Treasury MGMT in Banks

TREASURY MANAGEMENT IN BANKS
METs Institute of Management

December 2006
Treasury Management in Banks Presented by Namrata Padhye, Ritu Madan & Anand Iyer
BANK ??
Basel Accord Interest Rate Risk Management Liquidity Risk Management RBI Guidelines on ALM Banks Balance Sheet NDTL What is Treasury Management? Treasury Products
Treasury Management
Dynamics of Asset Liability Management

Risk Exposure in Money Market Instruments
Forex Market, Money Market Securities market Elements of Treasury Management
VaR, Price Gap & Time Gap 2 Treasury Management in Banks Presented by Namrata Padhye, Ritu Madan & Anand Iyer
What is a Bank???
A financial Institution that is owned by stockholders, operates for a profit, and engages in lending activities
Bank Goals and Constraints
A Banks Balance Sheet

LIABILITIES
Capital Reserves & Surplus Deposits Borrowings
ASSETS
Cash in hand Balances with RBI Balances with other banks, money at call and notice Investments
Other liabilities & provisions

Contingent Liabilities
Advances
Fixed Assets Others
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Net Demand Time Liabilities???

Banks have to maintain statutory reserves on their NDTL. For calculating its NDTL, a bank has to first sum up its total gross liabilities, which include all demand and term deposits. Once the gross demand and time liabilities (DTL) is determined, the bank can deduct its Interbank assets (IBA) from this DTL only to the extent of its Interbank liabilities (IBL). Usually NDTL is calculated with reference to alternate Fridays called "Reporting Fridays". The banks are required to maintain their CRR and SLR with reference to the NDTL as of the reporting Friday. Liabilities of a bank may be in the form of demand or time deposits or borrowings or other miscellaneous items of liabilities. Liabilities of the banks may be towards the banking system (as defined under Section 42 of RBI Act, 1934) or towards others in the form of Demand and Time deposits or borrowings or other miscellaneous items of liabilities. Reserve Bank of India has been authorized in terms of Section 42 (1C) of the RBI Act, 1934 to classify any particular liability and hence for any doubt regarding classification of a particular liability, the banks are advised to 6 Treasury Management in Banks Presented by Namrata Padhye, Ritu Madan & Anand Iyer approach RBI for necessary clarification.
Demand Liabilities
Demand Liabilities
They include current deposits, demand liabilities portion of savings bank deposits, margins held against letters of credit/guarantees, balances in overdue fixed deposits, cash certificates and cumulative/recurring deposits, outstanding Telegraphic Transfers (TTs), Mail Transfer (MTs), Demand Drafts (DDs), unclaimed deposits, credit balances in the Cash Credit account and deposits held as security for advances which are payable on demand. Money at Call and Short Notice from outside the Banking System should be shown against liability to others.
Time Liabilities
Time Liabilities
They include fixed deposits, cash certificates, cumulative
and recurring deposits, time liabilities portion of savings bank deposits, staff security deposits, margin held against
letters of credit if not payable on demand, deposits held as

securities for advances which are not payable on demand, India Millennium Deposits and Gold Deposits.
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Net Demand and Time Liabilities

Formula: NDTL = liabilities to others + liabilities to
banking system assets with

banking system

Liabilities to others = Deposits (total) deposits of banks Liabilities to banking system = borrowings from other banks (do not include borrowings from RBI) Assets with banking system = balances with other banks, money at call/notice
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Statutory Requirements:
Fortnightly Reporting
Form A
Section 42(2) of the RBI Act
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Fortnightly return in Form A

Under Section 42 (2) of RBI Act, 1934 submit
a provisional return in Form 'A' within 7 days

Final Form 'A' is required to be sent to RBI
within 20 days
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Form A
Memorandum to form 'A'- paid-up capital, reserves, time deposits i.e. of short term and Long term, CoD, NDTL, total CRR requirement etc.
Annexure A- foreign currency liabilities and assets Annexure B- investment in approved securities, investment in non-approved securities, memo items such as subscription to shares /debentures / bonds in primary market and subscriptions through private placement.
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Computation of DTL in Form A

