Treasury Management in Banks

8/13/2019 Treasury Management in Banks

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RISK MANAGEMENTTreasury Management

O Treasury Products

O Treasury Risk Management

O Derivative Products


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Integrated TreasuryO Integrated Treasury refers to

integration of money market, securitiesmarket and foreign exchangeoperations.

-Meeting reserve requirements-Efficient merchant services-Global cash management-Optimizing profit by exploiting marketopportunities in forex market, money

market and securities market-Risk management-Assisting bank management in ALM


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Treasury

Function Responsible for

Frontoffice

Dealing

Mid-

Office

Risk management,

accounting andmanagementinformation

Back

office

Confirmations,

settlement andreconciliation


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FRONT OFFICE

BACK OFFICEMID OFFICE

Dealing

MIS

settlement


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Treasury


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Money MarketO Certificate of Deposit (CD)

O Commercial Paper (C.P)

O Inter Bank Participation CertificatesO Inter Bank term Money

O Treasury Bills

O Call Money


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Certificate of DepositO CDs are short-term borrowings in the form

of Usance Promissory Notes having amaturity of not less than 15 days up to a

maximum of one year.O CD is subject to payment of Stamp Duty

under Indian Stamp Act, 1899 (Central Act)

O They are like bank term deposits accounts.Unlike traditional time deposits these are

freely negotiable instruments and areoften referred to as Negotiable Certificateof Deposits


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Features of CDO CDs can be issued by all scheduled commercialbanks except RRBs

O Minimum period 15 days

O Maximum period 1 year

O Minimum Amount Rs 1 lac and in multiples of Rs.

1 lac

O CDs are transferable by endorsementO CRR & SLR are to be maintained

O CDs are to be stamped


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Commercial PaperO Commercial Paper (CP) is an unsecured

money market instrument issued in the

form of a promissory note.O Who can issue Commercial Paper (CP)

Highly rated corporate borrowers, primary

dealers (PDs) and satellite dealers (SDs)

and all-India financial institutions (FIs)


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Eligibility for issue of CPa) the tangible net worth of the company, as

per the latest audited balance sheet, is

not less than Rs. 4 crore;b) the working capital (fund-based) limit of

the company from the banking system isnot less than Rs.4 crore

c) and the borrowal account of the

company is classified as a StandardAsset by the financing bank/s.


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Rating RequirementOAll eligible participants should

obtain the credit rating for issuanceof Commercial Paper

O Credit Rating Information Servicesof India Ltd. (CRISIL)

O Investment Information and CreditRating Agency of India Ltd. (ICRA)

O Credit Analysis and Research Ltd.(CARE)

O Duff & Phelps Credit Rating IndiaPvt. Ltd. (DCR India)

O The minimum credit rating shall be


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MaturityO CP can be issued for maturities between a

minimum of 15 days and a maximum upto

one year from the date of issue.O If the maturity date is a holiday, the

company would be liable to make

payment on the immediate preceding

working day.


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To whom issuedCP is issued to and held by individuals,

banking companies, other corporate

bodies registered or incorporated in Indiaand unincorporated bodies, Non-Resident

Indians (NRIs) and Foreign Institutional

Investors (FIIs).


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RepoO Uses of Repo

It helps banks to invest surplus cash

It helps investor achieve moneymarket returns with sovereign risk.

It helps borrower to raise funds at

better rates

An SLR surplus and CRR deficitbank can use the Repo deals as a

convenient way of adjusting

SLR/CRR positions simultaneously.

RBI uses Repo and Reverse repo


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Meaning of RepoO It is a transaction in which two

parties agree to sell and repurchase

the same security. Under such anagreement the seller sells specifiedsecurities with an agreement torepurchase the same at a mutually

decided future date and a priceO The Repo/Reverse Repo

transaction can only be done atMumbai between parties approved

by RBI and in securities asapproved by RBI (Treasury Bills,


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Coupon rate and YieldThe difference between coupon rate and

yield arises because the market price of a

security might be different from the facevalue of the security. Since coupon

payments are calculated on the face value,

the coupon rate is different from the

implied yield.


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ExampleO 10% Aug 2015 10 year Govt Bond

O Face Value RS.1000

O Market Value Rs.1200O In this case Coupon rate is 10%

O Yield is 8.33%


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Call Money MarketThe call money market is an integral part of

the Indian Money Market, where the day-to-day surplus funds (mostly of banks) are

traded. The loans are of short-termduration varying from 1 to 14 days.

The money that is lent for one day in this

market is known as "Call Money", and if itexceeds one day (but less than 15 days) itis referred to as "Notice Money".


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Call Money MarketBanks borrow in this market for thefollowing purpose

O To fill the gaps or temporary mismatchesin funds

O To meet the CRR & SLR mandatoryrequirements as stipulated by the Centralbank

O To meet sudden demand for funds arisingout of large outflows.


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Factors influencing interest

ratesThe factors which govern the interestrates are mostly economy related andare commonly referred to asmacroeconomic factors. Some of these

factors are:1) Demand for money2) Government borrowings3) Supply of money4) Inflation rate

5) The Reserve Bank of India and theGovernment policies which determinesome of the variables mentionedabove.


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Gilt edged securities

The term government securitiesencompass all Bonds & T-bills issued bythe Central Government, and stategovernments. These securities arenormally referred to, as "gilt-edged" asrepayments of principal as well as interest

are totally secured by sovereignguarantee.


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Treasury BillsTreasury bills, commonly referred to asT-Bills are issued by Government ofIndia against their short term borrowing

requirements with maturities rangingbetween 14 to 364 days.

All these are issued at a discount-to-face value. For example a Treasury billof Rs. 100.00 face value issued for Rs.

91.50 gets redeemed at the end of it'stenure at Rs. 100.00.


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Who can invest in T-Bill

Banks, Primary Dealers, State

Governments, Provident Funds, FinancialInstitutions, Insurance Companies,

NBFCs, FIIs (as per prescribed norms),

NRIs & OCBs can invest in T-Bills.


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What is auction of

SecuritiesAuction is a process of calling of bids with

an objective of arriving at the market price.

It is basically a price discoverymechanism


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DebentureO A Debenture is a debt security issued by a

company (called the Issuer), which offersto pay interest in lieu of the money

borrowed for a certain period.

O These are long-term debt instrumentsissued by private sector companies.

These are issued in denominations as lowas Rs 1000 and have maturities rangingbetween one and ten years.


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Difference between debenture

and bondO Long-term debt securities issued by the

Government of India or any of the State

Governments or undertakings owned by

them or by development financial

institutions are called as bonds.

O Instruments issued by other entities are

called debentures.


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Current yield

This is the yield or return derived by

the investor on purchase of theinstrument (yield related topurchase price)It is calculated by dividing thecoupon rate by the purchase priceof the debenture. For e. g: If aninvestor buys a 10% Rs 100debenture of ABC company at Rs90, his current Yield on the

instrument would be computed as:


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Primary Dealers & Satellite

Dealers

O Primary Dealers can be referred to

as Merchant Bankers toGovernment of India, comprising

the first tier of the government

securities market. Satellite Dealers

work in tandem with the Primary

Dealers forming the second tier of

the market to cater to the retail

requirements of the market.


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What role do Primary

Dealers play?The role of Primary Dealers is to;

(i) commit participation as Principals in

Government of India issues through

bidding in auctions

(ii) provide underwriting services

(iii) offer firm buy - sell / bid ask quotes for

T-Bills & dated securities

(v) Development of Secondary DebtMarket


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OMOO OMO or Open Market Operations is a

market regulating mechanism oftenresorted to by Reserve Bank of India.

Under OMO Operations Reserve Bank ofIndia as a market regulator keeps buyingor/and selling securities through it's openmarket window. It's decision to sell or/andbuy securities is influenced by factors

such as overall liquidity in the system,


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YIELD CURVE

O The relationship between time and yieldon a homogenous risk class of securitiesis called the Yield Curve. The relationshiprepresents the time value of money -showing that people would demand apositive rate of return on the money theyare willing to part today for a payback intothe future


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SHAPE OF YIELD CURVEA yieldcurve can be positive, neutral orflat. A positive yield curve, which is

most natural, is when the slope of thecurve is positive, i.e. the yield at thelonger end is higher than that at theshorter end of the time axis. This results,as people demand higher compensationfor parting their money for a longertime into the future. A neutral yieldcurve is that which has a zero slope, i.e.is flat across time. T his occurs when

people are willing to accept more or


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LIBOR

O LIBOR stands for the London

Interbank Offered Rate and is therate of interest at which banksborrow funds from other banks, inmarketable size, in the London

interbank market.O LIBOR is the most widely used

"benchmark" or reference rate forshort term interest rates. It is

compiled by the British Bankers


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CRR & SLRThe minimum and maximum levels

of CRR are prescribed at 3% and

20% of demand and term liabilities(DTL) of the bank, respectively,

under Reserve Bank of India Act of

1934. The minimum and maximum

SLR are prescribed at 25% and40% of DTL respectively, under

Banking Regulation Act of 1949.

The CRR and SLR are to be

maintained on fortnightly basis. The


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Demand and Time

LiabilitiesMain components of DTL are:

O Demand deposits (held in current and

savings accounts, margin money forLCs, overdue fixed deposits etc.)

O Time deposits (in fixed deposits,recurring deposits, reinvestment

deposits etc.)O Overseas borrowings

O Foreign outward remittances in transit(FC liabilities net of FC assets)

O Other demand and time liabilities


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SLRSLR is to be maintained in the form of the

following assets:

O

Cash balances (excluding balancesmaintained for CRR)

O Gold (valued at price not exceeding

current market price)

O

Approved securities valued as per normsprescribed by RBI.


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VaRValue at Risk (VaR)is the mostprobable loss that we may incur in

normal market conditions over agiven period due to the volatility of afactor, exchange rates, interestrates or commodity prices. Theprobability of loss is expressed as apercentageVaR at 95%confidence level, implies a 5%probability of incurring the loss; at99% confidence level the VaR

implies 1% probability of the stated


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VaRThe VaR is an estimate of potential loss,always for a given period, at a givenconfidence level.. A VaR of 5p in USD / INR

rate for a 30- day period at 95% confidencelevel means that Rupee is likely to lose 5p inexchange value with 5% probability, or inother words, Rupee is likely to depreciateby maximum 5p on 1.5 days of the period

(30*5% ) . A VaR of Rs. 100,000 at 99%confidence level for one week for ainvestment portfolio of Rs. 10,000,000similarly means that the market value ofthe portfolio is most likely to drop bymaximum Rs. 100,000 with 1% probability


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Exchange Rate QuotationO Exchange Quotations :

There are two methods

O

Exchange rate is expressed as the priceper unit of foreign currency in terms of thehome currency is known as the Homecurrency quotation or Direct Quotation

O Exchange rate is expressed as the price

per unit of home currency in terms of theforeign currency is known as the ForeignCurrency Quotation or IndirectQuotation

O Direct Quotation is used in New York and

other foreign exchange markets and


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PrinciplesO Direct Quotation: Buy Low, Sell High:

O The prime motive of any trader is to makeprofit. By purchasing the commodity atlower price and selling it at a higher pricea trader earns the profit. In foreignexchange, the banker buys the foreigncurrency at a lesser price and sells it at ahigher price.

O Indirect Quotation: Buy High, Sell Low:

O A trader for a fixed amount of investmentwould acquire more units of thecommodity when he purchases and for

the same amount he would part with


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Spot and Forward Transactions

O A Bank agrees to buy from B Bank USD

100000. The actual exchange ofcurrencies i.e. payment of rupees and

receipt of US Dollars, under the contract

may take place :

O on the same day or

O two days later or

O some day later, say after a month.


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Interpretation of QuotationO The market quotation for a currency

consists of the spot rate and the forwardmargin. The outright forward rate has to

be calculated by loading the forwardmargin into the spot rate. For exampleUS Dollar is quoted as under in the inter-bank market on a given day as under :

O Spot 1 USD =Rs.44.1000/1300

O Spot/November0200/0500

O Spot/December

1500/1800


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TT Buying RateO TT Buying Rate (TT stands for

Telegraphic Transfer)

O This is the rate applied when the

transaction does not involve any delayin realization of the foreign exchangeby the bank. In other words, the nostroaccount of the bank would alreadyhave been credited. The rate iscalculated by deducting from the inter-bank buying rate the exchange marginas determined by the Bank.


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Bills Buying Rate

O This is the rate to be applied when a

foreign bill is purchased. When a bill is

purchased, the proceeds will be realized

by the Bank after the bill is presented to

the drawee at the overseas center. In the

case of a usance bill the proceeds will be

realized on the due date of the bill which

includes the transit period and the usanceperiod of the bill.


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ProblemYou would like to import machinery from

USA worth USD 100000to be payable to the overseas supplier on

31st Oct

[a] Spot Rate USD =Rs.45.8500/8600

Forward PremiumSeptember 0.2950/3000October 0.5400/5450

November 0.7600/7650[b] exchange margin 0.125%[c] Last two digits in multiples of nearest 25

paiseO Calculate the rate to be quoted by the bank

?


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SolutionThis is an example Forward Sale Contract .Inter Bank Spot Selling Rate Rs. 45.8600Add Forward Margin .5450

--------------46.4050

Add Exchange Margin .0580---------------

Forward Rate 46.4630Rounded Off to multiple of 25 paise

Rs.46.4625Amount Payable to the bankRs.46,46,250


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SwapO A swap agreement between two parties

commits each counterparty to exchange

an amount of funds, determined by a

formula, at regular intervals, until the swap

expires.

O In the case of a currency swap, there is an

initial exchange of currency and a reverse

exchange at maturity.


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MechanicsO Firm A needs fixed rate loan AAA rated

O Firm B needs floating rate -A rated

O Firm A enjoys an absolute advantageinboth credit markets.

11%9%

LIBOR+0.0%

LIBOR

+1%

F irm A Fi rm B

Fixed-rate

finance

Floating-rate

finance


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MechanicsSTEP !

Firm A will borrow at Fixed rate 9%

Firm B will borrow at floating rate (LIBOR

+1)%STEP 2

Firm A will pay Floating rate [LIBOR] to FirmB

Firm B will Pay Fixed rate [9.5%] only

Gain

Net interest cost LIBOR- .5%

Net Interest cost 9+[ 1%+0.5%]=10.5%


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MechanicsGain

A B

Borrows at9.0%fixed

for 7 years

Borrows atLIBOR + 1%

floatingfor 7 years

9.5%

LIBOR

Interest payments to eachother in years t1to t7.

Documents

Treasury Management in Banks