
reporting. It is mandatory for all Negotiated Dealing System (NDS) members to
report their call/notice money market deals (other than those done on NDS-
CALL) on NDS. Deals should be reported within 15 minutes on NDS, irrespective
of the size of the deal or whether the counterparty is a member of the NDS or
not. In case there is repeated nonreporting of deals by an NDS member, it will be
considered whether non-reported deals by that member should be treated as
invalid.
7.2 The reporting time on NDS is upto 5.00 pm on weekdays and 2.30 pm on
Saturdays or as decided by RBI from time to time.
323
Technical Guide on Internal Audit of Treasury Function in Banks
324
Annexure – H
Annex - II
Daily Return on Call/Notice/Term Money Market Transactions
To
The Chief General Manager,
Financial Markets Department,
23rd Fl oor NCOB, RBI,
Mumbai-400001
Fax-91-22-22630981
Name of the Bank/Institution : _____________________________________
Code No.(As specified by RBI) : _____________________________________
Date : _____________________________________
Borrowed Lent
3. Term Money @
(15 Days
(1 Month
(3 Months
(6 Months
325
Technical Guide on Internal Audit of Treasury Function in Banks
(15 Days
(1 Month
(3 Months
(6 Months
_____________________
Authorised Signatories
Phone No. :
326
Annexure – H
Annex III
Definitions
327
Technical Guide on Internal Audit of Treasury Function in Banks
Sr.
Circular Number Subject
No.
5. Ref.DBOD.No.FSC.BC.68/24.91.001-95
dated June 27, 1995
6. CPC.BC.162/07.01.279/96-97 dated April Money Market - Routing of
15, 1997 Transactions through DFHI
7. CPC.BC.165/07.01.279/97-98 dated. Money Market - Routing of
April 21, 1997 Transactions through Primary
Dealers
8. CPC.BC.175/07.01.279/97-98 dated April
Money Market
29, 1998
9. CPC.BC.185/07.01.279/98-99 dated April Measures for Developing the
20, 1999 Money Market - Call/Notice
Money Market
10. Ref.No.MPD.2785/279A(MM)/98-99 Call/Notice Money and Bills
dated April 24, 1999 Rediscounting Markets - Routing
of Transaction
11. CPC.BC.190/07.01.279/99-2000 dated
Money Market
October 29, 1999
12. CPC.BC.196/07.01.279/99-2000 dated
Money Market
April 27, 2000
13. Ref.No.MPD.3513/279A(MM)/1999- 2000 Call/Notice Money and Bills
dated April 28, 2000 Rediscounting Markets - Routing
of Transactions - Extract from
the Statement on Monetary and
Credit Policy for the Year 2000-
01 dated April 27, 2000
328
Annexure – H
Sr.
Circular Number Subject
No.
and Bills Rediscounting Scheme
- Primary Dealers
20. MPD.BC.214/07.01.279/2001-02 dated Money Market - Moving towards
April 29, 2002 Pure Interbank Call Money
Market
21. DS.PCB.CIR.52/13.01.00/2001-02 dated Reporting of Call Money
June 24, 2002 Transactions
22. MPD.217/07.01.279/2001-02 dated June Reliance on Call/Notice Money
27, 2002 Market: Prudential Norm
23. MPD.220/07.01.279/2002-03 dated July Access to Call/Notice Money
31, 2002 Market for Primary Dealers:
Prudential Norms.
24. MPD.222/07.01.279/2002-03 dated
Money Market
October 29, 2002
25. MPD.225/07.01.279/2002-03 dated Reliance on Call/Notice Money
November 14, 2002 Market: Prudential Norm
26. MPD.226/07.01.279/2002-03 dated Reliance on Call/Notice Money
December 11, 2002 Market: Prudential Norm
27. DBOD.FSC.BC.85/24.91.001/2002-03 Permission to participate in
dated March 26, 2003 Call/Notice Money Market and
Bills Rediscounting Scheme -
Private Sector Mutual Funds
28. DBOD.FSC.BC.86/24.91.001/2002-03 Permission to participate in
dated March 26, 2003 Call/Notice/Term Money Market
and Bills Rediscounting Scheme
- Primary Dealers
29. MPD.BC.230/07.01.279/2002-03 dated Money Market - Moving towards
April 29, 2002 Pure Interbank Call Money
Market
30. MPD.BC.234/07.01.279/2002-03 dated Participation of Non-bank
April 29, 2003 Entities in Call/Notice Money
Market
31. MPD.BC.235/07.01.279/2002-03 dated Reporting of Call/Notice Money
April 29, 2003 Market Transactions on NDS
Platform.
32. MPD.BC.241/07.01.279/2003-04 dated Money Market - Moving towards
November 3, 2003 Pure Interbank Call/Notice
Money Market
329
Technical Guide on Internal Audit of Treasury Function in Banks
Sr.
Circular Number Subject
No.
33. MPD.BC.244/07.01.279/2003-04 dated Primary Dealers' Access to
November 5, 2003 Call/Notice Money Market
34. MPD.BC.242/07.01.279/2003-04 dated Moving towards Pure Inter-bank
November 5, 2003 Call/Notice Money Market
35. MPD.BC.250/07.01.279/2003-04 dated Moving towards Pure Inter-bank
May 25, 2004 Call/Notice Money Market
36. MPD.BC.253/07.01.279/2004-05 dated Master Circular on Call/Notice
July 3, 2005. Money Market Operations
37. MPD.BC.259/07.01.279/2004-05 dated Moving towards Pure Inter-bank
October 26, 2004. Call/Notice Money Market
38. MPD.BC.260/07.01.279/2004-05 dated Reporting of Call/Notice Money
December 10, 2004. Market Transactions.
39. MPD.BC.265/07.01.279/2004-05 dated Call/Notice Money Market –
April 29, 2005. Review of Benchmark.
40. MPD.BC.266/07.01.279/2004-05 dated Participation in Call/Notice
April 29, 2005. Money Market.
330
ANNEXURE – I
RBI MC CD 2009
RBI/2009-10/47
FMD.MSRG.No. 38/02.08.003/2009-10 July 1, 2009
The Chairmen / Chief Executives of
All Scheduled Banks (excluding RRBs and LABs)
and All-India Term Lending and Refinancing Institutions
Dear Sirs,
As you are aware, with a view to further widening the range of money market
instruments and giving investors greater flexibility in deployment of their short-
term surplus funds, Certificates of Deposit (CDs) were introduced in India in
1989. Guidelines for issue of CDs are presently governed by various directives
issued by the Reserve Bank of India, as amended from time to time.
A Master Circular incorporating all the existing guidelines / instructions /
directives on the subject has been prepared. It may be noted that this Master
Circular consolidates and updates all the instructions / guidelines contained in
the circulars listed in the Appendix, in so far as they relate to 'guidelines for issue
of CDs'. This master circular has been placed on RBI website at
www.mastercircular.rbi.org.in
Yours faithfully,
(Chandan Sinha)
Chief General Manager
Technical Guide on Internal Audit of Treasury Function in Banks
Introduction
Eligibility
Aggregate Amount
Minimum Size of Issue and Denominations
Who can Subscribe
Maturity
Discount
Reserve Requirements
Transferability
Loans / Buy-backs
Format of CDs
Payment of Certificate
Issue of Duplicate Certificates
Accounting
Standardised Market Practice and Documentation
Reporting
Annex I
Annex II
Appendix
332
Annexure – I
Introduction
Certificates of Deposit (CDs) is a negotiable money market instrument and
issued in dematerialised form or as a Usance Promissory Note, for funds
deposited at a bank or other eligible financial institution for a specified time
period. Guidelines for issue of CDs are presently governed by various directives
issued by the Reserve Bank of India, as amended from time to time. The
guidelines for issue of CDs incorporating all the amendments issued till date are
given below for ready reference.
Eligibility
2. CDs can be issued by (i) scheduled commercial banks excluding
Regional Rural Banks (RRBs) and Local Area Banks (LABs); and (ii) select all-
India Financial Institutions that have been permitted by RBI to raise short-term
resources within the umbrella limit fixed by RBI.
Aggregate Amount
3. Banks have the freedom to issue CDs depending on their requirements.
4. An FI may issue CDs within the overall umbrella limit fixed by RBI, i.e.,
issue of CD together with other instruments, viz., term money, term deposits,
commercial papers and inter-corporate deposits should not exceed 100 per cent
of its net owned funds, as per the latest audited balance sheet.
Minimum Size of Issue and Denominations
5. Minimum amount of a CD should be Rs.1 lakh, i.e., the minimum
deposit that could be accepted from a single subscriber should not be less than
Rs. 1 lakh and in the multiples of Rs. 1 lakh thereafter.
Who can Subscribe
6. CDs can be issued to individuals, corporations, companies, trusts,
funds, associations, etc. Non- Resident Indians (NRIs) may also subscribe to
CDs, but only on non-repatriable basis which should be clearly stated on the
Certificate. Such CDs cannot be endorsed to another NRI in the secondary
market.
Maturity
7. The maturity period of CDs issued by banks should be not less than 7
days and not more than one year.
333
Technical Guide on Internal Audit of Treasury Function in Banks
8. The FIs can issue CDs for a period not less than 1 year and not
exceeding 3 years from the date of issue.
Discount / Coupon Rate
9. CDs may be issued at a discount on face value. Banks / FIs are also
allowed to issue CDs on floating rate basis provided the methodology of
compiling the floating rate is objective, transparent and market-based. The
issuing bank / FI are free to determine the discount / coupon rate. The interest
rate on floating rate CDs would have to be reset periodically in accordance with a
pre-determined formula that indicates the spread over a transparent benchmark.
Reserve Requirements
10. Banks have to maintain the appropriate reserve requirements, i.e., cash
reserve ratio (CRR) and statutory liquidity ratio (SLR), on the issue price of the
CDs.
Transferability
11. Physical CDs are freely transferable by endorsement and delivery.
Dematted CDs can be transferred as per the procedure applicable to other demat
securities. There is no lock-in period for the CDs.
Loans / Buy-backs
12. Banks / FIs cannot grant loans against CDs. Furthermore, they cannot
buyback their own CDs before maturity. However, the Reserve Bank may relax
these restrictions for temporary periods through a separate notification.
Format of CDs
13. Banks / FIs should issue CDs only in the dematerialised form. However,
according to the Depositories Act, 1996, investors have the option to seek
certificate in physical form. Accordingly, if investor insists on physical certificate,
the bank / FI may inform the Chief General Manager, Financial Markets
Department, Reserve Bank of India, Central Office, Fort, Mumbai - 400 001
about such instances separately. Further, issuance of CDs will attract stamp
duty. A format (Annex I) is enclosed for adoption by banks / FIs. There will be no
grace period for repayment of CDs. If the maturity date happens to be holiday,
the issuing bank should make payment on the immediate preceding working day.
