TREASURY

MANAGEMENT
AND
ASSET LIABILITIES
MANAGEMENT
 TREASURY
MANAGEMENT
 INTRODUCTION
Traditional role of treasury was :
 Ensuring the maintenance of RBI stipulated
norms for Cash Reserve Ratio (CRR)
 Ensuring the maintenance of RBI stipulated
norms for Statutory Liquidity Ratio (SLR)
 Activity in foreign exchange was confined to
meeting merchants’ and customers’
requirements for imports, exports, remittances
and deposits
 INTRODUCTION Contd.
 Cash reserve ratio is a ratio which banks have to maintain
with it self in the form of cash reserves or by way of current
account with the RBI, computed as a certain percentage of
its demand and time liabilities. The objective is to ensure
the safety and liquidity of the deposits with the bank.

 Statutory Liquidity Ratio is a ratio which every banking

company has to maintain in the form of cash, gold or
unencumbered approved securities, an amount, which
shall not, at the close of business on any day be less than
such percentage of the total demand and time liabilities as
the RBI may specify from time to time.
 INTRODUCTION Contd.
• Indian money market was characterized by the
imperfections arising out from the
administered interest rates and therefore
hardly reflected the position of true liquidity
in the system.
 RBI INITIATIVES
• Discount and Finance House of India was set up to
provide to the Market Participants an institutional
mechanism to meet their liquidity requirements by
dealing in short term money market instruments
like treasury bills, bills rediscounting etc..
• Increasing the number of instruments by
introducing commercial papers and certificates of
deposits.
• To enable price discovery, cap on call money
interest rates was completely withdrawn in May
1989.
 RBI INITIATIVES Contd.
 Call Money and Money at Short Notice: loans
given by one bank to an other, repayable by the
borrowers when a call is made or after a short
notice. This asset has an advantage over cash
reserve as it satisfies both the attributes of
sound banking asset i.e. profitability as well as
liquidity
 RBI INITIATIVES Contd.
• Non-Banking Institutions like LIC, All India Financial
Institutions , Mutual Funds etc were allowed to enter
the Call Money Market for lending only.
• Delivery Versus Payment (DVP) system was introduced
for securities settlement at Public Debt Offices which
substantially reduced the counter party risk in security
transfers and infused confidence in the introduction of
REPOS and expansion of REPOable securities.
• REPO is a contract under which the seller of securities,
such as Treasury Bills, agrees to buy them back at a
specified time and price. This is also called repurchase
agreement or buyback.
 RBI INITIATIVES Contd.
• The RBI began using monetary intervention tools such as
REPOS and Open Market Operations to manage liquidity in
the financial system and make the determination of interest
rates on G-Secs more transparent and competitive by
holding auctions.
• Post liberalization, deregulation and financial markets
reforms led to evolution of a vibrant Bond Market.
• Just like equity prices and FOREX markets, interest rates
(yield ) on debt instruments are determined through the
interplay of various economic, financial (liquidity, inflation,
government’s / RBI’s policies, growth, FOREX demand and
supply, domestic interest rates etc) and political (local &
international) factors and events
 RBI INITIATIVES Contd.
 Market Makers are intermediaries between the end-users and the
financial system, but unlike general financial intermediaries, they
do not act as agents to end-users. Instead they act as principals
buying and selling securities for their own account.
 They hold an inventory of securities on their books which grows
when they buy the securities and vice versa.
 They are rewarded in one of the following two ways:

