Integrated Treasury Management
Chapter 1:- Integrated Treasury
? Introduction ? Need of integration of bank treasury ? Functions of integrated treasury ? Function of treasury – centralized v/s decentralized
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Integrated Treasury Management
Chapter 1: Integrated treasury ? Introduction
The reforms set in since the past few years has brought along with it host of risks for the banks, apart from a variety of opportunities. Now banks will have to learn to operate in a more deregulated environment a diversified and competitive market place, which will require them to manage risks better. Recent volatility in exchange rate movements and domestic interest rate levels has indicated the influence of the global market within the country. Such volatilities would precipitate substantial losses and at times irretrievable situations for several banks. These situations warrant proactive or prompt reactive moves from the banks. It is in the context of the urgent need of TREASURY MANAGEMENT for the banks emerge. Bank with an extensive branch network has to establish a centralized treasury and dealing room, to counter the market situations and contain the risk exposures at the earliest. Until the few years back, many of the Indian banks were giving a secondary importance to treasury management. There are dangers in giving treasury operations a secondary role. A significant proportion of the treasury related problems are to be attended immediately for instance, loss of interest arising from surplus funds available for the banks on day to day basis. An open currency risk which has been identified but not acted
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upon for lack of time means that banks profits are at risk for possibly one or more day‘s movement in volatile foreign exchange markets can be very expensive indeed. Therefore, that, even in a relatively small organization, it is essential that treasury work is under taken by at least one individual with a sole or primary responsibilities to cover, at least, cash , management and currency management. A few of the banks have already set up fully functioning treasuries and a couple of them have set up integrated treasuries with forex and domestic dealers sitting in the same dealing room. The word INTEGRATION means consolidation or merger or centralization. In the present context it is the consolidation or the centralization of the segmented financial markets like money market. Debt and capital market and forex market at the macro level and integration of the respective treasuries at the operational level at banks financial institutions. Let us discuss this in the following. Banking reforms which were initiated in the beginning of the 90‘s is slowly opening the domestic economy to the global market. Opportunities are winding for the banks, financial institutions, corporate and others, which would result in intense
market/economy is integrating with the global economy, it is needles to emphasize need for integration of the micro level units. For example different segments within the financial markets are almost integrated. The financial markets which were earlier segregated in different watertight compartments like money market, debt market, capital market, forex market etc. have been almost integrated. Now money can freely flow, of course with lesser regulations, from one market to the other market have been given partial freedom to enter other markets. Now financial institutions which earlier were confined to be long term market have been permitted to enter sort term in money market to lend in call and borrow not only from the open domestic market nut also from the global market. Banks have been permitted to enter the capital/debt market, forex market and money market with partial freedom in certain cases, to mobilize and/or deploy resources. Bank, if not for there own needs, are forced to enter these market very often
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and render services to their clients, which have access to these markets. For example a corporate accessing the overseas market for external commercial borrowing has to ultimately depend on bankers for utilizing the funds it has raised or converting the funds and bringing into the country. Thus we can say, with liberalization of the financial system, markets are almost fully integrated. Once the capital account convertibility (CAC) fully comes, all these markets would have been fully integrated. The impact of the financial integration on CAC can be summarized as follows: ? Promotes competition resulting in better quality products and services. ? Improves quality and number of financial assets as a result of greater liquidity and deeper market. ? Reduces margin and more efficient allocation/ intermediation interest rates to align with global interest rates differential to reflect in foreign exchange forward rates. ? Avoids inducements for tax evasion and capital flight opportunities for diversion/distribution of risk.
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? Needs of integration of the bank treasury
Presently except couple-of treasuries, almost all the treasuries of the public sectors banks are operating in isolations. For example, forex treasury and domestic treasury of many of the banks are operating independently. There may be times that the forex and domestic treasury of these banks might have worked on different directions there by neutralizing an advantageous position or even adversely affecting the banks financial position. This is because the forex treasure may not know the position of the domestic treasury or that the perceptions of both the treasuries may be different or in opposite directions =. Communication/information gap between these two treasuries also may lead to such detrimental position for the banks. This may even lead to the goodwill of the bank. There may be instance when the integrated treasuries of the other banks may take arbitraging opportunities on its unrelated/opposite levels/positions of the banks May ne lending funds to other banks, which may, in turn deploy in foreign currency deposit with the former. There are few banks where even the funds management (money market treasury) and investment management (capital and debt market treasury) are functioning independently.
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Here also these banks are losing opportunities within the domestic market when the interest rates and asset/security prices move in the same direction. Further almost all trade and capital movements which cross international border give rise to a foreign currency asset or create foreign currency liability. Subject to regulatory constraints these currencies may be restrained in that currency and placed or borrowed in the overseas market or domestic market for that currency. Moreover now that banks have been selectively permitted to invest in/borrow from oversea market, such opportunities can be planned only if the banks have an integrated treasury. Banks have now been selectively given licenses to import precious metals for the resident‘s metal traders. Since this operation involves buying of metal from the international market against dollar value and then pricing it in the domestic market, the bank dealing in such a trades has to operate from an integrated treasury. It is now well understood that reserve bank of India intervene in the domestic (rupee) market to regulate the foreign exchange market. For instance, when the Indian rupee started falling steely and crossed Rs. 40/$ and also simultaneously when forwards premium went to dizzy high in the beginning of the year 1998, RBI signaled rise in short term interest rates stayed above 50% continuously for a fortnight, this strengthened the rupee and cooled down forwards and normalcy came into the market within a month‘s time. In such situations, a bank should have its forex and rupees treasury operating with the same focus and in the same direction. There are chanced that the profit made by one treasury in such volatile situations is negated by the other treasury on account of its inadvertent operations.
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? Functions of integrated treasury
The major functions of the treasury units are as follows: Reserve management & investment: It involves, 1. Meeting CRR & SLR obligations 2. Having an appropriate mix of portfolio to optimize yield &duration.
Duration is the weighted average ?life‘ of a debt instrument over which investment in that instrument is recouped. Duration analysis is the tool used to monitor the price sensitivity of an investment instrument to interest rate changes. Funds and liability management: It involves, 1. Analysis of major cash flows arising out of asset liability transactions. 2. Providing a well developed & diversified liability base to fund the various assets in the balance sheet of the banks. 3. Providing policy inputs to the strategic planning group on the banks on funding mix (currency tenor & cost) & yield expected in credit & investment. Asset liability management & term money: ALM calls for determining the optimal size & growth rate of the balance sheet & also prices the asset liability in accordance with prescribed guidelines. Successive reductions in CRR rates & ALM practices by banks increases the demand of funds from tenor of above 15days (term money) to match duration of their assets.
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Risk management: Integrated treasury manages all markets risks associated with a bank‘s liabilities and assets. The market risk of liabilities to floating interest rate risk & asset liability mismatches. The market risk for assets can arise from; 1. Unfavorable changes in interest rates 2. Increasing level of disintermediation‘s 3. Securitization of assets. 4. Emergence of credit derivatives etc. While the credit risk assessment continues to lies in the hands of credit department, the treasury would monitor the cash inflows impact from changes in assets price due to interest rate changes by adhering to prudential exposure limits. Transfer pricing: Treasury is to ensure that the funds of the banks are deployed optimally, without sacrificing yield or liquidity. An integrated treasury unit has the idea of bank‘s overall funding needs as well as direct access to various markets (like money market, capital market, forex market, etc). Hence ideally banks should provide benchmark rates, after summing market risk to various business groups & products categories about the correct business strategy to adopt. Derivative products: Treasury can develop interest rate swaps & other rupee based/cross Currency derivatives products for hedging banks own exposures and also sell such products to customers/other banks. Arbitraging: Treasury units of banks undertake this by simultaneous buying and selling of the same type of assets in two different markets to make risk less profits.
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Capital adequacy: This function focuses on quality of assets; with return on assets (ROA) being a key criterion for measuring the efficiency of deploys funds. An integrated treasury is a major profit center. It has its own P&L measurement. It undertakes exposures through proprietary trading (deals done to make profits out of movements in market interest/exchange rates) that may not be required by general banking.
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? Treasury centralized or decentralized?
The whole treasury functions of the banks can either be centralized at one center or decentralized at different centers but under a single overall supervision. The advantages of a centralized treasury can be summarized as a follows: 1. A centrally organized treasury would have the total picture of liquidity (current/cash and long term) of the bank. This would enable it to take decision/control on the utilization/deployment of the funds to the best advantage of the bank. 2. As the reserve management is a vital function of the treasury, it is advantageous/ prudent to have a single centralized treasury so that it is monitored closely from time to time so that not only default averted but also bare minimum surplus only is maintained over the stationary requirements. 3. It ill is able to take advantage of funds in transit within the banks network like inter branch funds movement, movement of funds between RBI and non RBI centers, etc. otherwise there is possibility that these funds are ignored and left idle in the banking system. 4. Centralized treasury prevents unnecessary movement of funds around different centers but organizes in such a way that actual transmission of funds is minimized. 5. A centralized treasury enables the bank to deal in big quanta in the market and take advantage of the wholesale market. 6. A centralized treasury would have better managerial control, responsibility and risk control. If the treasury is decentralized in smaller units, one unit would not necessarily be aware of the exposure taken by the other unit. Likewise when the market is highly volatile, a proactive treasury may have to change its position within short time to avoid risk. This is possible only if the treasury is centralized. 7. Reporting and fast implementation of management/ALCO decisions is possible only if the treasury is centralized. If it is decentralized, time consumed for
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collection, complications, and analysis of the data will be costly. Later, implementation of the ALCO decisions may get delayed, which may cost to the bank further. Main disadvantage of the centralized treasury is that the bank may not be able to take advantage of the ?better market‘ at other centers. Likewise, as the involvement in financial matters is centralized other centers may not know the importance of treasury management, which may reflect in their actions/omissions.
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Chapter 2: Structure of integrated treasury A. organization
a. Dealing room/front office b. Middle office management c. Back office management
B. functional areas under integrated treasury/ treasury products
a. liquidity management b. audit c. money market d. foreign exchange market e. derivatives f. risk management
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Structure of Integrated Treasury
Introduction:
The structure of the treasury department is very simple. It consists of front offices, middle office, back office, treasurer, audit head, forex dealers, derivative dealers, money market dealers, funds and liquidity management and risk management. Treasurer is the person responsible for all the transactions of the treasury department. He has to report directly to the front office. The structure of integrated treasury can be better understood from the following diagram Elements of treasury
Front office
Middle office
Treasurer
Back office
Liquidity
Audit
Money market Risk management
ry
Foreign exchange
management model:
Derivatives
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Organization of Treasury
The treasury is organized either as a department of the banks, or as a specialized branch under direct control of the bank‘s head office. In either case the treasury functions with a group of autonomy with its own accounting system. The branch status is preferred as books of accounts of treasury can be maintained independently (with its own P&L account and GL accounts). On the other hand, the departmental from has the advantage of easier coordination with related departments at head office (such as accounts and credit department) in a line management. Treasury as a specialized branch enjoys as additional advantage as the branch can act as authorized dealer for foreign exchange business and can participate in clearing and settlement systems directly, while head office department can only act through a branch for its business operations. We may therefore conclude that in the context of integrated treasury operations, a treasury branch should be the preferred form of organization. The treasury is headed by a senior management person – a general manager, dy. General manager, vice-president or with some such designation. Treasury being a key activity of the bank, Head of treasury should be a person ho would report direct to the chief executive of the bank. However the level of reporting and delegation of powers would depend on the size of the bank and importance attached to the treasury activity within the bank. The treasury may be divided into three main divisions: the dealing room (for front office), the middle office, and the back office (or, treasury administration).
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Dealing Room
Middle Office
Back Office
a. Dealing room/front office:
The dealing room is headed by chief dealer, who is in charge of the front office. The dealer working under him buys and sells in the markets. Each dealer specializes in one of the markets, i.e. foreign exchange, money market or securities market, although in an integrated treasury, the dealers are generally familiar with all the markets depending on the size of operations, there may be dealers dedicated to major currencies, or dealers specializing only in forward markets or derivatives. It is also common to have a separate corporate dealer, exclusive to attend to major corporate customers/ merchant business. The securities market is normally divided in two parts, primary and secondary markets. The securities dealer deals only with secondary market i.e. buying and selling of securities already available in the market. As a matter of convenience, the dealer also participates in auction of government securities and T-bills, conducted periodically by RBI. The primary market comprises of new issues by way of private placement. The primary market issues are subscribed by investment department, situated outside the dealing room, but as part of the treasury. This is so, because primary issues need appraisal of credit risk, through examination of issue terms and where so stipulated, documentation for secured debt (through a Trustee). Often banks require inputs from market research, for which, either they may have an in-house Research dept, may collect it from published material.
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b. Middle office:
Middle office is created exclusively to provide information to the management (MIS) and to implement risk management system. Middle office monitors exposure limits and stop loss limits to treasury and reports to the management on key parameter of performance. Transfer pricing mechanism may also be implemented through middle office. In smaller banks, middle office may also functions as ALM support group, as the balance sheet risk management is closely connected to treasury risk management. Investment department, as stated earlier, will deal with primary issues. Whenever a suitable offer is received, the department would put up an investment proposal and obtain approval at appropriate level. Minimum marketable investment being Rs. 5 crores, the investment proposal are scrutinized closely and are generally considered by an investment committee, before the sanction is obtained at appropriate level. The other department in treasury, viz. accounts and administration, systems administration, remittance (swift/RTGS, etc) would be mainly administrative in nature. Some bank may also prefer to have their inter-branch cash transfer department as part of treasury, as the treasury maintains the bank‘s account RBI
c. Back office:
The back office is responsible for verification and settlement of the deals concluded by the dealers. The deals are verified on the basis of deal slips prepared by the dealers and also from the confirmation received from the counterparties. The back office staff also confirms the deals independently with the counterparties (banks and other institutions) over phone and verifies the authenticity of the confirmation document. The back office takes care of all related book-keeping and submission of periodical returns to RBI. Backoffice also maintains Nostro accounts (foreign currency accounts with correspondent banks), funding and security accounts with RBI, Demat account with depository
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participants and ensures that adequate margin money is held with clearing corporation of India for rupee and dollar settlements. Settlement refers to receipt and payment of accounts following deals made by dealers (i.e. sale and purchase of foreign currency, lending and borrowing, sale and purchase of securities etc.). Settlement is a key function of back office as all payment and receipts must take place on value date. Any delay in settlement would result in financial loss to the banks, and delay in payment is considered a default by the banks, severally affecting the bank‘s reputation.
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B. Treasury Products:
Fund Administration
Accounting
Investment Research
Compliance And Regulatory Reporting
Security And Position Administration All Instrument Classes In One System
Portfolio And Fund Management And Analysis
Pre-trade Complaince Trading And Order Management Risk Management
Cash And Custody Management Performance Measurement And Attribution
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Treasury management refers to the nature of treasury market and various treasury products available in the market, for raising and deploying funds, for investment, for trading in foreign exchange and securities markets Following are the treasury products used for controlling the overall funds of the banks: ? Liquidity Management ? Audit ? Money Market ? Foreign Exchange Market ? Derivatives ? Risk Management.
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a. Liquidity Management:
Introduction:
The textbook definition of liquidity is straight forward: the ability to provide sufficient funding at reasonable cost in a reasonable period. The definition is simple, but liquidity can be one the more challenging areas of the bank to manage. Maintaining sufficient liquidity is difficult enough under normal circumstances, but what do you do when: In the days following the October 1987 stock market crash, a radio DJ decides to select your bank and broadcast false stories of crowds forming at your door demanding their money? Fictitious stories of a bank run turned into real thing. What do you do? A relatively new bank has a bad quarter of credit losses and faces a major wetback in profitability. Its largest correspondent bank cancels its line of credit, other sources of borrowing follow suit, and suddenly the bank‘s sources of liquidity are cut off except for what is on their balance sheet. What do you do? September 11, 2001: following the terrorist attacks on our country, a number of banks called our office wanting to know if they should close temporarily, rumors of banks runs were starting. What do you do? The foregoing examples are real. They are examples of the kinds of things bank management must consider in their liquidity planning. Plan for the expected but prepare for the unexpected.