Banks / FIs may, therefore, so fix the period of deposit that the maturity date
does not coincide with a holiday to avoid loss of discount / interest rate.
334
Annexure – I
Security Aspect
14. Since physical CDs are freely transferable by endorsement and
delivery, it will be necessary for banks to see that the certificates are printed on
good quality security paper and necessary precautions are taken to guard
against tampering with the document. They should be signed by two or more
authorised signatories.
Payment of Certificate
15. Since CDs are transferable, the physical certificate may be presented
for payment by the last holder. The question of liability on account of any defect
in the chain of endorsements may arise. It is, therefore, desirable that banks take
necessary precautions and make payment only by a crossed cheque. Those who
deal in these CDs may also be suitably cautioned.
16. The holders of dematted CDs will approach their respective depository
participants (DPs) and have to give transfer / delivery instructions to transfer the
demat security represented by the specific ISIN to the 'CD Redemption Account'
maintained by the issuer. The holder should also communicate to the issuer by a
letter / fax enclosing the copy of the delivery instruction it had given to its DP and
intimate the place at which the payment is requested to facilitate prompt
payment. Upon receipt of the Demat credit of CDs in the "CD Redemption
Account", the issuer, on maturity date, would arrange to repay to holder /
transferor by way of Banker's cheque / high value cheque, etc.
Issue of Duplicate Certificates
17. In case of the loss of physical certificates, duplicate certificates can
be issued after compliance with the following:
(a) A notice is required to be given in at least one local newspaper
(b) Lapse of a reasonable period (say 15 days) from the date of the notice
in the newspaper; and
(c) Execution of an indemnity bond by the investor to the satisfaction of the
issuer of CDs.
18. The duplicate certificate should only be issued in physical form. No
fresh stamping is required as a duplicate certificate is issued against the original
lost CD. The duplicate CD should clearly state that the CD is a Duplicate one
stating the
335
Technical Guide on Internal Audit of Treasury Function in Banks
original value date, due date, and the date of issue (as "Duplicate issued on
________").
Accounting
19. Banks / FIs may account the issue price under the Head "CDs issued"
and show it under deposits. Accounting entries towards discount will be made as
in the case of "cash certificates". Banks / FIs should maintain a register of CDs
issued with complete particulars.
Standardised Market Practices and Documentation
20. Fixed Income Money Market and Derivatives Association of India
(FIMMDA) may prescribe, in consultation with the RBI, for operational flexibility
and smooth functioning of the CD market, any standardised procedure and
documentation that are to be followed by the participants, in consonance with the
international best practices. Banks / FIs may refer to the detailed guidelines
issued by FIMMDA in this regard on June 20, 2002.
Reporting
21. Banks should include the amount of CDs in the fortnightly return under
Section 42 of the Reserve Bank of India Act, 1934 and also separately indicate
the amount so included by way of a footnote in the return.
22. Further, banks / FIs should submit a fortnightly return, as per the format
given in Annex II, to the Chief General Manager, Financial Markets Department,
Reserve Bank of India, Central Office Building, Fort, Mumbai - 400 001, Fax: 91-
22-22630981 / 22634824 within 10 days from the end of the fortnight date.
-------------------------------
336
Annexure – I
Annex - I
Name of the Bank / Institution
No.
Rs. ___________
Dated ___________
___________ months / days after the date hereof, ___________ <Name of the
Bank / Institution> ___________, at ___________ <name of the place>
___________, hereby promise to pay to ___________ <name of the depositor>
___________ or order the sum of Rupees ___________ <in words>
___________ only, upon presentation and surrender of this instrument at the
said place, for deposit received. For ___________ <Name of the institution>
___________ Date of maturity ___________ without days of grace.
337
Technical Guide on Internal Audit of Treasury Function in Banks
Annex - II
Fortnightly Return on Certificates of Deposit (CDs)
(SFR III – D)
Face Value
Discounted Value
Face Value
Effective
Discounted value of Maturity Demat or
Sr. interest rate
CDs issued (Amount in period (in Physical CDs
No. (per cent per
Rs.) days) issued (D/P)
annum)
1.
2.
3.
4.
5.
6.
338
Annexure – I
Demat or
Face value of CDs Maturity
Sr. Physical
issued period Benchmark Spread
No. CDs issued
(Amount in Rs.) (in days)
(D/P)
1.
2.
3.
4.
5.
6.
339
Technical Guide on Internal Audit of Treasury Function in Banks
Appendix
List of Circulars
Sr.
Reference No. Date Subject
No
340
Annexure – I
341
ANNEXURE – J
------------------------------------------------------------------------------------------------------------
Master Circular
on
Guidelines for Issue of Commercial Paper
RBI/2009-10/ 45
Ref.No. FMD.MSRG.No.37/02.08.003/2009-10
July 1, 2009
Ashadha 09, 1931 (S)
The Chairmen/Chief Executives of
All Scheduled Banks, Primary Dealers
and All-India Financial Institutions
Dear Sir,
Guidelines for Issue of Commercial Paper
Yours faithfully,
(Chandan Sinha)
Chief General Manager
343
Technical Guide on Internal Audit of Treasury Function in Banks
Master Circular
on
Guidelines for Issue of Commercial
Paper (CP) as amended up to June 30, 2009
Introduction
Who can issue CP
Rating Requirement
Maturity
Denominations
Limits & Amount of Issue of CP
Who can be IPA
Investments in CP
Mode of Issuance
Preference for Dematerialised form
Payment of CP
Stand-by Facility
Procedure for Issuance
Role and Responsibilities
Documentation Procedure
Defaults in CP market
Non-applicability of Certain Other Directions
Schedule I
Schedule II
Schedule III
Annex I
Annex II
Appendix
344
Annexure – J
Introduction
Commercial Paper (CP) is an unsecured money market instrument issued in the
form of a promissory note. CP, as a privately placed instrument, was introduced
in India in 1990 with a view to enabling highly rated corporate borrowers to
diversify their sources of short-term borrowings and to provide an additional
instrument to investors. Subsequently, primary dealers, satellite dealers*and all-
India financial institutions were also permitted to issue CP to enable them to
meet their short-term funding requirements for their operations. Guidelines for
issue of CP are presently governed by various directives issued by the Reserve
Bank of India, as amended from time to time. The guidelines for issue of CP
incorporating all the amendments issued till date is given below for ready
reference.
Who can Issue Commercial Paper (CP)
2. Corporates, primary dealers (PDs) and the all-India financial institutions
(FIs) that have been permitted to raise short-term resources under the
umbrella limit fixed by the Reserve Bank of India are eligible to issue CP.
3. A corporate would be eligible to issue CP provided: (a) the tangible net
worth of the company, as per the latest audited balance sheet, is not less
than Rs.4 crore; (b) company has been sanctioned working capital limit by
bank/s or all- India financial institution/s; and (c) the borrowal account of
the company is classified as a Standard Asset by the financing bank/s/
institution/s.
Rating Requirement
4. All eligible participants shall obtain the credit rating for issuance of
Commercial Paper from either the Credit Rating Information Services of
India Ltd. (CRISIL) or the Investment Information and Credit Rating
Agency of India Ltd. (ICRA) or the Credit Analysis and Research Ltd.
(CARE) or the FITCH Ratings India Pvt. Ltd. or such other credit rating
agencies as may be specified by the Reserve Bank of India from time to
time, for the purpose. The minimum credit rating shall be P-2 of CRISIL or
such equivalent rating by other agencies. The issuers shall ensure at the
time of issuance of CP that the rating so obtained is current and has not
fallen due for review.
345
Technical Guide on Internal Audit of Treasury Function in Banks
Maturity
5. CP can be issued for maturities between a minimum of 7 days and a
maximum up to one year from the date of issue. The maturity date of the
CP should not go beyond the date up to which the credit rating of the
issuer is valid.
Denominations
6. CP can be issued in denominations of Rs.5 lakh or multiples thereof.
Amount invested by a single investor should not be less than Rs.5 lakh
(face value).
Limits and the Amount of Issue of CP
7. CP can be issued as a "stand alone" product. The aggregate amount of
CP from an issuer shall be within the limit as approved by its Board of
Directors or the quantum indicated by the Credit Rating Agency for the
specified rating, whichever is lower. Banks and FIs will, however, have the
flexibility to fix working capital limits duly taking into account the resource
pattern of companies’ financing including CPs.
8. An FI can issue CP within the overall umbrella limit fixed by the RBI, i.e.,
issue of CP together with other instruments, viz., term money borrowings,
term deposits, certificates of deposit and inter-corporate deposits should
not exceed 100 per cent of its net owned funds, as per the latest audited
balance sheet.
9. The total amount of CP proposed to be issued should be raised within a
period of two weeks from the date on which the issuer opens the issue for
subscription. CP may be issued on a single date or in parts on different
dates provided that in the latter case, each CP shall have the same
maturity date.
10. Every issue of CP, including renewal, should be treated as a fresh issue.
Who can Act as Issuing and Paying Agent (IPA)
11. Only a scheduled bank can act as an IPA for issuance of CP.
Investment in CP
12. CP may be issued to and held by individuals, banking companies, other
corporate bodies registered or incorporated in India and unincorporated
bodies, Non-Resident Indians (NRIs) and Foreign Institutional Investors
346
Annexure – J
(FIIs). However, investment by FIIs would be within the limits set for their
investments by Securities and Exchange Board of India (SEBI).
Mode of Issuance
13. CP can be issued either in the form of a promissory note (Schedule I) or
in a dematerialised form through any of the depositories approved by and
registered with SEBI.
14. CP will be issued at a discount to face value as may be determined by the
issuer.
15. No issuer shall have the issue of CP underwritten or co-accepted.
Preference for Dematerialisation
16. While option is available to both issuers and subscribers to issue/hold CP
in dematerialised or physical form, issuers and subscribers are
encouraged to prefer exclusive reliance on dematerialised form of
issue/holding. However, with effect from June 30, 2001, banks, FIs and
PDs are required to make fresh investments and hold CP only in
dematerialised form.
Payment of CP
17. The initial investor in CP shall pay the discounted value of the CP by
means of a crossed account payee cheque to the account of the issuer
through IPA. On maturity of CP, when CP is held in physical form, the
holder of CP shall present the instrument for payment to the issuer
through the IPA. However, when CP is held in demat form, the holder of
CP will have to get it redeemed through the depository and receive
payment from the IPA.
Stand-by Facility
18. In view of CP being a 'stand alone' product, it would not be obligatory in
any manner on the part of the banks and FIs to provide stand-by facility to
the issuers of CP. Banks and FIs have, however, the flexibility to provide
for a CP issue, credit enhancement by way of stand-by assistance/credit,
back-stop facility etc. based on their commercial judgement, subject to
prudential norms as applicable and with specific approval of their Boards.