1.Through the Bid Offer Spread-the difference between the bid

price at which they will buy a security and a higher offer price at
which they sell them.
2.Through taking a position (speculation) i.e. if they believe that
prices will rise in the future, they will increase their inventory
holding and vice versa.
 RBI INITIATIVES Contd.
• The Rupee’s exchange rate has become
volatile. The fluctuations in interday and
intraday prices enables one to earn trading
profits on buying and selling the currency.
• Cross-currency trading opportunities got new
impetus after liberalization.
 THUS…….
• The VOLATILITY in interest rates is at the heart of the
transformation of BANK TREASURIES from mere CRR
and SLR keepers to a profit centre.
• Downward and upward movements in the Gilt yields
offer excellent scope and opportunity for the Banks to
trade in the underlying securities and earn profits
and to take advantage of currency variations in the
FOREX market.
• Volatility is the measurement of the change in price
over a given period of time. It is often expressed as a
percentage and computed as the annualized standard
deviation of percentage change in daily price.
SOURCES OF PROFIT OF TREASURY
 INVESTMENTS: Where banks earn a higher
yield than its cost of funds. Eg. Buying a
corporate bond yielding 7% and maturing in
three years, financed by deposits costing only
6%.
 SPREADS: Between yields on money market
assets and money market funding. E.g. The
Bank may borrow short term for 5% and
deploy in commercial papers with return of
6%.
SOURCES OF PROFIT OF TREASURY
Contd.
 In the context of Over-the-counter market, the
term ‘Ask’ refers to the lowest price at which a
market maker will sell a specified number of
shares/securities at any given time.
 The term ‘Bid’ refers to the highest price a
market maker will pay to purchase the security.
 The ‘Ask’ price or The Offer Price will almost
always be higher than the Bid Price. Market
Makers make money on this difference known as
SPREAD.
 SOURCES OF PROFIT OF TREASURY
Contd.
• ARBITRAGE: Is a buy /sell SWAP in the FOREX market, where
the bank converts its Rupee funds into a Dollar deposit, earns
LIBOR (London Inter Bank Offer Rate)and gets back Rupee on
deposit maturity. This generates a risk free profit
(ARBITRAGE) if LIBOR plus the forward premium on Dollar/
Rupee is more than the domestic interest rate.

• RELATIVE VALUE: This is a form of Arbitrage in which bank

exploits the anomalies of the market prices. The bank may have
an ’AAA’ bond, which yields 6%, compared to another with the
same rating and maturity, but of a different issuer, which offers
6.5%. It is worthwhile to sell the first bond and invest in the
second and improve the yield by 50 pbs (point basis).
 SOURCES OF PROFIT OF TREASURY
Contd.
 LIBOR is the rate that the most credit worthy
international banks that deals in Euro-Dollars charge
each other for large loans. It is equivqlent to the Federal
Funds Rate in the US.
 Arbitrage :

1. Is a process of buying a product/security in one market

and selling it in another, and there by making profits
2. The act of obtaining risk free profits by simultaneously
buying and selling similar instruments in different
markets.
The process is known as Arbitrage and the person as
Arbitraguer.
SOURCES OF PROFIT OF TREASURY
Contd.
 PROPRIETARY TRADING: In this the focus is
entirely on the short term , as opposed to investment
which is long term. The aim is to earn trading profits
from movements in security and FOREX prices
during a day or a few days of trading.
Under this, a dealer may buy for example 9.81%
Government of India Security 2013 at Rs. 116.5at a
yield of 8.40% in anticipation of the yield falling to
7.70%, on fundamental grounds. If this happens, the
bond appreciates and the bank exits the position
with a profit.
SOURCES OF PROFIT OF TREASURY
Contd.
 CUSTOMER SERVICES: Bank Treasuries offer their
products and services to customers / non banking
customers. The income of banks from these activities
comprises fees and/or margins on trade execution.
Profits would be higher on structured (non standard
) transactions compared to plain vanilla (e.g. straight
forward buy sell USD/INR) deals.
 Treasuries are also involved in Investment Banking
where their responsibility covers trade execution on
behalf of the bank’s clients in the cash or derivatives
markets.
 SOURCES OF PROFIT OF TREASURY
Contd.
 Investment Bankers/merchant bankers : These
are agencies/organizations regulated and licensed
by SEBI, the Capital Market Regulator.
1. They arrange raising of funds through equity and
debt route and assist companies In completing
various formalities like filing the prescribed
documents and other compliances with the
regulator(s).
2. They advise the issuing company on book building,
pricing of issue, arranging registrars, bankers to the
issue and other support services.
 SOURCES OF PROFIT OF TREASURY
Contd.
BOOK BUILD: is a particular way of conducting a float where
the price at which shares are sold is not fixed, but rather is
determined following a process in which interested investors
bid for the shares. This is quite a common way of
determining the price paid for the shares by Institutional
Investors.

BOOK BUILDING: is a process used to ascertain and record

the indicative subscription bids of interested investors to a
planned issue of securities.
The advantages of this technique are that it results in:
1. Optimal pricing
2. Removes uncertainty regarding the mobilization of funds.
 MONEY MARKET
 DEFINITION
 Money Market, in general parlance is defined as
a market for instruments / transactions with an
initial maturity period of up to one year.
Money market embraces the various
arrangements that are related with issuance ,
Trading and redemption of low risk, short term,
marketable obligations.
Essentially this market is for short term financial
assets that are close substitutes for money.
 NEED FOR MONEY MARKET
 It provides an equilibrating mechanism for
evening out short term deficits and surpluses.
 It provides a focal point for central bank
intervention for influencing liquidity in the
economy.
 It provides reasonable access to users of short
term money to meet their requirements at a
realistic price.
FUNCTIONS OF MONEY MARKET
 To provide efficient facilities for adjustment of
liquidity positions of commercial banks, non
banking financial institutions, business firms and
other investors.
 It meets the short term fund requirements of the
borrowers and provides liquidity to the lenders.
 Narrows the interest rates differentials, both
geographically and industrially.
 Fosters the flow of funds to the most important
uses throughout the nation and the world, and
throughout the range of entire economic activity.
FUNCTIONS OF MONEY MARKET
 NON-BANKING FINANCIAL COMPANY: is a
financial intermediary that is engaged in certain
financing activities other that banking. These
activities are specified in the Non-Banking
Companies (reserve Bank) Directions 1977 and
amended thereto.
 The activities include equipment leasing, hire
purchase, housing finance and investments in
financial securities, bill discounting and factoring, fee
based services such as security issue management,
and advice on mergers and acquisitions and capital
restructuring etc.
MONEY MARKETS – INSTRUMENTS
 CALL MONEY: are those moneys which are lent where the borrower
has to repay the funds when called on to do so by the lender.
 NOTICE MONEY: refers to those moneys where the lender has to give
a certain number of days’ notice, which has been agreed on at the time
of the contract, to the borrower to repay the funds.

However in Indian context it refers to that transaction where in the

money is lent/borrowed between participants, permitted to operate in
the call/notice money market, for tenors ranging from overnight to
transactions to a maximum of 14 days.

This market is used by participants to manage their daily funding

mismatches and to comply with CRR stipulations. The participants who
are surplus of funds lend money to adjust the mismatch for the relative
period and vice versa.
 Contd…
 The Call/Notice money market has been made a pure inter bank
market recently. Only Scheduled Commercial Banks, Co-operative
Banks and Primary Dealers are permitted to operate in this market as
both borrowers and lenders.
 The placement of money/lending in the call/money market is
unsecured. As a prudential measure therefore , each lender fixes a
placement/counterparty exposure for each borrower. This limit
denotes the maximum amount the lender would lend to a specified
borrower.
 In addition to the exposure limits there is also a regulatory limit on
the amount a bank can lend/borrow in the call/notice money market.
In a reporting fortnight the average borrowing by a bank cannot
exceed 100% of its tier 1+tier 2 capital of the previous financial year
and on any given day the borrowing should not exceed 125% of the
same . In a reporting fortnight the average lending by a bank cannot
exceed 25% of its tier 1+tier 2 capital as of the previous financial year
and on any given day the lending should not exceed 50% of the same.
 Contd…

 PRIME LENDING RATE: The rate of interest

charged by the banks on working capital and
short term loans to their most credit worthy
borrowers. The prime rate serves as a
benchmark for deciding on the interest rate to be
charged to other borrowers.
 Accordingly, major banks and financial
institutions periodically announce theis PLRs
depending on the their cost of funds and
competitive lending rates.
 Recently banks have been given the freedom to
have different PLRs for different maturities.
 Contd…
 TIER I CAPITAL:
 1.Tier I capital in case of Indian Bank would comprise:

a. Paid up Capital
b. Statutory Reserves
c. Disclosed free Reserves
d. Cap[ital reserves representing Surplus arising out of sale proceeds of assets.

 2. Equity investments in subsidiaries (intangible assets and losses in the

current year and those brought forward from the previous period will be
deducted from Tier I capital).
 3. The total of Tier II capital will be limited to a maximum of 100% of the
total of Tier I capital for the purpose of compliance with the Capital
Adequacy Norm.
 4. Banks should mention on an ongoing basis additional Tier I capital of 5%
on foreign currency position limit approved by the RBI.
 5. Banks keeping open position in Gold should mention Tier I capital to the
extent of 5% of the open position limit laid down by banks with the
approval of their B.o.Ds and with the specific approval of the RBI .
 Contd…
 TIER II CAPITAL: TIER II CAPITAL will
consist of :
1. Undisclosed reserves and cumulative perpetual
preference shares.
2. General provisions and loss reserves.

3. Revaluation reserves.

4. Hybrid debt capital instruments.

5. Subordinated debt.

6. Limit on subordinated debts.

 CAPITAL ADEQUACY RATIO
 The Bank for International Settlement(BIS)
(Headquarters – Basel Switzerland) set up a committee
to examine the Capital Adequacy of an international
bank which recommended it to be at 8%. The Committee
on Banking Regulations and Supervisory Practices (The
Basel Committee) was headed by an Australian Banker
Mr. Peter Cooke is also known as Cooke Committee)

Narsimhan Committee has recommended capital

adequacy of 8% for Indian Banks.
It is computed as CAPITAL FUNDS/ RISK
WEIGHTED ASSETS+OTHER EXPOSURE.
 Contd…
 TERM MONEY: It refers to those borrowing and
lending transactions between the inter bank
participants which have tenors greater than 14
days. There is no regulatory limit on the amount
an inter-bank participant may lend or borrow.

 BANK FIXED DEPOSITS: Scheduled Commercial

Banks and Cooperative Banks accept term
deposits for a period of 7 days and above. The rate
of interest vary from bank to bank. These are non
transferable but can be liquidated easily subject to
penalty which again varies from bank to bank
which is in terms of loss of interest.
 Contd…
 CERTIFICATE OF DEPOSITS (CDs): is a negotiable
money market instrument and issued in a dematerialized
form or as a Promissory Note, for funds deposited at a
bank or other eligible financial institution for a specified
time period under the guidelines issued by the RBI.
 CDs can be issued by
i) Scheduled commercial banks excluding the RRBs and
Local Area Banks.
ii) select all-India FIs that have been permitted by the RBI
to raise short term resources, within the permissible
limits.(i.e. issue of CD together with other instruments viz
term money, term deposits, CPs & inter corporate
deposits should not exceed 100 % of its net owned funds
as per last audited balance sheet.
CERTIFICATE OF DEPOSITS (CDs):
FEATURES
 The maturity period of CDs is sued by banks should not be less than 7 days
and not more than 1 year.
 The FIs can issue CDs for a period exceeding 1 year but less than 3 years
from the date of issue.
 CDs can be issued to the individuals, corporations, companies, trusts,
associations etc..
 CDs can either be in physical form or in a DEMAT form.
 CDs are freely transferable by endorsement with the exception of NRIs who
can not endorse it to another NRI in a secondary market.
 There is no lock-in-period.(min. period 7 days)
 Minimum denomination is of Rs 100000 and in multiples thereof, there after.
 The rate of interest is determined by the parties and on the basis of demand
supply factor.
 The instrument is to be stamped as per the regulations of The Indian Stamp
Act.
 Banks/FIs cannot grant loans against CDs. Further they can not buy back
them before maturity.
 MONEY MARKET INSTRUMENTS Contd..
 COMMERCIAL PAPERS :
 Unsecured money market instrument issued in the form of promissory note or in

dematerialized form.
 Privately placed instrument enabling highly rated corporate to diversify their sources of

short term borrowings and to provide additional instrument to investors.

 Corporate & Primary Dealers, NRIs ,FIIs, and All India FIs have been permitted to issue

CPs.
 All eligible participants shall obtain the credit rating for issuance of CPs from either the

Credit Rating Information Services of India Ltd. (CRISIL) or the Investment Information
& Credit Rating Agency of India (ICRA) or the Credit Analysis & Research Ltd.(CARE)
or The FITCH Ratings India Pvt . Ltd. Or any other credit rating agency as the RBI may
notify from time to time.
 CPs can be issued for a period of 7 days to 1 year. The maturity date of the CP should not

go beyond the date up to which the credit rating of the issuer is valid.
 CP will be issued at a discount to face value as may be determined by the issuer.

 Every issuer must appoint an IPA (Issue and Pay Agent ) for issuance of CPs. Only a

scheduled bank can act as an IPA for issuance of CP.

 The rate of interest is determined by the parties to the transaction.

 The instrument is to be stamped according to the rates as prescribed in the Indian Stamp

Act.
 MONEY MARKET INSTRUMENTS Contd..
 BILL REDISCOUNTING SCHEME (BRDS) : Banks in
their normal course of business discount bill of
exchange. To provide liquidity and to promote bill
culture in the economy the RBI formulated a scheme
whereby a bank may raise funds by issue of Usance
Promissory Note (UPN) in convenient lots and
maturities ranging between 15 days to 90 days.
 Banks can only rediscount B/E which have the
following features:
1. The B/E should have arisen on account of bona
fide trade transaction.
2. The B/E should be unencumbered.
3. The unexpired tenor of the bill should not be more
than 90 days.
MONEY MARKET INSTRUMENTS Contd..
 The BRDS transaction is carried out on a
discounted basis and has the following features:
1. Interest is calculated on an actual/365 basis.
2. Interest is calculated on a front end basis and
rounded of to the nearest rupee.
3. The borrower receives an amount which is
the principal amount less the interest/discount.
4. The lender receives the principal amount
from the borrower on the maturity of the
transaction.
5. The effective yield on the bills discounting is
higher than the discount rate.
 MONEY MARKET INSTRUMENTS Contd..
 INTER-BANK PARTICIPATION CERTIFICATES (IBPCs): A short
term money market instrument whereby banks can raise/deploy
short term deficit/surplus. In case of IBPC the borrowing bank
passes/sells on the loans and credits that it has in its books, for
temporary period, to the lending bank. IBPC are of two types
1. With risk sharing
2. Without risk sharing
 Only Scheduled Commercial Banks can issue them

. Minimum period shall be 91 days and maximum of 180 days in

case of IBPCs on risk sharing basis and under non risk sharing
basis total period is limited to 90 days.
Interest rate is determined between the issuing and participating
bank.
These are non transferable.
They cannot be redeemed before the due date.
 MONEY MARKET INSTRUMENTS Contd..
 COLLATERALISED BORROWING AND
LENDING OBLIGATION (CBLO): This is a
product developed by CLEARING
CORPORATION OF INDIA LIMITED (CCIL) for
the benefit of entities who have either phased out
from inter bank call money market or have been
given restricted participation in terms of ceiling on
call borrowing and lending transactions and who
do not have access to call money market.
 CBLO is a discounted instrument Available in
electronic book entry form for the maturity period
ranging from 1 day to 90 days which can extend up
to 1 year as per RBI guidelines.
 MONEY MARKET INSTRUMENTS Contd..
 In order to enable the market participants to borrow and lend funds,
CCIL (Clearing Corporation of India) provides the Dealing System
through Indian Financial Network (INFINET), a closed user group to the
Members of the Negotiated Dealing System (NDS) who maintain
Current Account with RBI and through Internet for other entities who
do not maintain Current Account with RBI.
THUS:
CBLO is a borrowing arrangement, against those securities which are
placed with the Clearing Corporation Of India either as margin or
otherwise. The process thus can be summed up as under:
1. An obligation by the borrower to return money borrowed, at a specified
future date
2. An authority to the lender to receive money lent, at a specified future
date with an option/privilege to transfer the authority to another
person for value received.
3. An underlying charge on the securities held in custody (with CCIL) for
the amount borrowed/lent.
 MONEY MARKET INSTRUMENTS Contd..
TREASURY BILLS (T-BILLS) :
• Treasury Bill is a short term money market instrument issued
by the Govt. of India (GOI) through RBI for tenures of 14 days,
28 days, 91 days, 182 days and 364 days.
• The T-Bill is a discounted instrument i.e. it is issued at a
discount to its face value which is usually Rs. 100.
• Investment in T-Bill is reckoned for the purpose of SLR
requirements.
• T-Bills are issued in the primary market by the RBI,
periodically. Normally there are T-Bill auctions every week.
• The cut off is determined by the market forces under normal
circumstances.
• The T-Bills are moderately active In the secondary market and
are traded on a yield basis. The transfer of T-Bills is through
(SGL) Subsidiary General Ledger.
 MONEY MARKET INSTRUMENTS Contd..
REPURCHASE AGREEMENTS (REPOs):
• Is a money market instrument enabling collateralised short term
lending/borrowing through sale/purchase operations in debt
instruments.
• It is a process wherein a number of instruments (G-Secs,
PSU Bonds and other securities) can be used as underlying
securities to borrow and lend money in the market.
• It is essentially a lending/borrowing transaction at an
agreed rate of interest known as repo rate. In view of this
the forward clean price of the bond is set, at the time of
sale, at a level which is different from the spot clean price
by adjusting the difference between repo interest (known
as repo rate) and coupon income on the security.
• The rate of interest on repo will be market related.
 MONEY MARKET INSTRUMENTS Contd..
REPO RATE :
Is the annualized interest rate for the funds lent by the buyer of
the securities (lender) to the seller of the securities (borrower).
A Repo is sometimes called a ready forward action as it is a
means of funding by selling a security held on a Spot/ Ready
basis and repurchasing the same on a forward basis.
When an entity sells a security to another entity on repurchase
agreement basis and simultaneously purchase some other
security from the same entity on resell basis it is called a Double
Ready Forward.
The repo rate is lower than that offered on unsecured / clean
interbank loan for the reason that it is a collateralised transaction
and the creditworthiness of the issuer of the underlying security
is often than the seller.
 MONEY MARKET INSTRUMENTS Contd..
REPO is also undertaken by RBI for controlling liquidity in the
market as also to help banks in need of liquidity.
The banks can borrow funds from RBI by doing REPO and
deposit with RBI by doing a Reverse REPO. For the RBI it is
REVERSE REPO on the former and REPO on the latter. This is
known as LAF (Liquidity Adjustment Facility).
REPO is allowed in PSU bonds and private corporate debts
provided the debts are in dematerialized form.

The Repo transaction should have:

a. Present sale or purchase with a commitment to repurchase or
resell respectively at a future date
b. Contract between same parties
c. Same securities with the same quantum
d. Transactions must be entered on the same day for both legs*
 MONEY MARKET INSTRUMENTS Contd..
The Ready Forward Transaction is in two legs:
READY LEG :
The borrower of the funds sell securities at the prevailing market
price to the lender. (prevailing Market price is the rate of return on
risk free GOI securities)
Before the sale the borrower and lender agree on the tenor and the
rate of the repo transaction.

FORWARD LEG:
The borrower of the funds buys back the securities sold in the
Ready Leg from the lender at a computed price so that the lender
(seller of the securities) gets an amount which includes the
amount lent on the Ready Leg plus the interest for the amount
lent at the agreed interest rate for the TENOR of the Repo.
 MONEY MARKET INSTRUMENTS Contd..
TYPES OF REPOS: Broadly there are four types of
REPOS available in the international market. They are as
follows:
 BUY-SELL BACK REPO: Here the lender actually
takes possession of the collateral. Here a security is
sold outright and bought back simultaneously for
settlement on a later date. The ownership is passed
on to the buyer and hence he retains any coupon
interest due on the bonds.
 CLASSIC REPO: is an initial sale of securities with a
simultaneous agreement to repurchase them at a later
date. The start and end prices of the security is the
same and a separate payment of interest is made.
 MONEY MARKET INSTRUMENTS Contd..
 HOLD IN CUSTODY REPO: The counterparties enter into an
agreement where by the securities sold are held in custody by the seller
for the buyer until maturity of the REPO thus eliminating the
settlements requirements.
 BOND LENDING/BORROWING TRANSACTION: The customer
lends bonds for an open ended or fixed period in return for a fee.
 TRIPARTITE REPOS: Under this kind of repo a common custodian/
clearing agency arranges for a custody, clearing and settlement of repo
transactions. They operate under a global master purchase agreement
and provide for DVP (delivery versus payment) system, substitution of
securities, automatic marking to market, reporting and daily
administration by single agency which takes care of the risk by itself
and automatic roll-overs while does not insist on disclosing the
identities by counterparties. The system starts with signing of
agreement by all parties and the agreement includes Global Master
Repurchase and Tripartite Repo Service Agreements. This type of
arrangement minimizes credit risk and can be utilized when dealing
with clients with low credit rating.
 INTEREST RATE QUOTATIONS AND
MARKET TERMINOLOGY
There are different ways of calculating interest
amount on a money market / debt instrument.
They are as follows:
 FIXED and FLOATING RATE OF INTEREST