Treasury and Fund Management in Banks

Presentation by Eknath Birari

What is Treasury?
The management of banks liquidity. To ensure that the right amount of cash resources are available in the right place in the right currency and at the right time. Maximize the return on surplus funds & Minimize the financial costs of the business, Control interest rate risk and currency exposure to an acceptable level Efficient management of the financial risk and liquidity of the business Planning, organizing and controlling of cash and borrowings so as to optimize interest and currency flows, and minimize the cost of funds. As such treasury refers to the management of funds and revenue on a day to day basis. The treasury acts as the custodian of the cash and others assets. The art of the managing funds within the acceptable level of the risk and the consolidated management of funds of the bank optimally and profitably is called the treasury management.

Integrated Treasury
Integrated Treasury refers to integration of money market, securities market and foreign exchange operations. -Meeting reserve requirements -Efficient merchant services -Global cash management -Optimizing profit by exploiting market opportunities in forex market, money market and securities market -Risk management -Assisting bank management in ALM

MAIN OBJECTIVES OF TREASURY

Ensure Liquidity at all times Operate in Cost-effective manner Provide stable earnings Protect from possible adverse movements in interest rate and foreign exchange Take advantage of market movements to reduce interest cost and to avail earning opportunity

Main Focus of Treasury

CRR- Maintain Correctly- Non Interest earning- minimize flak SLR- Maintain Correctly- Maximize Yield Investments in GOI Securities Investment in State Government Securities Investment in other SLR securities Trading- Gain from market volatility Risk- Hedge and Profit

Investment Types
Fixed Income Securities Floating rate securities NAV based Securities Shares Bonds and Debentures Structured Instruments Securatised Instruments Derivatives

Instruments
Call & Notice Money Treasury Bills Government Securities
Central State

Bonds
PSU Others

Structured notes REPO Forex Forward Forex Option FRA IRS Swap- Currency Options

Investment Horizon
Short TermLong TermMedium Term Trading

Why Invest?
Invest for interest Invest for Dividend Capital Growth in the form of NAV or Price appreciation Capacity to Decide is important Risks Factors Interest rate risk price and valuation issues Credit Risk- default Volatility risk trading risk Liquidity Risk Trading Buying and Selling to arbitrage market volatility Rules and circumstances differ from market to market and instrument to instrument Idle assets do not earn! Trading Policy is needed. VAR to be decided

Constraints in Treasury
Valuation norms Risk Weight Norms NPA norms Capital Adequacy norms Settlement systems Exposure Norms Balance Sheet Function Asset Liability Management- Fixed and FloatingBalance Sheet limitations Capital Management Liquidity Management

WHAT IS TREASURY MANAGEMENT

Treasury Management is the management of cash flows, its banking, money market and capital market transactions; the effective control of the risks associated with those activities; and the pursuit of optimum performance consistent with those risks. IN FINANCIAL ENVIRONMENT, IMPORTANCE OF BANK TREASURY Banks represent a vital link between economic policies of the government & various economic factors. They are the most important financial intermediaries & impact the performance of the economy as a whole. They borrow at a lower rate & lend at higher rate. Or they borrow short and lend long. They accept retail and lend wholesale to take Credit risks Play on volatility The difference levels of risk results in spreads/profits. The main difficulty for banks is to earn profit on spreads but at the same time be liquid enough to meet the withdrawal demand. In present competitive world banks cannot restrict themselves to mere lending & borrowing. For lucrative business banks have to enter Equity & Debt Derivative market to earn more profits on its portfolio. Banks have also to look out for various investment avenues which will maximize their returns at acceptable level of risk and minimize the cost of investment. Due to these reasons TREASURY MANAGEMENT becomes an important function in Banking.

FRONT OFFICE

Dealing

MID OFFICE

BACK OFFICE

settlement MIS

Structure of Treasury
Function Front office Mid-Office Responsible for Dealing Risk management, accounting and management information Confirmations, settlement and reconciliation

Back office

Segment wise functions of Treasury

Front Office Front Office deals in Govt. Securities, Call Money market, Repo transactions, T-Bills, Short term deposits, CBLO, Forex, etc; Adheres to various exposure limits. Reviews, frequently, investment strategies Inflation forecasting and views on interest rates. Dealing in Derivative instruments like interest rate swaps, futures and currency swaps. Back Office Exchange of cheques and instruments Passing of Vouchers Accounting Verification of limit adherence ALM statement preparation Middle Office Market Risk management and Asset Liability Management. Monitoring adherence of investment parameters, viz; duration, value at risk, etc.Authorising payments, inter-bank investments, viz; call money, Term deposits, Mutual Fund instruments,

Treasury

Oversight of Treasury Function

Review of Dealing Room Operation Organization Set up vis--vis RBI Guidelines Infrastructure availability and adequacy Segregation of Front, Mid and Back office functions Compliance with Internal Control Guidelines- Investment policy Reconciliation of Nostro Accounts, SGL, CSGL, DP Accounts Submission of Periodical Regulatory Returns Physical Verification of Securities. Adherence to various exposure limits Review of NPA investments, disclosure and provisioning Verification of Interest / dividend income Valuation of investments

The approved activities of the Treasury Management operation

[a]Cash Flow (daily balances and longer term forecasting). [b] Investing surplus funds. [c] Borrowing to finance cash deficits. [d] Funding of capital payments through borrowing, capital receipts, grants or leasing. [e] Management of debt (including temporary borrowing) [f] Interest rate exposure management. [g] Dealing procedures with brokers, banks and the PWLB, and directly with counter parties. [h] Use of managers for investment of funds.

Integrated Treasury
Banks adopt a focused approach towards improving efficiency and profitability by successfully integrating the operations of different financial markets, viz. Domestic Money, Investments, Foreign Exchange and Derivatives. Traditionally the forex dealing room of a bank managed the forex dealing mainly arising out of merchant transactions by way of selling from and to customers and consequent cover operations in inter-bank market. The Domestic treasury /Investment operations were independent of forex dealing of a bank. Treasury operations were treated as cost centre specially devoted to reserve management (CRR and SLR) and consequent

CONCEPT OF INTEGRATION OF MONEY MARKET AND ITS BENEFITS

MONEY MARKET The money market is a key component of the financial system conducted by the central bank in its pursuit of monetary policy objectives. It is a market for short-term funds with maturity ranging from overnight to one year and includes financial instruments that are deemed to be close substitutes of money. The money market performs three broad functions. One, it provides an equilibrating mechanism for demand and supply of short-term funds. Two, it enables borrowers and lenders of short-term funds to fulfill their borrowing and investment requirements at an efficient market clearing price. Three, it provides an avenue for central bank intervention in influencing both quantum and cost of liquidity in the financial system, thereby transmitting monetary policy impulses to the real economy.

Objectives of Monetary Policy

goals of monetary policy is growth and price stability RBI modifies monetary policy in response to changes in the economic and financial environment. For e.g. recently RBI adopted policy to fight inflation. Traditionally monetary management was undertaken mainly through changes in the CRR & Bank rate, which is used to influence indirectly the marginal cost of borrowing by having an initial impact on the call money market. Financial sector reforms since the early 1990s have provided a strong impetus to the development of financial markets, which, along with interest rate deregulation, paved the way for introduction of market-based monetary policy instruments.

 Of late RBI is also using repo/reverse repo rates under the liquidity adjustment facility (LAF) from June 2000. This shift in emphasis from money to interest rates has been spurred by increased financial liberalization, greater trade openness and capital flows, and innovations in payment and transactions technologies. Such a shift was gradual and a logical outcome of measures implemented in the reform period since the early 1990s (Reddy, 2002). New money market instruments such as CP, CD and repos has been introduced in order to broaden the money market Due to increased sophistication of financial markets, the risk profiles of financial market participants also changed, necessitating introduction of derivative instruments as effective risk management tools. The greater integration of domestic and international markets also calls for flexible use of monetary policy instruments for modulating domestic liquidity conditions and correcting any serious misalignments between short-term and long-term interest rates.

Money Market
Certificate of Deposit (CD) Commercial Paper (C.P) Inter Bank Participation Certificates Inter Bank term Money Treasury Bills Call Money

Certificate of Deposit
CDs are short-term borrowings BY BANKS in the form of Usance Promissory Notes having a maturity of not less than 7 days up to a maximum of one year. CD is subject to payment of Stamp Duty under Indian Stamp Act, 1899 (Central Act)

Features of CD
Issued by all scheduled commercial banks except RRBs Minimum period 7 days Maximum period upto 1 year Minimum Amount Rs 1 lac and in multiples of Rs. 1 lac CDs are transferable by endorsement CRR & SLR are to be maintained CDs are to be stamped

Commercial Paper
Commercial Paper (CP) is an unsecured money market instrument issued in the form of a promissory note by corporates/PDs/FIs Who can issue Commercial Paper (CP) Highly rated corporate borrowers, primary dealers (PDs) and all-India financial institutions (FIs)

Eligibility for issue of CP

a) The tangible net worth of the company, as per the latest audited balance sheet, is not less than Rs. 4 crore; b) The borrowal account of the company is classified as a Standard Asset by the financing bank/s.

Rating Requirement
All eligible participants should obtain the credit rating for issuance of Commercial Paper Credit Rating Information Services of India Ltd. (CRISIL) Investment Information and Credit Rating Agency of India Ltd. (ICRA) Credit Analysis and Research Ltd. (CARE) Duff & Phelps Credit Rating India Pvt. Ltd. (DCR India)

The minimum credit rating shall be P-2 of CRISIL or such equivalent rating by other agencies

To whom issued
CP is issued to individuals, banking companies, other corporate bodies registered or incorporated in India and unincorporated bodies, Non-Resident Indians (NRIs) and Foreign Institutional Investors (FIIs).

Maturity
CP can be issued for maturities between a minimum of 7 days and a maximum upto one year from the date of issue. If the maturity date is a holiday, the company would be liable to make payment on the immediate preceding working day.

Meaning of Repo
It is a transaction in which two parties agree to sell and repurchase the same security. Under such an agreement the seller sells specified securities with an agreement to repurchase the same at a mutually decided future date and a price The Repo/Reverse Repo transaction can only be done at Mumbai between parties approved by RBI and in securities as approved by RBI (Treasury Bills, Central/State Govt securities).

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

Call Money Market

The call money market is an integral part of the Indian Money Market, where the day-to-day surplus funds (mostly of banks) are traded. The money that is lent for one day in this market is known as "Call Money", if it exceeds one day (but less than 15 days) it is referred to as "Notice Money".

Call Money Market

Banks borrow in this market for the following purpose To fill the gaps or temporary mismatches in funds To meet the CRR & SLR mandatory requirements as stipulated by the Central bank To meet sudden demand for funds arising out of large outflows.

Factors influencing interest rates

The factors which govern the interest rates are mostly economy related and are commonly referred to as macroeconomic factors. Some of these factors are: 1) Demand for money 2) Government borrowings 3) Supply of money 4) Inflation rate 5) The Reserve Bank of India and the Government policies determine some of the variables mentioned above.

Gilt edged securities

The term government securities encompass all Bonds & T-bills issued by the Central Government, and state governments. These securities are normally referred to, as "giltedged" as repayments of principal as well as interest are totally secured by sovereign guarantee.

Treasury Bills
Treasury bills, commonly referred to as T-Bills are issued by Government of India against their short term borrowing requirements with maturities ranging between 14 to 364 days. All these are issued at a discount-to-face value. For example a Treasury bill of Rs. 100.00 face value issued for Rs. 91.50 gets redeemed at the end of it's tenure at Rs. 100.00.

Who can invest in T-Bill

Banks, Primary Dealers, State Governments, Provident Funds, Financial Institutions, Insurance Companies, NBFCs, FIIs (as per prescribed norms), NRIs & OCBs can invest in T-Bills.

What is auction of Securities

Auction is a process of calling of bids with an objective of arriving at the market price. It is basically a price discovery mechanism

Yield of Treasury Bill

Y= (100-P)*365*100 ----------------------P*D Y = Yield P= Price D =Days to maturity

Example
91 days treasury bills maturing on 6-122008 Purchased on 12-10-2008 Rate quoted is Rs.99.1489 per Rs100 (100-99.1489)*365*100= 31065.15 ---------------------------(99.1489*55 days) =5453.18 =5.70%