Integrated Treasury Management in Banks

Brijash Kumar MOF and DGM BTC Mumbai brijashkumar@rbi.org.in

Treasury Management

Treasury generally refers to the funds and revenue at the disposal of the bank and day-to-day management of the same. The treasury acts as the custodian of cash and other liquid assets. The art of managing, within the acceptable level of risk, the consolidated fund of the bank optimally and profitably is called Treasury Management. It is the window through which banks raise funds or place funds for its operations.

Functions of an integrated treasury

Reserve Management and Investment Liquidity and Funds Management Asset-Liability Management Risk Management Transfer Pricing Derivatives Trading Arbitrage Capital Adequacy

Structure of an integrated treasury

The treasury department is manned by the front office, mid office, back office and the audit group. In some cases the audit group forms a part of the middle office only. The dealers and traders constitute the front office. In the course of their buying and selling transactions, they are the first point of interface with the other participants in the market (dealers of other banks, brokers and customers). They report to their department heads. They also interact amongst themselves to exploit arbitrage opportunities.

Structure of an integrated treasury

A mid office set up, independent of the treasury unit, responsible for risk monitoring, measurement analysis and reports directly to the Top management for control. This unit provides risk assessment to Asset Liability Committee (ALCO) and is responsible for daily tracking of risk exposures, individually as well as collectively. The back office undertakes accounting, settlement and reconciliation operations.

The audit group independently inspects/audits daily operations in the treasury department to ensure adherence to internal/regulatory systems and procedures.

Structure of an integrated treasury

Advantages of integrating treasury operations

Is to improve portfolio profitability, risk insulation and also to synergise banking assets with trading assets. This is achieved through efficient utilisation of funds, cost effective sourcing of liability, proper transfer pricing, availing arbitrage opportunities, online and offline exchange of information between the money and forex dealers, single window service to customers, effective MIS, improved internal control, minimisation of risks and better regulatory compliance. An integrated treasury acts as a centre of arbitrage and hedging activities. It seeks to maximise its currency portfolio and free transfer of funds from one currency to another so as to remain a proactive profit centre.

The Dealing Room

The Treasury has a responsibility to manage market risk in accordance with instructions received from the banks ALCO.

This is undertaken through the Dealing Room which acts as the banks interface to domestic and international financial markets.
it is the clearing house for such risk and has the responsibility to manage the market risk taken in all areas of the bank, on behalf of customers, and on behalf of the bank, within the policies and limits prescribed by the Board and RMC. For this reason significant authority is given to the Treasurer, and the Dealing Room staff to commit the bank to market risk. Thus controls over the activities of these staff are critical to ensure that the bank is protected from undue market risk.

Abuse of Dealing Authority

Trading for personal gain

Overtrading for self-aggrandizement or impressing peers and colleagues of the dealers market muscle
Over-limit positioning in an attempt to improve a lossmaking position by averaging out. Such trading often breaks both position limits and stop-loss limits. Overtrading and exceeding dealing limits and authorities can also be caused by inappropriate dealers bonus schemes and over-stretching or unrealistic profit targets.

The consequences of unauthorised trading are a well documented case history including Barings, various Japanese banks, etc.

Abuse of Dealing Authority

Frequent breaches, both justified and unjustified, may indicate that the banks control environment or management supervision is deficient. IOs to verify every breach of authority and limits has been carefully examined by the bank and appropriate action noted, from post facto approval by the required authority to a caution or formal warning to the miscreant. Many Dealing Room controls are performed in the Back Office.

The Middle Office

The duties and responsibilities of the Middle Office vary from bank to bank. Middle Office is a relatively new concept in the risk management structure, not all banks will have formal Middle Office structures. Middle Offices are in place primarily to provide market risk monitoring, evaluation and reporting for ALCO and Treasury. The Middle Office is the first line of review of dealing activities and it provides timely assessment of dealing activities and consolidated market risk exposures of the bank.

The Middle Office

The Middle Office must report to ALCO independent of the Treasury. It is inappropriate that any access to Middle Office systems is given to Treasury staff. As the Middle Office is the primary source for market risk analysis in the bank, it is essential that segregation of duty principles are clearly maintained. Middle Office provides key market risk analysis to Dealing Room management and ALCO, its reporting line to the ALCO Secretariat must be separate from Treasury to ensure independent risk evaluation.

The main functions of the Middle Office

monitoring performance of the Dealing Room - individual dealers performance analysis of use of approved risk limits analysis of usage of limits and recommending changes assessment and valuation of exposures analysis of dealing strategies analysis of risk of new instruments and products real-time evaluation of risk exposures verification of information used in gap and cash flow reports analysis of gap and cash flow reports maintenance of ALM model comment and analysis on output of ALM model maintenance of VaR model verification of data used in VaR model comment and analysis on output of VaR model Regulatory reporting/compliance.

The Back Office

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

The Back Office

Key controls performed in this area are

The control over confirmations both inward and outward.

All confirmations must be verified by Back Office staff for consistency with Dealing Room forms and reports. Any follow up of discrepancies between the two (including confirmations received where no dealers record is provided) must be performed independently by the Back Office in a timely manner. Confirmations must under no circumstances be sent out by or received by the dealing area. The control over dealing accounts, vostros and nostros must also be timely, accurate and discrepancies followed up independently and in a timely manner. Revaluations and marking-to-market risk exposures, where required by policy and RBI directives, must be carried out by the Back Office, for bank records, from rates received independent of the Dealing Room.

The Back Office

Monitoring and reporting of risk limits and usage including open positions, product usage, counterparty settlement, overall limits and portfolio limits are the responsibility of the Back Office or Middle Office, where in place. Reporting prompt resolution of exceptions and excesses are vital responsibilities of the Back and Middle Offices and key control considerations. Control over payments systems, particularly those related to Dealing Room activities is the responsibility of the Back Office. Under no circumstances should staff with access and/or authority to the Dealing Room or dealing mechanism have any authority, responsibility or access to bank payment systems.