19. Non-bank entities including corporates may also provide unconditional
and irrevocable guarantee for credit enhancement for CP issue provided:
347
Technical Guide on Internal Audit of Treasury Function in Banks
(i) the issuer fulfils the eligibility criteria prescribed for issuance of CP;
(ii) the guarantor has a credit rating at least one notch higher than the
issuer given by an approved credit rating agency; and
(iii) the offer document for CP properly discloses the net worth of the
guarantor company, the names of the companies to which the
guarantor has issued similar guarantees, the extent of the
guarantees offered by the guarantor company, and the conditions
under which the guarantee will be invoked.
Procedure for Issuance
20. Every issuer must appoint an IPA for issuance of CP. The issuer should
disclose to the potential investors its financial position as per the standard
market practice. After the exchange of deal confirmation between the
investor and the issuer, issuing company shall issue physical certificates
to the investor or arrange for crediting the CP to the investor's account
with a depository. Investors shall be given a copy of IPA certificate to the
effect that the issuer has a valid agreement with the IPA and documents
are in order (Schedule III).
Role and Responsibilities
21. The role and responsibilities of issuer, issuing and paying agent (IPA) and
credit rating agency (CRA) are set out below:
(a) Issuer
With the simplification in the procedures for CP issuance, issuers would
now have more flexibility. Issuers would, however, have to ensure that the
guidelines and procedures laid down for CP issuance are strictly adhered
to.
(b) Issuing and Paying Agent (IPA)
(i) IPA would ensure that issuer has the minimum credit rating as
stipulated by RBI and amount mobilised through issuance of CP is
within the quantum indicated by CRA for the specified rating or as
approved by its Board of Directors, whichever is lower.
(ii) IPA has to verify all the documents submitted by the issuer, viz.,
copy of board resolution, signatures of authorised executants
(when CP in physical form) and issue a certificate that documents
348
Annexure – J
are in order. It should also certify that it has a valid agreement with
the issuer (Schedule III).
(iii) Certified copies of original documents verified by the IPA should
be held in the custody of IPA.
(iv) Every CP issue should be reported to the Chief General Manager,
Financial Markets Department, Reserve Bank of India, Central
Office, Fort, Mumbai- 400001.
(v) IPAs, which are NDS member, should report the details of CP
issue on NDS platform within two days from the date of completion
of the issue.
(vi) Further, all scheduled banks, acting as an IPA, will continue to
report CP issuance details as hitherto within three days from the
date of completion of the issue, incorporating details as per
Schedule II till NDS reporting stabilises to the satisfaction of RBI.
(c) Credit Rating Agency (CRA)
(i) Code of Conduct prescribed by the SEBI for CRAs for undertaking
rating of capital market instruments shall be applicable to them
(CRAs) for rating CP.
(ii) Further, the credit rating agency would henceforth have the
discretion to determine the validity period of the rating depending
upon its perception about the strength of the issuer. Accordingly,
CRA shall at the time of rating, clearly indicate the date when the
rating is due for review.
(iii) While the CRAs can decide the validity period of credit rating, they
would have to closely monitor the rating assigned to issuers vis-a-
vis their track record at regular intervals and would be required to
make their revision in the ratings public through their publications
and website.
Documentation Procedure
22. Fixed Income Money Market and Derivatives Association of India
(FIMMDA) may prescribe, in consultation with the RBI, for operational
flexibility and smooth functioning of CP market, any standardised
procedure and documentation that are to be followed by the participants,
in consonance with the international best practices. Issuer / IPAs may
349
Technical Guide on Internal Audit of Treasury Function in Banks
350
Annexure – J
Schedule I
Stamp to be
Affixed as in force
in the State in which
it is to be issued
(NAME OF THE ISSUING COMPANY/INSTITUTION)
SERIAL NO.
Issued at :_______________________ Date of issue :_____________________
(PLACE)
Date of Maturity:___________________________without days of grace.
(If such date happens to fall on a holiday, payment shall be made on the
immediate preceding working day)
For value received ___________________________________________hereby
(NAME OF THE ISSUING COMPANY/ INSTITUTION)
Promises to pay _______________________________________or order on the
(NAME OF THE INVESTOR)
maturity date as specified above the sum of Rs._________________________
(in words) upon presentation and surrender of this Commercial Paper to
________________________________________________________________
(NAME OF THE ISSUING AND PAYING AGENT)
For and on behalf of ________________________________________
(NAME OF THE ISSUING COMPANY/INSTITUTION)
AUTHORISED AUTHORISED
SIGNATORY SIGNATORY
351
Technical Guide on Internal Audit of Treasury Function in Banks
352
Annexure – J
Schedule II
353
Technical Guide on Internal Audit of Treasury Function in Banks
_________________
(Name of the issuer)
354
Annexure – J
Schedule III
CERTIFICATE
We have a valid IPA agreement with the ________________________________
(Name of Issuing Company/Institution)
2. We have verified the documents viz., board resolution and certificate issued by
Credit Rating Agency submitted by ____________________________________
(Name of the Issuing Company/Institution)
and certify that the documents are in order. Certified copies of original
documents are held in our custody.
3.* We also hereby certify that the signatures of the executants of the attached
Commercial Paper bearing Sr. No. ______________ dated _______________
for Rs._______________ (Rupees ____________________________________)
(in words)
tally with the specimen signatures filed by _______________________________
( Name of the issuing Company/Institution)
(Authorised Signatory/Signatories)
(Name and address of Issuing and Paying Agent)
Place :
Date :
* (Applicable to CP in physical form)
355
Technical Guide on Internal Audit of Treasury Function in Banks
Annex I
Details of Defaults on Repayment of CP
Whether If so, the Whether
the CP name of the facility
Latest Rating
Initial Rating
enjoyed a providing has been
Amount
of
Name of the issuer standby the facility honoured
issue
assistance/ indicated and
of CP
credit back at Col. (7) payment
stop facility/ made.
guarantee
(1) (2) (3) (4) (5) (6) (7) (8) (9)
356
Annexure – J
Annex II
Definitions
In these guidelines, unless the context otherwise requires:
(a) "bank” or “banking company" means a banking company as defined in
clause (c) of Section 5 of the Banking Regulation Act, 1949 (10 of
1949) or a "corresponding new bank", "State Bank of India" or
"subsidiary bank" as defined in clause (da), clause (nc) and clause
(nd) respectively thereof and includes a "co-operative bank" as
defined in clause (cci) of Section 5 read with Section 56 of that Act.
(b) “scheduled bank” means a bank included in the Second Schedule of
the Reserve Bank of India Act, 1934.
(c) “All-India Financial Institutions (FIs)” mean those financial institutions
which have been permitted specifically by the Reserve Bank of India
to raise resources by way of Term Money, Term Deposits, Certificates
of Deposit, Commercial Paper and Inter-Corporate Deposits, where
applicable, within umbrella limit.
(d) "Primary Dealer" means a non-banking financial company which holds
a valid letter of authorisation as a Primary Dealer issued by the
Reserve Bank, in terms of the "Guidelines for Primary Dealers in
Government Securities Market" dated March 29, 1995, as amended
from time to time.
(e) "corporate” or “company" means a company as defined in Section 45 I
(aa) of the Reserve Bank of India Act, 1934 but does not include a
company which is being wound up under any law for the time being in
force.
(f) "non-banking company" means a company other than banking
company.
(g) “non-banking financial company” means a company as defined in
Section 45 I
(f) of the Reserve Bank of India Act, 1934.
(h) “working capital limit” means the aggregate limits, including those by
way of purchase/discount of bills sanctioned by one or more banks/FIs
for meeting the working capital requirements.
357
Technical Guide on Internal Audit of Treasury Function in Banks
(i) "Tangible net worth" means the paid-up capital plus free reserves
(including balances in the share premium account, capital and
debentures redemption reserves and any other reserve not being
created for repayment of any future liability or for depreciation in
assets or for bad debts or reserve created by revaluation of assets) as
per the latest audited balance sheet of the company, as reduced by
the amount of accumulated balance of loss, balance of deferred
revenue expenditure, as also other intangible assets.
(j) words and expressions used but not defined herein and defined in the
Reserve Bank of India Act, 1934 (2 of 1934) shall have the same
meaning as assigned to them in that Act.
358
Annexure – J
Appendix
List of Circulars
Sr.
Reference No. Date Subject
No
IECD.No.PMD.15/87 (CP)- 89/90 January Issue of Commercial paper
3,1990 (CP)
IECD.No.PMD.19/87 (CP)-89/90 January Issue of Commercial paper
23,1990 (CP)
IECD.No.PMD.28/87 (CP)- 89/90 April 24,1990 Commercial Paper (CP) -
Amendment to Directions.
IECD.No.PMD.1/08.15.01/93-94 July 2,1990 Guidelines for provision of
factoring services
IECD.No.PMD.2/87 (CP)-90/91 July 7,1990 Commercial Paper (CP) -
Renewal of existing issue.
IECD.No.PMD.57/87 (CP)-90/91 May 30,1991 Commercial Paper (CP) -
Amendment to Directions.
IECD.No.16/PMD/87 (CP)-91/92 August 20, Issue of Commercial paper
1991 (CP)
IECD.No.39/PMD/87 (CP)-91/92 December 20, Commercial Paper (CP) -
1991 Amendment to Directions.
IECD.No.49/CC&MIS/87/91-92 February 7, Issue of Commercial paper
1992 (CP) - Submission of
Returns etc.
IECD.No.63/08.15.01/91-92 May 13,1992 Commercial Paper (CP) -
Amendment to Directions.
IECD.No.34/08.15.01/92-93 May 19,1993 Commercial Paper (CP) –
Application of Stamp Duty
IECD.No.13/08.15.01/93-94 October 5, Commercial Paper (CP) -
1993 Amendment to Directions.
IECD.No.17/08.15.01/93-94 October 18, Commercial Paper (CP)-
1993 Amendment to Directions.
IECD.No.25/08.15.01/93-94 December 17, Issue of Commercial Paper
1993 (CP)
IECD.No.19/08.15.01/94-95 October 20, Commercial Paper - Stand
1994 by Arrangement
IECD.No.28/08.15.01/95-96 June 20, Commercial Paper (CP)-
1996
IECD.No.3/08.15.01/96-97 July 25, 1996 Commercial Paper (CP) -
Amendment to Directions.
359
Technical Guide on Internal Audit of Treasury Function in Banks
Sr.
Reference No. Date Subject
No
IECD.No.14/08.15.01/96-97 November 5, Commercial Paper
1996
IECD.No.25/08.15.01/96-97 April 15, 1997 Commercial Paper
IECD.No.14/08.15.01/97-98 October 27, Commercial Paper
1997
IECD.No.43/08.15.01/97-98 May 25, 1998 Commercial Paper
MPD.48/07.01.279/2000-01 July 6, 2000 Guidelines for Issue of
Commercial Paper
IECD. No. 15/08.15.01/2000-01 April 30, 2001 Guidelines for Issue of
Commercial Paper
IECD.No.2/08.15.01/2001-02 July 23, 2001 Guidelines for Issue of
Commercial Paper
IECD.No.11/08.15.01/2002-03 November 12, Guidelines for Issue of
2002 Commercial Paper
IECD. No. 19/08.15.01/2002-03 April 30, 2003 Guidelines for Issue of
Commercial Paper
IECD. No. /08.15.01/2003-04 August 19, Guidelines for Issue of
2003 Commercial Paper –
Defaults in Commercial
Paper market
MPD. NO. 251/07.01.279/2004-05 July 1, 2004 Guidelines for Issue of
Commercial Paper
MPD. NO. 258/07.01.279/2004-05 October 26, Guidelines for Issue of
2004 Commercial Paper
MPD. NO. 261/07.01.279/2004-05 April 13, 2005 Reporting of Commercial
Paper (CP) issuance on NDS
Platform
* The system of satellite dealers has since been discontinued with effect from
June 1, 2002.
360
ANNEXURE – K
RBI/ 2009-10/20
DBOD No. BP. BC.3 / 21.04.141 / 2009-10 July 1, 2009
All Commercial Banks
(excluding Regional Rural Banks)
Dear Sir,
Master Circular – Prudential norms for classification, valuation and
operation of investment portfolio by banks
Please refer to the Master Circular No. DBOD. BP. BC.5 / 21.04.141/ 2007-08
dated July 1, 2008, containing consolidated instructions/guidelines issued to
banks till June 30, 2008, on matters relating to prudential norms for classification,
valuation and operation of investment portfolio by banks. The above Master
Circular has since been suitably updated by incorporating instructions/guidelines
issued between July 1, 2008 and June 30, 2009, and furnished in the Annex.
This updated version has also been placed on the RBI web-site
(http://www.rbi.org.in).
2. An appendix containing a list of circulars referred for the purpose of the
current Master circular is furnished at the end of the Annex.
Yours faithfully,
(B.Mahapatra)
Chief General Manager
Encl: As above
Department of Banking Operations and Development, Central Office, 12th Floor, Central Office
Building, Shahid Bhagat Singh Marg,, Mumbai,400001
Tel No:22661602 Fax No:22705691 Email ID:cgmicdbodco@rbi.org.in
Technical Guide on Internal Audit of Treasury Function in Banks
362
Annexure – K
363
Technical Guide on Internal Audit of Treasury Function in Banks
364
Annexure – K
365
Technical Guide on Internal Audit of Treasury Function in Banks
366
Annexure – K
367
Technical Guide on Internal Audit of Treasury Function in Banks
368
Annexure – K
CSGL Account maintained with the RBI, Mumbai, with the Clearing
Corporation of India Ltd. (CCIL) acting as the central counter party for all
such ready forward transactions.
(f) The custodians should put in place an effective system of internal control
and concurrent audit to ensure that:
i) ready forward transactions are undertaken only against the clear
balance of securities in the gilt account,
ii) all such transactions are promptly reported on the NDS, and
iii) other terms and conditions referred to above have been complied
with.
(g) The RBI regulated entities can undertake ready forward transactions only
in securities held in excess of the prescribed Statutory Liquidity Ratio
(SLR) requirements.
(h) No sale transaction shall be put through, in the first leg of a ready forward
transaction by CSGL constituent entities, without actually holding the
securities in the portfolio.
(i) Securities purchased under the ready forward contracts shall not be sold
during the period of the contract except by entities permitted to undertake
short selling.
(j) Double ready forward deals in any security are strictly prohibited.
(k) The guidelines for uniform accounting for Repo / Reverse Repo
transactions are furnished in paragraph 4.
1.1.2 Transactions through SGL account
The following instructions should be followed by banks for purchase / sale of
securities through SGL A/c, under the Delivery Versus Payment (DvP) System
wherein the transfer of securities takes place simultaneously with the transfer of
funds. It is, therefore, necessary for both the selling bank and the buying bank to
maintain current account with the RBI. As no ‘Overdraft facility’ in the current
account would be extended, adequate balance in current account should be
maintained by banks for effecting any purchase transaction.
i) All transactions in Govt. securities for which SGL facility is available
should be put through SGL A/cs only.
ii) Under no circumstances, a SGL transfer form issued by a bank in favour
369
Technical Guide on Internal Audit of Treasury Function in Banks
370
Annexure – K
371
Technical Guide on Internal Audit of Treasury Function in Banks
372
Annexure – K
373
Technical Guide on Internal Audit of Treasury Function in Banks
for a trade is only to CCIL and not to the entity with whom a deal matches.
Besides, details of all deals on NDS-OM are available to the
counterparties as and when required by way of reports on NDS-OM itself.
In view of the above, the need for counterparty confirmation of deals
matched on NDS-OM does not arise. However, all government securities
transactions, other than those matched on NDS-OM, will continue to be
physically confirmed by the back offices of the counterparties, as hitherto.
(d) Once a deal has been concluded, there should not be any substitution of
the counter party bank by another bank by the broker, through whom the
deal has been entered into; likewise, the security sold/purchased in the
deal should not be substituted by another security.
(e) On the basis of vouchers passed by the back office (which should be
done after verification of actual contract notes received from the broker/
counterparty and confirmation of the deal by the counterparty), the
Accounts Section should independently write the books of account.
(f) In the case of transaction relating to PMS Clients' Accounts (including
brokers), all the relative records should give a clear indication that the
transaction belongs to PMS Clients/ other constituents and does not
belong to bank's own Investment Account and the bank is acting only in
its fiduciary/ agency capacity.
(g) (i) Records of SGL transfer forms issued/ received, should be
maintained.
(ii) Balances as per bank's books should be reconciled at quarterly
intervals with the balances in the books of PDOs. If the number of
transactions so warrant, the reconciliation should be undertaken
more frequently, say on a monthly basis. This reconciliation should
be periodically checked by the internal audit department.
(iii) 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.
(iv) A record of BRs issued/ received should be maintained.
(v) A system for verification of the authenticity of the BRs and SGL
transfer forms received from the other banks and confirmation of
authorised signatories should be put in place.
374
Annexure – K
(h) Banks should put in place a reporting system to report to the top
management, on a weekly basis, the details of transactions in securities,
details of bouncing of SGL transfer forms issued by other banks and BRs
outstanding for more than one month and a review of investment
transactions undertaken during the period.
(i) Banks should not draw cheques on their account with the RBI for third
party transactions, including inter-bank transactions. For such
transactions, bankers' cheques/ pay orders should be issued.
(j) In case of investment in shares, the surveillance and monitoring of
investment should be done by the Audit Committee of the Board, which
shall review in each of its meetings, the total exposure of the bank to
capital market both fund based and non- fund based, in different forms as
stated above and ensure that the guidelines issued by RBI are complied
with and adequate risk management and internal control systems are in
place;
(k) The Audit Committee should keep the Board informed about the overall
exposure to capital market, the compliance with the RBI and Board
guidelines, adequacy of risk management and internal control systems;
(l) In order to avoid any possible conflict of interest, it should be ensured that
the stockbrokers as directors on the Boards of banks or in any other
capacity, do not involve themselves in any manner with the Investment
Committee or in the decisions in regard to making investments in shares,
etc., or advances against shares.
(m) The internal audit department should audit the transactions in securities
on an on going basis, monitor the compliance with the laid down
management policies and prescribed procedures and report the
deficiencies directly to the management of the bank.
(n) The banks' managements should ensure that there are adequate internal
control and audit procedures for ensuring proper compliance of the
instructions in regard to the conduct of the investment portfolio. The banks
should institute a regular system of monitoring compliance with the
prudential and other guidelines issued by the RBI. The banks should get
compliance in key areas certified by their statutory auditors and furnish
such audit certificate to the Regional Office of DBS, RBI under whose
jurisdiction the HO of the bank falls.
375
Technical Guide on Internal Audit of Treasury Function in Banks
376
Annexure – K
377
Technical Guide on Internal Audit of Treasury Function in Banks
378
Annexure – K
379
Technical Guide on Internal Audit of Treasury Function in Banks
(e) The banks should put in place proper risk management systems
for capturing and analysing the risk in respect of these investments
and taking remedial measures in time.
(iv) Some banks / FIs have not exercised due precaution by reference to the
list of defaulters circulated / published by RBI while investing in bonds,
debentures, etc., of companies. Banks may, therefore, exercise due
caution, while taking any investment decision to subscribe to bonds,
debentures, shares etc., and refer to the ‘Defaulters List’ to ensure that
investments are not made in companies / entities who are defaulters to
banks / FIs. Some of the companies may be undergoing adverse financial
position, turning their accounts to sub- standard category due to recession
in their industry segment, like textiles. Despite restructuring facility
provided under RBI guidelines, the banks have been reported to be
reluctant to extend further finance, though considered warranted on merits
of the case. Banks may not refuse proposals for such investments in
companies whose director’s name(s) find place in the ‘Defaulter
Companies List’ circulated by RBI, at periodical intervals and particularly
in respect of those loan accounts, which have been restructured under
extant RBI guidelines, provided the proposal is viable and satisfies all
parameters for such credit extension.
Prudential guidelines on investment in Non-SLR securities
1.2.2 Coverage
These guidelines cover banks’ investments in non-SLR securities issued by
corporates, banks, FIs and State and Central Government sponsored institutions,
SPVs etc, including, capital gains bonds, bonds eligible for priority sector status.
The guidelines will apply to investments both in the primary market as well as the
secondary market.
1.2.3 The guidelines on listing and rating pertaining to non-SLR securities vide
paragraphs 1.2.7 to 1.2.16 are not applicable to banks’ investments in:
(a) Securities directly issued by the Central and State Governments, which
are not reckoned for SLR purposes.
(b) Equity shares
(c) Units of equity oriented mutual fund schemes, viz. those schemes where
any part of the corpus can be invested in equity
380
Annexure – K
381
Technical Guide on Internal Audit of Treasury Function in Banks
382
Annexure – K
1.2.14 With effect from January 1, 2005, only investment in units of such mutual
fund schemes, which have an exposure to unlisted securities of less than
10 per cent of the corpus of the fund, will be treated on par with listed
securities for the purpose of compliance with the prudential limits
prescribed in the above guidelines. While computing the exposure to the
unlisted securities for compliance with the norm of less than 10 percent of
the corpus of the mutual fund scheme, Treasury Bills, Collateralised
Borrowing and Lending Obligations (CBLO), Repo/Reverse Repo and
Bank Fixed Deposits may not be included in the numerator.
1.2.15 For the purpose of the prudential limits prescribed in the guidelines, the
denominator viz., 'non-SLR investments', would include investment under
the following four categories in Schedule 8 to the balance sheet viz.,
'shares', 'bonds & debentures', 'subsidiaries/joint ventures' and 'others'.
1.2.16 Banks whose investment in unlisted non-SLR securities are within the
prudential limit of 10 per cent of its total non-SLR securities as on March
31, of the previous year may make fresh investment in such securities
and up to the prudential limits.
Role of Boards
1.2.17 Banks should ensure that their investment policies duly approved by the
Board of Directors are formulated after taking into account all the relevant
issues specified in these guidelines on investment in non-SLR securities.
Banks should put in place proper risk management systems for capturing
and analysing the risk in respect of non-SLR investment and taking
remedial measures in time. Banks should also put in place appropriate
systems to ensure that investment in privately placed instruments is made
in accordance with the systems and procedures prescribed under
respective bank’s investment policy.
1.2.18 Boards of banks should review the following aspects of non-SLR
investment at least at quarterly intervals:
a) Total business (investment and divestment) during the reporting
period.
b) Compliance with the prudential limits prescribed by the Board for
non-SLR investment.
c) Compliance with the prudential guidelines issued by RBI on non-
SLR securities.
383
Technical Guide on Internal Audit of Treasury Function in Banks
384
Annexure – K
385
Technical Guide on Internal Audit of Treasury Function in Banks
ii) The following conditions are to be strictly observed by the banks operating
PMS or similar scheme with the specific prior approval of RBI:
(a) PMS should be entirely at the customer's risk, without
guaranteeing, either directly or indirectly, a pre-determined return.
(b) Funds should not be accepted for portfolio management for a
period less than one year.
(c) Portfolio funds should not be deployed for lending in call/notice
money; inter- bank term deposits and bills rediscounting markets
and lending to/placement with corporate bodies.
(d) Banks should maintain client wise account/record of funds
accepted for management and investments made there against
and the portfolio clients should be entitled to get a statement of
account.
(e) Bank's own investments and investments belonging to PMS clients
should be kept distinct from each other, and any transactions
between the bank's investment account and client's portfolio
account should be strictly at market rates.
(f) There should be a clear functional separation of trading and back
office functions relating to banks’ own investment accounts and
PMS clients' accounts.
iii) PMS clients' accounts should be subjected by banks to a separate audit
by external auditors as covered in paragraph 1.1.5 (a).
iv) Banks should note that violation of RBI instructions will be viewed
seriously and will invite deterrent action against the banks, which will
include raising of reserve requirements, withdrawal of facility of refinance
from the RBI and denial of access to money markets, apart from
prohibition from undertaking PMS activity.
v) Further, the aforesaid instructions will apply, mutatis mutandis, to the
subsidiaries of banks except where they are contrary to specific
regulations of the RBI or SEBI, governing their operations.
vi) Banks / merchant banking subsidiaries of banks operating PMS or similar
scheme with the specific prior approval of the RBI are also required to
comply with the guidelines contained in the SEBI (Portfolio Managers)
Rules and Regulations, 1993 and those issued from time to time.
386
Annexure – K
387
Technical Guide on Internal Audit of Treasury Function in Banks
388
Annexure – K
389
Technical Guide on Internal Audit of Treasury Function in Banks
390
Annexure – K
However, it will be permitted only under exceptional circumstances like not being
able to sell the security within 90 days due to tight liquidity conditions, or extreme
volatility, or market becoming unidirectional. Such transfer is permitted only with
the approval of the Board of Directors/ ALCO/ Investment Committee.
iv) Transfer of scrips from one category to another, under all circumstances,
should be done at the acquisition cost/ book value/ market value on the date of
transfer, whichever is the least, and the depreciation, if any, on such transfer
should be fully provided for. Banks may apply the values as on the date of
transfer and in case, there are practical difficulties in applying the values as on
the date of transfer, banks have the option of applying the values as on the
previous working day, for arriving at the depreciation requirement on shifting of
securities.
3. Valuation
3.1 Held to Maturity
i) Investments classified under HTM need not be marked to market and will
be carried at acquisition cost, unless it is more than the face value, in
which case the premium should be amortised over the period remaining to
maturity. The banks should reflect the amortised amount in ‘Schedule 13
– Interest Earned : Item II – Income on Investments’, as a deduction.
However, the deduction need not be disclosed separately. The book value
of the security should continue to be reduced to the extent of the amount
amortised during the relevant accounting period.
ii) Banks should recognise any diminution, other than temporary, in the
value of their investments in subsidiaries/ joint ventures, which are
included under HTM and provide therefore. Such diminution should be
determined and provided for each investment individually.
3.2 Available for Sale
The individual scrips in the Available for Sale category will be marked to market
at quarterly or at more frequent intervals. Domestic Securities under this category
shall be valued scrip-wise and depreciation/ appreciation shall be aggregated for
each classification referred to in item 2(i) above and foreign investments under
this category shall be valued scrip-wise and depreciation/ appreciation shall be
aggregated for five classifications (viz. Government securities (including local
authorities), Shares, Debentures & Bonds, Subsidiaries and/or joint ventures
abroad and Other investments (to be specified)). Further, the investment in a
391
Technical Guide on Internal Audit of Treasury Function in Banks
392
Annexure – K
(items as indicated at (a) above) and AFS category may treat the balance
in excess of 5 per cent of securities included under HFT and AFS
categories, in the IFR, as Tier I capital. Banks satisfying the above were
allowed to transfer the amount in excess of the said 5 per cent in the IFR
to Statutory Reserve.
(iv) Banks were advised in October 2005 that, if they have maintained capital
of at least 9 per cent of the risk weighted assets for both credit risk and
market risks for both HFT (items as indicated at (a) above) and AFS
category as on March 31, 2006, they would be permitted to treat the entire
balance in the IFR as Tier I capital. For this purpose, banks may transfer
the balance in the Investment Fluctuation Reserve ‘below the line’ in the
Profit and Loss Appropriation Account to Statutory Reserve, General
Reserve or balance of Profit & Loss Account.
Investment Reserve Account (IRA)
(v) In the event, provisions created on account of depreciation in the ‘AFS’ or
‘HFT’ categories are found to be in excess of the required amount in any
year, the excess should be credited to the Profit & Loss account and an
equivalent amount (net of taxes, if any and net of transfer to Statutory
Reserves as applicable to such excess provision) should be appropriated
to an IRA Account in Schedule 2 – “Reserves & Surplus” under the head
“Revenue and other Reserves”, and would be eligible for inclusion under
Tier-II within the overall ceiling of 1.25 per cent of total Risk Weighted
Assets prescribed for General Provisions/ Loss Reserves.
(vi) Banks may utilise IRA as follows:
The provisions required to be created on account of depreciation in the
AFS and HFT categories should be debited to the P&L Account and an
equivalent amount (net of tax benefit, if any, and net of consequent
reduction in the transfer to Statutory Reserve), may be transferred from
the IRA to the P&L Account. Illustratively, banks may draw down from the
IRA to the extent of provision made during the year towards depreciation
in investment in AFS and HFT categories (net of taxes, if any, and net of
transfer to Statutory Reserves as applicable to such excess provision). In
other words, a bank which pays a tax of 30% and should appropriate 25%
of the net profits to Statutory Reserves, can draw down Rs.52.50 from the
IRA, if the provision made for depreciation in investments included in the
AFS and HFT categories is Rs.100.
393
Technical Guide on Internal Audit of Treasury Function in Banks
(vii) The amounts debited to the P&L Account for provision should be debited
under the head ‘Expenditure - Provisions & Contingencies’. The amount
transferred from the IRA to the P&L Account, should be shown as ‘below
the line’ item in the Profit and Loss Appropriation Account, after
determining the profit for the year. Provision towards any erosion in the
value of an asset is an item of charge on the profit and loss account, and
hence should appear in that account before arriving at the profit for the
accounting period. Adoption of the following would not only be adoption of
a wrong accounting principle but would, also result in a wrong statement
of the profit for the accounting period:
(a) the provision is allowed to be adjusted directly against an item of
Reserve without being shown in the profit and loss account, OR
(b) a bank is allowed to draw down from the IRA before arriving at the
profit for the accounting period (i.e., above the line), OR
(c) a bank is allowed to make provisions for depreciation on
investment as a below the line item, after arriving at the profit for
the period,
Hence none of the above options are permissible.
(viii) In terms of our guidelines on payment of dividend by banks, dividends
should be payable only out of current year's profit. The amount drawn
down from the IRA will, therefore, not be available to a bank for payment
of dividend among the shareholders. However, the balance in the IRA
transferred ‘below the line’ in the Profit and Loss Appropriation Account to
Statutory Reserve, General Reserve or balance of Profit & Loss Account
would be eligible to be reckoned as Tier I capital.
3.5 Market value
The ‘market value’ for the purpose of periodical valuation of investments included
in the AFS and HFT would be the market price of the scrip as available from the
trades/ quotes on the stock exchanges, SGL account transactions, price list of
RBI, prices declared by Primary Dealers Association of India (PDAI) jointly with
the Fixed Income Money Market and Derivatives Association of India (FIMMDA)
periodically. In respect of unquoted securities, the procedure as detailed below
should be adopted.
394
Annexure – K
395
Technical Guide on Internal Audit of Treasury Function in Banks
396
Annexure – K
397
Technical Guide on Internal Audit of Treasury Function in Banks
398
Annexure – K
399
Technical Guide on Internal Audit of Treasury Function in Banks
400
Annexure – K
(ii) The above would apply mutatis-mutandis to preference shares where the
fixed dividend is not paid.
(iii) In the case of equity shares, in the event the investment in the shares of
any company is valued at Re.1 per company on account of the non
availability of the latest balance sheet in accordance with the instructions
contained in paragraph 28 of the Annex to the circular DBOD.BP.BC.32/
21.04.048/ 2000-01 dated October 16, 2000, those equity shares would
also be reckoned as NPI.
(iv) If any credit facility availed by the issuer is NPA in the books of the bank,
investment in any of the securities, including preference shares issued by
the same issuer would also be treated as NPI and vice versa. However, if
only the preference shares are classified as NPI, the investment in any of
the other performing securities issued by the same issuer may not be
classified as NPI and any performing credit facilities granted to that
borrower need not be treated as NPA.
(v) The investments in debentures / bonds, which are deemed to be in the
nature of advance would also be subjected to NPI norms as applicable to
investments.
(vi) In case of conversion of principal and / or interest into equity, debentures,
bonds, etc., such instruments should be treated as NPA abinitio in the
same asset classification category as the loan if the loan's classification is
substandard or doubtful on implementation of the restructuring package
and provision should be made as per the norms.
3.10.3 State Government guaranteed investments
For the year ending March 31, 2005, investment in State Government
guaranteed securities would attract prudential norms for identification of NPI and
provisioning, if interest and/or principal or any other amount due to the bank
remains overdue for more than 180 days. With effect from the year ending March
31, 2006, investment in State Government guaranteed securities, including those
in the nature of ‘deemed advance’, will attract prudential norms for identification
of non- performing investments and provisioning, when interest/ instalment of
principal (including maturity proceeds) or any other amount due to the bank
remains unpaid for more than 90 days.
4. Uniform accounting for Repo / Reverse Repo transactions.
4.1 In order to ensure uniform accounting treatment for accounting repo
401
Technical Guide on Internal Audit of Treasury Function in Banks
402
Annexure – K
403
Technical Guide on Internal Audit of Treasury Function in Banks
Sheet, if the sale price of the security offered under repo is higher than
the book value; and
(d) similarly the accrued interest paid / received in the repo / reverse repo
transactions outstanding on balance sheet dates should be shown as
"Other Assets" or "Other Liabilities" in the balance sheet.
4.5.4 Book value on re-purchase
The seller shall debit the repo account with the original book value (as existing in
the books on the date of the first leg) on buying back the securities in the second
leg.
4.5.5 Disclosure
The disclosures to be made by banks in the “Notes on Accounts’ to the Balance
Sheet is given in Annexure VII.
4.5.6 Accounting methodology
The accounting methodology to be followed is given below and illustrations are
furnished in Annexure VIII. While market participants, having different
accounting systems, may use accounting heads different from those used in the
illustration, there should not be any deviation from the accounting principles
enunciated above. Further, to obviate disputes arising out of repo transactions,
the participants may consider entering into bilateral Master Repo Agreement as
per the documentation finalized by FIMMDA.
4.5.7 Recommended Accounting Methodology for Uniform Accounting of Repo /
Reverse Repo transactions
a) The following accounts may be opened, viz. (i) Repo Account, (ii) Repo
Price Adjustment Account, (iii) Repo Interest Adjustment Account, (iv)
Repo Interest Expenditure Account, (v) Repo Interest Income Account,
(vi) Reverse Repo Account, (vii) Reverse Repo Price Adjustment Account,
and (viii) Reverse Repo Interest Adjustment Account.
b) The securities sold/ purchased under repo should be accounted for as an
outright sale / purchase.
c) The securities should enter and exit the books at the same book value.
For operational ease, the weighted average cost method whereby the
investment is carried in the books at their weighted average cost, may be
adopted.
404
Annexure – K
405
Technical Guide on Internal Audit of Treasury Function in Banks
l) The broken period interest accrued in the first and second legs will be
booked in Repo Interest Adjustment Account or Reverse Repo Interest
Adjustment Account, as the case may be. Consequently the difference
between the amounts booked in this account in the first and second legs
should be transferred to the Repo Interest Expenditure Account or Repo
Interest Income Account, as the case may be.
m) At the end of the accounting period the, for outstanding repos, the
balances in the Repo / Reverse Repo Price Adjustment Account and
Repo / Reverse repo Interest Adjustment account should be reflected
either under item VI - 'Others' under Schedule 11 - 'Other Assets' or under
item IV 'Others (including Provisions)' under Schedule 5 - 'Other Liabilities
and Provisions' in the Balance Sheet, as the case may be.
n) Since the debit balances in the Repo Price Adjustment Account at the end
of the accounting period represent losses not provided for in respect of
securities offered in outstanding repo transactions, it will be necessary to
make a provision therefore in the Profit & Loss Account.
o) To reflect the accrual of interest in respect of the outstanding repo/
reverse repo transactions at the end of the accounting period, appropriate
entries should be passed in the Profit and Loss account to reflect Repo
Interest Income / Expenditure in the books of the buyer / seller
respectively and the same should be debited / credited as an income /
expenditure accrued but not due. Such entries passed should be reversed
on the first working day of the next accounting period.
p) In respect of repos in interest bearing (coupon) instruments, the buyer
would accrue interest during the period of repo. In respect of repos in
discount instruments like Treasury Bills, the seller would accrue discount
during the period of repo based on the original yield at the time of
acquisition.
q) At the end of the accounting period the debit balances (excluding
balances for repos which are still outstanding) in the Repo Interest
Adjustment Account and Reverse Repo Interest Adjustment Account
should be transferred to the Repo Interest Expenditure Account and the
credit balances (excluding balances for repos which are still outstanding)
in the Repo Interest Adjustment Account and Reverse Repo Interest
Adjustment Account should be transferred to the Repo Interest Income
Account.
406
Annexure – K
407
Technical Guide on Internal Audit of Treasury Function in Banks
held in physical form. In order to extend the demat form of holding to other
instruments like bonds, debentures and equities, it was decided that, with effect
from October 31, 2001, banks, FIs, PDs and SDs would be permitted to make
fresh investments and hold bonds and debentures, privately placed or otherwise,
only in dematerialised form. Outstanding investments in scrip forms were
required to be converted into dematerialised form by June 30, 2002. As regards
equity instruments, banks were required to convert all their equity holding in scrip
form into dematerialised form by December 31, 2004.
408
Annexure – K
Annexure I-A
Short sale in Government Securities
Banks may undertake short sale of Central Government dated securities, subject
to the short position being covered within a maximum period of five trading days,
including the day of trade. In other words, the short sale position initiated today
(trade date, T+0) will have to be covered on or before close of T+4 day. Such
short positions shall be covered only by outright purchase of an equivalent
amount of the same security. The short positions may be reflected in ‘Securities
Short Sold (SSS) A/c’, specifically created for this purpose. For the purposes of
this circular short sale and notional short sale are defined as under:
‘Short Sale’ is defined as sale of securities one does not own. A bank can also
undertake 'notional' short sale where it can sell a security short from HFT even if
the security is held under its AFS/HTM book. The resultant 'notional' short
position would be subject to the same regulatory requirements as in the case of a
short sale. For the purpose of these guidelines, short sale would include 'notional'
short sale as well. The short sale by banks and the cover transaction shall not
affect the holdings and valuation of the same security in AFS/HTM categories in
any way.
Short sale transactions can be undertaken by banks, subject to the following
conditions:
Minimum requirements:
In respect of short sales, banks shall ensure adherence to the following
conditions:
a) The sale leg of the transaction should be executed only on the Negotiated
Dealing System – Order Matching (NDS-OM) platform. The cover leg of
the short sale transaction can, however, be executed either on or outside
the NDS-OM platform.
b) The sale leg as well as the cover leg of the transaction should be
accounted in the HFT category.
c) Under no circumstances, should participants fail to deliver, on settlement
date, the securities sold short. Failures to deliver securities short sold
shall be treated as an instance of ‘SGL bouncing’ and the concerned
banks will be liable to disciplinary action prescribed in respect of SGL
409
Technical Guide on Internal Audit of Treasury Function in Banks
410
Annexure – K
noted that the permission to use securities acquired under reverse repo as above
applies only to securities acquired under market repo and not to securities
acquired under RBI’s Liquidity Adjustment Facility.
Policy and internal control mechanisms:
Before actually undertaking transactions in terms of this circular, banks
shall put in place a written policy on short sale, which should be approved by
their respective Boards of Directors. The policy should lay down the internal
guidelines which should include, inter alia, risk limits on short position, an
aggregate nominal short sale limit (in terms of Face Value) across all eligible
securities, stop loss limits, the internal control systems to ensure adherence to
regulatory and internal guidelines, reporting of short selling activity to the Board
and the RBI, procedure to deal with violations, etc. Banks shall also put in place
a system to detect violations if any, immediately, certainly within the same trading
day.
In addition to the internal control mechanisms, the concurrent auditors should
specifically verify compliance with these instructions, as well as with internal
guidelines and report violations, if any, within a reasonably short time, to the
appropriate internal authority. As part of their monthly reporting, concurrent
auditors may verify whether the independent back/mid office has taken
cognizance of lapses, if any, and whether they have reported the same within the
required time frame to the appropriate internal authority. Any violation of
regulatory guidelines noticed in this regard should immediately be reported to the
respective Public Debt Office (PDO) where the SGL account is maintained and
Internal Debt Management Department, Reserve Bank of India, Mumbai.
411
Technical Guide on Internal Audit of Treasury Function in Banks
Annexure I-B
When Issued Market - Guidelines
Definition
‘When, as and if issued’ (commonly known as ‘when-issued’ (WI)) security refers
to a security that has been authorized for issuance but not yet actually issued.
‘WI’ trading takes place between the time a new issue is announced and the time
it is actually issued. All 'when issued' transactions are on an 'if' basis, to be
settled if and when the actual security is issued.
Mechanics of Operation
Transactions in a security on a ‘When Issued’ basis shall be undertaken in the
following manner:
a) ‘WI’ transactions can be undertaken in the case of securities that are
being reissued as well as newly issued, on a selective basis.
b) ‘WI’ transactions would commence on the issue notification date and it
would cease on the working day immediately preceding the date of issue.
c) All ‘WI’ transactions for all trade dates will be contracted for settlement on
the date of issue.
d) At the time of settlement on the date of issue, trades in the ‘WI’ security
will be netted off with trades in the existing security, in the case of
reissued securities.
e) The originating transactions (sale or purchase of 'WI' securities) shall be
undertaken only on NDS-OM. Any reversal of a When Issued transaction
can, however, be undertaken on or outside the NDS-OM platform.
f) Only PDs can take a short position in the ‘WI’ market. In other words, non-
PD entities can sell the ‘WI’ security to any counterparty only if they have
a preceding purchase contract for equivalent or higher amount.
g) Open Positions in the ‘WI’ market are subject to the following limits:
412
Annexure – K
h) In the event of cancellation of the auction for whatever reason, all ‘WI’
trades will be deemed null and void ab initio on grounds of force majeure.
Internal Control
All banks participating in the ‘WI’ market are required to have in place a written
policy on ‘WI’ trading which should be approved by the Board of Directors. The
policy should lay down the internal guidelines which should include, inter alia, risk
limits on ‘WI’ position (including, in the case of reissued securities, overall
position in the security, i.e., ‘WI’ plus the existing security), an aggregate nominal
limit (in terms of Face Value) for ‘WI’ and in the case of reissued securities, ‘WI’
plus the existing security, the internal control arrangements to ensure adherence
to regulatory and internal guidelines, reporting of ‘WI’ activity to the top
management, procedure to deal with violations, etc. A system should be in place
to detect violations immediately, certainly within the trading day.
The concurrent auditors should specifically verify compliance with these
instructions and report violations on the date of trade itself, within a reasonably
short time, to the appropriate internal authority. As part of their monthly reporting,
concurrent auditors may verify whether the independent back/mid office has
taken cognizance of all such lapses and reported the same within the required
time frame. Any violation of regulatory guidelines noticed in this regard should
immediately be reported to the Public Debt Office (PDO), Mumbai and IDMD,
Reserve Bank of India.
413
Technical Guide on Internal Audit of Treasury Function in Banks
Annexure I-C
Para 1.1 (i) (b)
Investment portfolio of banks – Transactions in securities –
Conditions subject to which securities allotted in the auctions for
primary issues can be sold
(i) The contract for sale can be entered into only once by the allottee
bank on the basis of an authenticated allotment advice issued by
Reserve Bank of India. The buyer from an allottee in a primary auction
is also permitted to re-sell the security subject to compliance with the
terms and conditions stipulated in our circular No.IDMD.PDRS.05/
10.02.01/2003-04 dated March 29, 2004. Any sale of securities should
be only on a T + 0 or T + 1 settlement basis.