Converting all the foreign current assets and bank credit of the following 4 major currencies viz. US dollar, GBP, Japanese Yen and Euro into Rupees Format of fortnightly returns in Form A and the method of computing DTL in Form A i.e. if (I-III) is positive, then [(IIII) plus II], otherwise only II. The explanations to item No's. I, II and III of the return in form 'A' are given below Item I - Liabilities to the Banking System in India . Item II - Liabilities to Others in India. Item III - Assets with the Banking System in India.
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SCBs
RBI act Section 42(2)

Banks
Two responsible officers
Return
(a) the amount of its demand and time liabilities and the amount of its borrowings from banks in India, classifying them into demand and time liabilities, (b) the total amount of legal tender notes and coins held by it in India, (c) the balance held by it at the Bank in India, (d) the balances held by it at other banks in current account and the money at call and short notice in India, (e) the investments (at book value) in Central and State Government securities including treasury bills and treasury deposit receipts, (f) the amount of advances in India, (g) the inland bills purchased and discounted in India and foreign bills purchased and discounted, 15
What is Treasury Management?

Treasury management is the management of an organizations 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.
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Objectives of Treasury
Funding of investment Working Capital Management
Short-term Investments
Risk (hedging) and Forex Management Responsibility for the judicious use of banks name Asset & liability management
Maintenance of statutory reserve requirements

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Integrated Treasury- A Typical set up

Top Management
Financial control
Middle office
Treasurer
Back-office
Balance sheet Money Market management activities
Forex activities
Derivatives
Treasury marketing
ALM Manage ment of: Reserves Gaps ,liquidity
Swap Trading Bond Trading (gilts & corporate paper
Spot trading ,merchant cover operations
Interest rate derivatives & Forex derivatives
Equities & Commodities
Marketing all the interest rate ,Foreign exchange & derivatives products
Trading in equities & commodities like gold, oil etc.

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TREASURY PRODUCTS
FOREIGN EXCHANGE MARKET

Most liquid market. Free currencies can be readily bought and sold. Not fully convertible currencies which have limited demand also have sufficient liquidity. Virtual market. Information dissemination through electronic media like Reuters, Bloomberg.
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PRODUCTS OF FOREX MARKET

SPOT TRADES Mostly bought and sold in spot trades Settlement happens on a T+2 basis Settlement can happen on the same day or the next day. Exchange rates displayed are for spot trades unless specified other wise. Same day or next day trading rates are at a discount to the SPOT rates.
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FORWARDS Refers to purchase or sale of currency on a future date. Treasury gets into forward contracts with customers (importers,exporters who do not want the currency risk) and simultaneously gets into reverse positions in the inter-bank market. Treasury may get into forward market to make speculative gains. Forward rates are arrived by adding the interest rate differential to the spot rate of low interest yielding and deducted from the spot rate of high interest yielding . However this is applicable in perfect markets where the currency is fully convertible. In India the demand for the currency influences the rate more than the 22 interest differentials. Treasury Management in Banks Presented by Namrata Padhye, Ritu Madan & Anand Iyer
SWAPS
Combination of spot and forward transaction. Generally used for funding requirements, but also arbitrage opportunity. INVESTMENT OF FOREX SURPLUSES Surpluses arise due to variety of reasons Can invest in Inter-bank loans Short term investments Nostro accounts
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REDISCOUNTING OF FOREIGN BILLS

Inter bank advance where treasury refinances bills purchased by another bank. Though it is an inter bank deal, RBI has asked the banks to include it in their credit portfolio.
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MONEY MARKET
Refers to raising and deployment of short term resources with maturity not exceeding 1 year It is sub-divided into CALL (over night placements), NOTICE ( < 14 days), TERM ( < 1 year typically 1 6 months) RBI has imposed restrictions on non- banks with a view to phase out their participation and make money market as a pure inter-bank market.
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Money Market Players & their Role

Player
Central Bank Government Banks Discount Houses Acceptance Houses FIs MFs FIIs Dealers Corporates
Role
Intermediary Borrower / Issuer Borrowers / Issuers Market Makers Market Makers Borrowers / Issuers Lenders / Investors Investors Intermediaries Issuers
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Money Market Instruments

Call Money
Treasury Bills Commercial Paper (CP) Certificate of Deposits (CDs)
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Bill Financing
Repurchase Agreements (REPOs) Interest Rate Swaps
Call Money
Participants Purpose Call Rates Operation Mechanism Location
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Treasury Bills
Issuer Investor Purpose Form and Size Types
Yields
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Commercial Papers
Definition Issuers Investors Features Maturity
Denomination and size

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Certificate of Deposits
Definition Issuers Subscribers Features Purpose Min size and denomination Term/maturity
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Repurchase Agreements (REPOs)

Purpose Participants Liquidity Term / Maturity
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Interest Rate Swaps

Basic Interest Rate Swap

Firm X Y Objective Fixed Rate Floating Rate Fixed Interest 12% 10.00% Floating Interest MIBOR + 0.50% MIBOR + 0.25 %
The difference in rates Fixed Market 12.00% - 10.00% = 2.00% Floating Market MIBOR+0.50% - (MIBOR + 0.25%) = 0.25%
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SECURITIES MARKET
Investment business is an important aspect of treasury. Involves buying and selling in securities market. GOVERNMENT SECURITIES Treasury invests primarily in Gsecs to comply with the SLR (25%). SLR gradually reduced over the years. Gsecs issued by public debt office of RBI on behalf of government. Interest is fixed known as coupon rate but price keeps on changing hence yield keeps 35 on changing. Treasury Management in Banks Presented by Namrata Padhye, Ritu Madan & Anand Iyer
Government uses securities to fund its deficit. RBI uses Gsecs to control liquidity through open market operations. As the interest rates were falling, Gsecs were very attractive and banks invested to the tune of 41% as against the requirement of 25%. However now with increasing interest rates, apprehension is the norm. Gsec yields are used as benchmark for other bonds.
CORPORATE DEBT PAPER Medium and long term bonds issued by corporate and financial inst. Yields higher than Gsec and they differ based on credit rating Fairly active secondary market, hence liquid.
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DEBENTURES AND BONDS Debt instruments secured or unsecured. Conventionally in India debentures issued by private sectors and bonds by public sector. Debentures are transferable only by registration whereas bonds are negotiable. Debentures governed by company law, bonds by contract act. Internationally no difference between the two. Debenture and bond holders have the prior legal claim ahead of preference share holders and equity shareholders.
EQUITY Banks are allowed to invest in equities subject to a ceiling.(currently at 5 % of total assets)
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Treasury Management
Money Markets
Foreign Exchange
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Money Markets
Measures affecting Money Markets:
Treasury Management
Changes in CRR Changes in SLR Open Market Operations Bank Rate
Repos
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Foreign Exchange
Funding avenues in Forex Market:
Treasury Management
Bonds Syndicate Credits Medium Term Loans Committed underwritten facilities
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Value at Risk (VaR)

VaR summarizes the worst loss over a target horizon with a given level of confidence. Risk measured in currency unit. It is an estimate Three factors
Time horizon Probability Actual rupee amount itself
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Computation of VaRIllustration
Change in Value
<=Rs 10,00,000 - Rs 5,00,000 to Rs 9,99,999 - Rs 2,50,000 to Rs 4,99,999 Rs 0 to Rs 2,49,999 Rs 1 to Rs 2,49,999 Rs 2,50,000 to Rs 4,99,999 Rs 5,00,000 to Rs 9,99,999 >= Rs 10,00,000
Probability
0.01 0.04 0.15 0.30 0.3 0.15 0.4 0.1
Expected change Standard deviation
E( V) ( V)
VaR (1%) = E( V)
2.33 ( V)
VaR (5%) = E( V)
1.65 ( V)
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Computation of VaRIllustration
E( V) ( V) Thus , - Rs 10,00,000 - Rs 15,00,000
VaR (1%) = 10,00,000 2.33 (15,00,000)

= - Rs 24,95,000 VaR (5%) = 10,00,000 1.64 (15,00,000) = - Rs 14,60,000
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Methods used to calculate VaR

Inputs to VaR computation are obtained through Historical Simulation Method
Value at mark to market
Requires at least 250 weeks of data.
Monte Carlo Simulation

Requires at least 1000 simulations
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Price Gap
Price Gap can be defined as the difference in the value (Price) of the assets and liabilities, which occurs due to changes in Interest rates.
Let us consider an example: XYZ bank issues a 5 year, 6% coupon rate bond at face value of Rs 1000 and invests in 5 year, 6% coupon rate bond at face value of Rs 500. Interest rate drops to 5% Market Price of Bond issued = 60/0.05 = Rs 1200. Market Price of the Bond Invested = 30/0.05 = Rs 600
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Time Gap
Time gap can be defined as the Gap occurring due to the difference in the maturity periods of assets and liabilities.
Let us consider an example: Mr. X deposits Rs. 1000 with a Bank at 6% rate of interest for a period of 1 year. Let us consider that the bank lends this money to Mr. Y at 11% rate of interest for 3 years. Thus at the time of payment to Mr. X after 1 year the bank has no money left with it since it has provided this to Mr. Y.
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Risks
Credit Risk
Market Risk
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Market Risks
Credit Risk Risks
Market Risk
Exchange Risks
Interest Rate Risks Liquidity Risks Equity Price Risk Commodity Risk
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Credit Risk
Treasury Management Risk
Counterparties may be unwilling or unable to fulfill obligations Losses due to credit risk can occur before actual default Credit risk is controlled by imposing
credit limits
Credit Risk Market Risk
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Market Risk
Treasury Management Risk
Definition: Market Risk is the risk to the Banks earnings and capital due to changes in the market level of interest rates or prices of securities, foreign exchange and equities as well as the volatilities of those changes.
Credit Risk Market Risk
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Asset Liability Management in Banks
Components of a Bank Balance sheet

Liabilities
1. 2. 3. 4. 5. Capital Reserve & Surplus Deposits Borrowings Other Liabilities
Assets
1. Cash & Balances with RBI 2. Bal. With Banks & Money at Call and Short Notices 3. Investments 4. Advances 5. Fixed Assets 6. Other Assets
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Contingent Liabilities
Banks Profit & Loss Account

A banks profit & Loss Account has the following components: Income: This includes Interest Income and Other Income. Expenses: This includes Interest Expended, Operating Expenses and Provisions & contingencies.
I.
II.
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It is a dynamic process of Planning, Organizing & Controlling of Assets & Liabilities- their volumes, mixes, maturities, yields and costs in order to maintain liquidity and NII. ALM is a system of matching cash inflows and outflows, and thus of liquidity management ALM is the act of Planning, Acquiring and Directing the 54 flow of funds through the bank
Assets Liability Management
Evolution of the concept of ALM

Managing liquidity on the bank's asset side Later shift to the liability side, termed liability management Using both the assets as well as liabilities sides of the balance sheet to achieve optimum resources management In the 1980s, volatility of interest rates in USA and Europe caused the focus to broaden to include the issue of interest rate risk Prior to the 1990s, there was no interest rate risk as the interest rates were regulated and prescribed by the RBI . Now the banks have been given a large amount of freedom to manage their balance sheets Reserve Bank of India to announce in its monetary and credit policy of October 1997 that it would issue ALM guidelines to banks Current decade focuses on earning a proper return of bank equity and hence maximization of its market value has meant that ALM covers the management of the entire balance sheet of a bank
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RBI DIRECTIVES
Issued draft guidelines on 10th Sept98. Final guidelines issued on 10th Feb99 for implementation of ALM w.e.f. 01.04.99. To begin with 60% of asset &liabilities will be covered; 100% from 01.04.2000. Initially Gap Analysis to be applied in the first stage of implementation. Disclosure to Balance Sheet on maturity pattern on Deposits, Borrowings, Investment & Advances w.e.f. 31.03.01 RBI has propose to switch over to Risk Based Supervision
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Objectives of ALM
Aimed at identification, measurement, monitoring and control of the market risk segment Its key objectives are: 1)stabilization of net interest income, 2)maximization of shareholders wealth, 3)managing liquidity The primary objective of an Asset Liability management system is liquidity risk management and interest rate risk management.
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Objectives of ALM in Banks

Interest Income
Banks NIM
Banks response to Interest Rate Changes Interest Expense Invest. Value, Profit & Risk Banks Net Worth Market Value of Banks Liabilities
Market Value of Banks Assets
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Prerequisites of ALM
Developing a better understanding of ALM concepts, Introducing an ALM information system, Setting up ALM decision-making processes (ALM Committee/ALCO). Awareness for ALM in the Bank staff at all levels supportive Management & dedicated Teams. Insight into the banking operations, economic forecasting, computerization, investment, credit. Linking up ALM to future Risk Management Strategies.
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ALCO
Administers on a daily basis the componenets tht affect financial performance Develops, implements and manages bankss annual budget or profit plan and its risk management programme Its compositions depends on: - size of the organisation - magnitude of operations - business mix - need for response to market dynamics 60
Composition of ALCO
Head of Committee CEO/CMD/ED
Chief of Investments
Chief of Credit
Chief of Planning
Chief of Treasury
Chief Int. Banking
Economic Research
Invitee
Head of Technical Division

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Responsibilities of ALCO Committee

Balance sheet planning from risk-return perspective - pricing banks liabilities (deposits) in accordance with its various assets - to arrrive at the appropriate maturity profile for the assets and lab and to have a proper product mix Articulate the current interest rate view and make future strategies Determine source and mix of assets and liabilities
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Responsibilities of ALCO Committee

Review of decisions and progress made Frequency of holding meetings
Strategic management of Structural

liquidity and interest rate risk.
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ALM Process
Efficiency of ALM process depends on ALM MIS and ALM structure Its primary goal is to identify risk parameters It takes care of foll. Risks
Liquidity Interest risk Currency Equity Commodity
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ALM Process
Risk Identification Risk Measurement
Risk Management
Risk Tolerance And Limit Levels
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Significance of ALM
Volatility Deregulation of financial system changed the dynamics of financial markets. Such free economic environment are reflected in Interest Rate Structure, Money Supply, Exchange Rate and Price Level Product Innovations & Complexities Rapid innovation take place in financial products of the bank. They have an impact on the risk profile of the bank Regulatory Environment 66 Management Recognition
Purpose & Aims of ALM

An effective Asset Liability Management Technique aims to manage the volume, mix, maturity, rate sensitivity, quality and liquidity of assets and liabilities as a whole so as to attain a predetermined acceptable risk/reward ration. It is aimed to stabilize short-term profits, long-term earnings and long-term substance of the bank. The parameters for stabilizing ALM system are: Net Interest Income (NII) Net Interest Margin (NIM) Economic Equity Ratio
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Scope of ALM
Liquidity Risk Management
Interest Rate Risk Management
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Liquidity risk
Liquidity risk is often related to banks inability to pay to its depositors It leads to distress pricing of assets and liabilities A bank with high degree of liquidity risk has 2 options - to borrow funds from money market at high rates - to increase its deposit rates Liquidity risk has strong co-relation to interest risk and credit risk.
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Adequacy of liquidity position for a bank

Analysis of following factors throw light on a banks adequacy of liquidity position: a. Historical Funding requirement b. Current liquidity position c. Anticipated future funding needs d. Sources of funds e. Options for reducing funding needs f. Present and anticipated asset quality g. Present and future earning capacity and h. Present and planned capital position
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Funding Avenues
To satisfy funding needs, a bank must perform one or a combination of the following: Dispose off liquid assets Increase short term borrowings Decrease holding of less liquid assets Increase liability of a term nature Increase Capital funds
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a. b. c. d. e.
Types of Liquidity Risk

Liquidity Exposure can stem from both internally and externally. External liquidity risks can be geographic, systemic or instrument specific. Internal liquidity risk relates largely to perceptions of an institution in its various markets: local, regional, national or international
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Other categories of liquidity risk

Funding Risk - arises due to maturing of liabilities Time Risk - arises if funds lent lent with structured repayment schedule do not come back as planned Call Risk - arises on crystallization of contingent liabilities
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Initially there was surplus liquidity but after 200405 the scenario changed so the need for LRM was felt evn more
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Liquidity management is viewed from 2 angles - Short term Implications - Long term Implications Short term Implications may be viewed as per convenience. The 2 set of tools for this purpose are: Working Funds approach and Cash flow Approach. Long term Implications takes into account 2 crucial aspects: Asset management and Liquidity management
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Dynamic v/s Static Liquidity management

Static Liquidity Management: - based on Balance sheet items - behavioral pattern of deposits and liabilities - sensitivity in response to pricing Dynamic Liquidity Management - analysis of cash flows - meeting fresh investments (regulatory priorities) - monitoring
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Structural liquidity statement

It is a framework for measuring liquidity risk RBIs prescription to have a fortnightly statement It is prepared on the basis of assets and liabilities It is to be reported every Friday Time Bucketing has to be made on residual maturity of each item
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TIME BUCKETS
All Assets & Liabilities to be reported as per their maturity profile into 8 maturity Buckets: i. 1 to 14 days
ii. 15 to 28 days iii. 29 days and up to 3 months
iv. Over 3 months and up to 6 months

v. Over 6 months and up to 1 year vi. Over 1 year and up to 3 years
vii. Over 3 years and up to 5 years

viii. Over 5 years
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Places all cash inflows and outflows in the maturity ladder as per residual maturity Maturing Liability: cash outflow Maturing Assets : Cash Inflow Classified in to 8 time buckets Mismatches in the first two buckets not to exceed 20% of outflows (RBI limits) Shows the structure as of a particular date Banks can fix higher tolerance level for other maturity buckets.
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For Outflows of Bucketing

1. Capital & R/S
2. Current deposits - volatile portion(15%) - core portion (85%) 3. Time deposits, CDs, Repos, bills discounted, interest payable 4. Bills payable - non core portion - core portion 5. All overdue liabilities 1.Over 5 yrs bucket 2. - 1 to 14 days - 1 to 3 yrs 3. Placed in respective time buckets depending on residual maturity 4. - 1 to 14 days - 1 to 3 yrs 5. 1 to 14 days 80
For Inflows of Bucketing

1.Cash, balances with RBI 2. Investments 3. Term loans , Leased Assets
4. NPA - Substandard - Doubtful 5. Fixed Assets 6. Reverse Repos, swaps, bills rediscntd, Int Rec
1. 1 to 14 days
2. Depends 3. Interim Cash flows under respectve maturity buckts 4. - 3 to 5 yrs - over 5 yrs 5. Over 5 yrs 6. Respective maturity Buckets
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An Example of Structural Liquidity Statement

15-28 1-14Days Days 30 Days- 3 Mths - 6 Mths - 1Year - 3 3 Years - Over 5 3 Month 6 Mths 1Year Years 5 Years Years Total
300 200 350 400 50 50 700 650 200 150 50 50 200 150 Loans BPLR Linked 100 150 Others 50 50 Total Inflow 600 550 Gap -100 -100 Cumulative Gap -100 -200 Gap % to Total Outflow -15.38 -14.29
Capital Liab-fixed Int Liab-floating Int Others Total outflow Investments Loans-fixed Int Loans - floating
200 600 600 300 200 350 450 500 450 450 0 550 1050 1100 750 650 250 250 300 100 350 0 100 150 50 100 200 150 150 150 50 200 500 350 500 100 0 0 0 0 0 650 1000 950 800 600 100 -50 -150 50 -50 -100 -150 -300 -250 -300
18.18 -4.76 -13.64 6.67 -7.69
200 200 450 200 1050 900 100 50 100 200 1350 300 0
28.57
200 2600 3400 300 6500 2500 600 1100 2000 300 6500 0 0
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Its Utility and Drawbacks

Utilities Mismatch control Dominance or weakness of a bucket Initiate policies Compute interest rate sensitivity Drawbacks Static and not dynamic Depends on residual maturity without considering the duration
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Dynamic Liquidity Statement

It shows inflows and outflows limited to a period of 90 days To capture negative mismatch in a short term period Total of 3 buckets in this statement : - 1 to 14 days - 15 to 28 days - 29 to 90 days
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Particulars
Short term liquidity statement format

1 to 14 days 15 to 28 days
29 to 30 days
Outflows
Inflows Mismatch Cumulative mismatch Mismatch as a % to outflow
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Strategies to Address the Mismatches

Mismatches can be positive or negative
Positive Mismatch: M.A.>M.L. and Negative Mismatch M.L.>M.A.

In case of +ve mismatch, excess liquidity can be deployed in money market instruments, creating new assets & investment swaps etc. For ve mismatch,it can be financed from market borrowings (Call/Term), Bills rediscounting, Repos & deployment of foreign currency converted into rupee. 86
STRATEGIEScontd
To meet the mismatch in any maturity bucket, the bank has to look into taking deposit and invest it suitably so as to mature in time bucket with negative mismatch. The bank can raise fresh deposits of Rs 300 crore over 5 years maturities and invest it in securities of 1-29 days of Rs 200 crores and rest matching with other out flows.
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Maturity Pattern of Select Assets & Liabilities of A Bank Liability/Assets Rupees (In Cr) In Percentage
I. Deposits 15200 100 a. Up to 1 year 8000 52.63 b. Over 1 yr to 3 yrs 6700 44.08 c. Over 3 yrs to 5 yrs 230 1.51 d. Over 5 years 270 1.78 II. Borrowings 450 100 a. Up to 1 year 180 40.00 b. Over 1 yr to 3 yrs 00 0.00 c. Over 3 yrs to 5 yrs 150 33.33 d. Over 5 years 120 26.67 III. Loans & Advances 8800 100 a. Up to 1 year 3400 38.64 b. Over 1 yr to 3 yrs 3000 34.09 c. Over 3 yrs to 5 yrs 400 4.55 d. Over 5 years 2000 22.72 Iv. Investment 5800 100 a. Up to 1 year 1300 22.41 b. Over 1 yr to 3 yrs 300 5.17 88 c. Over 3 yrs to 5 yrs 900 15.52 Treasury Over 5 years in Banks Presented by Namrata Padhye, Ritu Madan & Anand Iyer d. Management 3300 56.90
Accounting Ratios in Liquidity Risk Management

LRM is management of Balance sheet and ratios provide a direction to this. Some of the ratios are and what is desirable from liquidity point of view: - Loans and advances to Total Assets(60% to 65%) - Loans and advances to Core deposits(70% to 75%) - Large liabilities to Earning assets(50%) - Purchased funds to Total Assets(10% to 15%) - Cash Ratio(30%) 89 - Loan losses to Presented by Namrata Treasury Management in BanksNet loans(1%) Padhye, Ritu Madan & Anand Iyer
Interest Rate Risk

Interest rate risk maybe defined as the probability of loss on account of movement in interest rates, having an effect on the value of assets, liabilities, Net Interest Income (NII) and Net Interest Margin (NIM) over a period of time.
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Interest Rate Risk

Net Interest Income - Difference between the interest income and interest expenses Net Interest Margin - Net Interest Income as a percentage of average assets.
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Impact of Interest rate fluctuations

Change in interest rate causes Change in the value of Assets & Liabilities.
Change in the Net Interest Income (NII)
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Earnings at Risk
Outcome of application of a notional interest rate shock in the interest segment of a bank or a financial institution to give a stress tested earning position. Basel Norms suggest: - Standardized interest rate shock of 2% - Danger incase of economic value below 20% of tier I and tier 2 capital.
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Earnings at Risk
Calculations - Classification - Multiply by the remaining months of maturity - Sum up the totals - Find the net product - Compute the risk or fall based on 1% shock.
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Components
Price Risk
Market Risks
Basis Risk Embedded Option Risk Mismatch Risk Reinvestment Risk

Exchange Risk Interest Rate Risk Liquidity Risk95
Maturity or Static Gap Analysis

Measures how much Interest Rate Risk a Bank evidences at a fixed point time. Interest Rate risk is measured by calculating GAPs over different time periods on aggregate Balance sheet data at a Fixed point in time hence termed as Static GAP.
Static Gap Analysis Duration Gap Analysis 96
GAP STATEMENT
1.
Gap for 1-14 & 15-28 Days is within limits. It does not exceed 20% of Outflows.
2. Not liquid up to 3 years horizon. Severe liquidity problems 3 months on Wards. 3. Short term deposits are funding investments 1-3 yrs and 3-5 yrs. This is Creating liquidity 97 crunch.

There are 2 Methods for managing Interest Rate Risk. GAP Analysis Duration Analysis
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Rate Sensitivity
An Asset / Liability is classified as rate sensitive if
Within the Time Interval in consideration there is a cash flow

The interest rate resets / re-prices during the interval RBI changes the interest rate It is prepayable or withdrawable before the stated maturity
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Classification of Liabilities as Risk Sensitive
Liabilities 1 Capital, Reserves & Surplus

2 3 4 5 Current Deposits Saving Bank Deposits Term Deposits and Certificate of Deposit Borrowings - Fixed
Rate Sensitivity Non-Sensitive

Non-Sensitive Sensitive - To the Extent of Interest paying (Core) portion. