TREASURY AND RISK MANAGEMENT

Mumbai Institute of mgmt and research

TREASURY AND RISK MANAGEMENT

Index
1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. Introduction Evolution of Treasury Management in Banks Objectives of the Treasury Functions of a Treasurer Responsibility of a Treasurer Bank Of India - Pursuit of Growth Treasury Management of Bank Of India Responsibilities and Elements Of BOI Treasury Call/Notice Money Market Repo/Reverse-Repo Market: Debt Market Foreign Exchange Market Capital Market Certificates of Deposits Commercial Paper (CP) Commercial Bills BONDS & DEBENTURES Mutual Funds Risk Management in Banks Managing Risks

Mumbai Institute of mgmt and research

TREASURY AND RISK MANAGEMENT

Introduction
Treasury management can be defined as Treasury management is the management of an organization s liquidity to ensure that the right amount of cash resources are available in the right place in the right currency and at the right time in such a way as to maximize the return on surplus funds, minimize the financing costs of the business, and control interest rate risk and currency exposure to an acceptable level The organization of finance department differs from organization to organization. There is no statutory pattern. Legally and theoretically, the right of managing a company vests in its shareholders, but their numbers being large and scattered, this task is entrusted to the Board of Directors. The main representative of the Board of Directors is the Chief Executive Officer/ Managing Director. He is the competent authority to take decisions on matters relating to the overall policy formulations and execution. To learn about the constitution of the treasury, a study can be made about the constitution of the Finance department. The Vice-President (Finance) is the chief (head) of the Finance department, to whom the Treasurer and the Controller are responsible. The dynamics of financial markets the world over are undergoing a transformation as businesses are increasingly getting globalized and more and more economies are becoming market driven. As a result of this changing scenario, one of the major consequences is the increasing volatility in the level of market (interest) rates, exchange rates, money supply and general level of prices.

Treasury management in banks is the management of an organization s liquidity to ensure that the right amount of cash resources are available in the right place in the right currency and at the right time in such a way to satisfy the statutory requirement and to maximize the return on surplus finds, minimize the financial costs of the business, and control interest rate risk and currency exposure to an acceptable level. . Depending on the size of the organization and nature of the business, the role of treasury can vary from simple cash management to all financial affairs excluding financial accounting, internal audit and other functions of a controller. Treasury management in banks is primarily concerned with efficient allocation of banks resources. It aims to optimize the banks return with minimum risk and thereby improves the profitability of the bank. It does myriad functions ranging from cash and liquidity management, reserves management, funds management to transfer pricing, risk management and forex management. An efficient treasury is always a profit centre to the bank.
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The middle office usually cares about the risk management aspects such as Asset Liability Management. The front office also looks after the market intelligence. tracking of exchange rates etc. treasury management skills. Back office does all the background work like keeping the records and managing the past data and accounting systems. the solution provider manages these functions for a host of other companies also the clients benefit on reduced costs through economies of scale. each deal with different markets like forex. proper infrastructure. The solution provider through the use of an integrated computer system coupled with internet processes all the information and trade orders in real time. disbursement of information on various positions to the front office and compliance of reporting requirements. etc. In treasury integration. The front office is the strategic decision-making part of corporate treasury.TREASURY AND RISK MANAGEMENT The key factors required for an effective treasury management are its organizational structure. A typical treasury comprises three sub-sections . However. its involvement in the ALCO of the bank. middle and back office. money market. relationships with investor and banks. control and supervision. fixed income etc. The front office usually performs the market trading. Mumbai Institute of mgmt and research . asset and liability management skills. policy guidelines.front. It may consist of different desks. it is a usual practice that a specialized solution provider maintains both the back and middle office functions of treasury. lending and funding policy. the strategic front office is managed by an internal team. Because. Each office has specified functions and goals to achieve.

Investments are now viewed as alternative to credit. RBI began using monetary intervention tools like repo and open market operations (OMO) to manage liquidity in the financial system and make the determination of interest rates more transparent for govt. in Indian banking sector the role of treasury was limited only to ensure the proper maintenance of the statutory ratios like CRR and SLR. So these developments have initiated excellent opportunities for Indian banks to cash in on the fluctuations of various yields. As financial investments are tradable assets. further. operations Indian capital market was restricted. a vibrant capital market as well as debt market has evolved in the country. deregulation and financial market reforms. This has enhanced the relative importance of investments in the banking balance sheets. Exchange Traded deals and deal reporting for transparency and information dissemination. etc). Further. DFHI (Discount and Finance House of India) was set up to give market participants a mechanism to meet their short term liquidity requirements by dealing in money Market instruments like T-bills. payment) system for security settlement at public debt offices substantially reduced the counter party risk. Accordingly RBI has initiated various measures to reform the market and to develop institutional infrastructure and instruments needed to widen and deepen the market. introduction of instruments like commercial papers and certificate of deposits greatly contributed to the development of the money market. now. auction system. Post liberalization. therefore hardly reflected position of true liquidity in the system. Following the recommendations of different committees and working groups to study the structure and role of bank and other organizations in the face of reforms. is at the heart of the transformation of bank treasuries from mere CRR and SLR keepers to profit canters. The introduction of DVP (delivery vs. activity in foreign exchange was confined to meeting merchants and customers requirements for imports. CCIL. exports. bills rediscounting etc. An active treasury can arbitrage (earning profit with minimum risk) by borrowing cheap and investing in high yield Mumbai Institute of mgmt and research . securities. the age old source of profit for banks.(mention about SEBI. currencies and prices. were allowed to enter into the money market for lending. Non-banking institutions like LIC. The risk regulated volatility. DVP mechanism. globalisation and capital account convertibility. Primary Dealers. mutual fund houses etc. NDs and NDFSD OM trading platforms. Indian debt market was also not developed cause of lack of liquidity and high SLR limit.TREASURY AND RISK MANAGEMENT Evolution of Treasury Management in Banks Traditionally. With deregulation of financial markets. removal of TDS on secondary market transactions. Again cap on call money market was lifted in phases and was completely removed in 1989. they offer both interest spreads and capital appreciation. remittances and deposits. This also won the confidence for introduction of Repo and expansion of repoable securities. Indian money market was ripe with imperfections arising out of administered interest rates. Custodians.

Corporate have been permitted borrow in INR and/or in foreign currencies. 2003 resolved to transfer the activities of the Company relating to Forex Dealing Platform and Collateralised Borrowing and Lending (CBLO) dealing platform to Clearcorp and the same has been made operational from January 1. Accordingly. and. also to alternate between the INR loan and the Foreign Currency Loan (FCL). the Shareholders of CCIL at their meeting held on June 4. a risk bearing activity. Mumbai Institute of mgmt and research . New accounting procedures requiring banks to revalue the investment portfolio at market prices and making provision for depreciation (which affects the profitability) has also made banks to monitor the risks and manage the investment portfolio. foreign currencies of all kinds. 2004. a wholly owned subsidiary of CCIL. This aspect has also contributed towards the integration of Forex and money markets Clearcorp Dealing Systems (India) Limited (Clearcorp). Banks can raise rupee resources by sale of foreign currencies for meeting their rupee requirements for lending to corporate provided such lending is profitable. 2003 to facilitate. set up and carry on the business of providing dealing systems/platform in Collateralised Borrowing and Lending Obligation(CBLO). Clearcorp has been set up to facilitate CCIL to segregate its other activities from the Clearing & Settlement activity. Repos and all money market instruments of any kind and also in foreign exchange.TREASURY AND RISK MANAGEMENT giving portfolios. Corporations will compare the cost of borrowings in INR and in foreign currencies and decide to borrow in the currency on which the effective cost is less. was incorporated in June.

settlement and risk management in treasury operations.  To deploy profitably and without compromising the liquidity.  To take advantage of the attractive trading and arbitrage opportunities in the money. bond and forex markets.  To manage and contain the treasury risk within the approved and prudential norms of bank and regulatory authority.  To identify and borrow on the best terms from the market to meet the clearing deficits of the bank. the clearing surpluses of the bank.  To asses and advise and manage the financial risk of the non-treasury assets and liabilities of the bank.TREASURY AND RISK MANAGEMENT Objectives of the Treasury The treasury of a bank undertakes various operations for fulfilling the following objectives.  To fund the bank s balance sheet on a current and forward basis as cheaply as possible taking into account the marginal impact of these actions.  To effectively manage the forex assets and liabilities of the bank. Mumbai Institute of mgmt and research .  To maintain the CRR and SLR as mandated by the RBI.  To offer value added treasury and related services to the bank s customers and to act as a profit centre as well.  To adopt the best practices in dealing clearing.

and extending products and services to its customers for hedging the interest rate risks. imports. It has been realized that credit function alone is not efficient and banks should look to investments for earning market related returns on funds. etc. a) Ensuring strict compliance with the statutory requirements of maintaining the stipulated Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR). the treasury also takes care of the associated functions like liquidity management and asset-liability management of the domestic as well as foreign exchange resources and deployment. remittances. Investments have thus gained importance as an equally important part of the banks balance sheets. While doing so. the historical source of profits.TREASURY AND RISK MANAGEMENT Functions of a Treasurer In this dynamic world of financial markets where a perfect risk return match is the key to success. The treasury operations also include providing of cover to the customers of the bank in respect of their foreign exchange exposure for their trade transactions like exports. banks have been compelled to look for avenues for alternatives to credit.. With financial market reforms. Therefore. and b) Liquidity management by ensuring the optimum utilization of the residual resources through investments (ii) raising additional resources required for meeting credit demands at optimal cost and (iii) managing market and liquidity risks in the transactions. Treasury operations of a commercial bank consist mainly of two vital functions viz. as SLR. Basic Treasury Functions Domestic Operations a) Maintenance of statutory reserves b) Managing liquidity c) Profitability reserves deployment of Forex Operations a) Extending cover to foreign exchange trade transactions b) Funding and managing forex assets and liabilities c) Providing hedge to forex risks proprietary and for its constituents d) Trading and a arbitrate Mumbai Institute of mgmt and research . a substantial portion of banks resources are deployed in government/corporate bonds and other products as an alternative to credit. over and above the statutory holding of government securities.

TREASURY AND RISK MANAGEMENT e) Hedge and cover operations f) Mid / Back Office function/s d) Trading and Arbitrage e) Mid / Back Office functions Mumbai Institute of mgmt and research .

risk management.  Balance Sheet Management: The ongoing reforms have provided the banks freedom to price most of their assets and liabilities by themselves although there exists a broad band specified by the RBI. add to the liquidity and continuously strive to provide value added solutions to specific financial needs. give correct pricing signals keeping in mind the liquidity profile of the bank. Liquidity essentially means the ability to meet all contractual obligations as and when they arise. This would be in the nature of a monthly rolling forecast. investments. It is well known that the balance sheet management is a dynamic and proactive process. analysis of market changes and controls. Demand and supply forces will impact the optimal balance sheet size and its growth rate. Liquidity planning involves an analysis of all major cash flows that arise in the bank as a result of changes in the assets and liabilities and projecting these cash flows over the future.  Liquidity Management: An important aspect of balance sheet management is Liquidity management. such that corrective action can then be taken to maintain adequate liquidity. It requires continuous monitoring. On the external front he has to provide active trading support to the market. technology and operations. He performs a myriad of functions such as. liquidity management. Ideally. He has to arrive on an optimum size of balance sheet. reserves management. interface with various liability and asset groups internally. very crucial to the balance sheet management. This will enable the treasury manager to identify any potential liquidity problems that may arise in the future. as well as the ability to satisfy funds requirement to meet new business opportunities. funds management.TREASURY AND RISK MANAGEMENT Responsibility of a Treasurer In today s highly competitive environment. The pricing of treasury assets and liabilities which form a critical mass of the balance sheet. the treasurer plays a vital role in the viability and success of a bank and calls for effective internal and external interface. is therefore. transfer pricing. managing capital adequacy. balance sheet projections should be prepared for a twelve month period on a monthly basis. trading activities and offering hedge products. Liquidity analysis involves a study of the maturity profile of existing assets and liabilities over which is superimposed the impact of transactions that are planned for the future Mumbai Institute of mgmt and research .

The ALCO (Asset and Liability Committee) should meet every month for the aspect of strategic business planning. Very often banks put up excessive assets in the form of cash credit loans or 0ments in securities without having matching source of funds of similar tenure. due to actuarial andbehaviour4 reasons. At the other end of the spectrum are the funds obtained from the interbank money market which are very short term in tenure and volatile as regards rate as well as availability. Asset and liability levels need to be monitored and managed periodically to iron out any structural imbalances. because the bank starts depending chronically and excessively on the most easily accessible source of funds i. Customer deposits are often the most suitable source of funds for a bank. so that there is no large structural mismatch in the balance sheet that can lead to liquidity problems. the inter-bank call money market. Therefore. with return on assets being a key criterion for measuring the efficiency of deployment of funds. the focus has now to shift on to the quality of assets.  Transfer Pricing: Mumbai Institute of mgmt and research .term assets through overnight borrowings on an ongoing basis.TREASURY AND RISK MANAGEMENT Effective liquidity management requires careful attention to balance sheet structure and growth. through a variety of instruments and for a variety of tenures. the bank may end up funding long . This mismatch in the maturities of assets and liabilities may result in the bank being subjected to liquidity risk. The treasury also has the responsibility for setting target balance sheet size and key ratios. It is also advisable that the maturity profile of assets conform broadly to that of the liabilities. Diversified liabilities imply raising funds from a variety of sources. This is because balance sheet growth will call for additional capital in accordance with BIS guidelines and capital is increasingly scarce. Thus. It should be borne in mind that dependence on the call market may not be advisable due to the sharp fluctuations in market rates as well as volatility in the availability of funds in the market. A balance sheet that is wing rapidly needs careful scrutiny to determine whether the liquidity of the bank is being adversely affected. The size of the balance she is a matter of great importance for a bank.  Funds Management: Funds management by the treasury involves providing a balanced and well diversified liability base to fund the various assets in the balance sheet of the bank. in consultation with all business groups. in light of capital adequacy guidelines. The treasury has to decide on an optimal mix of funds from various sources to ensure that there is no excessive dependence on single category. A bank cannot afford to be driven just by volume goals which aim at a certain percentage growth in credit and deposits year after year.e.

Depending on the signals provided by the treasury in the form of benchmark rates for assets and liabilities. which can provide correct signal to various business groups as to their future asset and liability strategies. Commercial Papers. This will give a measure of the precise risk profile of the security holdings. Public Sector Bonds. This is done very effectively through the means of a transfer pricing mechanism administered by the treasury. Along with this.TREASURY AND RISK MANAGEMENT The treasury not only provides the interface between the bank and the external market. and enable the portfolio manager to initiate suitable corrective action in line with the treasury s overall investment strategy and risk return parameters. focus of the individual business groups can be shifted from asset growth to liability growth or vice versa as dictated by the needs of the bank. Along with investment for statutory reserves. and Corporate Debts etc. It helps to provide a balance between the two. a large asset base of a bank consists of investments on account of statutory reserves. The treasury is ideally placed for this purpose since it has an overview of the balance sheet of the bank. Therefore the choice of an appropriate mix of maturity patterns in the SLR portfolio is a very important function of the treasury manager. it also provides an interface between the asset and liability groups of the bank. they are most susceptible to fall in price due to changes in the yield curve. management of these reserves is a very important factor in the overall profitability of the bank. short dated securities have low price risk but they also give lower returns. On the other hand. Benchmarking of rates provides a ready reference for business groups about the correct business strategy to adopt given the balance sheet structure of the bank as well as the conditions prevailing in the money markets and the treasury s forecast about the expected rate movements in the future. These investment decisions depends on factors such Mumbai Institute of mgmt and research . a thorough understanding of the bank s overall funding needs as well as direct access to the external market. Benchmarking is extremely important in today s market environment which allows free market pricing of assets and liabilities. the treasury al makes investments in various other kinds of instruments such as Certificate of Deposits. Thus a correct transfer pricing provides a versatile tool in the hands of the treasury manager in optimizing the asset-liability mix on the balance sheet and the returns generated thereon. It should ideally take into account both liquidity as well as yield considerations. the market risk of the portfolio in terms of its price sensitivity to interest rate change needs to be quantified and periodically monitored by means of analytical tools such as duration analysis. The treasurer has to ensure that the funds of the bank are deployed in the most appropriate manner without sacrificing either yield or liquidity. Even though the long maturity securities offer the highest yields.  Reserve Management & Investments: In the Indian banking scenario. Since such a large proportion of funds are deployed in such reserves. Units. so that optimum returns can be obtained on the assets without compromising liquidity.

On the other hand cost of various liabilities is rising. Securitization of debt is likely to be an important growth area in the Indian market too in the near future. spreads in traditional banking products are decreasing regularly. Trading in instruments creates more liquidity and increases investor appetite. etc. Tradability provides liquidity in various instruments and generates non-fund based revenues. non. market liquidity in various instruments. debentures. traditional funds based incomes banks are gradually being eroded.  Trading and Distribution: Trading and Distribution skills are keys to the success of any treasury. This has been the trend in financial markets the world over. Borrowers are directly accessing through the medium of debt instruments like CPs. Treasury may hold investment in these instruments till their maturity or it can trade on them to take advantage of market opportunities. With the onset of reforms it is also seen that there is an increasing trend towards disintermediation in the financial markets. In such a situation. money market condition tenure of funding available. With increasing competition among banks. or through forex external borrowings.TREASURY AND RISK MANAGEMENT as bank s liquidity position. It can then distribute these debt instruments to investors who were till now only depositors. It can help to transform a borrower of funds into an issuer of debt. Mumbai Institute of mgmt and research .. This will enable the bank to earn a fee income without any balance sheet growth and without locking up funds of its own. yield and tax planning requirements. and that in turn entails higher capital adequacy requirements. fund-based exposures require balance sheet growth. Moreover.fund based revenue gains greater importance. It is here that the strength of the treasury lies. As a consequence.

These limits should be monitored by an independent risk manager. It is imperative for treasury to clearly define and explain these risks to their corporate clients and to help them effectively manage these risks keeping in mind the dynamic nature of the foreign exchange markets. While these products provide the client with the much desired interest saving. With the growing liberalization and the opening up of the economy to international financial markets and investors. There will be pressure on the treasury to offer various rupee-based and cross currency hedge products to their clients who have foreign currency exposures on their balance sheets. over a period of time. and the reports highlighting these limits. The success of any treasury thus depends a great deal on strong risk management. which are essentially volatile in nature. with the help of the Foreign Exchange Unit of the treasury. it is worth reiterating that in today s fast changing market environment. The most important risks which it has to manage are liquidity risk and price risk in addition to counterparty risk and issuer risk. independent Mumbai Institute of mgmt and research . term structure for interest rate limits. maximum cumulative overflow limits. their usage and excesses. if any. treasury should also have nonvolatile sources of revenue which are reflected in the diversified customer base of the bank. ensure the convergence of local currency and foreign currency yield curves and enable the clients to manage their foreign currency assets and liabilities in a more profitable manner through the use of foreign exchange derivatives both in the area of currency and interest rates. monitored and managed by technology and operations.  Risk Management: Treasury risk management is a separate topic in its own right. In addition to trading avenues. treasury should never lose its customer focus. Factor sensitivities. One of the major responsibilities of a successful treasury is to manage the risks arising out of the financial transactions entered into by the treasury. multi-currency environment and cater to the multiple needs of its customers. the recent changes in the 1regulations would. there should be a well-defined contingency liquidity plan. Customers today. etc.TREASURY AND RISK MANAGEMENT  Customer Focus: In a competitive environment. should be generated by an independent system. In fact. In order to manage various risks. treasury management has acquired a greater degree of complexity and sophistication. the treasury departments of various banks would have to function in a multi-product. are able to raise foreign currency funds either through direct commercial borrowing or through use of export credit agency schemes and are also able to reduce the interest costs through embedded options or arrear swaps. In conclusion. these are not without inherent risks.

These issues have become all the more important as profitability and commercial viability have become key criteria for assessing performance. Mumbai Institute of mgmt and research .TREASURY AND RISK MANAGEMENT back-office operations and first rate technology. And. it is these very fundamentals that form the edifice of a successful treasury that can sustain efficient allocation of internal resources on the one hand and accelerate the globalisation of our financial markets on the other.

71 crore during the year 2007-08.03. The CAR is higher than the regulatory requirement of 9%.645 branches in India spread over all states/ union territories including 93 specialised branches.95 % during the year as against 11.Treasury Rs. 3701.75% during the previous year. As per Basel II framework. Bank Of India recorded an operating profit of Rs. 592 crores in 2008. one of the leading Public Sector Bank in India.77 crore from Rs. at 12. The Bank s Capital Adequacy Ratio. Net Profit increased to Rs. It is one of India's leading banks. MASS MARKET AND RURAL MARKETS. The Bank was under private ownership and control till July 1969 when it was nationalized along with 13 other banks. with about 2. MEDIUM BUSINESSES AND UPMARKET RETAIL CUSTOMERS AND TO PROVIDE COST EFFECTIVE DEVELOPMENTAL BANKING FOR SMALL BUSINESS.21 crore.2479 crores in 2006 and 2101 crores in 2007 to 1931 crores in 2008 while he net NPA has came down from Rs.44 crore and Retail Banking Rs. There are 24 branches/ offices (including three representative offices) abroad.TREASURY AND RISK MANAGEMENT Bank Of India . 5503. 1120 crores in 2006 and Rs 812crores in 2007 to Rs.04% as on 31. WHILE PROVIDING COST-EFFECTIVE. Net worth of the Bank in FY 2007-08 has increased to Rs. Mumbai Institute of mgmt and research . MEET THE REQUIREMENTS OF OUR STAKEHOLDERS. The contribution from different segments of operations was .80 crore. In 2008.Pursuit of Growth Bank Of India. Bank of India was founded in 1906 by a by a group of businessmen from Mumbai with a paid up capital of Rs. PROACTIVE BANKING SERVICE TO NICHE MARKETS GLOBALLY. 8627.12%. RESPONSITVE SERVICE TO OTHERS IN OUR ROLE AS A DEVELOPMENT BANK AND IN SO DOING.78%. Wholesale Banking Rs. has the objective of progress and prosperity of all.40 crore recording growth of 78. 334. 2009. 1006. Gross NPA s has came down from Rs. the Capital Adequacy Ratio of the bank stood at 12.The Bank earned a profit before tax of Rs. MISSION: TO PROVIDE SUPERIOR. growth of 54.50 lacs and work force of 50 employees. These branches are controlled through 48 Zonal Offices.54% as against previous year s growth of 40. 1750.2008. 2684.92 crore. in its outlook and approach.73 crore.90% as against previous year s growth of 60. VISION: TO BECOME THE BANK OF CHOICE FOR CORPORATES.

TREASURY AND RISK MANAGEMENT

Treasury Operations: Bank continued to play an active role in all segments of the market Funds, Equity, Forex and Bonds during the year 2007-08. During the year the equity market reached historic levels but fell sharply in January 2008. Bank earned substantial income from the various IPOs and follow on offers. The equity desk made significant contribution towards Treasury income. Forex Business: The forex business handled by the bank showed a robust growth. While the
export turnover during the year 2007-08 was Rs. 28326 crore, the Import turnover was Rs. 24471 crore for the year 2007-08. The Bank continues to be a leading player in forex market. The aggregate turnover of Bank s Treasury Branch during the year 2007-08 was Rs. 1365252 crore.

Investments: During the year the market interest rates moved within a short band in tandem
with market liquidity conditions. The yield on benchmark 10- year G-sec on 31-03-07 was at 7.98 % and it ended the year on 31-03-08 at 7.94%. Bank maintained an optimum level of investments keeping a balance between yield income and market risk. As against the SLR requirement of 25% of Net Demand and Time Liabilities (NDTL), Bank maintained SLR investments marginally higher at 1.27 of NDTL. At year end SLR investments on gross basis amounted to Rs. 33806.03 crore (89.71% of total investments) and Non SLR investments stood at Rs. 3875.57 crore (10.29% of total investments). Investments are made in accordance with the comprehensive policy in this regard approved by the Board. The policy is reviewed periodically to respond to market developments / regulatory requirements.

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TREASURY AND RISK MANAGEMENT

Treasury Management of Bank Of India
Treasury of Bank Of India is a profit centre constantly endeavouring to cater to the ever dynamic investment requirements of the bank. Bank of India s treasury (H.O) is concerned with trading in money, debt, capital and forex market. Bank Of India have an integrated treasury which provides a holistic approach to funding the balance sheet and deployment of funds across the domestic as well as global money and forex markets. This approach also enables the bank to optimize its asset-liability management and also capitalize on arbitrage opportunities. Organizational structure of a Bank Of India treasury facilitate the handling of all market operations, from dealing to settlement, custody and accounting, in both the domestic and foreign exchange markets. The organizational set up of the treasury of Bank Of India ensures greater efficiency and transparency with Chairman, Board of Directors and Executive Director at the top most position in the hierarchy. Assets Liability Management Committee (ALCO) prepares the Investment Policy in consultation with the GM and AGMs of the treasury department on the grounds of the report prepared by the treasury s mid-office. The treasury department (H.O) is headed by General Manager who directs controls and co-ordinates the activities of the department along with the AGMs. AGM Front-Office (Forex, Bonds, MM, Derivatives ) and AGM Mid & Back-Office heads the representative departments. Highly knowledgeable and professional executives work under the guidance of the respective AGMs to optimize its asset-liability management and also capitalize on investment, trading and arbitrage opportunities to earn profits. In money market the bank transacts in almost all instruments including the CCIL (Clearing Corporation of India Ltd.) created CBLO (Collateralized Borrowing and Lending Obligations) market. The treasury of Bank of India is an active member of Negotiated Dealing System (NDS) and Real Time Gross Settlement (RTGS). Bank is also a member of FIMMDA. Coming to the operations, the bank operates through front office, back office and mid office, though the mid office is not fully functional. The front office consists of the dealers who take on the dealing transactions in different instruments with the counter party through the NDS platform. Appropriate Information technology (process, package and infrastructure) is necessary for treasury management as the operations/transactions are distinct from branch banking and are also very critical. As best software packages available in the market which suit it the bank s needs are adopted.

In view of the voluminous and complex nature of transactions handled by the BOI treasury, various functions are segregated as under:
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TREASURY AND RISK MANAGEMENT

Front

Office: The front office of a treasury has a responsibility to manage investment and

market risks in accordance with instructions received from the bank s ALCO. This is undertaken through the Dealing Room which acts as the bank s interface to international and domestic financial markets.  Study the market trends and risk.  Buying securities for investment purposes.  Buying/selling in securities for taking advantage of the fluctuations in the market  Executing deals for the portfolio management/strategic operations of the bank  Borrow/lend in the inter-bank money market  To borrow/lend in CBLO, repo markets  Maintenance of front office records  Keeping liaisons with counter-parties, brokers and back office to ensure that all deals have been completed

Mid

Office: Mid-office is responsible for onsite risk measurement, monitoring and

management reporting. The other functions of Mid Office are:  Limit setting and monitoring exposures in relation to limits;  Assessing likely market movements based on internal assessments and external / internal research;  Evolving hedging strategies for assets and liabilities;  Interacting with the bank s Risk Management Department on liquidity and market risk;  Monitoring open currency positions;  Calculating and reporting VAR;  Stress testing and back testing of investment and trading portfolios;  Risk-return analysis; and  Marking open positions to market to assess unrealized gain and losses.

Back Office: The key functions of back-office are:
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 Monitoring approved exposure and position limits. and  Accounting.  Management of Nostro Funds-to advise latest Funds position to enable the F/O to take the decision for the surplus/short fall of funds. non scheduled PCBs are governed by the provisions of section 18 read with section 56 of the Banking Regulation Act. hereinafter referred as Act. In regard to cash reserve. governs the scheduled PCBs whereas. The provisions of section 24 of the Act ibid govern maintenance of SLR for all the banks (scheduled as well as non-scheduled).  Monitoring receipt of confirmations of forward contracts.  Settlement through CCIL or direct through Nostro as applicable.  Reconciliation of Nostro/other accounts. the provisions of section 42(1) of the Reserve Bank of India Act. Responsibilities and Elements Of BOI Treasury  Maintenance of CRR and SLR Bank Of India along with other banks in India is required to maintain stipulated level of cash reserve ratio (CRR) and statutory liquidity ratio (SLR). Statutory Minimum CRR Mumbai Institute of mgmt and research . (It) Statutory reports to the RBI.  Effecting/receiving payments.  Monitoring receipt of forex funds in interbank contracts. 1934.  Monitoring receipt of confirmations from counterparty banks. 1949 (As applicable to co operative Societies ) .  Generation and dispatch of interbank confirmations.TREASURY AND RISK MANAGEMENT  Deal slip verification.

an amount which shall not. Consequent upon the amendment to sub-section (1) of Section 42 of the RBI Act 1934. at the close of the business on any day. or b) In gold valued at a price not exceeding the current market price. a) In cash. can prescribe the Cash Reserve Ratio (CRR) for Scheduled Commercial Banks without any floor rate or ceiling rate. in addition to the average daily balance which they are required to maintain under Section 42 of the RBI.(this is at the market price or the market value as announced by the FIMMDA) SLR Securities: 1. Act. of the total of its demand and time liabilities in India as on the last Friday of the second preceding fortnight.5 per cent of the demand and time liabilities. by notification in gazette of India. However.TREASURY AND RISK MANAGEMENT In terms of section 42(1) of the Reserve Bank of India (RBI) Act. 1949 all Scheduled Commercial Banks. specify. The compliance with this obligation is monitored ordinarily with reference to the position of the SLR as on the relevant alternate Friday. 2009 of their total net demand and time liabilities (NDTL) in India obtaining on the last Friday of the second preceding fortnight. Statutory Liquidity Ratio (SLR) In terms of Section 24 (2-A) of the B. Govt Of India Securities 2. 2006 the Reserve Bank having regard to the needs of securing monetary stability in the country. 1934. and ending with the second following Friday. 2006. Other approved securities. securities lodged in the Gilt Account of the bank maintained with CCIL under CSGL facilities Mumbai Institute of mgmt and research . In term of the proviso to sub-section (1) of section 42 of the RBI Act 1934. The obligation to maintain the required liquid assets arises on each day of a fortnight commencing from Saturday. Act. State Development Loans 3.R. are required to maintain in India. be less than 24 % (this is now amended and there is no floor in terms of the Act . the scheduled PCBs were required to maintain with the RBI during the fortnight. Banks are also required to maintain SLR on borrowing through CBLO. a minimum average daily balance of 5 % as on 31st January. the said rate up to 15% of the NDTL. 1934. The statutory minimum CRR requirement of 3 per cent of total demand and time liabilities no longer exists with effect from June 22. It could now be specified by the RBI)or such other percentage not exceeding 40 per cent as the RBI may from time to time. or c) In unencumbered approved securities valued at a price as specified by the RBI from time to time. through Gazette notification. RBI is empowered to increase. effective from June 22. RBI has decided to continue with the status quo on the rate of CRR required to be maintained by Scheduled Commercial Banks at the rate of 6.

the penal interest for that day at the rate of 3 per cent per annum above the bank rate on the shortfall and if the default continues on the next succeeding working day. If a bank fails to maintain the required amount of SLR. the bank which has issued the form will be liable for the following penal action: 1. The purchasing bank should issue the cheques only after receipt of the SGL transfer forms from the selling bank. and Stock Holding Corporation of India Ltd. should an SGL transfer form issued by a bank in favour of another bank. Banks. For this purpose. All the PCBs are required to maintain investments in government securities. Subsidiary General Ledger (SGL) Bank investing in government securities has to hold the securities book-entry form (commonly known as Subsidiary General Ledger form). Primary Dealers (PDs). The amount of SGL form (cost of purchase paid by the purchaser of the bank) will be debited immediately to the current account of the selling bank with the Reserve Bank. banks should ensure that they have sufficient balance in the respective SGL accounts. If the SGL transfer form bounces for want of sufficient balance in the SGL Account. only in SGL Accounts with Reserve Bank or in Constituent SGL Accounts of scheduled commercial banks.. SHCIL and NSDL to provide CSGL facilities to subscribers. Mumbai Institute of mgmt and research . Current a/c with RBI As every bank is required to have a current a/c with RBI. bounce for want of sufficient balance in the SGL account. CCIL provides a daily statement to banks/RBI listing the securities lodged/utilized/remaining unencumbered. Bank Of India is also required to have a current a/c with RBI and the daily closing balance of this current a/c is considered for CRR calculation and the excess balance over CRR requirement for SLR calculation. Certain amount of cushion is needed in the balance on the last day of the reporting fortnight. it shall be liable to pay to RBI in respect of that default. Central Depository Services Ltd. primary dealers and certain other entities like NSCCL. (NSCCL). the penal interest may be increased to a rate of 5 percent per annum above the Bank Rate for the concerned days of default on the shortfall.TREASURY AND RISK MANAGEMENT remaining unencumbered at the end of any day can be reckoned for SLR purposes by the concerned bank. for SLR purposes. or in the dematerialized accounts with depositories such as National Securities Depositories Ltd (NSDL). Before issue of SGL transfer forms covering the sale transactions. The RBI has permitted banks. (CDSL) and National Securities Clearing Corporation Ltd. Under no circumstances. Transfers through SGL accounts by the banks having SGL facility can be made only if they maintain a regular current account with the Reserve Bank. State Co-op.

 Creation of IFR as per the above guidelines is mandatory for primary (urban) co-operative banks having aggregate Demand and Time Liabilities of Rs. the bank will be permanently debarred from the use of the SGL facility in all the PDOs of the Reserve Bank. If after restoration of the facility. 3. banks are free to build up a higher percentage of IFR up to 10 per cent of the portfolio depending on the size and composition of their portfolio. any SGL form of the bank bounces again. in future. penal interest will be charged by the Reserve Bank on the amount of the overdraft at a rate of 3% points above the SBI DFHI s call money lending rate on the day in question. Held for Trading and Available for Sale .  The IFR. would be eligible for inclusion in Tier II capital.  Banks may utilise the amount held in IFR to meet. If the bouncing of the SGL form occurs thrice. However. the bank will be debarred from trading with the use of the SGL facility for a period of 6 months from the date of occurrence of the third bouncing. In the event of an overdraft arising in the current account following such a debit.TREASURY AND RISK MANAGEMENT 2. viz. consisting of realised gains from the sale of investments from the two categories.. and optional for smaller banks. of a minimum of 5 per cent of the investment portfolio by March 2008. viz.  Distinction between IFR and IDR It may be noted that Investment Fluctuation Reserve (IFR) is created out of appropriation from the realised net profits / out of profits earned on account of sale of investments initially held under HTM category but subsequently shifted Mumbai Institute of mgmt and research . and Held for Trading (HFT) and Available for Sale (AFS). with the approval of their Board of Directors.  Banks should transfer maximum amount of the gains realised on sale of investment in securities to the IFR. 100 crore and above. Investment Fluctuation Reserve (IFR) With a view to build up adequate reserves to guard against market risks:  Banks should build up Investment Fluctuation Reserve (IFR) out of realised gains on sale of investments.  Transfer from IFR to the Profit & Loss Account to meet depreciation requirement on investments would be a below the line extraordinary item. It will not be necessary to include investment under Held to Maturity category for the purpose.. and subject to available net profit.  Banks should ensure that the unrealised gains on valuation of the investment portfolio are not taken to the Income Account or to the IFR. the depreciation requirement on investment in securities. Transfer to IFR shall be as an appropriation of net profit after appropriation to Statutory Reserve. This minimum requirement should be computed with reference to investments in two categories.

Mumbai Institute of mgmt and research .TREASURY AND RISK MANAGEMENT to AFS or HFT category. and forms part of the reserves of the bank qualifying under Tier II capital. whereas Investment Depreciation Reserve (IDR) is a provision created by charging diminution in investment value to Profit & Loss Account. While the amount held in IFR should be shown in the balance sheet as such. the amount held in IDR should be reported as Contingent provisions against depreciation in Investment.

in this project. Co-operative Banks and primary dealers are allowed to borrow and lend in this market for adjusting their cash reserve requirements. funds are transacted for the period between 2 days and 14 days and money lent for 15 days to 1 year is called Term money . Intervening holidays and/or Sundays are excluded for this purpose. The call/notice money market forms an important segment of the Indian Money Market. Features:  The call market enables the banks and institutions to even out their day-to-day deficits and surpluses of money.  To fill the gaps or temporary mismatches in funds  To meet the CRR & SLR Mandatory requirements as stipulated by the Central bank  To meet sudden demand for funds arising out of large outflows  Commercial banks. Under call money market. An attempt has been made.  It is a completely inter-bank market hence non-bank entities are not allowed access to this market. Call/Notice Money Market The money market is a market for short-term financial assets that are close substitutes of money. Bank of India deals in four types of market instruments i. to portray in brief the various treasury transactions undertaken by the bank for investment and trading purposes to gain profit. debt market and forex market instruments.  It serves as an outlet for deploying funds on short-term basis to the lender having steady inflow of funds Mumbai Institute of mgmt and research .e.TREASURY AND RISK MANAGEMENT Financial Instruments With an integrated independent treasury. Mutual Funds and certain specified entities are allowed to access Call/Notice money only as lenders.  In view of the short tenure of such transactions.  Interest rates in the call and notice money markets are market determined. both the borrowers and the lenders are required to have current accounts with the Reserve Bank of India. money market. funds are transacted on overnight basis and under notice money market. capital. 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 avenue for equilibrating the short-term surplus funds of lenders and the requirements of borrowers.  Specified All-India Financial Institutions.

banks are allowed to lend a maximum of 50 per cent of their capital funds on any day. Banks in call/notice money market on a daily basis should not exceed 2. up to 200 per cent of their net owned funds (NOF) PDs are allowed to lend in call/notice money market. both as borrowers and lenders Prudential Limits: The prudential limits in respect of both outstanding borrowing and lending transactions in call/notice money market for banks and PDs are as follows:Sr. during a fortnight. banks are allowed to borrow a maximum of 125 per cent of their capital funds on any day. Lending On a fortnightly average basis.TREASURY AND RISK MANAGEMENT Participants: Participants in call/notice money market currently include banks (excluding RRBs) and Primary Dealers (PDs). however.e.0 per cent of their aggregate deposits as at end March of the previous financial year. borrowing outstanding should not exceed 100 per cent of capital funds (i. 2 Co-operative Banks Borrowings outstanding by No Limit. 3 Primary PDs are allowed to borrow. lending outstanding should not exceed 25 per cent of their capital funds. sum of Tier I and Tier II capital) of latest audited balance sheet. up to 25 per cent Mumbai Institute of mgmt and research . State Co-operative Banks/District Central Cooperative Banks/ Urban Co-op.No. during a fortnight.. 1 Participant Scheduled Commercial Banks Borrowing On a fortnightly average basis. on Dealers (PDs) average in a reporting fortnight. on average in a reporting fortnight. However.

30 pm on Saturdays or as decided by RBI from time to time. In case there is repeated non-reporting of deals by an NDS member. Reporting Requirement: All dealings in call/notice money on screen-based negotiated quote-driven system (NDSCALL) launched since September 18. the practice of reporting of call/notice/term money transactions by fax to RBI has been discontinued with effect from December 11. 2004.  Calculation of interest payable would be based on FIMMDA s (Fixed Income Money Market and Derivatives Association of India) Handbook of Market Practices.00 pm on weekdays and 2. Deals should be reported within 15 minutes on NDS. Reserve Bank may call for information in respect of money market transactions of eligible participants by fax. Dealing Session: Deals in the call/notice money market can be done up to 5. In case the situation so warrants. y Non-bank institutions are not permitted in the call/notice money market with effect from August 6.00 pm on weekdays and 2. Documentation: Eligible participants may adopt the documentation suggested by FIMMDA from time to time. Interest Rate:  Eligible participants are free to decide on interest rates in call/notice money market. The reporting time on NDS is up to 5. the of their NOF.30 pm on Saturdays or as specified by RBI from time to time. It is mandatory for all Negotiated Dealing System (NDS) members to report their call/notice money market deals (other than those done on NDS-CALL) on NDS. 2007 do not require separate reporting. Platforms: Mumbai Institute of mgmt and research . irrespective of the size of the deal or whether the counterparty is a member of the NDS or not. 2005. However. it will be considered whether non-reported deals by that member should be treated as invalid.TREASURY AND RISK MANAGEMENT as at end-March of previous financial year. deals between non-NDS members will continue to be reported to the Financial Markets Department (FMD) of RBI by fax as hitherto. With the stabilisation of reporting of call/notice money transactions over NDS as also to reduce reporting burden.

Interest rates are higher than the CBLO platform due to absence of any collateral securities.  Now the Deal Ticket is transferred to the Back office and record is maintained through a register entry.TREASURY AND RISK MANAGEMENT Call money market operates through 3 platforms: 1) Call money 2) CBLO Call Money Market (NDS Platform) Call Money Market (NDS Platform) is an independent platform where banks can lend or borrow money for a short period. interest rate period of lending and the reversal date etc. then telephonic negotiation is done and deal is confirmed when the agreed rate is arrived at. but if money is lent on Friday. or any holiday then settlements could take 2/3 days. Collateral securities are not required. counter party. for a T+0 settlement. Procedure for dealing in call market Before any call transactions availability of surplus or deficit cash with the bank is ensured. then desired interest rate and the amount is quoted to the pre-specified counter parties.  Then the RTGS department is notified to transfer the deal amount to the counter party s account. then deal is confirmed.  If there is surplus then the money is lent.  After the generation of deal ticket. But if the counter party shows an interest for the amount but is not satisfied with the rate of interest.e.  On confirmation a deal ticket is generated specifying the deal id. date.  Settlement for call transactions generally happens in 1 day. Volumes traded on NDS platforms are lower than those in CBLO platform. time. it s signed by the respective authority and finally by the head of treasury dept. and if there is any deficit then money is borrowed from the call market. CBLO Market: Mumbai Institute of mgmt and research .  It s important to note here that for a transaction a reversal transaction is also made at the expiry of the specified time (i.  If a lending transaction is intended to be closed in on the NDS. amount. a reversal transaction is done after 1 day).  If the counter party accepts the quote on the NDS.

 At the time of lending the borrower deducts the interest and lends the remaining.  After the deal is struck.  When the bid/quote/offer is matched against another it s confirmed by production of a ticket having the details of the transaction made which is printed at the member s terminal bearing member s name. settlement type. yield %. user number. But at the time of repayment the borrower repays the whole amount. money is transferred from the lenders a/c to the borrower s a/c and a lien on the same amount of security of borrower is created by CCIL for the lender. the buy n sell of CBLO is done. [For example. Unlike call market. BOI qualifies for trading in CBLO market as it s a member of CCIL and has a CSGL a/c with CCIL.  With the help of the NDS intended lenders and borrowers quote their bids. Interest rates are lower than the Call Money Market (NDS Platform) as there is zero risk of default. market type.  T+0 and T+1 instrument are only available in a CBLO market.TREASURY AND RISK MANAGEMENT CBLO market has been developed by CCIL (clearing corporation of India ltd) with the help of RBI for the purpose of facilitating liquidity through interbank transactions. in CBLO market the counter party is totally anonymous and CCIL takes responsibility of payment in case of default by holding securities (G-sec) of the borrowing banks. Mumbai Institute of mgmt and research . trade number.  Once the quote i. automated matching of buying to selling happens through NDS platform. Volumes traded on CBLO platforms are higher than those in Call Money Market (NDS Platform). price consideration (the amount to be given after interest adjustments) etc. time. order number.  When the borrower returns the money to the lender.  This deal ticket is then transferred to the back office for record keeping purposes. trade date. the lien on those securities is removed.a (yield). face value. Procedure for dealing at CBLO market At the beginning of the day the CCIL assigns a limit to the bank as per the request of the bank and within the purview of the pre specified guidelines of CCIL and RBI.e. rate of 10% p. trade type (sell/buy). CBLO here means an instrument to enable the member either to borrow or to lend. CBLO id. which are settled in 1 and 2 day respectively. if a lender buys a CBLO to lend 5 cr at an int.  Securities of the limit s worth are transferred to the CSGL a/c of the bank in CCIL.  One buys CBLO to lend money and one sells CBLO to borrow.

Mumbai Institute of mgmt and research .  The balance in the Repo Account is netted from the Bank s Investment account for balance sheet purposes.TREASURY AND RISK MANAGEMENT Then 13698(5cr * 10% divided by 365 days as we assume repayment in 1day) as int.] Repo/Reverse-Repo Market: In addition to call and CBLO market BOI deals in repo and reverse repo transactions also. Repo. most often sovereign securities. On the termination date. The purchase and sale is accounted for in the Reverse Repo Account.  The difference between the market price and the book value in the first leg of the repo is booked in Repo Price adjustment account. i. will be deducted and the rest amount. short for repurchase agreements. Legally a sequential pair of sales. the securities are sold in the first leg at market related prices and repurchased in the second leg at the derived prices. is contracts for the sale and future repurchase of a financial asset.e. 49986302 will be forwarded to the borrower. and pays interest for the use of the funds.97 in this case. All Repo contracts are settled through the current account maintained with the RBI. the securities are purchased in the first leg at prevailing market prices and sold in the second leg at the derived price. The sale and repurchase is accounted in the repo account. Procedure for Reverse Repo:  In a reverse repo transaction.e. the seller repurchases the asset at the same price at which he sold it. a repo is essentially a short-term interest-bearing loan against collateral. But at the time of repayment the borrower repays 5cr. Procedure for Repo:  In a repo transaction. In the deal ticket % of money lent is expressed i.  The balances in the Reverse Repo Account is transferred to the Investment Account for balance sheet purposes and is then reckoned for SLR purposes if the securities acquired under reverse repo transactions are approved securities. and the transactions are done through NDS platform. Repo can sometimes be done through telephone as it requires negotiation between the two parties. Similarly the difference between the derived price and the book value in the second leg of the repo is booked in the Repo Price Adjustment Account. 99. Interest is fixed by RBI.

coupon. Investment day to day trading is done through 2 platforms: GOMS or OTC(NDS). G-Secs and T-Bills are issued by the way of auction process. G-Secs are coupon based securities while the T-Bills are discounted instruments. The securities are accounted in the dematerialized form in the Subsidiary General Ledger (SGL). G-Secs & T-Bills: G-Secs are dated long-term debt obligation of Central Government while the Treasury Bills are short-term debt obligations of the Central government. date of redemption. calendar interest payments. Sate Development Loans (SDLs). date of redemption. date of issue. On the issue date the successful bidders are required to deposit money at the counters of the RBI. On the basis of the amount RBI decides to retain the notified amount and refund the excess received or to retain the entire subscription and allots. Generally only three types of treasury bills are issued: 14-day. calendar interest payments. All the investments are classified into 3 categories: Available for Sale (AFS). Held to Maturity (HTM) and Held for Trading (HFT). etc Normally SDL are issued at a fixed coupon which is accounted for the issue.. The difference between the derived price and the book value in the second leg of the reverse repo is lastly booked in the Reverse Repo Price Adjustment Account. The securities are accounted in the dematerialized form in the Subsidiary General Ledger (SGL). Procedure for day to day trading: Mumbai Institute of mgmt and research . Closer to the dates specified in the calendar. liquidity in the firm and earn profits. date of issue. Investments in HFT cannot be kept for more than 80 days while the investments in AFS can be more than 80 days or till maturity in case of HTM. Bank Of India deal in various debt market securities like SLR Securities (Government Securities (G-Secs).term maturity bonds floated to enable fund their budget deficits. SDLs: The State Government issues securities termed as State Development Loans (SDLs). At the beginning of every half of the financial year government announces an issue calendar for G-Secs and T-Bills. of the respective instruments. RBI notifies the quantum.TREASURY AND RISK MANAGEMENT  The security purchased in the reverse repo is then entered in the books at the market price (excluding broken period interest).. and 364-day. etc. RBI announces the quantum. Debt Market The main aim of the desk is to maintain the SLR statutory requirements. 182-day. Treasury Bills(T-Bills) & Other approved securities) and Non-SLR Securities (PSU & Corporate Bonds and Corporate Debentures). coupon. which are medium to long. SDLs also issued on auctioned mechanisms.

 Back-Office Executives verifies the deal in terms of limits and sanctioned the deal. Let s analyze three of them separately. The Normal Yield Curve: Normal yield curve is sometimes referred to as "positive yield curve". Basic Concept: Coupon: It is the rate of interest stipulated payable on a security Current Yield (CY): Current yield is the effective rate of interest paid on a bond.  The integrated software manages the stock account. inverted yield curve and flat yield curve. A yield curve in which short-term debt instruments have a lower yield than long-term debt instruments of the same credit quality is called a normal yield curve. YTM is considered a long-term bond yield expressed as an annual rate. The calculation of YTM takes into account the current market price. par value. Also. Mumbai Institute of mgmt and research .TREASURY AND RISK MANAGEMENT  Front-Office Executives undergoes trade issues the deal slips. coupon interest rate and time to maturity. Types of Yield Curve: In general yield curves are of three types. so the investor should be compensated for this through the time value of money component of the yield. This yield curve is considered "normal" because the market usually expects more compensation for greater risk. Yield to Maturity (YTM): YTM is the rate of return anticipated on a bond if it is held until the maturity date.normal yield curve. Yield Curve: Yield curve is the relation between the interest rate (or cost of borrowing) and the time to maturity of the debt for a given borrower. Longer-term bonds are exposed to more risks such as changes in interest rates and an increased exposure to potential defaults. calculated by the coupon rate divided by the bond's market price. investing money for a long period of time means an investor is unable to use the money in other ways.

TREASURY AND RISK MANAGEMENT Flat or Humped Yield Curve: A flat yield curve is observed when all maturities have similar yields. Inverted Yield Curve: An interest rate environment in which long-term debt instruments have a lower yield than short-term debt instruments of the same credit quality. This mixed signal can revert back to a normal curve or could later result into an inverted curve. Mumbai Institute of mgmt and research . This type of yield curve is the rarest of the three main curve types and is considered to be a predictor of economic recession. whereas a humped curve results when short-term and long-term yields are equal and medium-term yields are higher than those of the short-term and long-term. A flat curve sends signals of uncertainty in the economy.

the yield curve is often seen as an accurate forecast of the turning points of the business cycle. Because the modified duration formula shows how a bond's duration changes in relation to interest rate movements. as bonds with higher durations carry more risk and have higher price volatility than bonds with lower durations. It is an important measure for investors to consider. It is a measurement of how long. inversions of the yield curve have preceded recessions. so there is an inverse relationship between modified duration and an approximate 1% change in yield. Due to this historical correlation. so this modified formula shows how much the duration changes for each percentage change in yield.TREASURY AND RISK MANAGEMENT Partial inversion occurs when only some of the short-term Treasuries (five or 10 years) have higher yields than the 30-year Treasuries do. and then settled 'dirty'. Whenever a coupon payment is made. Modified Duration: Modified duration is a modified version of the Macaulay model that accounts for changing interest rates. Historically. Modified duration is calculated as the following: Mumbai Institute of mgmt and research . without accrued interest. For bonds without any embedded features. Because they affect yield. in years. Duration: The term duration has a special meaning in the context of bonds. bond price and interest rate move in opposite directions. fluctuating interest rates will affect duration. the formula is appropriate for investors wishing to measure the volatility of a particular bond. Dirty Price: Bond prices are usually quoted 'clean'. with accrued interest. the dirty price immediately falls by the amount of the coupon. So the dirty price is dirty because it contains an additional cost that was not mentioned in the quoted price. that is. it takes for the price of a bond to be repaid by its internal cash flows. that is. Clean Price: The clean price is the price payable for the face value of the bond. An inverted yield curve is sometimes referred to as a "negative yield curve".

the book value of the individual securities in this category would also not undergo any change after marking to market.TREASURY AND RISK MANAGEMENT OR. if any. Banks should recognise any diminution. in which case the premium should be amortised over the period remaining to maturity. Securities under this category shall be valued scrip-wise and depreciation/ appreciation shall be aggregated for each classification referred above. other than temporary. Valuation Held to Maturity: Investments classified under Held to Maturity category need not be marked to market and will be carried at acquisition cost. Available for Sale: The individual scripts in the Available for Sale category will be marked to market at quarterly or at more frequent intervals. The book value of the individual securities would not undergo any change after the marking of market. Consequently. Net appreciation. Net depreciation. in the value of their investments in subsidiaries/ joint ventures which are included under Held to Maturity category and provide therefore. shall be provided for. should be ignored. Net depreciation required to be provided for in any one classification should not be reduced on account of net appreciation in any other classification. if any. Held for Trading: The individual scripts in the Held for Trading category will be marked to market at monthly or at more frequent intervals and provided for as in the case of those in the Available for Sale category. Market value The market value for the purpose of periodical valuation of investments included in the Available for Sale and Held for Trading categories would be the market price of the scrip as Mumbai Institute of mgmt and research . unless it is more than the face value. Such diminution should be determined and provided for each investment individually.

(c) Where the debenture/ bonds is quoted and there have been transactions within 15 days prior to the valuation date.e. the procedure as detailed below should be adopted. which may be marked to market with reference to the market value. the value adopted should not be higher than the rate at which the transaction is recorded on the stock exchange. Other approved Securities: Other approved securities will be valued applying the YTM method by marking it up by 25 basis points above the yields of the Central Government Securities of equivalent maturity put out by PDAI/ FIMMDA periodically. Such debentures/ bonds may be of different companies having different ratings. The mark-up will be graded according to the ratings assigned to the debentures/ bonds by the rating agencies subject to the following: (a) The rate used for the YTM for rated debentures/ bonds should be at least 50 basis points above the rate applicable to a Government of India loan of equivalent maturity.. Treasury Bills should be valued at carrying cost. prices declared by Primary Dealers Association of India (PDAI) jointly with the Fixed Income Money Market and Derivatives Association of India (FIMMDA) periodically. These will be valued with appropriate mark-up over the YTM rates for Central Government securities as put out by PDAI/ FIMMDA periodically. In respect of unquoted securities. the zero coupon bonds may be marked to market with reference to the present value of the Mumbai Institute of mgmt and research . Unquoted SLR securities Central Government Securities: Banks should value the unquoted Central Government securities on the basis of the prices/ YTM rates put out by the PDAI/ FIMMDA at periodical intervals.TREASURY AND RISK MANAGEMENT available from the trades/ quotes on the stock exchanges. (b) The rate used for the YTM for unrated debentures/ bonds should not be less than the rate applicable to rated debentures/ bonds of equivalent maturity. The mark-up for the unrated debentures/ bonds should appropriately reflect the credit risk borne by the bank. State Government Securities: State Government securities will be valued applying the YTM method by marking it up by 25 basis points above the yields of the Central Government Securities of equivalent maturity put out by PDAI/ FIMMDA periodically. Zero Coupon Bonds: Zero coupon bonds should be shown in the books at carrying cost. In the absence of market value. price list of RBI. i. Unquoted Non-SLR securities Debentures/ Bonds: All debentures/ bonds other than debentures/ bonds which are in the nature of advance should be valued on the YTM basis. acquisition cost plus discount accrued at the rate prevailing at the time of acquisition. SGL account transactions.

g.1999. etc. In case the bank is still carrying the zero coupon bonds at acquisition cost. Central Office. Currencies of the countries that have taken capital account convertibility are deemed to be freely tradable or they are said to float freely in FX markets. BOP position. Japanese Yen (JPY). Relative strengths of the economies fir a given pair of currencies Trade. Foreign Exchange Market Foreign Exchange Markets are dynamic round the clock markets.TREASURY AND RISK MANAGEMENT zero coupon bond. etc besides the other continental and exotic currencies. The statement as at the end of each calendar quarter should reach RBI.surplus/ deficit vis-à-vis the currencies of the countries concerned A host of economic factors like GNP. JPY.g. before marking it to market. Industrial production data. E. E. on quarterly basis. USD. the discount accrued on the instrument should be notionally added to the book value of the scrip. The world currency market are marked by the presence of currencies like US Dollar (USD). GBP. REPORTING Commercial banks are required to submit a statement containing information on their investments in approved securities and money market instruments. etc Currencies of countries whose economies are partially open on the capital account and fully or partially open on the current account follow a managed float. Swiss Franc (CHF). etc  Monetary Policies of the Government/ Central Bank  Political and the security climate  Inflation and Interest rate differential The role of banks in Indian FX market comes into focus as the customers cannot deal in the FX market without banking medium. Commercial Banks Department within 10 days from the close of the quarter. RBI is the regulatory Mumbai Institute of mgmt and research . The present value of the zero coupon bonds may be calculated by discounting the face value using the Zero Coupon Yield Curve with appropriate mark up as per the zero coupon spreads put out by FIMMDA periodically. Fiscal Deficit. EUR. Euro (EUR). INR Factors influencing exchange rates:     Demand and Supply for the individual currency. Banks while catering clients FX requirements also ensures that all the transactions are well within the ambit of the provisions the Exchange Control Regulations under Foreign Exchange Management Act. Great British Pound (GBP).

Customers requirement for purchase of foreign currency also arise from capital account transactions such as Foreign Currency Borrowings or their repayment. which refers to entering of a particular transaction in the books of Banks on behalf of a client. acquisition of domestic companies by an overseas entity or acquisition of overseas companies by domestic entity. Apart from the trade transactions there are inward or outward remittances of foreign currency. Hence Merchant Desk is supposed to earn profit and never book a loss. Bank of India Forex Dept consists of Merchant Desk and Inter-Bank Desk . Here the merchant dealers immediately cover the operations in respect of such deals so that they are insulated from any risk arising out of adverse exchange rate movements against the quotes already offered to the client. RBI issues guidelines/regulations/instructions from time to time which govern the functioning of the market. day limit and overnight limit for the Inter-Bank Desk to avoid heavy losses due to high fluctuation in exchange rate and to avoid the greed of the dealers. Fee Based Income. BOI maintains Foreign Currency Accounts (Nostro A/c) at the foreign centers and simultaneously maintains Indian Rupee Account (Vostro A/c) of the foreign correspondents in India. Activities undertaken by BOI forex dept  Issuing Forex Card every morning as a reference to branches. BOI FX dept earns from: Exchange income.TREASURY AND RISK MANAGEMENT authority for the Indian FX market. clients.  Merchant Desk: Merchant Desk is concerned with merchant trading. ALCO committee sets open position stop limit. issue of ADRs/GDRs. Here the Inter-Bank dealers have to quote according to the prevailing market rate and their position. etc  Undertaking buying and selling (Trading) transactions in forex markets. Exporters sell foreign currency while the importers buy the foreign currency.  Entering into futures and options trade for hedging the exchange risk of the bank and its clients  Undertaking International Trade Transactions  Handling international collection bills Mumbai Institute of mgmt and research . which refers to entering a particular transaction for bank. Interest Income. Consultancy Income and Certification Income.  Inter-Bank Desk: Inter-Bank Desk is concerned with inter-bank trading. Merchant Desk is concerned with trading with the customers or BOI branches on behalf of the customers. BOI s Foreign Exchange Management Bank of India is the Authorized Foreign Exchange Dealer with RBI. Inter-Bank Desks concerned with trading with other banks. financial institutions or PD.

51 41.49 TCS 41.55 42.25 31.41 39.87 66.TREASURY AND RISK MANAGEMENT     Opening import letters of credit Opening Indian rupee and foreign currency accounts for NRI and local customers Offering inward/outward remittance service Offering encashment service for clients/ tourists of foreign currency notes and travelers cheques  Issuing foreign currency notes and traveler cheques to tourists and clients.No.1 Note : These are indicative rates & subject to change according to market movement Mumbai Institute of mgmt and research .85 8. 1 2 3 4 5 6 7 8 9 10 11 12 13 Currency AUD CAD CHF DKK EUR GBP HKD JPY NOK NZD SEK SGD USD TTS 41.85 41.05 67.75 8.05 TCB 40.52 39.65 42.15 41.8 40.32 42.82 5.7 85.8 9.55 42.1 67.18 31.2 31.04 30.55 40.49 32.6 6.8 7.33 31.75 83.9 30.38 84.65 5.6 7.4 8.32 83.05 5.25 5.93 42.96 7.7 65.2 8.4 40. Forex Card issued by BOI treasury dept on 26/6/2008 Forex Rates Sr.64 41.85 8.55 32.7 43.57 9.05 8.86 TTB 40.35 38.

front-office executive feeds the details regarding the type of contract. add some spread and quote the rate. day limit and overnight limit  After sanctioning the transaction back office executive settles the transactions through CCIL.  Deal slip is forwarded to the back office. Further to develop the capital market banks were allowed to trade in the capital market. RTGS or SWIFT system Forward Contracts: Forward Exchange Contract is an agreement whereby the exporter/importer hedges his position by entering into an agreement with the bank to sell/buy the foreign currency at a specified exchange rate on or during specified future date/dates. Investments are classified into 3 categories: Mumbai Institute of mgmt and research . Banks do invest in large amount in the high yielding capital market both in primary and secondary market. If bank has a positive balance. ( Merchant Dealers checks the current market rate add appropriate spread and quotes. they short the currency futures and if the banks have a negative balance they long the currency futures Capital Market Priory banks were not allowed to participate in the capital market due to high risk embedded in the equity trading. The dealer quotes the forward contract rate by adding a spread to the ongoing forward market rate. Through forward contracts bank also hedge their open position by crystallizing the currency at a specific rate.TREASURY AND RISK MANAGEMENT Procedure of forex deals:  Customers approach the bank to ask for the best quote of offer for the required currency. rate applicable. quantum of money.  Back-office executives sanction the deal by verifying quoted rate through the recorded conversation and the market rate at the moment of transaction. Banks are not allowed to perform intraday trading and arbitrage in the market.  Back-office executives verifies the inter-bank transactions in terms of the prescribed limits in terms of the open position stop limit. etc and enters the deals into the system. while the Inter-Bank Dealers checks the banks current position along with the inter-bank rate and quotes)  If the quantum of the deal is more than 1 million cross desk transaction takes place. It is done cause inter-bank rate are usually lower the market rate and hence customer will get the lowest rate or to avoid the market rate risk.  If the customer accepts the deal. Interbank executives check the rate in the inter-bank market.  Front-office executives quote the best possible rates with an intention to get the deal done.

AGM can increase the stop loss limit to 30%.15 crores. Old Available for Sale (Old AFS):  This category consists of script taken from AMCs and other financial institutions. Bank of India has a network of around 200 brokers and sub brokers. Investment can be further increased by the consent of AGM and Executive Director.TREASURY AND RISK MANAGEMENT 1) Available for Sale(AFS) 2) Trading 3) Old Available for Sale(Old AFS) Available for Sale (AFS):  Only BSE-200 or Nifty-50 scripts which have good potential and momentum are hold under this category.5 crores. Trading:  Non BSE-200 or Non Nifty-50 scripts which have good potential and momentum are hold under this category.  Script can be held as long as the script is in profit or has not reached the stop loss limit. Equity management is confined to front and back office.  Maximum investment per script is Rs.  Maximum investment per script is Rs. Mumbai Institute of mgmt and research . AGM can increase the stop loss limit to 17%. Investment can be further increased by the consent of AGM and Executive Director. AGM can increase the stop loss limit to 17%. Bank of India utilizes the Reuter and Net Wire for its equity portfolio management.  Stop loss limit is 15%.  Stop loss limit is 15%. and Executive Directors can further increase the stop loss limit 27%.  Script can be held as long as the script is in profit or has not reached the stop loss limit. Holding period can be increased by the consent of AGM and Executive Director  Stop loss limit is 25%. and Executive Directors can further increase the stop loss limit 40%.  Scripts taken from financial institution are valued and their potential is determined prior to their purchase. and Executive Directors can further increase the stop loss limit 27%.  Stocks received through primary capital market (IPO subscription) are also hold under this category.  Script can be held for maximum 90 days.

 In case of sale. In case of equity shares for which current quotations are not available or where the shares are not quoted on the stock exchanges. Though RBI has allowed CD s up to one year maturity.  Back office executives also monitor and collect the dividends on the scripts.TREASURY AND RISK MANAGEMENT The equity shares in the bank's portfolio should be marked to market preferably on a daily basis. the secondary market for this instrument does not have much depth but the instrument itself is highly secure.  Settlement is done in T+2 days. Mumbai Institute of mgmt and research . Since CD s are not homogenous in terms of issuer. then calculates the amount receivable ( Sale price Brokerage ) and informs the broker about the same.  Entire port folio in mark to market on a weekly basis and the loss or profit is taken into consideration by the back office executives.  Front office executives place the order to buy/sell the script. Procedure for dealing in capital markets:  Front office executives regularly receive the fundamental analysis from various brokers and other sources.  Front office executives regularly receive calls from the brokers regarding the potential script. In case the latest balance sheet is not available the shares are to be valued at Re. maturity.  Front office executives verify the brokers information through technical and fundamental analysis and arrive at the decision. They are similar to the traditional term deposits but are negotiable and can be traded in the secondary market.  Front office executives manually feed the rate. but at least on a weekly basis.  Back office executives validate the transaction by verifying the transactions details with the broker. Certificates of Deposits Certificates of Deposit (CDs) are rupee denominated short-term borrowings in the form of Usance Promissory Notes having a maturity of not less than 15 days up to a maximum of one year.  In case of buying the script back office executives calculate the brokerage and transfer the funds (Cost + Brokerage) in the evening. they are generally issued for 90 days. back office executives evaluates the front office operation in terms of stop loss limit. interest rate and other features. if any) which is to be ascertained from the company s latest balance sheet (which should not be more than one year prior to the date of valuation). They are often referred to as Negotiable Certificate of Deposit.1 per company. should be valued at break-up value (without considering revaluation reserves . quantity and the amount of the transaction.

e. i. term deposits. associations. but only on nonrepatriable basis which should be clearly stated on the Certificate. Issuance of CDs will attract stamp duty. An FI may issue CDs within the overall umbrella limit fixed by RBI. The interest rate on floating rate CDs would have to be reset periodically in accordance with a pre-determined formula that indicates the spread over a transparent benchmark.. Aggregate Amount & Minimum Size of Issue and Denominations: Banks have the freedom to issue CDs depending on their requirements. according to the Depositories Act. There is no lock-in period for the CDs. Loans/Buy-backs: Banks/FIs cannot grant loans against CDs. they cannot buyback their own CDs before maturity. Subscription: CDs can be issued to individuals. Furthermore. non-Resident Indians (NRIs) may also subscribe to CDs. 1 lakh thereafter. Discount/ Coupon Rate: CDs may be issued at a discount on face value. as per the latest audited balance sheet. investors have the option to seek certificate in physical form. Such CDs cannot be endorsed to another NRI in the secondary market.. However. cash reserve ratio (CRR) and statutory liquidity ratio (SLR). i. trusts. commercial papers and inter-corporate deposits should not exceed 100 per cent of its net owned funds. Format of CDs: Banks/FIs should issue CDs only in the dematerialised form. issue of CD together with other instruments.. Dematted CDs can be transferred as per the procedure applicable to other demat securities. etc. 1996. 1 lakh and in the multiples of Rs. transparent and market-based. funds. term money. companies.1 lakh..e. i. viz. the issuing bank should make payment on the Mumbai Institute of mgmt and research . The FIs can issue CDs for a period not less than 1 year and not exceeding 3 years from the date of issue. The issuing bank/FI is free to determine the discount/coupon rate. on the issue price of the CDs. corporations.e.TREASURY AND RISK MANAGEMENT Eligibility: CDs can be issued by (i) scheduled commercial banks excluding Regional Rural Banks (RRBs) and Local Area Banks (LABs). Minimum amount of a CD should be Rs. the minimum deposit that could be accepted from a single subscriber should not be less than Rs. Transferability: Physical CDs are freely transferable by endorsement and delivery. There will be no grace period for repayment of CDs. Maturity: The maturity period of CDs issued by banks should be not less than 7 days and not more than one year. Banks/FIs are also allowed to issue CDs on floating rate basis provided the methodology of compiling the floating rate is objective. Reserve Requirements: Banks have to maintain the appropriate reserve requirements. If the maturity date happens to be holiday. and (ii) select all-India Financial Institutions that have been permitted by RBI to raise short-term resources within the umbrella limit fixed by RBI.

Banks should include the amount of CDs in the fortnightly return under Section 42 of the Reserve Bank of India Act. to the Chief General Manager. therefore. Accounting: Banks/FIs may account the issue price under the Head "CDs issued" and show it under deposits. Upon receipt of the Demat credit of CDs in the "CD Redemption Account". Further. so fix the period of deposit that the maturity date does not coincide with a holiday to avoid loss of discount / interest rate.Counterparty risk is minimal since CD is a secure instrument. The question of liability on account of any defect in the chain of endorsements may arise. Banks/FIs may. as per the format given in Annex II. desirable that banks take necessary precautions and make payment only by a crossed cheque. Payment of Certificate: Since CDs are transferable. The holders of dematted CDs will approach their respective depository participants (DPs) and have to give transfer/delivery instructions to transfer the demat security represented by the specific ISIN to the CD Redemption Account maintained by the issuer. Reserve Bank of India within 10 days from the end of the fortnight date. would arrange to repay to holder/transferor by way of Banker s cheque/high value cheque. Those who deal in these CDs may also be suitably cautioned.TREASURY AND RISK MANAGEMENT immediate preceding working day. Risks  Price risk as exposed to interest rate risk  Credit risk . therefore. The holder should also communicate to the issuer by a letter/fax enclosing the copy of the delivery instruction it had given to its DP and intimate the place at which the payment is requested to facilitate prompt payment. Documentation: Bank of India mid office operates on the prescribed policy by Fixed Income Money Market and Derivatives Association of India (FIMMDA) for operational flexibility and smooth functioning of the CD market. It is. Banks/FIs should maintain a register of CDs issued with complete particulars. the physical certificate may be presented for payment by the last holder. banks/FIs should submit a fortnightly return. on maturity date. Mumbai Institute of mgmt and research . 1934 and also separately indicate the amount so included by way of a footnote in the return. the issuer. etc. Accounting entries towards discount will be made as in the case of "cash certificates". Financial Markets Department.

primary dealers (PDs) and satellite dealers (SDs) and all-India financial institutions (FIs) which have been permitted to raise resources through money market instruments under the umbrella limit fixed by Reserve Bank of India are eligible to issue CP. (ICRA) or the Credit Analysis and Research Ltd. (CARE) or the Duff & Phelps Credit Rating India Pvt. Non-Resident Indians (NRIs) and Foreign Institutional Investors (FIIs). A company shall be eligible to issue CP provided . Mumbai Institute of mgmt and research . (DCR India) or such other credit rating agency as may be specified by the Reserve Bank of India from time to time. from either the Credit Rating Information Services of India Ltd. 4 crore. Further. Eligibility: Highly rated corporate borrowers. Rating Requirement: All eligible participants should obtain the credit rating for issuance of Commercial Paper. investment by FIIs would be within the 30 per cent limit set for their investments in debt instruments. Mode of Issuance: CP can be issued only in a dematerialized form through any of the depositories approved by and registered with SEBI. Ltd. the company would be liable to make payment on the immediate preceding working day. Maturity: CP can be issued for maturities between a minimum of 15 days and a maximum up to one year from the date of issue. banking companies.CP can be held only in dematerialized form. If the maturity date is a holiday. CP will be issued at a discount to face value as may be determined by the issuer. CP was introduced in India in 1990 with a view to enabling highly rated corporate borrowers to diversify their sources of short-term borrowings and to provide an additional instrument to investors. as per the latest audited balance sheet.4 crore and (c) the borrowal account of the company is classified as a Standard Asset by the financing bank/s. is not less than Rs. The minimum credit rating shall be P-2 of CRISIL or such equivalent rating by other agencies. However.TREASURY AND RISK MANAGEMENT Commercial Paper (CP) Commercial Paper (CP) is an unsecured money market instrument issued in the form of a promissory note.5 lakh or multiples thereof. (b) the working capital (fund-based) limit of the company from the banking system is not less than Rs. Denominations: CP can be issued in denominations of Rs. other corporate bodies registered or incorporated in India and unincorporated bodies.(a) the tangible net worth of the company. (CRISIL) or the Investment Information and Credit =Rating Agency of India Ltd. Investment in CP: CP may be issued to and held by individuals. the participants shall ensure at the time of issuance of CP that the rating so obtained is current and has not fallen due for review. for the purpose. Banks and AllIndia financial institutions are prohibited from underwriting or co-accepting issues of Commercial Paper.

). However the interest rates in the BRDS are less volatile than in the call money market. If the bill is payable at a future date and the seller needs money during the currency of the bill then he may approach his bank for discounting the bill. from the drawee. will be received by the bank. discounted by the discounting bank. With the intention of reducing paper movements and facilitate multiple rediscounting. Risks involved  Liquidity risk : this risk is managed be laying down deal size limits for the dealers. y y Mumbai Institute of mgmt and research . The RBI introduced the Bills Market scheme (BMS) in 1952 and the scheme was later modified into New Bills Market scheme (NBMS) in 1970.TREASURY AND RISK MANAGEMENT Payment of CP: On maturity of CP. Development Financial Institutions. with approved institutions (viz. Credit risk: This risk is managed by laying down counterparty limits based upon the financial strength of the counterparty. Mutual Funds. Primary Dealer. commercial banks can rediscount the bills. heads of desk and heads of groups. Under the scheme. So the need for physical transfer of bills has been waived and the bank that originally discounts the bills only draws DUPN. Liquidity risk: this risk is managed be laying down deal size limits for the dealers. The maturity proceeds or face value of discounted bill.. etc. These bills are called trade bills. which were originally discounted by them. If the bank needs fund during the currency of the bill then it can rediscount the bill already discounted by it in the commercial bill rediscount market at the market related discount rate. Risks involved y Interest rate risk: market forces dictate the Bill Rediscounting rate. the RBI introduced an instrument called Derivative Usance Promissory Notes (DUPN). heads of desk and heads of groups. Commercial Banks. These trade bills are called commercial bills when they are accepted by commercial banks. These DUPNs are sold to investors in convenient lots of maturities (from 15 days up to 90 days) on the basis of genuine trade bills. the holder of the CP will have to get it redeemed through the depository and receive payment from the IPA.  Credit risk : This risk is managed by laying down counterparty limits based upon the financial strength of the counterparty Commercial Bills Bills of exchange are negotiable instruments drawn by the seller (drawer) of the goods on the buyer (drawee) of the goods for the value of the goods delivered.

Debentures can be classified on the basis of convertibility into:  Non Convertible Debentures (NCD): These instruments retain the debt character and cannot be converted in to equity shares  Partly Convertible Debentures (PCD): A part of these instruments are converted into Equity shares in the future at notice of the issuer. Over and above the scheduled interest payments as and when applicable. obviously get traded at lower yields. which offers to pay interest in lieu of the money borrowed for a certain period. This has diverted a lot of corporate to issue bonds. These bonds referred to as tax-free bonds.TREASURY AND RISK MANAGEMENT BONDS & DEBENTURES Long-term debt securities issued by the Government of India or any of the State Government s or undertakings owned by them or by development financial institutions are called as bonds. depend on bond issues for raising funds. Bonds can be issued by companies. A Debenture is a debt security issued by a company (called the Issuer). The PSUs are also given an advantage in terms of tax breaks for the investors on investments in specified PSU bonds.  Public sector unit bonds: PSUs bonds are in the high-risk category due to their poor financial condition. The corporate bond market consists of issuers of three different categories.government owned financial institutions (FIs). Mumbai Institute of mgmt and research . There are highly rated and hence quote the lowest rate of funds. the holder of a bond is entitled to receive the par value of the instrument at the specified maturity date. The ratio of conversion is decided by the issuer. or even the government. A Bond is a loan given by the buyer to the issuer of the instrument. The issuer decides the ratio for conversion. This is normally decided at the time of subscription  Fully convertible Debentures (FCD): These are fully convertible into Equity shares at the issuer's notice. Upon conversion the investors enjoy the same status as ordinary shareholders of the company. only the better managed PSUs approach the markets to raise the funds. which do not have access to retail deposits like banks. This phenomenon has increased of late as the primary capital markets have been dull for the last two years.  Corporate bonds: Private corporate also access the bond market to raise funds. The investors in these markets are mainly banks. Instruments issued by other entities are called debentures. Investments in rest of PSU bonds are taxed like any other bonds. mutual funds etc. financial institutions. government owned public sector units (PSUs) and private corporate  Financial institutional bonds: The FIs. FIs.

as investors are not comfortable with such maturities The rates in these markets differ for different issuer categories. In line with the general trend in the interest rates in the economy.TREASURY AND RISK MANAGEMENT  Optionally Convertible Debentures (OCD): The investor has the option to either convert these debentures into shares at price decided by the issuer/agreed upon at the time of issue. and all bonds are priced on the same macroeconomic information. While top rated private corporate and PSUs are treated on par. Bonds issued by the Government of India i. are the pre-dominant and the most liquid component of the bond market.e. his assets can be sold to repay the liability to the investors  Unsecured Debentures: These instrument are unsecured in the sense that if the issuer defaults on payment of the interest or principal amount. is dominated by government bonds. unless otherwise agreed. Mumbai Institute of mgmt and research . Since government bonds have much lower volatilities than equities. So if the issuer fails on payment of either the principal or interest amount. bond market liquidity is normally much higher than stock market liquidity. Central Government. FIs pay less coupon on their issues. This downward trend has been mainly due to higher liquidity with the banking system along with the new found enthusiasm of banks for bonds in comparison to loans due to capital adequacy requirements. The bond market though composed of government bonds and corporate bonds. debentures are classified into:  Secured Debentures: These instruments are secured by a charge on the fixed assets of the issuer company. Long maturity debentures are rarely issued. On basis of Security. These are long-term debt instruments issued by private sector companies. These are issued in denominations as low as Rs 1000 and have maturities ranging between one and ten years. the rates on these bonds have come down from the high levels in 1995 and 1996. In essence it represents a loan taken by the issuer who pays an agreed rate of interest during the lifetime of the instrument and repays the principal normally. on maturity. the investor has to be along with other unsecured creditors of the company.

uncertainties in cash inflows and/or outflows also create uncertainties in net cash flow or profits. This could be favourable as well as unfavourable. Risk of the business would lie where profits are adversely affected. purchase price and administrative and transportation expenses. The variation in sales volume and unit price realization would create uncertainties in cash inflows. variations in net cash flow take place. Uncertainties in purchase price (assuming goods are always available at a price) and other cost would create uncertainties in cash outflows.TREASURY AND RISK MANAGEMENT INTRODUCTION We may define Risks as uncertainties resulting in adverse outcome. This can happen due to adverse impact of uncertainties associated with sales volume. which are risk factors or risk elements. Under the impact of uncertainties. it will result in higher profits. But if sales volume and/or sales price decline or purchase price rises or other expenses increase. cash outflows would arise from purchases and administrative and transportation costs. If sales price and/or sales volume are more than what was expected or purchase price decline or other expenses incurred are less. Similarly. Factors that are responsible for creating uncertainties in cash outflows and cask inflows are the risk elements. In a simple case of a trading business that involves purchase of goods for sale with some administrative and transportation costs. Uncertainties in both. The possible unfavourable impact is the RISK of the business. Mumbai Institute of mgmt and research . Insofar as profit or loss of business depends up on the net result of all cash inflows and cash outflows. cash inflows would arise from sale. it will result in lower profits or even outright losses. adverse in relation to planned objective or expectations. Uncertainties associated with risk elements impact the net cash flow of any business or investment. Financial Risks are uncertainties resulting in adverse variation of probability or outright losses. This can affect profits favourably or unfavourably. cash outflows and inflows would result in uncertainties in net cash flow or profits. sales price.

if variability in net cash flow is lower. Higher risk would imply higher upside and downside potential. RISK IN BANKING BUSINESS The major risk in banking business or Banking risks is listed below: Liquidity Risk  Interest Rate Risk  Market Risk  Default or Credit Risk. it will result in lower profits and lower losses and the business would have lower risk. Similarly.TREASURY AND RISK MANAGEMENT In the same example. suppose that the trader engages in trading of a commodity where demand fluctuates widely and/or prices also change substantially over a short period. Reverse would be true if everything moves adversely. Zero risk would imply no variation in net cash flow. In such cases if everything moves favourably. Return on zero risk investment would be low as compared to other opportunities available in the market. and  Operational Risks Banking Risk Interest Rate Risk Liquid Risk Market Risk Default/Credit Risk Operational Risk Mumbai Institute of mgmt and research . the trader can earn very high profits. as is observed in case of in trading of shares. variability in net cash flow would be high in such cases and because of that it may result in higher profits or in adverse situations. So such business is a business with higher risk. Lower risk implies lower variability in net cash flow with lower upside and downside potential. higher losses. In other words.

and  Call Risk: This arises due to crystallization or contingent liabilities. thereby creating exposure to unexpected changes in the level of market interest rates. An asset maturing in two years at a fixed rate of interest have been funded by a liability maturing in six months. liabilities and OBS positions. In case the banks use two different instruments maturing at different time horizon for pricing their assets and liabilities.g. fixed deposit rates. This may also arise when a bank may not be able to undertake profitable business opportunities when it arises. Funding liquidity risk is defined as the inability to obtain funds to meet cash flow obligations. treasury bills yields. banks may price their assets and liabilities based on different benchmarks. The liquidity risk in banks manifest in different dimensions:  Funding Risk: This arises from the need to replace net outflows due to unanticipated withdrawal/non-renewal of deposits (wholesale and retail). call money rates. as liability would be reprised up on maturity causing variation in net interest income. MIBOR. Thus banks should evaluate the movement in yield curves and the impact of that on the portfolio values and income. Its impact is on the earnings of the bank or its impact on the economic value of the bank s assets. subject to rollover or refinancing risk. The movements in yield curve are rather frequent. performing assets turning into non-performing assets. Interest Rate Risk can take different forms.e. IRR can be viewed in two ways. thereby making the liabilities. i.  Time Risk: This arises from the need to compensate for non-receipt of expected inflows of funds i. Interest Rate Risk (IRR) refers to potential impact on Net Interest Income or Net Interest Margin or Market Value of Equity (MVE). The interest margin would undergo a change after six months. etc. caused by unexpected changes in market interest rates. any non-parallel movements in yield curves would affect the NII.  Gap or Mismatch Risk: A gap of mismatch risk arises from holding assets and liabilities and off balance-sheet items with different principal amounts. For banks. maturity dates or reprising rates. Mumbai Institute of mgmt and research . INTEREST RATE RISK Interest Rate Risk (IRR) is the exposure of a Bank s financial condition to adverse movements in interest rates. E.e. funding liquidity risk is crucial.TREASURY AND RISK MANAGEMENT LIQUIDITY RISK The liquidity risk of banks arises from funding of long-term assets by short-term liabilities.  Yield Curve Risk: In a floating interest rate scenario.

g. The present interest rate restructuring taking place in the Indian markets is a very good example of this aspect. interest rate risk arises when the market interest rates adjust downwards.g. Every time the CRR is lowered. This phenomenon will. The basis risk is quite visible in volatile interest rate scenarios.  Reinvestment Risk: Uncertainty with regard to interest rate at which the future cash flows could be reinvested is called reinvestment risk.  Rate Level Risk: During a given period there is possibility for restructuring the interest rate levels either due to the market conditions or due to regulatory intervention.TREASURY AND RISK MANAGEMENT E. has been lowering the Statutory Cash Reserve Ratio for banks in a phased manner from 12% to 8% since 1996. liabilities and off-balance sheet items may change in different magnitude is termed as basis risk. The embedded option risk is becoming a reality in India and is experienced in volatile situations. A liability raised at a rate linked to say 91 days T Bill is used to fund an asset linked to 364 days Treasury Bills. 91 days and 364 days Treasury Bills may increase but not identically due to non-parallel movement of yield curve creating a variation in net interest earned.  Embedded Option Risk: Significant changes in market interest rates create the source of risk to banks profitability by encouraging prepayment of cash credit/demand loans term loans and exercise of call/put options on bonds/debentures and/or premature withdrawal of term deposits before their stated maturities. liabilities and OBS positions. the basis has moved against the banks. affect decisions regarding the type and the mix of assets/liabilities to be maintained and their maturing periods. A 2% cut Mumbai Institute of mgmt and research . the banks have experienced favourable basis shifts and if the interest rate movement causes the NII to contract. Any mismatches in cash flows would expose the banks to variations in NII as the market interest rates move in different directions. The Reserve Bank of India which is the apex body regulating the Indian monetary system.  Basis Risk: The risk that the interest rate of different assets. E. The faster and higher the magnitude of changes in interest rate. The Loan book in India is funded out of a composite liability portfolio and is exposed to a considerable degree of basis risk. in the long run. Such banks will experience a reduction in NII as the market interest rate declines and increases when interest rate rises. When the variation in market interest rate causes the NII to expand. there is an increase in the liquidity which further results in lowering of the interest rate levels. the greater will be the embedded option risk to the banks NII. The result is reduction of projected cash flow and income for the bank. In a rising interest rate scenario both.  Net Interest Position Risk: Where banks have more earning assets than paying liabilities. The degree of basis risk is fairly high in respect of banks that create composite assets out of composite liabilities. Its impact is on the earnings of the bank or its impact on the economic value of the bank s assets. In a rising interest rate scenario asset interest rate may rise in different magnitude than the interest rate on corresponding liability creating variation in net interest income.

the risk will acquire serious proportions in a highly volatile market when the impact will be felt on the cash flows and profits. it may include call/put options. A call option is generally exercised in a declining interest rate scenario. Consequently the loss of interest income on assets is likely to be higher than the reduction in the interest cost of deposits leading to lower spreads. which generally hovered around 5-7 %. While some banks defaulted in the maintenance of CRR. the affect will be seen on all the existing assets. which had substantially reduced their profits. instalments on loans etc. The risk that arises due to this reduction can be understood from the fact that the revised rates of interest will be applicable to all the new deposits. many banks borrowed funds at high rates. any cash inflows that arise due to prepayment of loans will have to be redeployed at a lower rate invariably resulting in lowered yields.  Reinvestment Risk: The risk can be associated to the intermediate cash flows arising due to the payment of interest. there are short term fluctuations which are to be considered in deciding on the mix of assets and liabilities. The 1994 volatility witnessed in the Indian call money market explains the presence and the impact of volatility risk. However.  Volatility Risk: In additions to the long run implications of the interest rate changes. it can be seen that the affect of fluctuations in the short term have a greater impact since the adjustment period is very short. These two options expose to a risk when the interest rate fluctuate. For instance.  Call/Put Risk: Sometimes when the funds are raised by the issue of bonds/securities. Thus. the pricing policies and thereby the business volumes. Mumbai Institute of mgmt and research . these intermediate cash flows when received may have to be reinvested at a lower rates resulting in lower yields. This variability in the returns from the reinvestments due to changes in the interest rates is called the reinvestment risk.TREASURY AND RISK MANAGEMENT in the CRR from 10% to 8% in the Busy Season Credit Policy announced in October 1997 was immediately followed by a cut in the PLR/interest rates of Banks and FI s. However. when the investor exercises the put option in an increasing interest rate scenario. Similarly. in a situation where the interest rate is declining. which will lower the marginal costs of funds. Due to the volatility in the interest rates. which issue the bonds. The interest rate in the call money market. This will affect the bank if it invests in such bonds since the intermediate cash inflows will have to be reinvested at a lower rate. zoomed to 95% within a couple of weeks during September. while the put option is exercised by the investor to seek redemption before maturity. 1994. the banks. will have to face greater replacement costs. These intermediate cash flows arising from a security/loan are usually reinvested and the income from such reinvestments will depend on the prevailing rate of interest at the time of reinvestment and the reinvestment strategy. A call option is exercised by an issuer to redeem the bonds before maturity.  Prepayment Risk: The fluctuations in the interest rate may sometimes lead to prepayment of loans.

which is created for making profit out of short-term movements in interest rates. commodities and currencies. The price risk is closely associated with the trading book. MARKET RISK Market risk is the risk of adverse deviations of the mark-market-value of the trading portfolio. DEFAULT AND CREDIT RISK Mumbai Institute of mgmt and research . bond prices and yields are inversely related. In the financial market. due to market movements. Market Risk is also referred to as Price Risk. equities. This results from adverse movements in the level or volatility of the market prices of interest rate instruments.  Forex Risk: Forex risk is the risk that a bank may suffer losses as a result of adverse exchange rate movements during a period in which it has an open position. either spot or forward. The term market risk applies to (i) that part of IRR which affects the price of interest rate instruments.TREASURY AND RISK MANAGEMENT Approaches to Quantify Interest Rate Risks are as follows: a) Maturity Gap Method b) Rate Adjusted Gap c) Duration Analysis d) Hedging e) Sensitivity Analysis f) Simulation and Game Theory. (ii) Pricing Risk for all other assets/portfolio that are held in the trading book of the bank and (iii) Foreign Currency Risk. or a combination of the two.  Market Liquidity Risk: Market liquidity risk arises when a bank is unable to conclude a large transaction in a particular instrument near the current market price. in an individual foreign currency. Price Risk occurs when assets are sold before there stated maturities. during the period required to liquidate the transactions.

 Compliance Risk: Compliance risk is the risk of legal or regulatory sanction.TREASURY AND RISK MANAGEMENT Credit risk is most simply defined as the potential of a bank borrower or counterparty to fail to meet its obligations in accordance with agreed terms. which form the part of operational risk. Communication Risk. Two of these. As mentioned above that Strategic Risk and Reputation Risks fall outside the scope of Operational Risk. financial loss or reputation loss that a bank may suffer as a result of its failure to comply with any or all of the applicable laws. Documentation risk. Competence risk. OPERATIONAL RISKS Operational risk is the risk of loss resulting from inadequate or failed internal processes. both internal and external. transaction and compliance risk has been defined below. For most banks.  Country Risk: This is also a type of credit risk where non-performance by a borrower or counter-party arises due to constraints or restrictions imposed by a country. Legal risk. External events risk. Operational risk may loosely be comprehended as any risk which is not categorized as market or credit risk. which are frequently used namely. Model risk. Compliance risk. codes of conduct and standards of good practice. Scope of operational risk is very wide.  Transaction Risk: Transaction risk is the risk arising from fraud. failed business processes and the inability to maintain business continuity and manage information. loans are the largest and most obvious source of credit risk. Cultural risk. The counterparty risk is generally viewed as a transient financial risk associated with trading rather than standard credit risk. It is also called integrity risk since a bank s reputation is closely linked to its adherence to principles of integrity and fair dealing. people and systems or from external events. Strategic risk and reputation risk are not a part of operational risk. Regulatory risk. regulations. Here reason for non-performance is external factors on which the borrower or the counterparty has no control. It includes Fraud risk. System risk and so on. These are defined below: Mumbai Institute of mgmt and research .  Counterparty Risk: This is a variant of credit risk and is related to non-performance of the trading partners due to counterparty s refusal or inability to perform.

or lack of responsiveness to industry changes.TREASURY AND RISK MANAGEMENT Strategic Risk: Strategic Risk is the risk arising from adverse business decisions. the resources deployed against these goals and the quality of implementation. This risk may expose the institution to litigation. The risk is a function of the compatibility of an organization s strategic goals. or a decline in customer base. the business strategies developed to achieve those goals. financial loss. Reputation Risk: Reputation risk is the risk arising from negative public opinion. Mumbai Institute of mgmt and research . improper implementation of decisions.

TREASURY AND RISK MANAGEMENT RISK MANAGEMENT Managing credit risk Credit risk arises from the potential that an obligor is either unwilling to perform on an obligation or its ability to perform such obligation is impaired resulting in economic loss to the bank. Banks need to enunciate a system that enables them to monitor quality of the credit portfolio on day-today basis and take remedial measures as and when any deterioration occurs. For instance the default could be due to country in which there is exposure or problems in settlement of a transaction. In addition to direct accounting loss. settlement and other financial transactions. In a bank s portfolio. however. transaction costs and expenses associated with a non-performing asset over and above the accounting loss. loans are the largest and most obvious source of credit risk. credit risk should be viewed in the context of economic exposures. financial institutions or a sovereign. the overall risk profile is within limits established by management and compliance of regulatory limits. At the minimum it should lay down procedure relating to: a) The roles and responsibilities of individuals responsible for credit risk monitoring b) The assessment procedures and analysis techniques (for individual loans & overall portfolio) c) The frequency of monitoring d) The periodic examination of collaterals and loan covenants Mumbai Institute of mgmt and research . The same source that endangers credit risk for the institution may also expose it to other risk. corporate. Credit Risk Monitoring & Control Credit risk monitoring refers to incessant monitoring of individual credits inclusive of OffBalance sheet exposures to obligors as well as overall credit portfolio of the bank. Consequently the management could fine tune or reassess its credit strategy /policy accordingly before encountering any major setback. Establishing an efficient and effective credit monitoring system would help senior management to monitor the overall quality of the total credit portfolio and its trends. credit risk could stem from activities both on and off balance sheet. Alternatively losses may result from reduction in portfolio value due to actual or perceived deterioration in credit quality. Such a system would enable a bank to ascertain whether loans are being serviced as per facility terms. the adequacy of provisions. losses stem from outright default due to inability or unwillingness of a customer or counter party to meet commitments in relation to lending. For most banks. Credit risk not necessarily occurs in isolation. Credit risk can be further sub-categorized on the basis of reasons of default. The banks credit policy should explicitly provide procedural guideline relating to credit risk monitoring. trading. Credit risk emanates from a bank s dealing with individuals. This encompasses opportunity costs.

a) Delineate banks overall risk tolerance in relation to market risk. b) To appoint senior managers who have ability to manage liquidity risk and delegate them the required authority to accomplish the job. and staff having relevant expertise and efficient systems and procedures. Mumbai Institute of mgmt and research . For its part. LIQUIDITY RISK MANAGEMENT The prerequisites of an effective liquidity risk management include an informed board. The board has to ensure that the bank has necessary liquidity risk management framework and bank is capable of confronting uneven liquidity scenarios. d) Ensure that the bank implements sound fundamental principles that facilitate the identification. Generally speaking the board of a bank is responsible: a) To position bank s strategic direction and tolerance level for liquidity risk. and controlled. monitored. measurement. capable management. b) Ensure that bank s overall market risk exposure is maintained at prudent levels and consistent with the available capital. c) To continuously monitors the bank's performance and overall liquidity risk profile. e) Ensure that adequate resources (technical as well as human) are devoted to market risk management. c) Ensure that top management as well as individuals responsible for market risk management possess sound expertise and knowledge to accomplish the risk management function. monitoring and control of market risk. Effective board and senior management oversight of the bank s overall market risk exposure is cornerstone of risk management process. the board of directors has following responsibilities. measured.TREASURY AND RISK MANAGEMENT e) The frequency of site visits f) The identification of any deterioration in any loan Managing Market Risk Likewise other risks. the concern for management of Market risk must start from the top management. It is primarily the duty of board of directors to understand the liquidity risk profile of the bank and the tools used to manage liquidity risk. c) To ensure that liquidity risk is identified.

e) All business and support functions should be an integral part of the overall operational risk management framework in order to enable the institution to manage effectively the key operational risks facing the institution. Furthermore. including those that do not readily lend themselves to measurement. f) Line management should establish processes for the identification. This should incorporate a clearly defined organizational structure. and the level of risk that the organization accepts. a) Ultimate accountability for operational risk management rests with the board. assessment. should address in their approach to operational risk management. These operational risk management policies and procedures should be aligned to the overall business strategy and should support the continuous improvement of risk management. understand and have defined all categories of operational risk applicable to the institution. d) Operational risk policies and procedures that clearly define the way in which all aspects of operational risk are managed should be documented sand communicated. operate consistently over time and support an organizational view of operational risks and material failures.TREASURY AND RISK MANAGEMENT Managing Operational Risk There are 6 fundamental principles that all institutions. together with the basis for managing those risks. easy to implement. b) The board and executive management should ensure that there is an effective. monitoring and reporting of operational risks that are appropriate to the needs of the institution. mitigation. c) Board and executive management should recognize. Mumbai Institute of mgmt and research . with defined roles and responsibilities for all aspects of operational risk management/monitoring and appropriate tools that support the identification. they should ensure that their operational risk management framework adequately covers all of these categories of operational risk. assessment. is driven from the top down by those charged with overall responsibility for running the business. regardless of their size or complexity. control and reporting of key risks. integrated operational risk management framework.

TREASURY AND RISK MANAGEMENT Mumbai Institute of mgmt and research .

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