(ii) The contract for sale of allotted securities can be entered into by
banks with entities maintaining SGL Account with RBI as well as with
and between CSGL account holders for delivery and settlement on the
next working day through the Delivery versus Payment (DvP) system.
(iii) The face value of securities sold should not exceed the face value of
securities indicated in the allotment advice.
(iv) The sale deal should be entered into directly without the involvement
of broker/s.
(v) Separate record of such sale deals should be maintained containing
details such as number and date of allotment advice, description and
the face value of securities allotted, the purchase consideration, the
number, date of delivery and face value of securities sold, sale
consideration, the date and details of actual delivery i.e. SGL Form
No., etc. This record should be made available to RBI for verification.
Banks should immediately report any cases of failure to maintain such
records.
(vi) Such type of sale transactions of Government securities allotted in the
auctions for primary issues on the same day and based on
authenticated allotment advice should be subjected to concurrent audit
and the relative audit report should be placed before the Executive
414
Annexure – K
415
Technical Guide on Internal Audit of Treasury Function in Banks
Annexure – II
Para 1.1.6 (i) (g)
Investment portfolio of banks - Transactions in securities -
Aggregate contract limit for individual brokers
Sr.
Issue Raised Response
No.
1. The year should be calendar Since banks close their accounts at the
year or financial year? end of March, it may be more
convenient to follow the financial year.
However, the banks may follow
calendar year or any other period of 12
months provided, it is consistently,
followed in future.
2. Whether the limit is to be The limit has to be observed with
observed with reference to reference to the year under review.
total transactions of the While operating the limit, the bank
previous year as the total should keep in view the expected
transactions of the current turnover of the current year which may
year should be known only at be based on turnover of the previous
the and of the year? year and anticipated rise or fall in the
volume of business in the current year.
3. Whether to arrive at the total Not necessary. However, if there are
transactions of the year, any direct deals with the brokers as
transactions entered into purchasers or sellers the same would
directly with counter-parties have to be included in the total
i.e. where no brokers are transactions to arrive at the limit of
involved would also be taken transactions to be done through an
into account individual broker.
4. Whether in case of ready Yes. This is however only theoretical as
forward deals both the legs of R/F transactions in Govt. security now
the deals i.e. purchase as prohibited except in Treasury Bills and
well as sale will be included the 3 year dated securities issued by
to arrive at the volume of total conversion of Treasury Bills recently
transactions?
416
Annexure – K
Sr.
Issue Raised Response
No.
5. Whether central loan /state No, as brokers are not involved as
loan /treasury bills etc. intermediaries.
purchased subscriptions/
auction will be, included in
the volume of total
transactions?
6. It is possible that even though If the offer received is more
bank considers that a advantageous the limit for the broker
particular broker has touched may be exceeded the reasons therefor
the prescribed limit of 5% he recorded and approval of the competent
may come with an offer authority / Board obtained post facto.
during the remaining period of
the year which the bank may
find it to its advantage as
compared to offers
received from the other
brokers who have not yet
done business upto the
prescribed limit.
7. Whether the transactions Yes. If they are conducted through the
conducted on behalf of the brokers.
clients would also be included
in the total transactions of the
year?
8. For a bank which rarely deals There may be no need to split an order.
through brokers and If any deal causes the particular
consequently the volume of broker's share to exceed 5% limit, our
business is small maintaining circular provides the necessary
the broker-wise limit of 5% flexibility in as much as Board's post
may mean splitting the orders facto approval can be obtained.
in small values amongst
different brokers and there
may also arise price
differential.
417
Technical Guide on Internal Audit of Treasury Function in Banks
Sr.
Issue Raised Response
No.
9. During the course of the year The bank may get post facto approval
it may not be possible to from the Board after explaining to it the
reasonably predict what will circumstances in which the limit was
be the total quantum of exceeded.
transactions through brokers
as a result of which there
could be deviation in
complying with the norm of
5% .
10. Some of the small private As already observed the limit of 5% can
sector banks have mentioned be exceeded subject to reporting the
that where the volume of transactions to the competent authority
business particularly the post facto. Hence, no change in our
transaction done through instructions is considered necessary.
brokers is small the
observance of 5% limit may
be difficult. A suggestion has
therefore been made that the
limit may be required to be
observed if the business done
through a broker exceeds a
cut-off point of say Rs.10
crores
418
Annexure – K
Annexure III
Para 1.2(ii)
Recommendations of the Group on Non-SLR Investments of Banks
Pro-forma of minimum disclosure requirements in respect of
private placement issues - Model Offer Document
All issuers must issue an offer document with terms of issue, authorised by
Board Resolution not older than 6 months from the date of issue. The offer
document should specifically mention the Board Resolution authorising the issue
and designations of the officials who are authorized to issue the offer document.
The offer document may be printed or typed "For Private Circulation Only". The
‘Offer Document’ should be signed by the authorised signatory. The offer
document should contain the following minimum information:
I. General Information
1. Name and address of registered office of the company
2. Full names (expanded initials), addresses of Directors and the
names of companies where they are Directors.
3. Listing of the issue (If listed, name of the Exchange)
4. Date of opening of the issue
Date of closing of the issue
Date of earliest closing of the issue.
5. Name and addresses of auditors and Lead Managers /
arrangers
6. Name address of the trustee - consent letter to be produced (in
case of debenture issue)
7. Rating from any Rating Agency and / or copy of the rationale of
latest rating.
II. Particulars of the issue
(a) Objects
(b) Project cost and means of financing (including contribution of
promoters) in case of new projects.
419
Technical Guide on Internal Audit of Treasury Function in Banks
III. The model offer document should also contain the following
information:
(1) Interest rate payable on application money till the date of
allotment.
(2) Security: If it is a secured issue, the issue is to be secured, the
offer documents should mention description of security, type
of security, type of charge, Trustees, private charge-holders, if
any, and likely date of creation of security, minimum security
cover, revaluation, if any.
(3) If the security is collateralised by a guarantee, a copy of the
guarantee or principal terms of the guarantee are to be
included in the offer document.
(4) Interim Accounts, if any.
(5) Summary of last audited Balance Sheet and Profit & Loss
Account with qualifications by Auditors, if any.
(6) Last two published Balance Sheet may be enclosed.
(7) Any conditions relating to tax exemption, capital adequacy etc.
are to be brought out fully in the documents.
(8) The following details in case of companies undertaking major
expansion or new projects :- (copy of project appraisal may be
made available on request)
(a) Cost of the project, with sources and uses of funds
(b) Date of commencement with projected cash flows
(c) Date of financial closure (details of commitments by
other institutions to be provided)
(d) Profile of the project (technology, market etc)
(e) Risk factors
(9) If the instrument is of tenor of 5 years or more, projected cash
flows.
IV. Banks may agree to insist upon the following conditionalities for
issues under private placements
All the issuers in particular private sector corporates, should be willing to
execute a subscription agreement in case of all secured debt issues, pending
420
Annexure – K
421
Technical Guide on Internal Audit of Treasury Function in Banks
----------------------------------------------
422
Annexure – K
Annexure - IV
Para 1.2.4
Guidelines on Investments by Banks in Non-SLR Investment
Portfolio by Banks - Definitions
1. With a view to imparting clarity and to ensure that there is no
divergence in the implementation of the guidelines, some of the terms
used in the guidelines on non-SLR investments are defined below.
2. A security will be treated as rated if it is subjected to a detailed rating
exercise by an external rating agency in India, which is registered with
SEBI and is carrying a current or valid rating. The rating relied upon
will be deemed to be current or valid if
(i) The credit rating letter relied upon is not more than one month
old on the date of opening of the issue, and
(ii) The rating rationale from the rating agency is not more than
one year old on the date of opening of the issue, and
(iii) The rating letter and the rating rationale is a part of the offer
document.
(iv) In the case of secondary market acquisition, the credit rating of
the issue should be in force and confirmed from the monthly
bulletin published by the respective rating agency. Securities,
which do not have a current or valid rating by an external rating
agency, would be deemed as unrated securities.
3. The investment grade ratings awarded by each of the external rating
agencies operating in India would be identified by the IBA / FIMMDA.
These would also be reviewed by IBA / FIMMDA at least once a year.
4. A 'listed' security is a security which is listed in a stock exchange. If
not so, it is an 'unlisted' security.
----------------------------------------------
423
Technical Guide on Internal Audit of Treasury Function in Banks
Annexure - V
Para 1.2.20
Prudential Guidelines on Management of the Non-SLR Investment
Portfolio by Banks - Disclosures Requirements
Banks should make the following disclosures in the 'Notes on Accounts' of
the balance sheet in respect of their non-SLR investment portfolio, with effect
from the financial year ending 31 March 2004.
(i) Issuer composition of Non SLR investments
(Rs. in crore)
Sl. Issuer Amount Extent of Extent of Extent of Extent of
No. private 'below 'unrated' 'unlisted'
placement investment securities securities
grade'
securities
1 2 3 4 5 6 7
1. PSUs
2. FIs
3. Banks
4. Private
Corporates
5. Subsidiaries/
Joint ventures
6. Others
7. Provision held
towards XXX XXX XXX XXX
depreciation
Total *
Note: 1. * Total under column 3 should tally with the total of investments
included under the following categories in Schedule 8 to the balance
sheet:
(a) Shares
424
Annexure – K
Amount
Particulars
(Rs. Crore)
Opening balance
Additions during the year since 1st April
Reductions during the above period
Closing balance
Total provisions held
----------------------------------------------
425
Technical Guide on Internal Audit of Treasury Function in Banks
Annexure VI
Para 1.3.1
RETURN / STATEMENT NO. 9
Proforma Statement showing the position of Reconciliation of Investment
Account as on 31st March
Name of the bank/ Institution: ______________________________________
SGL Balance
Outstandin g
deliveries
General
BRs held
As per
Particulars of As per
Ledger bank’s /
securities PDO
Balance institution’s
Books
books
1 2 3 4 5 6 7 8
Central Govt
State Government
Other approved
securities
Public Sector Bonds
Units of UTI (1964)
Others (Shares &
Debenture etc)
TOTAL
426
Annexure – K
427
Technical Guide on Internal Audit of Treasury Function in Banks
g) General
Face value of securities indicated against each item in column two should be
accounted for under any one of the columns from four to seven. Similarly,
amount of outstanding deliveries (BRs issued) which has been indicated in
column eight will have to be accounted for under one of the columns four to
seven. Thus the total of columns two and eight should tally with total of
columns four to seven.
428
Annexure – K
Annexure - VII
Para 4.5.5
Disclosures
The following disclosures should be made by banks in the ‘Notes on
Accounts' to the Balance Sheet.
(Rs. in crore)
Minimum Maximum Daily Average As on
outstanding outstanding outstanding March
during the during the during the
31
year year year
Securities sold under repos
Securities purchased under
reverse repos
429
Technical Guide on Internal Audit of Treasury Function in Banks
Annexure - VIII
Para 4.5.6
Illustrative examples for uniform accounting of Repo /
Reverse repo transactions
A. Repo / Reverse Repo of Coupon bearing security
1. Details of Repo in a coupon bearing security:
430
Annexure – K
Debit Credit
Cash Repo Account 118.1435 120.0000
(Book value)
Repo Price Adjustment account 7.0000 (Difference
between BV & repo
price)
Repo Interest Adjustment account 5.1435
Debit Credit
Repo Account 120.0000 7.02 (the difference
Repo Price Adjustment account between the BV and
2nd leg price)
Repo Interest Adjustment account 5.2388 118.2188
Cash account
The balances in respect of the Repo Price Adjustment Account and Repo
Interest Adjustment Account at the end of the second leg of repo transaction
are transferred to Repo Interest Expenditure Account. In order to analyse the
balances in these accounts, the ledger entries are shown below:
Debit Credit
Difference in price for the 1st 7.00 Difference in price for the 7.02
leg 2nd leg
Balance carried forward to 0.02
Repo Interest Expenditure
account
Total 7.02 Total 7.02
431
Technical Guide on Internal Audit of Treasury Function in Banks
Debit Credit
Broken period interest for 5.2388 Broken period interest for 5.1435
the 2nd leg the 1st leg
Balance carried forward to 0.0953
Repo Interest Expenditure
account
Total 5.2388 Total 5.2388
Debit Credit
Balance from Repo 0.0953 Balance from Repo Price 0.0200
Interest Adjustment Adjustment account
account
Balance carried forward to 0.0753
P & L a/c.
Total 0.0953 Total 0.0953
Debit Credit
Reverse Repo Account 113.0000
Reverse Repo Interest Adjustment account 5.1435
Cash account 118.1435
432
Annexure – K
Debit Credit
Cash account 118.2188
Reverse Repo Price Adjustment account 0.0200
(Difference between the 1st and 2nd leg
prices)
Reverse Repo account 113.0000
Reverse Repo Interest Adjustment account 5.2388
Debit Credit
Difference in price of 1st & 0.0200 Balance to Repo Interest 0.0200
2nd leg Income a/c.
Total 0.0200 Total 0.0200
Debit Credit
Broken period interest for 5.1435 Broken period interest for 5.2388
the 1st leg the 2nd leg
Balance carried forward to 0.0953
Repo Interest Income
Account
Total 5.2388 Total 5.2388
433
Technical Guide on Internal Audit of Treasury Function in Banks
434
Annexure – K
* For the sake of simplicity the interest accrual has been considered for 2
days.
(d) Entries in Buyer's Books on January 21, 2003
435
Technical Guide on Internal Audit of Treasury Function in Banks
Debit Credit
Cash Repo Account 96.0000 95.0000 (Book value)
Repo Price adjustment account 1.0000 (Difference
between BV & repo
price )
436
Annexure – K
Debit Credit
Difference in price for 1.0612 Difference in price for 1.0000
the 2nd leg the 1st leg
Balance carried forward 0.0612
to Repo Interest
Expenditure account
Total 1.0612 Total 1.0612
Debit Credit
Balance from Repo 0.0612 Balance carried 0.0612
Price Adjustment forward to P & L a/c.
account
Total 0.0612 Total 0.0612
The Seller will continue to accrue the discount at the original discount
rate during the period of the repo.
437
Technical Guide on Internal Audit of Treasury Function in Banks
Debit Credit
Reverse Repo Account 96.0000
Cash account 96.0000
Debit Credit
Cash account 96.0612
Repo Interest Income account 0.0612
(Difference between the 1st and 2nd
leg prices)
Reverse Repo account 96.0000
The Buyer will not accrue for the discount during the period of the repo.
4. Additional accounting entries to be passed on a Repo /
Reverse Repo transaction on a Treasury Bill, when the
accounting period is ending on an intervening day
438
Annexure – K
439
Technical Guide on Internal Audit of Treasury Function in Banks
Appendix
List of Circulars consolidated by the Master Circular
Para no.
Relevant
of the
No. Circular No. Date para no. of Subject
master
the circular
circular
1. DBOD.No.FSC.BC.69/C Jan 18, 1,2,4 Portfolio Management 1.3. 3
.469- 90/91 1991 on behalf of clients
(xvi)- 1.2.3,
(xvii), 1.2.5,
3(II), 1.2.6,
3(III), 1.2.7
3(V)- (i)-
(ii)- (iii),
(3) & (4)
4. DBOD.No.FSC.BC.11/2 July 30, 3,4,5,6 Portfolio Management 1.3.3
4.01.009/ 92-93 1992 on behalf of clients
440
Annexure – K
Para no.
Relevant
of the
No. Circular No. Date para no. of Subject
master
the circular
circular
9 DBOD.No.FMC.BC.1/27 Jan 10, 1 Investment portfolio of 1.2.2
.02.001/ 93-94 1994 banks- Transaction in
securities- Bouncing
of SGL transfer forms-
Penalties to be
imposed.
10 DBOD.No.FMC.73/27.0 June 7, 1,2 Acceptance of 1.3.3
7.001/ 94-95 1994 deposits under
Portfolio Management
Scheme
11. DBOD.No.FSC.BC.130/ Nov 15, 1 Investment portfolio of 1.2.3
24.76.002/ 94-95 1994 banks- Transaction in
securities-Bank
Receipts (BRs)
12. DBOD.No.FSC.BC.129/ Nov 16, 2&3 Investment portfolio of 1.2.6
24.76.002/ 94-95 1994 banks- Transaction in
securities-Role of
brokers
13. DBOD.No.FSC.BC.142/ Dec 9, 1& 2 Do 1.2.6
24.76.002/ 94-95 1994
14. DBOD.No.FSC.BC.70/2 June 8, 2 Retailing of 1.2.4
4.76.002/ 95-96 1996 Government
Securities
15. DBOD.No.FSC.BC.71/2 June 11, 1 Investment portfolio of 1.2.2
4.76.001/ 96 1996 banks- Transaction in
securities
16. DBOD.No.BC.153/24.76 Nov 29, 1 Do 1.2.6
.002/96 1996
17. DBOD.BP.BC.9/21.04.0 29 Jan 3 Prudential norms - 5.1 (iii) &
48/98 1997 capital adequacy, (iv)
income recognition,
asset classification
and provisioning.
18. DBOD.BP.BC.32/21.04. April 12, 1&2 Do 5.1 (i)
048/97 1997 &(ii)
441
Technical Guide on Internal Audit of Treasury Function in Banks
Para no.
Relevant
of the
No. Circular No. Date para no. of Subject
master
the circular
circular
brokers
21. DBOD.BP.BC.75/21.04. 4 Aug All Acquisition of 5.2
048/98 1998 Government and other
approved securities -
Broken Period
Interest, - Accounting
Procedure
22. DBS.CO.FMC.BC.1/22. July 7, 1 Investment portfolio of 1.3.1(i)
53.014/98-99 1999 banks – Transactions
in securities
23. DBS.CO.FMC.BC.18/22 Oct 28, 2, 3, 4 & Do 1.2.2
.53.014/ 99-2000 1999 5
24. DBOD.No.FSC.BC.26/2 Oct 6, 2 Sale of Government 1.2(i)(b)
4.76.002/ 2000 2000 securities allotted in
the auctions for
Primary issues
25. DBOD.BP.BC.32/21.04. Oct 16, All Guidelines on 2&3
048/ 2000-01 2000 classification and
valuation of
investments.
26 DBOD.FSC.BC.No.39/2 Oct 25, 1 Investment portfolio of 1.2.6
4.76.002/ 2000 2000 banks- Transaction in
securities-Role of
brokers
27. Dir.BC.107/13.03.00/20 April 19, 6 Monetary and Credit 5.3
00-01 2001 Policy for the year
2000-
2002 - Interest
Rate Policy
28. DBOD.BP.BC.119/21.04 May 11, Annex - 5 Bank financing of 1.2, 1.2.5
.137/ 2000-2001 2001 &12 equities and
investments in shares
- Revised guidelines 1.3, 1.3.1
29. DBOD.BP.BC.127/21.04 June 7, All Non- SLR Investments 1.2.8
.048/ 2000- 01 2001 of Banks Annexure
III
30. DBOD.BP.BC.61/21.04. Jan 25, All Guidelines for 1.2.8 (iv)
048/ 2001-02 2002 investments by
banks/Fis and
Guidelines for
financing of
442
Annexure – K
Para no.
Relevant
of the
No. Circular No. Date para no. of Subject
master
the circular
circular
restructured accounts
by banks/FIs
31. DBOD.No.FSC.BC.113/ June 7 All On Investment 1.3.4
24.76.002/ 2001- 2002 Portfolio of Banks
02 Transaction in Govt.
Securities
32. DBS.CO.FMC.BC.7/22. Nov 7, Para 2 Operation of 1.2.7(c)
53.014/ 2002-03 2002 investment
portfolio by banks-
submission of
concurrent audit
reports by banks
33. DBOD.No.FSC.BC.90/2 March 31 All Ready Forward 1.2.1(i),
4.76.002/ 2002-03 2003 Contracts (ii) and
(iii)
34. IDMC.3810/11.08.10/20 March 24 All Guidelines for uniform 4, Anne-
02-03 2003 accounting for Repo / xure VII &
Reverse Anne-
Repo transactions xure VIII
1.2.1 (c)
443
Technical Guide on Internal Audit of Treasury Function in Banks
Para no.
Relevant
of the
No. Circular No. Date para no. of Subject
master
the circular
circular
41. IDMD.PDRS/4783/10.02 May 11, 3 Government securities 1.2(i) (c)
.01/ 2004-05 2005 transactions - T+1
settlement
42. DBOD.FSC.BC.28/24.7 Aug 12, 2 Transactions in 1.2(i)(a)
6.002/ 2004-05 2004 Government securities
444
Annexure – K
Para no.
Relevant
of the
No. Circular No. Date para no. of Subject
master
the circular
circular
with them
53 IDMD.No. Jan 31, All Secondary Market 1.2.(i)a
/11.01.01(B)/2006-07 2007 transactions in
Government
Securities- Short
selling
54 Mailbox Clarification July 11, All HTM Securities 3.1.(i)
2007
55 DBOD.No.BP.BC.56/21. December All Limits on investment 1.2.7
04.141/2007-08 6, 2007 in unrated Non-SLR
securities-
infrastructure
bonds
56. DBOD.No.BP.BC.86/21. May 22, All Valuation of securities 3.7.1
04.141/2007-08 2008
57. Mailbox Clarification February All Non-SLR Securities 1.2.12
6,2009
58. Mailbox Clarification February All Unlisted Non-SLR 1.2.13
5,2009 Securities
445