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Objectives of liquidity management: The objectives of liquidity management are to maintain statutory prescription, meet contractual and maturing cash outflows and to profitably deploy surplus cash. Sound liquidity management involves prudently managing cash flows as also concentration of assets and liabilities (both on and off balance sheet) with a view to satisfy that cash flows; have an appropriate relationship to approaching cash outflows. Holding excess liquidity has a bearing on profitability because liquid assets in the form of cash and short term securities generate lower yields. A trade off between liquidity needs and profitability necessitates determination of optimum level of liquidity this will have to be supported by liquidity planning that assesses potential future liquidity needs taking into account changes in economic, political, regulatory and other operating conditions. The primary objectives of liquidity management: ? ? An optimum liquidity position Avoid concentration of funding that may leave the bank vulnerable to potential liquidity problems. Liquidity management in banks: Liquidity management is an important function of any business because it is the determinant of whether the entity will be in operation in the foreseeable future. For banks, liquidity management is even more crucial as the lifeline of banking itself is money. This function is so important in the industry that the central bank closely monitors commercial banks to ensure that they are within their regularity limits. In providing this important economic function, banks protect their customers against liquidity problems, but at the same time become exposed to such risks themselves. In an extreme case, such liquidity problems can manifest themselves in runs, even on second banks when customers withdraw their deposits on massive scale. All commercial banks also have dedicated dealers to ensure the liquidity is constantly put in check.
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For a bank, liquidity means having sufficient funds to meet regulatory, contractual and relationship obligations when required and at a reasonable cost to the banks. Once central bank regulatory requirement are met; the two main liquidity demands on a bank are deposit withdrawals and loan demands by customers. Liquidity management has always been an important matter for banks. In today‘s world, many banks face increased liquidity strains, as competition for deposits forces them to look for alternative funding sources. At the same time, financial development has increased both the opportunities and risks in liquidity management. As a result, it is increasingly important that banks plan for there liquidity needs to ensure that they are using stable and low cost methods to fund their operations. In a highly competitive world, only the efficient survive, and using high cost funds puts a bank at a competitive disadvantage.
Short term and long term liquidity needs:
Short term: Short term liquidity needs of a bank may arise several sources. For example, seasonal factors often affect deposit flows and loan demand. A bank pre dominantly catering to agricultural sector may experience fall in deposits and high demand for loans during procurement and harvest period when there is demand for procurement of seeds, plants and fertilizers. Banks, which are heavily dependent on some large customers in this segment, may find seasonal liquidity needs particularly important. Most seasonal fluctuations can predict reasonably accurately on the basis of past experience. The holder of sizable deposits balances and the customers who borrow in substantial amounts also may influence short term liquidity needs of an individual bank to a degree that is directly related to bank‘s size. The short term funding needs of important customers strongly affect the bar short-term liquidity needs short term needs of some customers are very difficult to predict. Much of the needs and intentions of large customers.
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Banks in India can borrow in call money market for overnight as also interbank term money market for short term duration generally upon 14days. Banks can also meet short term liquidity needs through repo transactions. In case borrowings in money market turn out to be costly, banks can look sale of certain liquid assets. Banks also have investment in 91 days and 364 days treasury bills, which are considered most liquid and are available to meet any short term liquidity needs. Long term: Long term liquidity needs are generally related to secular trends of the community or market that a bank serves. In rapidly expanding areas, loans often grow faster than deposits. Banks in such a situation needs sources of liquidity to provide funds for loan expansion. In stable communities, on the other hand deposits may show a steady rise while loans remain virtually unchanged. In such cases, the longer view of liquidity requirements may enable the banks to keep more fully invested than it otherwise would be required. To gauge the banks liquidity needs over a long term, a bank‘s management must attempt long range economic forecasting as the basis on which it can reasonably estimate loan and deposit level for the next one year or for a period up to 5 years. Long term liquidity needs can be determined by classifying every item on the asset side either as liquid or illiquid depending on whether that particular assets can be converted into useable assets within a period of less than 90 days with a little loss if any on sale of that asset. Similarly on the liability side, various sources of funds, deposits and capital are classified as either volatile or stable depending on withdrawal pattern on the basis of seasonal, rate or other pressures. The gap is positive if liquid assets exceed volatile sources and negative if the reverse is the case. Meeting long term liquidity needs can be more complex. As loan growth exceeds deposits growth for most banks, they will be faced with long term liquidity needs. Selling liquidity assets or resort to borrowing can finance such net growth.
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b. Audit:
Introduction:
Audit of an integrated treasury is a complex task requiring high level of skills, knowledge of market practices and the relevant regulatory environment. Treasury income constitutes significant portion of a bank‘s income, many a time equal to the entire income received from advances and the extensive branch network of banks. An audit of integrated bank treasury operations will have to be aware of the relevant regulatory standards, the valuation methods applicable terminologies used that he has to be familiar with and then proceeds with broad guidelines for evaluation of internal control (including those relating to information systems). A model audit program that can be tailor made to suit individual needs has also been attempted. Many banks have set up integrated treasuries, encompassing both rupee and forex denominated transactions. An integrated approach to treasury management involves a common dealer or desk dealing in both domestic and forex financial markets. This enables the banks to optimize its funding and funds deployment and take advantage of arbitrage opportunities between these markets treasury income constitutes a significant portion of a bank‘s income, many a time equal to the entire income received from advances and the extensive branch network of banks. Treasury operations are invariably of high value and due to the very nature of its operations, are susceptible to manipulation, fraud or error and consequently to the various types of risk envisaged by audit and assurance standards (AAS) 6.
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Audit approach change:
By now it has dawned on all auditors that they cannot afford to ignore the computers and from the integral part of the organization they are auditing. These systems affect the working of the organization to such a level that in extreme cases, unsuitable solutions can even kill the company and the auditor better forecast this. The question then comes to mind is that should the ?new generation‘ computer savvy generation auditors tackle it while the rest go to the hills and retrieve?
Knowledge of business
AAS 20)
Knowledge of business of bank treasury is usually low, even in an enlightened community like chartered accountants. Consequently, it is important to acquire a through knowledge of the products in vogue in the market, market practices, the permissible valuation methods, the regulatory standards prescribed by the RBI, Foreign Exchange Dealers Association of India and fixed income money market and derivative association (FIMMDA), the process followed by the bank, internal controls exercised, information systems use etc. an idea of the types of trades, settlement, instruments in vogue, certain operational issue relating thereto, principles of valuation etc are set out in the ensuing paragraphs for general understanding.
EDP CONTROLS (AAS 29):
The extent of computerization is usually extensive in treasuries. This calls for strict controls in such an environment. Robust software covering the entire gamut of functionality required for smooth functioning of treasury, a proper security environment, control in place to prevent unauthorized usage of files, systems, etc, start/end of the day process, business continuity and disaster recovery plans, well documented user and technical manuals, audit trails in the software, exemption report, complete trail of all backend changes made are a must. Computer assisted audit techniques and a tool, which could extract data to analyze them and identify exceptions, would be invaluable for review of EDP controls.
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c. Money Market:
Introduction:
The money market is a whole sale market for low risk highly liquid IOUs (IOU = promissory note (I owe you)). It is a market for various sorts of dept securities rather than equities. Within the confines of the money market each day banks actively trade in various instruments. The transactions include outright as well as ?repo transaction?. The heart of the activity in the money occurs in the trading rooms of dealers and brokers of money market instruments. Financial literature provides no standardized definition of the term ?money market?. Some writers employ the term broadly to include the complex arrangements by which lender and borrower of money capital (capital other than equity capital) are bought and sold. This approach is similar to the meaning of the ?capital market? embraces only open markets for near money, liquid assets. As per the narrow definition, money market embraces the various arrangements that have to do with issuance, trading and redemption of low risk, short term, marketable obligation whose prices vary only moderately. Both long term obligations and customer loans are excluded. The boundary lines are drawn to include only those instruments that possess high degree of liquidity and at the same time provide a moderate yield. The money market is a market for short term financial assets that are close substitutes for money. The important feature of a money market instrument is that it is liquid and can be turned over quickly at low cost and it provides an avenue for equilibrating the short term surplus funds of lenders and the requirements of borrowers. There is strictly no demarcated distinction between short term money market and long term capital market and in fact there are integral links between the two markets as the array of instrument in the two markets invariably forms a continuum.
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Economic functions: The basic functions of the money market is to provide efficient facilities for adjustment of liquidity positions, of commercial banks, non bank financial institutions business corporations and other investors! A smoothly functioning money market foster the flow if funds to the most important uses throughout the nation and the world, throughout the range of entire economic activities. In the process interest rate differentials are narrowed, both geographically and industrially, and economic growth is promoted. In contrast with customer‘s loans, the open market is the entire objective and free from personal considerations. Obligation is bought from dealers who offer to sell at lowest prices (highest yields) and are sold to dealers who bid to buy at the highest prices (lowest yields). The money market is essentially a market dealing in short term instruments spanning for a period of one year or below. A number of transactions take place daily shifting for a period of one year or below. A number of transactions take place daily shifting vast sums of money between the banks. The money market offers a forum for the banks in managing their short term liquidity. Banks may have to borrow or lend in call money market. Since the surplus cannot be kept idle, banks with surplus will have to deploy these funds profitably. Money market offers opportunity for short term placement of funds through short term money market instrument. A part from the banks, money market provides opportunities to other institutions and corporate to deploy their short term surpluses. Reserve bank of India through various open market operations in the form of repos and tbill auctions monitor the money supply in the economy. The rates of interest are deregulated. At present, there is no benchmark rate for either short term or long term investment in securities/ instruments. The varied activities of money market participants determine short term rates.
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Short term money market instruments:
The money market is a market for short-term financial assets that are close substitutes of money. The most important feature of a money market instrument is that it is liquid and can be turned over quickly at low cost and provides an opportunity for balancing the short-term surplus funds of lenders and the requirements of borrowers. By convention, the term "Money Market" refers to the market for short-term requirement and deployment of funds. Money market instruments are those instruments, which have a maturity period of less than one year. The most active part of the money market is the market for overnight call and term money between banks and institutions and repo transactions. Call Money / Repo are very short-term Money Market products. There is a wide range of participants (banks, primary dealers, financial institutions, mutual funds, trusts, provident funds etc.) dealing in money market instruments. Money Market Instruments and the participants of money market are regulated by RBI and SEBI.As a primary dealer SBI DFHI is an active player in this market and widely deals in Short Term Money Market Instruments. The below mentioned instruments are normally termed as money market instruments: ? ? ? ? ? ? ? Call/ Notice/ Term Money Repo/ Reverse Repo Inter Corporate Deposits Commercial Paper Certificate of Deposit T-bills Inter Bank Participation Certificate
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1. Call/ Notice/ Term Money The call/notice/term money market is a market for trading very short term liquid financial assets that are readily convertible into cash at low cost. The money market primarily facilitates lending and borrowing of funds between banks and entities like Primary Dealers. An institution which has surplus funds may lend them on an uncollateralized basis to an institution which is short of funds. The period of lending may be for a period of 1 day which is known as call money and between 2 days and 14 days which is known as notice money. Term money refers to borrowing/lending of funds for a period exceeding 14 days. The interest rates on such funds depend on the surplus funds available with lenders and the demand for the same which remains volatile.
This market is governed by the Reserve Bank of India which issues guidelines for the various participants in the call/notice money market. The entities permitted to participate both as lender and borrower in the call/notice money market are Scheduled Commercial Banks (excluding RRBs), Co-operative Banks other than Land Development Banks and Primary Dealers. 2. Repo/ Reverse Repo A repurchase agreement, also known as a repo, RP, or sale and repurchase agreement, is the sale of securities together with an agreement for the seller to buy back the securities at a later date. The repurchase price should be greater than the original sale price, the difference effectively representing interest, sometimes called the repo rate. The party that originally buys the securities effectively acts as a lender. The original seller is effectively acting as a borrower, using their security as collateral for a secured cash loan at a fixed rate of interest. A repo is equivalent to a spot sale combined with a forward contract. The spot sale results in transfer of money to the borrower in exchange for legal transfer of the security to the lender, while the forward contract ensures repayment of the loan to the lender and return of the collateral of the borrower. The difference between the forward price and the spot
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price is effectively the interest on the loan, while the settlement date of the forward contract is the maturity date of the loan.
3. Inter Corporate Deposits An Inter-Corporate Deposit (ICD) is an unsecured loan extended by one corporate to another. Existing mainly as a refuge for low rated corporate, this market allows funds surplus corporate to lend to other corporate. Also the better-rated corporate can borrow from the banking system and lend in this market. As the cost of funds for a corporate in much higher than a bank, the rates in this market are higher than those in the other markets. ICDs are unsecured, and hence the risk inherent in high. The ICD market is not well organized with very little information available publicly about transaction details. 4. Commercial Paper: Commercial paper is an unsecured promissory note with a fixed maturity of 1 to 271 days. Commercial paper is a money-market security issued (sold) by large corporations to get money to meet short term debt obligations (for example, payroll), and is only backed by an issuing bank or corporation's promise to pay the face amount on the maturity date specified on the note. Since it is not backed by collateral, only firms with excellent credit ratings from a recognized rating agency will be able to sell their commercial paper at a reasonable price. Commercial paper is usually sold at a discount from face value, and carries higher interest repayment rates than bonds. Typically, the longer the maturity on a note, the higher the interest rate the issuing institution must pay. Interest rates fluctuate with market conditions, but are typically lower than banks' rates. 5. Certificate of Deposit A savings certificate entitling the bearer to receive interest. A CD bears a maturity date, a specified fixed interest rate and can be issued in any denomination. CDs are generally issued by commercial banks and are insured by the FDIC. The term of a CD generally ranges from one month to five years.
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A certificate of deposit is a promissory note issued by a bank. It is a time deposit that restricts holders from withdrawing funds on demand. Although it is still possible to withdraw the money, this action will often incur a penalty. For example, let's say that you purchase a $10,000 CD with an interest rate of 5% compounded annually and a term of one year. At year's end, the CD will have grown to $10,500 ($10,000 * 1.05). CDs of less than $100,000 are called "small CDs"; CDs for more than $100,000 are called "large CDs" or "jumbo CDs". Almost all large CDs, as well as some small CDs, are negotiable. 6. T-bills A short-term debt obligation backed by the government with a maturity of less than one year. T-bills are sold in denominations of $1,000 up to a maximum purchase of $5 million and commonly have maturities of one month (four weeks), three months (13 weeks) or six months (26 weeks). T-bills are issued through a competitive bidding process at a discount from par, which means that rather than paying fixed interest payments like conventional bonds, the appreciation of the bond provides the return to the holder. 7. Inter Bank Participation Certificate With a view to providing an additional instrument for evening out short-term liquidity within the banking system, two types of Inter-Bank Participations (IBPs) were introduced, one on risk sharing basis and the other without risk sharing. These are strictly inter-bank instruments confined to scheduled commercial banks excluding regional rural banks. The IBP with risk sharing can be issued for 91-180 days and only in respect of advances classified under Health Code No. 1 Status. Under the uniform grading system introduced by Reserve Bank for application by banks to measure the health of bank advances portfolio, a borrower account considered satisfactory or assigned Health Code No. 1 is the one in which the conduct of account is satisfactory, the safety of advance is
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not in doubt, all the terms and conditions are complied with, and all the accounts of the borrower are in order. The IBP risk sharing provides flexibility in the credit portfolio of banks. The rate of interest is left free to be determined between the issuing bank and the participating bank subject to a minimum 14.0 per cent per annum. The aggregate amount of such IBPs under any loan account at the time of issue is not to exceed 40 per cent of the outstanding in the account.
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d. Foreign exchange market:
The foreign exchange market or forex market as it is often called is the market in which currencies are traded. Currency Trading is the world‘s largest market consisting of almost trillion in daily volumes and as investors learn more and become more interested, the market continues to rapidly grow. Not only is the forex market the largest market in the world, but it is also the most liquid, differentiating it from the other markets. In addition, there is no central marketplace for the exchange of currency, but instead the trading is conducted over-the-counter. Unlike the stock market, this decentralization of the market allows traders to choose from a number of different dealers to make trades with and allows for comparison of prices. Typically, the larger a dealer is the better access they have to pricing at the largest banks in the world, and are able to pass that on to their clients. The spot currency market is open twenty-four hours a day, five days a week, with currencies being traded around the world in all of the major financial centers. All trades that take place in the foreign exchange market involve the buying of one currency and the selling of another currency simultaneously. This is because the value of one currency is determined by its comparison to another currency. The first currency of a currency pair is called the ?base currency,? while the second currency is called the counter currency. The currency pair shows how much of the counter currency is needed to purchase one unit of the base currency. Currency pairs can be thought of as a single unit that can be bought or sold. When purchasing a currency pair, the base currency is being bought, while the counter currency is being sold. The opposite is true, when the sale of a currency pair takes place. There are four major currency pairs that are traded most often in the foreign exchange market. These include the EUR/USD, USD/JPY, GBP/USD, and USD/CHF. Forex Capital Markets (FXCM) is an online currency trading firm that offers a free demo account to traders who are new and interested in the foreign exchange market. Registering for a demo account allows a new trader to download the online trading platform that is used by the company‘s clients trading live accounts and make trades as if they were doing it with real money. The demo account is an excellent way to experiment
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with the foreign exchange market while learning your way around the trading platform. It allows you to experience every step of currency trading including choosing currency pairs, deciding how much risk to take, tracking the time and dates of placed trades, deciding how long to stay in the trade, and when to exit the trade. It also allows the placing of stop and limit orders on trades. Information about trading and specifically about how to use the online trading platform can be found on the FXCM webpage. In addition, FXCM offers that are extremely useful to both new and experienced currency traders. These ?educational webinars,? as they are called are run by experienced financial strategists and range in topics from trading specific news events to trading the Euro. In addition to the webinars, FXCM also offers numerous online courses that teach investors how to trade the currency market.
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e. Derivatives:
The term ?Derivative‘ stands for a contract whose price is derived from or is dependent upon an underlying asset. The underlying asset could be a financial asset such as currency, stock and market index, an interest bearing security or a physical commodity. Today, around the world, derivative contracts are traded on electricity, weather, temperature and even volatility. According to the Securities Contract Regulation Act, (1956) the term ?derivative? includes: (i) a security derived from a debt instrument, share, loan, whether secured or unsecured, risk instrument or contract for differences or any other form of security; (ii) A contract which derives its value from the prices, or index of prices, of underlying securities. Derivatives that trade on an exchange are called exchange traded derivatives, whereas privately negotiated derivative contracts are called OTC contracts. The OTC derivatives markets have the following features compared to exchange-traded derivatives: (i) The management of counter-party (credit) risk is decentralized and located within individual institutions, (ii) There are no formal centralized limits on individual positions, leverage, or margining, (iii) There are no formal rules for risk and burden-sharing, (iv) There are no formal rules or mechanisms for ensuring market stability and integrity, and for safeguarding the collective interests of market participants, and (iv) The OTC contracts are generally not regulated by a regulatory authority and the exchange‘s self-regulatory organization. They are however, affected indirectly by national legal systems, banking supervision and market surveillance.
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Types of Derivative Contracts
Derivatives comprise four basic contracts namely Forwards, Futures, Options and Swaps. Over the past couple of decades several exotic contracts have also emerged but these are largely the variants of these basic contracts. Let us briefly define some of the contracts ?
Forward Contracts: These are promises to deliver an asset at a predetermined date in future at a predetermined price. Forwards are highly popular on currencies and interest rates. The contracts are traded over the counter (i.e. outside the stock exchanges, directly between the two parties) and are customized according to the needs of the parties. Since these contracts do not fall under the purview of rules and regulations of an exchange, they generally suffer from counterparty risk i.e. the risk that one of the parties to the contract may not fulfill his or her obligation.
?
Futures Contracts: A futures contract is an agreement between two parties to
buy or sell an asset at a certain time in future at a certain price. These are basically exchange traded, standardized contracts. The exchange stands guarantee to all transactions and counterparty risk is largely eliminated. The buyers of futures contracts are considered having a long position whereas the sellers are considered to be having a short position. It should be noted that this is similar to any asset market where anybody who buys is long and the one who sells in short. Futures contracts are available on variety of commodities, currencies, interest rates, stocks and other tradable assets. They are highly popular on stock indices, interest rates and foreign exchange.
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Options Contracts: Options give the buyer (holder) a right but not an
obligation to buy or sell an asset in future. Options are of two types - calls and puts. Calls give the buyer the right but not the obligation to buy a given quantity
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of the underlying asset, at a given price on or before a given future date. Puts give the buyer the right, but not the obligation to sell a given quantity of the underlying asset at a given price on or before a given date. One can buy and sell each of the contracts. When one buys an option he is said to be having a long position and when one sells he is said to be having a short position. It should be noted that, in the first two types of derivative contracts (forwards and futures) both the parties (buyer and seller) have an obligation; i.e. the buyer needs to pay for the asset to the seller and the seller needs to deliver the asset to the buyer on the settlement date. In case of options only the seller (also called option writer) is under an obligation and not the buyer (also called option purchaser). The buyer has a right to buy (call options) or sell (put options) the asset from / to the seller of the option but he may or may not exercise this right. Incase the buyer of the option does exercise his right, the seller of the option must fulfill whatever is his obligation (for a call option the seller has to deliver the asset to the buyer of the option and for a put option the seller has to receive the asset from the buyer of the option). An option can be exercised at the expiry of the contract period (which is known as European option contract) or anytime up to the expiry of the contract period (termed as American option contract). ?
Swaps: Swaps are private agreements between two parties to exchange cash
flows in In future according to a pre arranged formula. They can be regarded as portfolios of forward contracts. The two commonly used swaps are: • •
Interest rate swaps: These entail swapping only the interest related cash flows between the parties in the same currency. Currency swaps: These entail swapping both principal and interest between the parties, with the cash flows in one direction being in a different currency than those in the opposite direction.
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f. Risk management:
Risk management is the identification, assessment, and prioritization of risks (defined in ISO 31000 as the effect of uncertainty on objectives, whether positive or negative) followed by coordinated and economical application of resources to minimize, monitor, and control the probability and/or impact of unfortunate events or to maximize the realization of opportunities. Risks can come from uncertainty in financial markets, project failures (at any phase in design, development, production, or sustainment lifecycles), legal liabilities, credit risk, accidents, natural causes and disasters as well as deliberate attack from an adversary, or events of uncertain or unpredictable root-cause. Several risk management standards have been developed including the Project
Management Institute, the National Institute of Standards and Technology, actuarial societies, and ISO standards, Methods, definitions and goals vary widely according to whether the risk management method is in the context of project management, security, engineering, industrial processes, financial portfolios, actuarial assessments, or public health and safety. The strategies to manage risk typically include transferring the risk to another party, avoiding the risk, reducing the negative effect or probability of the risk, or even accepting some or all of the potential or actual consequences of a particular risk. Certain aspects of many of the risk management standards have come under criticism for having no measurable improvement on risk, whether the confidence in estimates and decisions seem to increase. In ideal risk management, a prioritization process is followed whereby the risks with the greatest loss (or impact) and the greatest probability of occurring are handled first, and risks with lower probability of occurrence and lower loss are handled in descending order. In practice the process of assessing overall risk can be difficult, and balancing resources used to mitigate between risks with a high probability of occurrence but lower
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loss versus a risk with high loss but lower probability of occurrence can often be mishandled. Intangible risk management identifies a new type of a risk that has a 100% probability of occurring but is ignored by the organization due to a lack of identification ability. For example, when deficient knowledge is applied to a situation, a knowledge risk materializes. Relationship risk appears when ineffective collaboration occurs. Processengagement risk may be an issue when ineffective operational procedures are applied. These risks directly reduce the productivity of knowledge workers, decrease cost effectiveness, profitability, service, quality, reputation, brand value, and earnings quality. Intangible risk management allows risk management to create immediate value from the identification and reduction of risks that reduce productivity. Risk management also faces difficulties in allocating resources. This is the idea of opportunity cost. Resources spent on risk management could have been spent on more profitable activities. Again, ideal risk management minimizes spending (or manpower or other resources) and also minimizes the negative effects of risks.
First let's revise the simple meaning of two words, viz., Types and Risk. In general and in context of this finance-related article, 1. Types mean different classes or various forms / kinds of something or someone. 2. Risk implies in the extend to which any chosen action or an inaction that may lead to a loss or some unwanted outcome. The notion implies that a choice may have an influence on the outcome that exists or has existed. However, in financial management, risk relates to any material loss attached to the project that may affect the productivity, tenure, legal issues, etc. of the project.In finance, different types of risk can be classified under two main groups, viz. 1. Systematic risk. 2. Unsystematic risk.
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Two main groups under which types of risk are classified is depicted below.
Now let's discuss the simple meaning of systematic and unsystematic risk. Systematic risk is uncontrollable by an organization and macro in nature. Unsystematic risk is controllable by an organization and micro in nature.
Systematic Risk
Systematic risk is due to the influence of external factors on an organization. Such factors are normally uncontrollable from an organization's point of view. Systematic risk is a macro in nature as it affects a large number of organizations operating under a similar stream or same domain. It cannot be planned by the organization. Types of risk under the group of systematic risk are listed as follows: 1. Interest rate risk. 2. Market risk. 3. Purchasing power or Inflationary risk. The types of risk grouped under systematic risk are depicted below.
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Now let's discuss each risk classified under the group of systematic risk.
1. Interest rate risk
Interest-rate risk arises due to variability in the interest rates from time to time. It particularly affects debt securities as they carry the fixed rate of interest. The interest-rate risk is further classified into following types.
1. Price risk. 2. Reinvestment rate risk.
The types of interest-rate risk are depicted below.
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The meaning of various types of interest-rate risk is discussed below. Price risk arises due to the possibility that the price of the shares, commodity, investment, etc. may decline or fall in the future. Reinvestment rate risk results from fact that the interest or dividend earned from an investment can't be reinvested with the same rate of return as it was acquiring earlier. 2. Market risk Market risk is associated with consistent fluctuations seen in the trading price of any particular shares or securities. That is, it is a risk that arises due to rise or fall in the trading price of listed shares or securities in the stock market. The market risk is further classified into following types. 1. Absolute risk. 2. Relative risk. 3. Directional risk. 4. Non-directional risk. 5. Basis risk. 6. Volatility risk.
The types of market risk are depicted in the following diagram.
The meaning of different types of market risk is briefly discussed below.
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Absolute Risk is the risk without any content. For e.g., if a coin is tossed, there is fifty percentage chance of getting a head and vice-versa. Relative risk is the assessment or evaluation of risk at different levels of business functions. For e.g. a relative risk from a foreign exchange fluctuation may be higher if the maximum sales accounted by an organization are of export sales. Directional risks are those risks where the loss arises from an exposure to the particular assets of a market. For e.g. an investor holding some shares experience a loss when the market price of those shares falls down. Non-Directional risk arises where the method of trading is not consistently followed by the trader. For e.g. the dealer will buy and sell the share simultaneously to mitigate the risk. Basis risk is due to the possibility of loss arising from imperfectly matched risks. For e.g. the risks which are in offsetting positions in two related but non-identical markets. Volatility risk is the risk of a change in the price of securities as a result of changes in the volatility of a risk factor. For e.g. volatility risk applies to the portfolios of derivative instruments, where the volatility of its underlying is a major influence of prices.
3. Purchasing power or inflationary risk
Purchasing power risk is also known as inflation risk. It is so, since it emanates (originates) from the fact that it affects a purchasing power adversely. It is not desirable to invest in securities during an inflationary period. The purchasing power or inflationary risk is classified into following types. 1. Demand inflation risk. 2. Cost inflation risk. The types of purchasing power or inflationary risk are depicted below.
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Demand inflation risk arises due to increase in price, which result from an excess of demand over supply. It occurs when supply fails to cope with the demand and hence cannot expand anymore. In other words, demand inflation occurs when production factors are under maximum utilization. Cost inflation risk arises due to sustained increase in the prices of goods and services. It is actually caused by higher production cost. A high cost of production inflates the final price of finished goods consumed by people.
Unsystematic Risk
Unsystematic risk is due to the influence of internal factors prevailing within an organization. Such factors are normally controllable from an organization's point of view. Unsystematic risk is a micro in nature as it affects only a particular organization. It can be planned, so that necessary actions can be taken by the organization to mitigate (reduce the effect of) the risk. The types of risk grouped under unsystematic risk are depicted below. 1. Business or liquidity risk. 2. Financial or credit risk. 3. Operational risk.
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The types of risk grouped under unsystematic risk are depicted below
Now let's discuss each risk classified under the group of unsystematic risk. 1. Business or liquidity risk Business risk is also known as liquidity risk. It is so, since it emanates (originates) from the sale and purchase of securities affected by business cycles, technological changes, etc. The business or liquidity risk is further classified into following types. 1. Asset liquidity risk. 2. Funding liquidity risk. The types of business or liquidity risk are depicted and explained below.
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Asset liquidity risk is the risk of losses arising from an inability to sell or pledge assets at, or near, their carrying value when needed. For e.g. assets sold at a lesser value than their book value. Funding liquidity risk is the risk of not having an access to sufficient funds to make a payment on time. For e.g. when commitments made to customers are not fulfilled as discussed in the SLA (service level agreements). 2. Financial or credit risk Financial risk is also known as credit risk. This risk arises due to change in the capital structure of the organization. The capital structure mainly comprises of three ways by which funds are sourced for the projects. These are as follows: 1. Owned funds. For e.g. share capital. 2. Borrowed funds. For e.g. loan funds. 3. Retained earnings. For e.g. reserve and surplus. The financial or credit risk is further classified into following types. 1. Exchange rate risk. 2. Recovery rate risk. 3. Credit event risk. 4. Non-Directional risk. 5. Sovereign risk. 6. Settlement risk. The types of financial or credit risk are depicted and explained below.
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Exchange rate risk is also called as exposure rate risk. It is a form of financial risk that arises from a potential change seen in the exchange rate of one country's currency in relation to another country's currency and vice-versa. For e.g. investors or businesses face an exchange rate risk either when they have assets or operations across national borders, or if they have loans or borrowings in a foreign currency. Recovery rate risk is an often neglected aspect of a credit risk analysis. The recovery rate is normally needed to be evaluated. For e.g. the expected recovery rate of the funds tendered (given) as a loan to the customers by banks, non-banking financial companies (NBFC), etc. Sovereign risk is the risk associated with the government. In such a risk, government is unable to meet its loan obligations, reneging (to break a promise) on loans it guarantees, etc. Settlement risk is the risk when counterparty does not deliver a security or its value in cash as per the agreement of trade or business. 4. Operational risk Operational risks are the business process risks failing due to human errors. This risk will change from industry to industry. It occurs due to breakdowns in the internal procedures, people, policies and systems.
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The operational risk is further classified into following types. 1. Model risk. 2. People risk. 3. Legal risk. 4. Political risk. The types of operational risk are depicted and explained below.
Model risk is the risk involved in using various models to value financial securities. It is due to probability of loss resulting from the weaknesses in the financial model used in assessing and managing a risk. People risk arises when people do not follow the organization‘s procedures, practices and/or rules. That is, they deviate from their expected behavior. Legal risk arises when parties are not lawfully competent to enter an agreement among them. Furthermore, this relates to regulatory risk, where a transaction could conflict with a government policy or particular legislation (law) might be amended in the future with retrospective effect. Political risk is the risk that occurs due to changes in government policies. Such changes may have an unfavorable impact on an investor. This risk is especially prevalent in the third-world countries.
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chapter 3 Mechanics ? Introduction ? Case study. ? Treasury management system ? Treasury software
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Chapter 3:-Mechanism:
Integrating Treasury Mechanism a typical treasury comprises three sub-sections – front, middle and back office. Each office has specified functions and goals to achieve. The front office usually performs the market trading, tracking of exchange rate etc. it may consist of different desks, each dealing with different market like forex, money market, fixed income etc. the front office also looks after the market intelligence, relationships with investors and banks. In fact, the front office is the strategic decision making part of corporate treasury. The middle office usually looks after the risk management aspects such as Asset Liability Management (ALM), disbursement of information on various positions to the front office and compliance of reporting requirement. Back office does all the background work like keeping the records and managing the past data and accounting systems. In treasury integration it is a usual practice that a specialized solution provider maintains both the back and middle office function of treasury. However, the strategic front office is managed by an internal team. Computer system coupled with internet processes all the information and trade orders in real time because the solution provider manages these functions for a host of other companies also the clients benefit on reduced costs through economies of scale. (See figure) Integrated treasury is now a global phenomenon. Financial borders between countries are breaking down. Cross-country movements of currency, goods and services are now practically free from impediments, giving rise to widening and deepening of growth of capital and money markets. To cope with such Transfer pricing Transfer pricing mechanism is one by which the efficiency of a treasury is monitored; profit allocation between various profit centers of the bank is properly done
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? Case study:
SBI is one of the India's largest banks. It is also home to the country's biggest and most powerful Treasury,
contributing to a major part of the total turnover in the money and forex markets. Through a network of stateof-the-art dealing rooms in India and abroad, backed by the assured
expertise of informed professionals, the SBI extends round-the-clock
support to clients in managing their forex and interest rate exposures. SBI's relationships with over 700 correspondent banks are also leveraged in extracting maximum value from treasury operations. SBI's treasury operations are channeled through the Rupee Treasury, the Forex Treasury and the Treasury Management Group.
Rupees treasury: The Rupee Treasury deals in the domestic money (Rs) and debt markets while the Forex Treasury deals mainly in the local foreign exchange market. The Treasury Management Group monitors the investment, risk and asset-liability management aspects of the Bank's overseas offices. The Rupee Treasury carries out the bank‘s rupee-based treasury functions in the domestic market. Broadly, these include asset liability management, investments and trading. The Rupee Treasury also manages the bank‘s position regarding statutory requirements like the cash reserve ratio and the statutory liquidity ratio; as per the norms of the Reserve Bank of India.
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? Treasury Management System:
DEFINITION: A ?Treasury Management System? (TMS) (also known as a Treasury Workstation) is a term for a treasury-oriented system or software package that specializes in the automation of manually-intensive, repetitive steps needed to manage a company‘s cash flows. The system allows a company to efficiently communicate with financial institutions in order to manage cash, transactions, forecasts, FX, and even investments and debt. The TMS can seamlessly interface with a company‘s general ledger offering an instant financial dashboard. The financial crisis has heightened the need for better transparency into a company's cash positions as the traditional lines of credit have become increasingly scarce. Through the proper selection and implementation of a TMS corporate treasurers can efficiently respond to the financial needs of the company.
Why A Treasury Management System:
Over the past two years our global economy has experienced a meltdown. The financial markets are fraught with uncertainty and caution. We have witnessed several large financial institutions collapse, experienced the scarcity of tightened credit, stressed over increase of liquidity risk, lost sleep over tanked investments, and were burned by the exposures to fluctuating currencies. All this sheds light on the need for better controls, quicker access to information, and better transparency. As this transformation has taken place the corporate needs continue to emerge. They need real-time access to information, system integration, and consolidated global reporting capabilities with the ability to create on demand reports for senior management. Excel spreadsheets have their place but are manual and risk prone. Companies must open their eyes to the need for treasury solutions. In short, to remain competitive companies need to ensure optimal use of treasury technology such as a Treasury Management System (TMS).
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Selection Process:
With a large variety of Treasury Management Systems (TMS) and vendors available today (over 40), the selection process can be a daunting challenge for a treasurer to navigate. To further complicate matters the market is maturing, meaning the available systems currently meet the functional needs of most companies. So a treasurer must look into the future and select a vendor whose TMS will be flexible enough to evolve with the rapidly developing technologies that surface. As you can imagine there is corporate (and personal) risk involved in selecting a TMS. This risk is derived from cost and time. The cost can be from $20,000 to $250,000+ plus while the resources and time spent on selection and implementation can range from 5 month to 1 year. Whether you are selecting a bank-offered system, in-house installed application, the treasury module of an ERP, or an Application Service Provider (ASP) system you can see the importance of utilizing a structured and disciplined selection process that ensures all requirements are met. My approach is quite simple and intuitive but it helps to have a website where you can come back and review the steps again and again. Here we go….
Step 1 – Build the TMS Team
First and foremost - ensure that you have executive support. The CFO or Treasurer must understand and believe the need for the new system is critical. They need to understand the complexities of the project and the critical nature of its success. Once on board, you can lean on him or her for support and resources. What you do not want, is to be in the process of selecting or implementing and at the same time explaining to the executives what you are doing. Get support before you move on. The lack thereof can be careerending. This is a large undertaking at best. It is critical that you get a solid project manager on board right from the beginning. The best project managers are those that bring a combined skill set of project management methodologies and treasury knowledge. As IT,
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Treasury, Accounting and other departments will be stakeholders you will need someone to manage the players to ensure timelines, approvals, and issue resolutions are met. You will also need a proficient IT person who has an understanding of treasury concepts and a good grasp of technological advances. This will be a lengthy project, so secure someone who is solid. Lastly, ensure that there is representation from each of the stakeholders. This would involve Treasury, IT, Accounting, Investor Reporting, etc. Make sure every and any department that will be touched by this project is represented. This involvement assures that the selection and implementation process will be clear, approved, and disciplined.
Step 2 – Define the TMS Project
From the beginning, the project should be clearly defined. At a minimum a proper project definition should include:
1234-
A task list - which includes forecasting start and completion times and dates. A list of resources - details what is needed for the completion of these tasks. A list of dependencies among the tasks. Project milestones - allowing the tasks to be assessed and the progress are noted.
The milestones should be realistic so that the defined project can be strictly adhered to. A clearly defined project that is communicated from the onset will ensure that the stakeholders are clear as to what their responsibilities will be and time frames associated with those responsibilities.
Step 3 – Define the Project Requirements (Build Your Wish List!)
Correctly defining the Project Requirements is critical to the project's success. This can take anywhere from a week to a few months to complete depending on the complexities involved. It is important to draw up the requirements before any vendor presentations are given. This way you will stick to defining the core features needed by your company and not get caught up in the bells and whistles of the vendor presentations. Also, through defining your requirements in this manner, you may find that all you need is an additional module or change in process rather than a new Treasury Management System (TMS).
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This process will also help you highlight the weaknesses in the existing system in relation to the required core functionality. Properly documented requirements facilitate the creation of a benchmark by which a comparison to proposed solutions may be evaluated. This document must describe in sufficient detail the treasury features and the environment in which it will operate. There are many ways to obtain the requirements but I suggest the following steps: 1Capture What You Know. This step must be provided by the users of the system.
Review your current system and detail each feature you use. Define the weaknesses if any. Note the functionality and features you want to retain from your old system as well as the required improvements from the new system. Add this to your list. 2Automation. Analyze the treasury processes. Break them down into step-by-step
tasks to identify where a new system could improve efficiency through automation. Add this to your list of requirements. 3Dependencies and Integrations. In detail, list out how your old system integrates
with other systems, i.e., banking, general ledger, reporting and market data. What dependencies do you have and what is the timing of those dependencies? Are there other departments that utilize your old system for balances or transaction information? Does investor reporting utilize the BAI download for transaction information that you were not aware of? Add this to your list of requirements. 4What Is The Plan? Understand your company‘s strategic plan. The selection of
your TMS must be in harmony with the plans of the company. Is your company going from a decentralized to a centralized treasury group next year? Is there significant growth planned for the future? Is your company diversifying into other product categories? This will help you in the selection process as to whether you need a modular (scalable, flexible, deployable) solution or a canned solution (one that will not change over time). 5Your Wish List. List all the treasury features you would have in a perfect world.
In addition to balance reporting, cash positioning, and payment processing.
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? Treasury Software: KASTLE:-Treasury Management Solution
KASTLE™ Treasury is a leading, integrated treasury management solution used by financial institutions worldwide to meet their business objectives. KASTLE™ Treasury:
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Provides organizations with a sophisticated, multi-entity, multi-portfolio, multidealing room environment supported by robust risk management, back-office management, and MIS
? ?
Presents a holistic picture of an organization‘s financial health Covers several key markets such as foreign exchange, money, equity, and their related derivative instruments
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Identifies open positions, measures risks in real time, assists in generating P&L statements, and facilitates settlements
Kastle Treasury can also be deployed with Oracle Database 11g Release 2. Kastle Treasury is now Oracle Exadata & Exalogic ready.
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Key features
Automation and analyses features ? ? ? ? Wide range of MIS reports Real-time feed integration from multiple service providers for many instruments and currencies Structured portfolio approach enabling simulation analysis Decision support via exhaustive pre- and post-trade support tools and analytics, including pricing and valuation of plain vanilla and complex derivative instruments ? ? ? ? ? Intelligent messaging module capable of handling SWIFT, RTGS, and other formats Full-fledged Nostro reconciliation module (Nostroplus) User-friendly interface to capture exchange rates, benchmark rates, scrip rates, and prices of stocks in F&O segment VC++ component library for automated mathematical computations Complete straight-through processing functionality, covering front-, middle-, and back-office MIS and reporting requirements
Flexibility and customization features
? ? ? ? ? ? ? ? Multi-entity system Multi-dealing-room capability Multi-portfolio enabled Multicurrency accounting Platform-independent database Seamless interface with 3rd-party market information systems High level of parameterization—varying requirements can be met by simply changing settings Transaction downloads across various dealing systems (e.g., Dealing 3000)
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Key differentiators
? ? ? ? ? ? ? ? Convenient, right-click enabled deal entry and retrieval criteria Comprehensive analytics for front-office users Extensive limit management User-definable accounting policies Compliant with SOX, Basel II, IFRS, MiFID, and hedge accounting rules Extensive online context sensitive help available at a single click Unicode compliant, with language localization for all screens and interfaces Modular yet seamless approach (front-, middle- and back-office operations work in an independent yet integrated fashion)
Key business benefits
? 100% accuracy in execution and accelerated decision-making made possible through treasury management tools (real-time information from multiple sources, MIS, and analytical solutions) and functionalities like historical simulation and ?what-if? analyses that enable dealers to respond quickly and accurately to market conditions ? ? ? Tailored solutions to real-time business problems via flexible, intelligent, and user-friendly systems and interfaces Process efficiency achieved through implementation of best practices
incorporated into the solution Improved productivity and reduced costs—automated analyses lead to efficient operations with 60% increase in productivity and swift decision-making, while minimizing overheads and cutting costs incurred on salary by 42% ? Enhanced security with user access, control, and administration security features
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Chapter 4: Treasury Management at International Level.
? International level
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Chapter 4: International level.
Functions of treasury management at international level:
At the international level the functions of treasury management is concerned with the management of funds in the foreign
currencies. Foreign exchange as a subject refers to the means and methods by which the rights to income and wealth in one currency are converted into similar fights in terms of another countries currency. Such exchanges may be in the form of one currency to another or on the conversion of credit instruments denominated in different currencies such as cheques, drafts, telegraphic transfers, bills of exchange, trade bills or promissory notes. Exchange is done through dealers in foreign exchange regulated by the central bank of the country. Banks are usually a dealer apart from other specialized agencies. One of the important components of the international financial system is the foreign exchange market. The various trade and commercial transaction between countries results in receipts and payment between them. These transactions are carried out t between the currencies of the concerned countries- any one of them or mutually agreed common currency. Either way transaction involves the conversion of currency to the other. The foreign exchange market facilitates such operations. The demand for goods and services from one country to another is the basis for demand for currencies in the market. Thus basically, demand for and supply of the foreign currencies arises from exporter and importers or the public having some transactions with foreign currencies.
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Companies having an import or export components in their business profile have to frequently deal in the forex operations. Forex operations in the country being supervised by the central bank, reference to the central bank in one form or the other is necessary use foreign exchange. If the country on the whole is a net exporter of goods and services. It would have surplus of foreign exchange, if on the other hand, it is a net importer then it would have the shortage of foreign exchange. The extent of regulation of the foreign market depends on the availability of foreign exchange in a country. If the forex is scares, then holding and using it would be subject to a lot of regulatory control. It also matters whether international trade forms a significant percentage of the GDP of a nation. If it is so, then the awareness about the forex regulation would be much more wide spread as compared to the situation where the foreign trade forms a significant portion of GDP. Presently, however, with increasing globalization, forex dealing has become a normal part of treasury operations. Every foreign exchange transaction involves a two way conversion- a purchase and sale. Conversion of domestic currency into foreign currency involves purchase of the later and sale of the former and vice versa. These transactions are routed through the banks. The takes the shape of either outright release of foreign currency for meeting the travel and related requirements or payment to outside parties in the denominated currency via the medium of correspondent banks. For effecting payment, following instruments are generally used:
Telegraphic transfers (TT)
A TT is a transfer of money by telegram or cable or telex or fax from one center to another in a foreign currency. It is a method used by banks with their own codes and correspondent relations with banks and abroad for transmission of funds. As there is no loss if interest or capital risk in this mode, it enjoys the best rate for the value of receipts.
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Mail transfers (MT)
It is an order to pay cash to a third party sent by a bank to its correspondent or branch abroad. It is issued in duplicate, one to the party buying it and the other to the correspondent bank. The amount is paid by the correspondent bank to the third party mentioned therein in the transferee country by its own cheque or by the by crediting in the party‘s account. As the payment is made after the mail advice is received at the other end, which will take few days, the rate charged to the purchaser is cheaper to the extent of the interest gain to the seller bank.
Drafts and cheques:
Draft is a pay order issued by the banks on its own branch or correspondent bank abroad. It is payable on the sight but there is always a time lapse in the transit to in post between the payment by the purchaser of the drafts to his banks and the receipt of the money by the seller in the foreign center. As in the case of MT, there is risk of loss of draft in transit or delay in release of payment to the beneficiary and loss of interest in the intervening period.
Bills of exchange:
It is an unconditional order in writing addressed by one person to another, requiring the person to whom the order is addressed, to pay certain sum on demand or within a specified time period. If it is payable on demand, it is called a sight bill. If it is payable after a gap of some time, it is called a usance bill. Such bills can be banker‘s bill or trader‘s bill. Banker‘s bill are drawn on banks abroad while trade bills are made between individual parties
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Chapter 5:- Regulation and Supervision ? Internal and External Audit
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? Internal and external audit
Internal and external auditors have mutual interests regarding the effectiveness of internal financial controls. Both professions adhere to codes of ethics and professional standards set by their respective professional associations. There are, however, major differences with regard to their relationships to the organization, and to their scope of work and objectives. The internal auditors' are part of the organization. Their objectives are determined by professional standards, the board, and management. Their primary clients are management and the board. External auditors are not part of the organization, but are engaged by it. Their objectives are set primarily by statute and their primary client - the board of directors. The internal auditor‘s scope of work is comprehensive. It serves the organization by helping it accomplish its objectives, and improving operations, risk management, internal controls, and governance processes. Concerned with all aspects of the organization - both financial and non-financial - the internal auditors focus on future events as a result of their continuous review and evaluation of controls and processes. They also are concerned with the prevention of fraud in any form. The primary mission of the external auditors is to provide an independent opinion on the organization's financial statements, annually. Their approach is historical in nature, as they assess whether the statements conform to generally accepted accounting principles, whether they fairly present the financial position of the organization, whether the results of operations for a given period of time are accurately represented, and whether the financial statements have been materially affected. The internal and external auditors should meet periodically to discuss common interests; benefit from their complementary skills, areas of expertise, and perspectives; gain understanding of each other's scope of work and methods; discuss audit coverage and scheduling to minimize redundancies; provide access to reports, programs and working papers; and jointly assess areas of risk. In fulfilling its oversight responsibilities for assurance, the board should require coordination of internal and external audit work to increase economy, efficiency, and effectiveness of the overall audit process.
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The ever changing role of the Corporate Treasurer, specifically his evolution into ?manager of corporate risk‘ increasing transaction volumes and complexity of transactions and information requirements, and continued globalization of treasury operations will drive the development of treasury systems in future. Vendors and solutions will continue their consolidation and ?best of breed‘ solutions will evolve from the conglomeration of vendors and systems. Big names in software like ORACLE, SAP and Microsoft will offer solutions or form partnerships with leading treasury system vendors. Treasury Department is directly or indirectly involved in day –to- day business of the Bank and it is involved in the day-to-day asset liability management of the bank. Treasury will be able to, through various techniques, manage risks through its various operations bring down the cost of funds and also improve the margins. Reserves Management, Investment Management, Liquidity (both short term and long term) Management, is the other major functions of the Treasury Management.
It is certain that major international corporate are seeing real added value in being able to link treasury centers together and make stronger links with their own subsidiaries. The technology making this happen is the internet and web-enabling of TMSs. Major corporate can see real value in being able to merge their treasury centers into a single, central database, allowing for more accurate and quicker analysis of the group‘s finances. New technology that brings about greater functionality and flexibility. In structuring treasury operations means that it is now possible to redefine the scope of a bank‘s treasury requirements to better suit each bank‘s business.
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Treasury handles very sensitive and very important function of the Bank. Hence it ha s been set up in specific structure for smooth but transparent operations. As technology develops , so there is the ability for systems to become more advanced ; with this advanced technology available, treasuries are then forced to look at ways to increase ate cost effectiveness of their functions.
Thus making the Treasury Centralised will lead to betterment of Banking & Industry & will one day form a Single Banking system all over the world.
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doc_248055734.docx
Chapter 1:- Integrated Treasury
? Introduction ? Need of integration of bank treasury ? Functions of integrated treasury ? Function of treasury – centralized v/s decentralized
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Integrated Treasury Management
Chapter 1: Integrated treasury ? Introduction
The reforms set in since the past few years has brought along with it host of risks for the banks, apart from a variety of opportunities. Now banks will have to learn to operate in a more deregulated environment a diversified and competitive market place, which will require them to manage risks better. Recent volatility in exchange rate movements and domestic interest rate levels has indicated the influence of the global market within the country. Such volatilities would precipitate substantial losses and at times irretrievable situations for several banks. These situations warrant proactive or prompt reactive moves from the banks. It is in the context of the urgent need of TREASURY MANAGEMENT for the banks emerge. Bank with an extensive branch network has to establish a centralized treasury and dealing room, to counter the market situations and contain the risk exposures at the earliest. Until the few years back, many of the Indian banks were giving a secondary importance to treasury management. There are dangers in giving treasury operations a secondary role. A significant proportion of the treasury related problems are to be attended immediately for instance, loss of interest arising from surplus funds available for the banks on day to day basis. An open currency risk which has been identified but not acted
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upon for lack of time means that banks profits are at risk for possibly one or more day‘s movement in volatile foreign exchange markets can be very expensive indeed. Therefore, that, even in a relatively small organization, it is essential that treasury work is under taken by at least one individual with a sole or primary responsibilities to cover, at least, cash , management and currency management. A few of the banks have already set up fully functioning treasuries and a couple of them have set up integrated treasuries with forex and domestic dealers sitting in the same dealing room. The word INTEGRATION means consolidation or merger or centralization. In the present context it is the consolidation or the centralization of the segmented financial markets like money market. Debt and capital market and forex market at the macro level and integration of the respective treasuries at the operational level at banks financial institutions. Let us discuss this in the following. Banking reforms which were initiated in the beginning of the 90‘s is slowly opening the domestic economy to the global market. Opportunities are winding for the banks, financial institutions, corporate and others, which would result in intense
market/economy is integrating with the global economy, it is needles to emphasize need for integration of the micro level units. For example different segments within the financial markets are almost integrated. The financial markets which were earlier segregated in different watertight compartments like money market, debt market, capital market, forex market etc. have been almost integrated. Now money can freely flow, of course with lesser regulations, from one market to the other market have been given partial freedom to enter other markets. Now financial institutions which earlier were confined to be long term market have been permitted to enter sort term in money market to lend in call and borrow not only from the open domestic market nut also from the global market. Banks have been permitted to enter the capital/debt market, forex market and money market with partial freedom in certain cases, to mobilize and/or deploy resources. Bank, if not for there own needs, are forced to enter these market very often
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and render services to their clients, which have access to these markets. For example a corporate accessing the overseas market for external commercial borrowing has to ultimately depend on bankers for utilizing the funds it has raised or converting the funds and bringing into the country. Thus we can say, with liberalization of the financial system, markets are almost fully integrated. Once the capital account convertibility (CAC) fully comes, all these markets would have been fully integrated. The impact of the financial integration on CAC can be summarized as follows: ? Promotes competition resulting in better quality products and services. ? Improves quality and number of financial assets as a result of greater liquidity and deeper market. ? Reduces margin and more efficient allocation/ intermediation interest rates to align with global interest rates differential to reflect in foreign exchange forward rates. ? Avoids inducements for tax evasion and capital flight opportunities for diversion/distribution of risk.
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? Needs of integration of the bank treasury
Presently except couple-of treasuries, almost all the treasuries of the public sectors banks are operating in isolations. For example, forex treasury and domestic treasury of many of the banks are operating independently. There may be times that the forex and domestic treasury of these banks might have worked on different directions there by neutralizing an advantageous position or even adversely affecting the banks financial position. This is because the forex treasure may not know the position of the domestic treasury or that the perceptions of both the treasuries may be different or in opposite directions =. Communication/information gap between these two treasuries also may lead to such detrimental position for the banks. This may even lead to the goodwill of the bank. There may be instance when the integrated treasuries of the other banks may take arbitraging opportunities on its unrelated/opposite levels/positions of the banks May ne lending funds to other banks, which may, in turn deploy in foreign currency deposit with the former. There are few banks where even the funds management (money market treasury) and investment management (capital and debt market treasury) are functioning independently.
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Here also these banks are losing opportunities within the domestic market when the interest rates and asset/security prices move in the same direction. Further almost all trade and capital movements which cross international border give rise to a foreign currency asset or create foreign currency liability. Subject to regulatory constraints these currencies may be restrained in that currency and placed or borrowed in the overseas market or domestic market for that currency. Moreover now that banks have been selectively permitted to invest in/borrow from oversea market, such opportunities can be planned only if the banks have an integrated treasury. Banks have now been selectively given licenses to import precious metals for the resident‘s metal traders. Since this operation involves buying of metal from the international market against dollar value and then pricing it in the domestic market, the bank dealing in such a trades has to operate from an integrated treasury. It is now well understood that reserve bank of India intervene in the domestic (rupee) market to regulate the foreign exchange market. For instance, when the Indian rupee started falling steely and crossed Rs. 40/$ and also simultaneously when forwards premium went to dizzy high in the beginning of the year 1998, RBI signaled rise in short term interest rates stayed above 50% continuously for a fortnight, this strengthened the rupee and cooled down forwards and normalcy came into the market within a month‘s time. In such situations, a bank should have its forex and rupees treasury operating with the same focus and in the same direction. There are chanced that the profit made by one treasury in such volatile situations is negated by the other treasury on account of its inadvertent operations.
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? Functions of integrated treasury
The major functions of the treasury units are as follows: Reserve management & investment: It involves, 1. Meeting CRR & SLR obligations 2. Having an appropriate mix of portfolio to optimize yield &duration.
Duration is the weighted average ?life‘ of a debt instrument over which investment in that instrument is recouped. Duration analysis is the tool used to monitor the price sensitivity of an investment instrument to interest rate changes. Funds and liability management: It involves, 1. Analysis of major cash flows arising out of asset liability transactions. 2. Providing a well developed & diversified liability base to fund the various assets in the balance sheet of the banks. 3. Providing policy inputs to the strategic planning group on the banks on funding mix (currency tenor & cost) & yield expected in credit & investment. Asset liability management & term money: ALM calls for determining the optimal size & growth rate of the balance sheet & also prices the asset liability in accordance with prescribed guidelines. Successive reductions in CRR rates & ALM practices by banks increases the demand of funds from tenor of above 15days (term money) to match duration of their assets.
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Risk management: Integrated treasury manages all markets risks associated with a bank‘s liabilities and assets. The market risk of liabilities to floating interest rate risk & asset liability mismatches. The market risk for assets can arise from; 1. Unfavorable changes in interest rates 2. Increasing level of disintermediation‘s 3. Securitization of assets. 4. Emergence of credit derivatives etc. While the credit risk assessment continues to lies in the hands of credit department, the treasury would monitor the cash inflows impact from changes in assets price due to interest rate changes by adhering to prudential exposure limits. Transfer pricing: Treasury is to ensure that the funds of the banks are deployed optimally, without sacrificing yield or liquidity. An integrated treasury unit has the idea of bank‘s overall funding needs as well as direct access to various markets (like money market, capital market, forex market, etc). Hence ideally banks should provide benchmark rates, after summing market risk to various business groups & products categories about the correct business strategy to adopt. Derivative products: Treasury can develop interest rate swaps & other rupee based/cross Currency derivatives products for hedging banks own exposures and also sell such products to customers/other banks. Arbitraging: Treasury units of banks undertake this by simultaneous buying and selling of the same type of assets in two different markets to make risk less profits.
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Capital adequacy: This function focuses on quality of assets; with return on assets (ROA) being a key criterion for measuring the efficiency of deploys funds. An integrated treasury is a major profit center. It has its own P&L measurement. It undertakes exposures through proprietary trading (deals done to make profits out of movements in market interest/exchange rates) that may not be required by general banking.
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? Treasury centralized or decentralized?
The whole treasury functions of the banks can either be centralized at one center or decentralized at different centers but under a single overall supervision. The advantages of a centralized treasury can be summarized as a follows: 1. A centrally organized treasury would have the total picture of liquidity (current/cash and long term) of the bank. This would enable it to take decision/control on the utilization/deployment of the funds to the best advantage of the bank. 2. As the reserve management is a vital function of the treasury, it is advantageous/ prudent to have a single centralized treasury so that it is monitored closely from time to time so that not only default averted but also bare minimum surplus only is maintained over the stationary requirements. 3. It ill is able to take advantage of funds in transit within the banks network like inter branch funds movement, movement of funds between RBI and non RBI centers, etc. otherwise there is possibility that these funds are ignored and left idle in the banking system. 4. Centralized treasury prevents unnecessary movement of funds around different centers but organizes in such a way that actual transmission of funds is minimized. 5. A centralized treasury enables the bank to deal in big quanta in the market and take advantage of the wholesale market. 6. A centralized treasury would have better managerial control, responsibility and risk control. If the treasury is decentralized in smaller units, one unit would not necessarily be aware of the exposure taken by the other unit. Likewise when the market is highly volatile, a proactive treasury may have to change its position within short time to avoid risk. This is possible only if the treasury is centralized. 7. Reporting and fast implementation of management/ALCO decisions is possible only if the treasury is centralized. If it is decentralized, time consumed for
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collection, complications, and analysis of the data will be costly. Later, implementation of the ALCO decisions may get delayed, which may cost to the bank further. Main disadvantage of the centralized treasury is that the bank may not be able to take advantage of the ?better market‘ at other centers. Likewise, as the involvement in financial matters is centralized other centers may not know the importance of treasury management, which may reflect in their actions/omissions.
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Chapter 2: Structure of integrated treasury A. organization
a. Dealing room/front office b. Middle office management c. Back office management
B. functional areas under integrated treasury/ treasury products
a. liquidity management b. audit c. money market d. foreign exchange market e. derivatives f. risk management
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Structure of Integrated Treasury
Introduction:
The structure of the treasury department is very simple. It consists of front offices, middle office, back office, treasurer, audit head, forex dealers, derivative dealers, money market dealers, funds and liquidity management and risk management. Treasurer is the person responsible for all the transactions of the treasury department. He has to report directly to the front office. The structure of integrated treasury can be better understood from the following diagram Elements of treasury
Front office
Middle office
Treasurer
Back office
Liquidity
Audit
Money market Risk management
ry
Foreign exchange
management model:
Derivatives
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Organization of Treasury
The treasury is organized either as a department of the banks, or as a specialized branch under direct control of the bank‘s head office. In either case the treasury functions with a group of autonomy with its own accounting system. The branch status is preferred as books of accounts of treasury can be maintained independently (with its own P&L account and GL accounts). On the other hand, the departmental from has the advantage of easier coordination with related departments at head office (such as accounts and credit department) in a line management. Treasury as a specialized branch enjoys as additional advantage as the branch can act as authorized dealer for foreign exchange business and can participate in clearing and settlement systems directly, while head office department can only act through a branch for its business operations. We may therefore conclude that in the context of integrated treasury operations, a treasury branch should be the preferred form of organization. The treasury is headed by a senior management person – a general manager, dy. General manager, vice-president or with some such designation. Treasury being a key activity of the bank, Head of treasury should be a person ho would report direct to the chief executive of the bank. However the level of reporting and delegation of powers would depend on the size of the bank and importance attached to the treasury activity within the bank. The treasury may be divided into three main divisions: the dealing room (for front office), the middle office, and the back office (or, treasury administration).
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Dealing Room
Middle Office
Back Office
a. Dealing room/front office:
The dealing room is headed by chief dealer, who is in charge of the front office. The dealer working under him buys and sells in the markets. Each dealer specializes in one of the markets, i.e. foreign exchange, money market or securities market, although in an integrated treasury, the dealers are generally familiar with all the markets depending on the size of operations, there may be dealers dedicated to major currencies, or dealers specializing only in forward markets or derivatives. It is also common to have a separate corporate dealer, exclusive to attend to major corporate customers/ merchant business. The securities market is normally divided in two parts, primary and secondary markets. The securities dealer deals only with secondary market i.e. buying and selling of securities already available in the market. As a matter of convenience, the dealer also participates in auction of government securities and T-bills, conducted periodically by RBI. The primary market comprises of new issues by way of private placement. The primary market issues are subscribed by investment department, situated outside the dealing room, but as part of the treasury. This is so, because primary issues need appraisal of credit risk, through examination of issue terms and where so stipulated, documentation for secured debt (through a Trustee). Often banks require inputs from market research, for which, either they may have an in-house Research dept, may collect it from published material.
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b. Middle office:
Middle office is created exclusively to provide information to the management (MIS) and to implement risk management system. Middle office monitors exposure limits and stop loss limits to treasury and reports to the management on key parameter of performance. Transfer pricing mechanism may also be implemented through middle office. In smaller banks, middle office may also functions as ALM support group, as the balance sheet risk management is closely connected to treasury risk management. Investment department, as stated earlier, will deal with primary issues. Whenever a suitable offer is received, the department would put up an investment proposal and obtain approval at appropriate level. Minimum marketable investment being Rs. 5 crores, the investment proposal are scrutinized closely and are generally considered by an investment committee, before the sanction is obtained at appropriate level. The other department in treasury, viz. accounts and administration, systems administration, remittance (swift/RTGS, etc) would be mainly administrative in nature. Some bank may also prefer to have their inter-branch cash transfer department as part of treasury, as the treasury maintains the bank‘s account RBI
c. Back office:
The back office is responsible for verification and settlement of the deals concluded by the dealers. The deals are verified on the basis of deal slips prepared by the dealers and also from the confirmation received from the counterparties. The back office staff also confirms the deals independently with the counterparties (banks and other institutions) over phone and verifies the authenticity of the confirmation document. The back office takes care of all related book-keeping and submission of periodical returns to RBI. Backoffice also maintains Nostro accounts (foreign currency accounts with correspondent banks), funding and security accounts with RBI, Demat account with depository
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participants and ensures that adequate margin money is held with clearing corporation of India for rupee and dollar settlements. Settlement refers to receipt and payment of accounts following deals made by dealers (i.e. sale and purchase of foreign currency, lending and borrowing, sale and purchase of securities etc.). Settlement is a key function of back office as all payment and receipts must take place on value date. Any delay in settlement would result in financial loss to the banks, and delay in payment is considered a default by the banks, severally affecting the bank‘s reputation.
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B. Treasury Products:
Fund Administration
Accounting
Investment Research
Compliance And Regulatory Reporting
Security And Position Administration All Instrument Classes In One System
Portfolio And Fund Management And Analysis
Pre-trade Complaince Trading And Order Management Risk Management
Cash And Custody Management Performance Measurement And Attribution
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Integrated Treasury Management
Treasury management refers to the nature of treasury market and various treasury products available in the market, for raising and deploying funds, for investment, for trading in foreign exchange and securities markets Following are the treasury products used for controlling the overall funds of the banks: ? Liquidity Management ? Audit ? Money Market ? Foreign Exchange Market ? Derivatives ? Risk Management.
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a. Liquidity Management:
Introduction:
The textbook definition of liquidity is straight forward: the ability to provide sufficient funding at reasonable cost in a reasonable period. The definition is simple, but liquidity can be one the more challenging areas of the bank to manage. Maintaining sufficient liquidity is difficult enough under normal circumstances, but what do you do when: In the days following the October 1987 stock market crash, a radio DJ decides to select your bank and broadcast false stories of crowds forming at your door demanding their money? Fictitious stories of a bank run turned into real thing. What do you do? A relatively new bank has a bad quarter of credit losses and faces a major wetback in profitability. Its largest correspondent bank cancels its line of credit, other sources of borrowing follow suit, and suddenly the bank‘s sources of liquidity are cut off except for what is on their balance sheet. What do you do? September 11, 2001: following the terrorist attacks on our country, a number of banks called our office wanting to know if they should close temporarily, rumors of banks runs were starting. What do you do? The foregoing examples are real. They are examples of the kinds of things bank management must consider in their liquidity planning. Plan for the expected but prepare for the unexpected.
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Objectives of liquidity management: The objectives of liquidity management are to maintain statutory prescription, meet contractual and maturing cash outflows and to profitably deploy surplus cash. Sound liquidity management involves prudently managing cash flows as also concentration of assets and liabilities (both on and off balance sheet) with a view to satisfy that cash flows; have an appropriate relationship to approaching cash outflows. Holding excess liquidity has a bearing on profitability because liquid assets in the form of cash and short term securities generate lower yields. A trade off between liquidity needs and profitability necessitates determination of optimum level of liquidity this will have to be supported by liquidity planning that assesses potential future liquidity needs taking into account changes in economic, political, regulatory and other operating conditions. The primary objectives of liquidity management: ? ? An optimum liquidity position Avoid concentration of funding that may leave the bank vulnerable to potential liquidity problems. Liquidity management in banks: Liquidity management is an important function of any business because it is the determinant of whether the entity will be in operation in the foreseeable future. For banks, liquidity management is even more crucial as the lifeline of banking itself is money. This function is so important in the industry that the central bank closely monitors commercial banks to ensure that they are within their regularity limits. In providing this important economic function, banks protect their customers against liquidity problems, but at the same time become exposed to such risks themselves. In an extreme case, such liquidity problems can manifest themselves in runs, even on second banks when customers withdraw their deposits on massive scale. All commercial banks also have dedicated dealers to ensure the liquidity is constantly put in check.
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For a bank, liquidity means having sufficient funds to meet regulatory, contractual and relationship obligations when required and at a reasonable cost to the banks. Once central bank regulatory requirement are met; the two main liquidity demands on a bank are deposit withdrawals and loan demands by customers. Liquidity management has always been an important matter for banks. In today‘s world, many banks face increased liquidity strains, as competition for deposits forces them to look for alternative funding sources. At the same time, financial development has increased both the opportunities and risks in liquidity management. As a result, it is increasingly important that banks plan for there liquidity needs to ensure that they are using stable and low cost methods to fund their operations. In a highly competitive world, only the efficient survive, and using high cost funds puts a bank at a competitive disadvantage.
Short term and long term liquidity needs:
Short term: Short term liquidity needs of a bank may arise several sources. For example, seasonal factors often affect deposit flows and loan demand. A bank pre dominantly catering to agricultural sector may experience fall in deposits and high demand for loans during procurement and harvest period when there is demand for procurement of seeds, plants and fertilizers. Banks, which are heavily dependent on some large customers in this segment, may find seasonal liquidity needs particularly important. Most seasonal fluctuations can predict reasonably accurately on the basis of past experience. The holder of sizable deposits balances and the customers who borrow in substantial amounts also may influence short term liquidity needs of an individual bank to a degree that is directly related to bank‘s size. The short term funding needs of important customers strongly affect the bar short-term liquidity needs short term needs of some customers are very difficult to predict. Much of the needs and intentions of large customers.
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Banks in India can borrow in call money market for overnight as also interbank term money market for short term duration generally upon 14days. Banks can also meet short term liquidity needs through repo transactions. In case borrowings in money market turn out to be costly, banks can look sale of certain liquid assets. Banks also have investment in 91 days and 364 days treasury bills, which are considered most liquid and are available to meet any short term liquidity needs. Long term: Long term liquidity needs are generally related to secular trends of the community or market that a bank serves. In rapidly expanding areas, loans often grow faster than deposits. Banks in such a situation needs sources of liquidity to provide funds for loan expansion. In stable communities, on the other hand deposits may show a steady rise while loans remain virtually unchanged. In such cases, the longer view of liquidity requirements may enable the banks to keep more fully invested than it otherwise would be required. To gauge the banks liquidity needs over a long term, a bank‘s management must attempt long range economic forecasting as the basis on which it can reasonably estimate loan and deposit level for the next one year or for a period up to 5 years. Long term liquidity needs can be determined by classifying every item on the asset side either as liquid or illiquid depending on whether that particular assets can be converted into useable assets within a period of less than 90 days with a little loss if any on sale of that asset. Similarly on the liability side, various sources of funds, deposits and capital are classified as either volatile or stable depending on withdrawal pattern on the basis of seasonal, rate or other pressures. The gap is positive if liquid assets exceed volatile sources and negative if the reverse is the case. Meeting long term liquidity needs can be more complex. As loan growth exceeds deposits growth for most banks, they will be faced with long term liquidity needs. Selling liquidity assets or resort to borrowing can finance such net growth.
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b. Audit:
Introduction:
Audit of an integrated treasury is a complex task requiring high level of skills, knowledge of market practices and the relevant regulatory environment. Treasury income constitutes significant portion of a bank‘s income, many a time equal to the entire income received from advances and the extensive branch network of banks. An audit of integrated bank treasury operations will have to be aware of the relevant regulatory standards, the valuation methods applicable terminologies used that he has to be familiar with and then proceeds with broad guidelines for evaluation of internal control (including those relating to information systems). A model audit program that can be tailor made to suit individual needs has also been attempted. Many banks have set up integrated treasuries, encompassing both rupee and forex denominated transactions. An integrated approach to treasury management involves a common dealer or desk dealing in both domestic and forex financial markets. This enables the banks to optimize its funding and funds deployment and take advantage of arbitrage opportunities between these markets treasury income constitutes a significant portion of a bank‘s income, many a time equal to the entire income received from advances and the extensive branch network of banks. Treasury operations are invariably of high value and due to the very nature of its operations, are susceptible to manipulation, fraud or error and consequently to the various types of risk envisaged by audit and assurance standards (AAS) 6.
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Audit approach change:
By now it has dawned on all auditors that they cannot afford to ignore the computers and from the integral part of the organization they are auditing. These systems affect the working of the organization to such a level that in extreme cases, unsuitable solutions can even kill the company and the auditor better forecast this. The question then comes to mind is that should the ?new generation‘ computer savvy generation auditors tackle it while the rest go to the hills and retrieve?
Knowledge of business
AAS 20)Knowledge of business of bank treasury is usually low, even in an enlightened community like chartered accountants. Consequently, it is important to acquire a through knowledge of the products in vogue in the market, market practices, the permissible valuation methods, the regulatory standards prescribed by the RBI, Foreign Exchange Dealers Association of India and fixed income money market and derivative association (FIMMDA), the process followed by the bank, internal controls exercised, information systems use etc. an idea of the types of trades, settlement, instruments in vogue, certain operational issue relating thereto, principles of valuation etc are set out in the ensuing paragraphs for general understanding.
EDP CONTROLS (AAS 29):
The extent of computerization is usually extensive in treasuries. This calls for strict controls in such an environment. Robust software covering the entire gamut of functionality required for smooth functioning of treasury, a proper security environment, control in place to prevent unauthorized usage of files, systems, etc, start/end of the day process, business continuity and disaster recovery plans, well documented user and technical manuals, audit trails in the software, exemption report, complete trail of all backend changes made are a must. Computer assisted audit techniques and a tool, which could extract data to analyze them and identify exceptions, would be invaluable for review of EDP controls.
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c. Money Market:
Introduction:
The money market is a whole sale market for low risk highly liquid IOUs (IOU = promissory note (I owe you)). It is a market for various sorts of dept securities rather than equities. Within the confines of the money market each day banks actively trade in various instruments. The transactions include outright as well as ?repo transaction?. The heart of the activity in the money occurs in the trading rooms of dealers and brokers of money market instruments. Financial literature provides no standardized definition of the term ?money market?. Some writers employ the term broadly to include the complex arrangements by which lender and borrower of money capital (capital other than equity capital) are bought and sold. This approach is similar to the meaning of the ?capital market? embraces only open markets for near money, liquid assets. As per the narrow definition, money market embraces the various arrangements that have to do with issuance, trading and redemption of low risk, short term, marketable obligation whose prices vary only moderately. Both long term obligations and customer loans are excluded. The boundary lines are drawn to include only those instruments that possess high degree of liquidity and at the same time provide a moderate yield. The money market is a market for short term financial assets that are close substitutes for money. The important feature of a money market instrument is that it is liquid and can be turned over quickly at low cost and it provides an avenue for equilibrating the short term surplus funds of lenders and the requirements of borrowers. There is strictly no demarcated distinction between short term money market and long term capital market and in fact there are integral links between the two markets as the array of instrument in the two markets invariably forms a continuum.
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Economic functions: The basic functions of the money market is to provide efficient facilities for adjustment of liquidity positions, of commercial banks, non bank financial institutions business corporations and other investors! A smoothly functioning money market foster the flow if funds to the most important uses throughout the nation and the world, throughout the range of entire economic activities. In the process interest rate differentials are narrowed, both geographically and industrially, and economic growth is promoted. In contrast with customer‘s loans, the open market is the entire objective and free from personal considerations. Obligation is bought from dealers who offer to sell at lowest prices (highest yields) and are sold to dealers who bid to buy at the highest prices (lowest yields). The money market is essentially a market dealing in short term instruments spanning for a period of one year or below. A number of transactions take place daily shifting for a period of one year or below. A number of transactions take place daily shifting vast sums of money between the banks. The money market offers a forum for the banks in managing their short term liquidity. Banks may have to borrow or lend in call money market. Since the surplus cannot be kept idle, banks with surplus will have to deploy these funds profitably. Money market offers opportunity for short term placement of funds through short term money market instrument. A part from the banks, money market provides opportunities to other institutions and corporate to deploy their short term surpluses. Reserve bank of India through various open market operations in the form of repos and tbill auctions monitor the money supply in the economy. The rates of interest are deregulated. At present, there is no benchmark rate for either short term or long term investment in securities/ instruments. The varied activities of money market participants determine short term rates.
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Short term money market instruments:
The money market is a market for short-term financial assets that are close substitutes of money. The most important feature of a money market instrument is that it is liquid and can be turned over quickly at low cost and provides an opportunity for balancing the short-term surplus funds of lenders and the requirements of borrowers. By convention, the term "Money Market" refers to the market for short-term requirement and deployment of funds. Money market instruments are those instruments, which have a maturity period of less than one year. The most active part of the money market is the market for overnight call and term money between banks and institutions and repo transactions. Call Money / Repo are very short-term Money Market products. There is a wide range of participants (banks, primary dealers, financial institutions, mutual funds, trusts, provident funds etc.) dealing in money market instruments. Money Market Instruments and the participants of money market are regulated by RBI and SEBI.As a primary dealer SBI DFHI is an active player in this market and widely deals in Short Term Money Market Instruments. The below mentioned instruments are normally termed as money market instruments: ? ? ? ? ? ? ? Call/ Notice/ Term Money Repo/ Reverse Repo Inter Corporate Deposits Commercial Paper Certificate of Deposit T-bills Inter Bank Participation Certificate
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1. Call/ Notice/ Term Money The call/notice/term money market is a market for trading very short term liquid financial assets that are readily convertible into cash at low cost. The money market primarily facilitates lending and borrowing of funds between banks and entities like Primary Dealers. An institution which has surplus funds may lend them on an uncollateralized basis to an institution which is short of funds. The period of lending may be for a period of 1 day which is known as call money and between 2 days and 14 days which is known as notice money. Term money refers to borrowing/lending of funds for a period exceeding 14 days. The interest rates on such funds depend on the surplus funds available with lenders and the demand for the same which remains volatile.
This market is governed by the Reserve Bank of India which issues guidelines for the various participants in the call/notice money market. The entities permitted to participate both as lender and borrower in the call/notice money market are Scheduled Commercial Banks (excluding RRBs), Co-operative Banks other than Land Development Banks and Primary Dealers. 2. Repo/ Reverse Repo A repurchase agreement, also known as a repo, RP, or sale and repurchase agreement, is the sale of securities together with an agreement for the seller to buy back the securities at a later date. The repurchase price should be greater than the original sale price, the difference effectively representing interest, sometimes called the repo rate. The party that originally buys the securities effectively acts as a lender. The original seller is effectively acting as a borrower, using their security as collateral for a secured cash loan at a fixed rate of interest. A repo is equivalent to a spot sale combined with a forward contract. The spot sale results in transfer of money to the borrower in exchange for legal transfer of the security to the lender, while the forward contract ensures repayment of the loan to the lender and return of the collateral of the borrower. The difference between the forward price and the spot
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price is effectively the interest on the loan, while the settlement date of the forward contract is the maturity date of the loan.
3. Inter Corporate Deposits An Inter-Corporate Deposit (ICD) is an unsecured loan extended by one corporate to another. Existing mainly as a refuge for low rated corporate, this market allows funds surplus corporate to lend to other corporate. Also the better-rated corporate can borrow from the banking system and lend in this market. As the cost of funds for a corporate in much higher than a bank, the rates in this market are higher than those in the other markets. ICDs are unsecured, and hence the risk inherent in high. The ICD market is not well organized with very little information available publicly about transaction details. 4. Commercial Paper: Commercial paper is an unsecured promissory note with a fixed maturity of 1 to 271 days. Commercial paper is a money-market security issued (sold) by large corporations to get money to meet short term debt obligations (for example, payroll), and is only backed by an issuing bank or corporation's promise to pay the face amount on the maturity date specified on the note. Since it is not backed by collateral, only firms with excellent credit ratings from a recognized rating agency will be able to sell their commercial paper at a reasonable price. Commercial paper is usually sold at a discount from face value, and carries higher interest repayment rates than bonds. Typically, the longer the maturity on a note, the higher the interest rate the issuing institution must pay. Interest rates fluctuate with market conditions, but are typically lower than banks' rates. 5. Certificate of Deposit A savings certificate entitling the bearer to receive interest. A CD bears a maturity date, a specified fixed interest rate and can be issued in any denomination. CDs are generally issued by commercial banks and are insured by the FDIC. The term of a CD generally ranges from one month to five years.
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A certificate of deposit is a promissory note issued by a bank. It is a time deposit that restricts holders from withdrawing funds on demand. Although it is still possible to withdraw the money, this action will often incur a penalty. For example, let's say that you purchase a $10,000 CD with an interest rate of 5% compounded annually and a term of one year. At year's end, the CD will have grown to $10,500 ($10,000 * 1.05). CDs of less than $100,000 are called "small CDs"; CDs for more than $100,000 are called "large CDs" or "jumbo CDs". Almost all large CDs, as well as some small CDs, are negotiable. 6. T-bills A short-term debt obligation backed by the government with a maturity of less than one year. T-bills are sold in denominations of $1,000 up to a maximum purchase of $5 million and commonly have maturities of one month (four weeks), three months (13 weeks) or six months (26 weeks). T-bills are issued through a competitive bidding process at a discount from par, which means that rather than paying fixed interest payments like conventional bonds, the appreciation of the bond provides the return to the holder. 7. Inter Bank Participation Certificate With a view to providing an additional instrument for evening out short-term liquidity within the banking system, two types of Inter-Bank Participations (IBPs) were introduced, one on risk sharing basis and the other without risk sharing. These are strictly inter-bank instruments confined to scheduled commercial banks excluding regional rural banks. The IBP with risk sharing can be issued for 91-180 days and only in respect of advances classified under Health Code No. 1 Status. Under the uniform grading system introduced by Reserve Bank for application by banks to measure the health of bank advances portfolio, a borrower account considered satisfactory or assigned Health Code No. 1 is the one in which the conduct of account is satisfactory, the safety of advance is
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not in doubt, all the terms and conditions are complied with, and all the accounts of the borrower are in order. The IBP risk sharing provides flexibility in the credit portfolio of banks. The rate of interest is left free to be determined between the issuing bank and the participating bank subject to a minimum 14.0 per cent per annum. The aggregate amount of such IBPs under any loan account at the time of issue is not to exceed 40 per cent of the outstanding in the account.
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d. Foreign exchange market:
The foreign exchange market or forex market as it is often called is the market in which currencies are traded. Currency Trading is the world‘s largest market consisting of almost trillion in daily volumes and as investors learn more and become more interested, the market continues to rapidly grow. Not only is the forex market the largest market in the world, but it is also the most liquid, differentiating it from the other markets. In addition, there is no central marketplace for the exchange of currency, but instead the trading is conducted over-the-counter. Unlike the stock market, this decentralization of the market allows traders to choose from a number of different dealers to make trades with and allows for comparison of prices. Typically, the larger a dealer is the better access they have to pricing at the largest banks in the world, and are able to pass that on to their clients. The spot currency market is open twenty-four hours a day, five days a week, with currencies being traded around the world in all of the major financial centers. All trades that take place in the foreign exchange market involve the buying of one currency and the selling of another currency simultaneously. This is because the value of one currency is determined by its comparison to another currency. The first currency of a currency pair is called the ?base currency,? while the second currency is called the counter currency. The currency pair shows how much of the counter currency is needed to purchase one unit of the base currency. Currency pairs can be thought of as a single unit that can be bought or sold. When purchasing a currency pair, the base currency is being bought, while the counter currency is being sold. The opposite is true, when the sale of a currency pair takes place. There are four major currency pairs that are traded most often in the foreign exchange market. These include the EUR/USD, USD/JPY, GBP/USD, and USD/CHF. Forex Capital Markets (FXCM) is an online currency trading firm that offers a free demo account to traders who are new and interested in the foreign exchange market. Registering for a demo account allows a new trader to download the online trading platform that is used by the company‘s clients trading live accounts and make trades as if they were doing it with real money. The demo account is an excellent way to experiment
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with the foreign exchange market while learning your way around the trading platform. It allows you to experience every step of currency trading including choosing currency pairs, deciding how much risk to take, tracking the time and dates of placed trades, deciding how long to stay in the trade, and when to exit the trade. It also allows the placing of stop and limit orders on trades. Information about trading and specifically about how to use the online trading platform can be found on the FXCM webpage. In addition, FXCM offers that are extremely useful to both new and experienced currency traders. These ?educational webinars,? as they are called are run by experienced financial strategists and range in topics from trading specific news events to trading the Euro. In addition to the webinars, FXCM also offers numerous online courses that teach investors how to trade the currency market.
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e. Derivatives:
The term ?Derivative‘ stands for a contract whose price is derived from or is dependent upon an underlying asset. The underlying asset could be a financial asset such as currency, stock and market index, an interest bearing security or a physical commodity. Today, around the world, derivative contracts are traded on electricity, weather, temperature and even volatility. According to the Securities Contract Regulation Act, (1956) the term ?derivative? includes: (i) a security derived from a debt instrument, share, loan, whether secured or unsecured, risk instrument or contract for differences or any other form of security; (ii) A contract which derives its value from the prices, or index of prices, of underlying securities. Derivatives that trade on an exchange are called exchange traded derivatives, whereas privately negotiated derivative contracts are called OTC contracts. The OTC derivatives markets have the following features compared to exchange-traded derivatives: (i) The management of counter-party (credit) risk is decentralized and located within individual institutions, (ii) There are no formal centralized limits on individual positions, leverage, or margining, (iii) There are no formal rules for risk and burden-sharing, (iv) There are no formal rules or mechanisms for ensuring market stability and integrity, and for safeguarding the collective interests of market participants, and (iv) The OTC contracts are generally not regulated by a regulatory authority and the exchange‘s self-regulatory organization. They are however, affected indirectly by national legal systems, banking supervision and market surveillance.
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Types of Derivative Contracts
Derivatives comprise four basic contracts namely Forwards, Futures, Options and Swaps. Over the past couple of decades several exotic contracts have also emerged but these are largely the variants of these basic contracts. Let us briefly define some of the contracts ?
Forward Contracts: These are promises to deliver an asset at a predetermined date in future at a predetermined price. Forwards are highly popular on currencies and interest rates. The contracts are traded over the counter (i.e. outside the stock exchanges, directly between the two parties) and are customized according to the needs of the parties. Since these contracts do not fall under the purview of rules and regulations of an exchange, they generally suffer from counterparty risk i.e. the risk that one of the parties to the contract may not fulfill his or her obligation.
?
Futures Contracts: A futures contract is an agreement between two parties to
buy or sell an asset at a certain time in future at a certain price. These are basically exchange traded, standardized contracts. The exchange stands guarantee to all transactions and counterparty risk is largely eliminated. The buyers of futures contracts are considered having a long position whereas the sellers are considered to be having a short position. It should be noted that this is similar to any asset market where anybody who buys is long and the one who sells in short. Futures contracts are available on variety of commodities, currencies, interest rates, stocks and other tradable assets. They are highly popular on stock indices, interest rates and foreign exchange.
?
Options Contracts: Options give the buyer (holder) a right but not an
obligation to buy or sell an asset in future. Options are of two types - calls and puts. Calls give the buyer the right but not the obligation to buy a given quantity
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of the underlying asset, at a given price on or before a given future date. Puts give the buyer the right, but not the obligation to sell a given quantity of the underlying asset at a given price on or before a given date. One can buy and sell each of the contracts. When one buys an option he is said to be having a long position and when one sells he is said to be having a short position. It should be noted that, in the first two types of derivative contracts (forwards and futures) both the parties (buyer and seller) have an obligation; i.e. the buyer needs to pay for the asset to the seller and the seller needs to deliver the asset to the buyer on the settlement date. In case of options only the seller (also called option writer) is under an obligation and not the buyer (also called option purchaser). The buyer has a right to buy (call options) or sell (put options) the asset from / to the seller of the option but he may or may not exercise this right. Incase the buyer of the option does exercise his right, the seller of the option must fulfill whatever is his obligation (for a call option the seller has to deliver the asset to the buyer of the option and for a put option the seller has to receive the asset from the buyer of the option). An option can be exercised at the expiry of the contract period (which is known as European option contract) or anytime up to the expiry of the contract period (termed as American option contract). ?
Swaps: Swaps are private agreements between two parties to exchange cash
flows in In future according to a pre arranged formula. They can be regarded as portfolios of forward contracts. The two commonly used swaps are: • •
Interest rate swaps: These entail swapping only the interest related cash flows between the parties in the same currency. Currency swaps: These entail swapping both principal and interest between the parties, with the cash flows in one direction being in a different currency than those in the opposite direction.
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f. Risk management:
Risk management is the identification, assessment, and prioritization of risks (defined in ISO 31000 as the effect of uncertainty on objectives, whether positive or negative) followed by coordinated and economical application of resources to minimize, monitor, and control the probability and/or impact of unfortunate events or to maximize the realization of opportunities. Risks can come from uncertainty in financial markets, project failures (at any phase in design, development, production, or sustainment lifecycles), legal liabilities, credit risk, accidents, natural causes and disasters as well as deliberate attack from an adversary, or events of uncertain or unpredictable root-cause. Several risk management standards have been developed including the Project
Management Institute, the National Institute of Standards and Technology, actuarial societies, and ISO standards, Methods, definitions and goals vary widely according to whether the risk management method is in the context of project management, security, engineering, industrial processes, financial portfolios, actuarial assessments, or public health and safety. The strategies to manage risk typically include transferring the risk to another party, avoiding the risk, reducing the negative effect or probability of the risk, or even accepting some or all of the potential or actual consequences of a particular risk. Certain aspects of many of the risk management standards have come under criticism for having no measurable improvement on risk, whether the confidence in estimates and decisions seem to increase. In ideal risk management, a prioritization process is followed whereby the risks with the greatest loss (or impact) and the greatest probability of occurring are handled first, and risks with lower probability of occurrence and lower loss are handled in descending order. In practice the process of assessing overall risk can be difficult, and balancing resources used to mitigate between risks with a high probability of occurrence but lower
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loss versus a risk with high loss but lower probability of occurrence can often be mishandled. Intangible risk management identifies a new type of a risk that has a 100% probability of occurring but is ignored by the organization due to a lack of identification ability. For example, when deficient knowledge is applied to a situation, a knowledge risk materializes. Relationship risk appears when ineffective collaboration occurs. Processengagement risk may be an issue when ineffective operational procedures are applied. These risks directly reduce the productivity of knowledge workers, decrease cost effectiveness, profitability, service, quality, reputation, brand value, and earnings quality. Intangible risk management allows risk management to create immediate value from the identification and reduction of risks that reduce productivity. Risk management also faces difficulties in allocating resources. This is the idea of opportunity cost. Resources spent on risk management could have been spent on more profitable activities. Again, ideal risk management minimizes spending (or manpower or other resources) and also minimizes the negative effects of risks.
First let's revise the simple meaning of two words, viz., Types and Risk. In general and in context of this finance-related article, 1. Types mean different classes or various forms / kinds of something or someone. 2. Risk implies in the extend to which any chosen action or an inaction that may lead to a loss or some unwanted outcome. The notion implies that a choice may have an influence on the outcome that exists or has existed. However, in financial management, risk relates to any material loss attached to the project that may affect the productivity, tenure, legal issues, etc. of the project.In finance, different types of risk can be classified under two main groups, viz. 1. Systematic risk. 2. Unsystematic risk.
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Two main groups under which types of risk are classified is depicted below.
Now let's discuss the simple meaning of systematic and unsystematic risk. Systematic risk is uncontrollable by an organization and macro in nature. Unsystematic risk is controllable by an organization and micro in nature.
Systematic Risk
Systematic risk is due to the influence of external factors on an organization. Such factors are normally uncontrollable from an organization's point of view. Systematic risk is a macro in nature as it affects a large number of organizations operating under a similar stream or same domain. It cannot be planned by the organization. Types of risk under the group of systematic risk are listed as follows: 1. Interest rate risk. 2. Market risk. 3. Purchasing power or Inflationary risk. The types of risk grouped under systematic risk are depicted below.
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Now let's discuss each risk classified under the group of systematic risk.
1. Interest rate risk
Interest-rate risk arises due to variability in the interest rates from time to time. It particularly affects debt securities as they carry the fixed rate of interest. The interest-rate risk is further classified into following types.
1. Price risk. 2. Reinvestment rate risk.
The types of interest-rate risk are depicted below.
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The meaning of various types of interest-rate risk is discussed below. Price risk arises due to the possibility that the price of the shares, commodity, investment, etc. may decline or fall in the future. Reinvestment rate risk results from fact that the interest or dividend earned from an investment can't be reinvested with the same rate of return as it was acquiring earlier. 2. Market risk Market risk is associated with consistent fluctuations seen in the trading price of any particular shares or securities. That is, it is a risk that arises due to rise or fall in the trading price of listed shares or securities in the stock market. The market risk is further classified into following types. 1. Absolute risk. 2. Relative risk. 3. Directional risk. 4. Non-directional risk. 5. Basis risk. 6. Volatility risk.
The types of market risk are depicted in the following diagram.
The meaning of different types of market risk is briefly discussed below.
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Absolute Risk is the risk without any content. For e.g., if a coin is tossed, there is fifty percentage chance of getting a head and vice-versa. Relative risk is the assessment or evaluation of risk at different levels of business functions. For e.g. a relative risk from a foreign exchange fluctuation may be higher if the maximum sales accounted by an organization are of export sales. Directional risks are those risks where the loss arises from an exposure to the particular assets of a market. For e.g. an investor holding some shares experience a loss when the market price of those shares falls down. Non-Directional risk arises where the method of trading is not consistently followed by the trader. For e.g. the dealer will buy and sell the share simultaneously to mitigate the risk. Basis risk is due to the possibility of loss arising from imperfectly matched risks. For e.g. the risks which are in offsetting positions in two related but non-identical markets. Volatility risk is the risk of a change in the price of securities as a result of changes in the volatility of a risk factor. For e.g. volatility risk applies to the portfolios of derivative instruments, where the volatility of its underlying is a major influence of prices.
3. Purchasing power or inflationary risk
Purchasing power risk is also known as inflation risk. It is so, since it emanates (originates) from the fact that it affects a purchasing power adversely. It is not desirable to invest in securities during an inflationary period. The purchasing power or inflationary risk is classified into following types. 1. Demand inflation risk. 2. Cost inflation risk. The types of purchasing power or inflationary risk are depicted below.
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Demand inflation risk arises due to increase in price, which result from an excess of demand over supply. It occurs when supply fails to cope with the demand and hence cannot expand anymore. In other words, demand inflation occurs when production factors are under maximum utilization. Cost inflation risk arises due to sustained increase in the prices of goods and services. It is actually caused by higher production cost. A high cost of production inflates the final price of finished goods consumed by people.
Unsystematic Risk
Unsystematic risk is due to the influence of internal factors prevailing within an organization. Such factors are normally controllable from an organization's point of view. Unsystematic risk is a micro in nature as it affects only a particular organization. It can be planned, so that necessary actions can be taken by the organization to mitigate (reduce the effect of) the risk. The types of risk grouped under unsystematic risk are depicted below. 1. Business or liquidity risk. 2. Financial or credit risk. 3. Operational risk.
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The types of risk grouped under unsystematic risk are depicted below
Now let's discuss each risk classified under the group of unsystematic risk. 1. Business or liquidity risk Business risk is also known as liquidity risk. It is so, since it emanates (originates) from the sale and purchase of securities affected by business cycles, technological changes, etc. The business or liquidity risk is further classified into following types. 1. Asset liquidity risk. 2. Funding liquidity risk. The types of business or liquidity risk are depicted and explained below.
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Asset liquidity risk is the risk of losses arising from an inability to sell or pledge assets at, or near, their carrying value when needed. For e.g. assets sold at a lesser value than their book value. Funding liquidity risk is the risk of not having an access to sufficient funds to make a payment on time. For e.g. when commitments made to customers are not fulfilled as discussed in the SLA (service level agreements). 2. Financial or credit risk Financial risk is also known as credit risk. This risk arises due to change in the capital structure of the organization. The capital structure mainly comprises of three ways by which funds are sourced for the projects. These are as follows: 1. Owned funds. For e.g. share capital. 2. Borrowed funds. For e.g. loan funds. 3. Retained earnings. For e.g. reserve and surplus. The financial or credit risk is further classified into following types. 1. Exchange rate risk. 2. Recovery rate risk. 3. Credit event risk. 4. Non-Directional risk. 5. Sovereign risk. 6. Settlement risk. The types of financial or credit risk are depicted and explained below.
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Exchange rate risk is also called as exposure rate risk. It is a form of financial risk that arises from a potential change seen in the exchange rate of one country's currency in relation to another country's currency and vice-versa. For e.g. investors or businesses face an exchange rate risk either when they have assets or operations across national borders, or if they have loans or borrowings in a foreign currency. Recovery rate risk is an often neglected aspect of a credit risk analysis. The recovery rate is normally needed to be evaluated. For e.g. the expected recovery rate of the funds tendered (given) as a loan to the customers by banks, non-banking financial companies (NBFC), etc. Sovereign risk is the risk associated with the government. In such a risk, government is unable to meet its loan obligations, reneging (to break a promise) on loans it guarantees, etc. Settlement risk is the risk when counterparty does not deliver a security or its value in cash as per the agreement of trade or business. 4. Operational risk Operational risks are the business process risks failing due to human errors. This risk will change from industry to industry. It occurs due to breakdowns in the internal procedures, people, policies and systems.
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The operational risk is further classified into following types. 1. Model risk. 2. People risk. 3. Legal risk. 4. Political risk. The types of operational risk are depicted and explained below.
Model risk is the risk involved in using various models to value financial securities. It is due to probability of loss resulting from the weaknesses in the financial model used in assessing and managing a risk. People risk arises when people do not follow the organization‘s procedures, practices and/or rules. That is, they deviate from their expected behavior. Legal risk arises when parties are not lawfully competent to enter an agreement among them. Furthermore, this relates to regulatory risk, where a transaction could conflict with a government policy or particular legislation (law) might be amended in the future with retrospective effect. Political risk is the risk that occurs due to changes in government policies. Such changes may have an unfavorable impact on an investor. This risk is especially prevalent in the third-world countries.
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chapter 3 Mechanics ? Introduction ? Case study. ? Treasury management system ? Treasury software
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Chapter 3:-Mechanism:
Integrating Treasury Mechanism a typical treasury comprises three sub-sections – front, middle and back office. Each office has specified functions and goals to achieve. The front office usually performs the market trading, tracking of exchange rate etc. it may consist of different desks, each dealing with different market like forex, money market, fixed income etc. the front office also looks after the market intelligence, relationships with investors and banks. In fact, the front office is the strategic decision making part of corporate treasury. The middle office usually looks after the risk management aspects such as Asset Liability Management (ALM), disbursement of information on various positions to the front office and compliance of reporting requirement. Back office does all the background work like keeping the records and managing the past data and accounting systems. In treasury integration it is a usual practice that a specialized solution provider maintains both the back and middle office function of treasury. However, the strategic front office is managed by an internal team. Computer system coupled with internet processes all the information and trade orders in real time because the solution provider manages these functions for a host of other companies also the clients benefit on reduced costs through economies of scale. (See figure) Integrated treasury is now a global phenomenon. Financial borders between countries are breaking down. Cross-country movements of currency, goods and services are now practically free from impediments, giving rise to widening and deepening of growth of capital and money markets. To cope with such Transfer pricing Transfer pricing mechanism is one by which the efficiency of a treasury is monitored; profit allocation between various profit centers of the bank is properly done
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? Case study:
SBI is one of the India's largest banks. It is also home to the country's biggest and most powerful Treasury,
contributing to a major part of the total turnover in the money and forex markets. Through a network of stateof-the-art dealing rooms in India and abroad, backed by the assured
expertise of informed professionals, the SBI extends round-the-clock
support to clients in managing their forex and interest rate exposures. SBI's relationships with over 700 correspondent banks are also leveraged in extracting maximum value from treasury operations. SBI's treasury operations are channeled through the Rupee Treasury, the Forex Treasury and the Treasury Management Group.
Rupees treasury: The Rupee Treasury deals in the domestic money (Rs) and debt markets while the Forex Treasury deals mainly in the local foreign exchange market. The Treasury Management Group monitors the investment, risk and asset-liability management aspects of the Bank's overseas offices. The Rupee Treasury carries out the bank‘s rupee-based treasury functions in the domestic market. Broadly, these include asset liability management, investments and trading. The Rupee Treasury also manages the bank‘s position regarding statutory requirements like the cash reserve ratio and the statutory liquidity ratio; as per the norms of the Reserve Bank of India.
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? Treasury Management System:
DEFINITION: A ?Treasury Management System? (TMS) (also known as a Treasury Workstation) is a term for a treasury-oriented system or software package that specializes in the automation of manually-intensive, repetitive steps needed to manage a company‘s cash flows. The system allows a company to efficiently communicate with financial institutions in order to manage cash, transactions, forecasts, FX, and even investments and debt. The TMS can seamlessly interface with a company‘s general ledger offering an instant financial dashboard. The financial crisis has heightened the need for better transparency into a company's cash positions as the traditional lines of credit have become increasingly scarce. Through the proper selection and implementation of a TMS corporate treasurers can efficiently respond to the financial needs of the company.
Why A Treasury Management System:
Over the past two years our global economy has experienced a meltdown. The financial markets are fraught with uncertainty and caution. We have witnessed several large financial institutions collapse, experienced the scarcity of tightened credit, stressed over increase of liquidity risk, lost sleep over tanked investments, and were burned by the exposures to fluctuating currencies. All this sheds light on the need for better controls, quicker access to information, and better transparency. As this transformation has taken place the corporate needs continue to emerge. They need real-time access to information, system integration, and consolidated global reporting capabilities with the ability to create on demand reports for senior management. Excel spreadsheets have their place but are manual and risk prone. Companies must open their eyes to the need for treasury solutions. In short, to remain competitive companies need to ensure optimal use of treasury technology such as a Treasury Management System (TMS).
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Selection Process:
With a large variety of Treasury Management Systems (TMS) and vendors available today (over 40), the selection process can be a daunting challenge for a treasurer to navigate. To further complicate matters the market is maturing, meaning the available systems currently meet the functional needs of most companies. So a treasurer must look into the future and select a vendor whose TMS will be flexible enough to evolve with the rapidly developing technologies that surface. As you can imagine there is corporate (and personal) risk involved in selecting a TMS. This risk is derived from cost and time. The cost can be from $20,000 to $250,000+ plus while the resources and time spent on selection and implementation can range from 5 month to 1 year. Whether you are selecting a bank-offered system, in-house installed application, the treasury module of an ERP, or an Application Service Provider (ASP) system you can see the importance of utilizing a structured and disciplined selection process that ensures all requirements are met. My approach is quite simple and intuitive but it helps to have a website where you can come back and review the steps again and again. Here we go….
Step 1 – Build the TMS Team
First and foremost - ensure that you have executive support. The CFO or Treasurer must understand and believe the need for the new system is critical. They need to understand the complexities of the project and the critical nature of its success. Once on board, you can lean on him or her for support and resources. What you do not want, is to be in the process of selecting or implementing and at the same time explaining to the executives what you are doing. Get support before you move on. The lack thereof can be careerending. This is a large undertaking at best. It is critical that you get a solid project manager on board right from the beginning. The best project managers are those that bring a combined skill set of project management methodologies and treasury knowledge. As IT,
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Integrated Treasury Management
Treasury, Accounting and other departments will be stakeholders you will need someone to manage the players to ensure timelines, approvals, and issue resolutions are met. You will also need a proficient IT person who has an understanding of treasury concepts and a good grasp of technological advances. This will be a lengthy project, so secure someone who is solid. Lastly, ensure that there is representation from each of the stakeholders. This would involve Treasury, IT, Accounting, Investor Reporting, etc. Make sure every and any department that will be touched by this project is represented. This involvement assures that the selection and implementation process will be clear, approved, and disciplined.
Step 2 – Define the TMS Project
From the beginning, the project should be clearly defined. At a minimum a proper project definition should include:
1234-
A task list - which includes forecasting start and completion times and dates. A list of resources - details what is needed for the completion of these tasks. A list of dependencies among the tasks. Project milestones - allowing the tasks to be assessed and the progress are noted.
The milestones should be realistic so that the defined project can be strictly adhered to. A clearly defined project that is communicated from the onset will ensure that the stakeholders are clear as to what their responsibilities will be and time frames associated with those responsibilities.
Step 3 – Define the Project Requirements (Build Your Wish List!)
Correctly defining the Project Requirements is critical to the project's success. This can take anywhere from a week to a few months to complete depending on the complexities involved. It is important to draw up the requirements before any vendor presentations are given. This way you will stick to defining the core features needed by your company and not get caught up in the bells and whistles of the vendor presentations. Also, through defining your requirements in this manner, you may find that all you need is an additional module or change in process rather than a new Treasury Management System (TMS).
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This process will also help you highlight the weaknesses in the existing system in relation to the required core functionality. Properly documented requirements facilitate the creation of a benchmark by which a comparison to proposed solutions may be evaluated. This document must describe in sufficient detail the treasury features and the environment in which it will operate. There are many ways to obtain the requirements but I suggest the following steps: 1Capture What You Know. This step must be provided by the users of the system.
Review your current system and detail each feature you use. Define the weaknesses if any. Note the functionality and features you want to retain from your old system as well as the required improvements from the new system. Add this to your list. 2Automation. Analyze the treasury processes. Break them down into step-by-step
tasks to identify where a new system could improve efficiency through automation. Add this to your list of requirements. 3Dependencies and Integrations. In detail, list out how your old system integrates
with other systems, i.e., banking, general ledger, reporting and market data. What dependencies do you have and what is the timing of those dependencies? Are there other departments that utilize your old system for balances or transaction information? Does investor reporting utilize the BAI download for transaction information that you were not aware of? Add this to your list of requirements. 4What Is The Plan? Understand your company‘s strategic plan. The selection of
your TMS must be in harmony with the plans of the company. Is your company going from a decentralized to a centralized treasury group next year? Is there significant growth planned for the future? Is your company diversifying into other product categories? This will help you in the selection process as to whether you need a modular (scalable, flexible, deployable) solution or a canned solution (one that will not change over time). 5Your Wish List. List all the treasury features you would have in a perfect world.
In addition to balance reporting, cash positioning, and payment processing.
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Integrated Treasury Management
? Treasury Software: KASTLE:-Treasury Management Solution
KASTLE™ Treasury is a leading, integrated treasury management solution used by financial institutions worldwide to meet their business objectives. KASTLE™ Treasury:
?
Provides organizations with a sophisticated, multi-entity, multi-portfolio, multidealing room environment supported by robust risk management, back-office management, and MIS
? ?
Presents a holistic picture of an organization‘s financial health Covers several key markets such as foreign exchange, money, equity, and their related derivative instruments
?
Identifies open positions, measures risks in real time, assists in generating P&L statements, and facilitates settlements
Kastle Treasury can also be deployed with Oracle Database 11g Release 2. Kastle Treasury is now Oracle Exadata & Exalogic ready.
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Integrated Treasury Management
Key features
Automation and analyses features ? ? ? ? Wide range of MIS reports Real-time feed integration from multiple service providers for many instruments and currencies Structured portfolio approach enabling simulation analysis Decision support via exhaustive pre- and post-trade support tools and analytics, including pricing and valuation of plain vanilla and complex derivative instruments ? ? ? ? ? Intelligent messaging module capable of handling SWIFT, RTGS, and other formats Full-fledged Nostro reconciliation module (Nostroplus) User-friendly interface to capture exchange rates, benchmark rates, scrip rates, and prices of stocks in F&O segment VC++ component library for automated mathematical computations Complete straight-through processing functionality, covering front-, middle-, and back-office MIS and reporting requirements
Flexibility and customization features
? ? ? ? ? ? ? ? Multi-entity system Multi-dealing-room capability Multi-portfolio enabled Multicurrency accounting Platform-independent database Seamless interface with 3rd-party market information systems High level of parameterization—varying requirements can be met by simply changing settings Transaction downloads across various dealing systems (e.g., Dealing 3000)
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Key differentiators
? ? ? ? ? ? ? ? Convenient, right-click enabled deal entry and retrieval criteria Comprehensive analytics for front-office users Extensive limit management User-definable accounting policies Compliant with SOX, Basel II, IFRS, MiFID, and hedge accounting rules Extensive online context sensitive help available at a single click Unicode compliant, with language localization for all screens and interfaces Modular yet seamless approach (front-, middle- and back-office operations work in an independent yet integrated fashion)
Key business benefits
? 100% accuracy in execution and accelerated decision-making made possible through treasury management tools (real-time information from multiple sources, MIS, and analytical solutions) and functionalities like historical simulation and ?what-if? analyses that enable dealers to respond quickly and accurately to market conditions ? ? ? Tailored solutions to real-time business problems via flexible, intelligent, and user-friendly systems and interfaces Process efficiency achieved through implementation of best practices
incorporated into the solution Improved productivity and reduced costs—automated analyses lead to efficient operations with 60% increase in productivity and swift decision-making, while minimizing overheads and cutting costs incurred on salary by 42% ? Enhanced security with user access, control, and administration security features
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Chapter 4: Treasury Management at International Level.
? International level
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Chapter 4: International level.
Functions of treasury management at international level:
At the international level the functions of treasury management is concerned with the management of funds in the foreign
currencies. Foreign exchange as a subject refers to the means and methods by which the rights to income and wealth in one currency are converted into similar fights in terms of another countries currency. Such exchanges may be in the form of one currency to another or on the conversion of credit instruments denominated in different currencies such as cheques, drafts, telegraphic transfers, bills of exchange, trade bills or promissory notes. Exchange is done through dealers in foreign exchange regulated by the central bank of the country. Banks are usually a dealer apart from other specialized agencies. One of the important components of the international financial system is the foreign exchange market. The various trade and commercial transaction between countries results in receipts and payment between them. These transactions are carried out t between the currencies of the concerned countries- any one of them or mutually agreed common currency. Either way transaction involves the conversion of currency to the other. The foreign exchange market facilitates such operations. The demand for goods and services from one country to another is the basis for demand for currencies in the market. Thus basically, demand for and supply of the foreign currencies arises from exporter and importers or the public having some transactions with foreign currencies.
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Integrated Treasury Management
Companies having an import or export components in their business profile have to frequently deal in the forex operations. Forex operations in the country being supervised by the central bank, reference to the central bank in one form or the other is necessary use foreign exchange. If the country on the whole is a net exporter of goods and services. It would have surplus of foreign exchange, if on the other hand, it is a net importer then it would have the shortage of foreign exchange. The extent of regulation of the foreign market depends on the availability of foreign exchange in a country. If the forex is scares, then holding and using it would be subject to a lot of regulatory control. It also matters whether international trade forms a significant percentage of the GDP of a nation. If it is so, then the awareness about the forex regulation would be much more wide spread as compared to the situation where the foreign trade forms a significant portion of GDP. Presently, however, with increasing globalization, forex dealing has become a normal part of treasury operations. Every foreign exchange transaction involves a two way conversion- a purchase and sale. Conversion of domestic currency into foreign currency involves purchase of the later and sale of the former and vice versa. These transactions are routed through the banks. The takes the shape of either outright release of foreign currency for meeting the travel and related requirements or payment to outside parties in the denominated currency via the medium of correspondent banks. For effecting payment, following instruments are generally used:
Telegraphic transfers (TT)
A TT is a transfer of money by telegram or cable or telex or fax from one center to another in a foreign currency. It is a method used by banks with their own codes and correspondent relations with banks and abroad for transmission of funds. As there is no loss if interest or capital risk in this mode, it enjoys the best rate for the value of receipts.
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Mail transfers (MT)
It is an order to pay cash to a third party sent by a bank to its correspondent or branch abroad. It is issued in duplicate, one to the party buying it and the other to the correspondent bank. The amount is paid by the correspondent bank to the third party mentioned therein in the transferee country by its own cheque or by the by crediting in the party‘s account. As the payment is made after the mail advice is received at the other end, which will take few days, the rate charged to the purchaser is cheaper to the extent of the interest gain to the seller bank.
Drafts and cheques:
Draft is a pay order issued by the banks on its own branch or correspondent bank abroad. It is payable on the sight but there is always a time lapse in the transit to in post between the payment by the purchaser of the drafts to his banks and the receipt of the money by the seller in the foreign center. As in the case of MT, there is risk of loss of draft in transit or delay in release of payment to the beneficiary and loss of interest in the intervening period.
Bills of exchange:
It is an unconditional order in writing addressed by one person to another, requiring the person to whom the order is addressed, to pay certain sum on demand or within a specified time period. If it is payable on demand, it is called a sight bill. If it is payable after a gap of some time, it is called a usance bill. Such bills can be banker‘s bill or trader‘s bill. Banker‘s bill are drawn on banks abroad while trade bills are made between individual parties
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Chapter 5:- Regulation and Supervision ? Internal and External Audit
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? Internal and external audit
Internal and external auditors have mutual interests regarding the effectiveness of internal financial controls. Both professions adhere to codes of ethics and professional standards set by their respective professional associations. There are, however, major differences with regard to their relationships to the organization, and to their scope of work and objectives. The internal auditors' are part of the organization. Their objectives are determined by professional standards, the board, and management. Their primary clients are management and the board. External auditors are not part of the organization, but are engaged by it. Their objectives are set primarily by statute and their primary client - the board of directors. The internal auditor‘s scope of work is comprehensive. It serves the organization by helping it accomplish its objectives, and improving operations, risk management, internal controls, and governance processes. Concerned with all aspects of the organization - both financial and non-financial - the internal auditors focus on future events as a result of their continuous review and evaluation of controls and processes. They also are concerned with the prevention of fraud in any form. The primary mission of the external auditors is to provide an independent opinion on the organization's financial statements, annually. Their approach is historical in nature, as they assess whether the statements conform to generally accepted accounting principles, whether they fairly present the financial position of the organization, whether the results of operations for a given period of time are accurately represented, and whether the financial statements have been materially affected. The internal and external auditors should meet periodically to discuss common interests; benefit from their complementary skills, areas of expertise, and perspectives; gain understanding of each other's scope of work and methods; discuss audit coverage and scheduling to minimize redundancies; provide access to reports, programs and working papers; and jointly assess areas of risk. In fulfilling its oversight responsibilities for assurance, the board should require coordination of internal and external audit work to increase economy, efficiency, and effectiveness of the overall audit process.
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The ever changing role of the Corporate Treasurer, specifically his evolution into ?manager of corporate risk‘ increasing transaction volumes and complexity of transactions and information requirements, and continued globalization of treasury operations will drive the development of treasury systems in future. Vendors and solutions will continue their consolidation and ?best of breed‘ solutions will evolve from the conglomeration of vendors and systems. Big names in software like ORACLE, SAP and Microsoft will offer solutions or form partnerships with leading treasury system vendors. Treasury Department is directly or indirectly involved in day –to- day business of the Bank and it is involved in the day-to-day asset liability management of the bank. Treasury will be able to, through various techniques, manage risks through its various operations bring down the cost of funds and also improve the margins. Reserves Management, Investment Management, Liquidity (both short term and long term) Management, is the other major functions of the Treasury Management.
It is certain that major international corporate are seeing real added value in being able to link treasury centers together and make stronger links with their own subsidiaries. The technology making this happen is the internet and web-enabling of TMSs. Major corporate can see real value in being able to merge their treasury centers into a single, central database, allowing for more accurate and quicker analysis of the group‘s finances. New technology that brings about greater functionality and flexibility. In structuring treasury operations means that it is now possible to redefine the scope of a bank‘s treasury requirements to better suit each bank‘s business.
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Treasury handles very sensitive and very important function of the Bank. Hence it ha s been set up in specific structure for smooth but transparent operations. As technology develops , so there is the ability for systems to become more advanced ; with this advanced technology available, treasuries are then forced to look at ways to increase ate cost effectiveness of their functions.
Thus making the Treasury Centralised will lead to betterment of Banking & Industry & will one day form a Single Banking system all over the world.
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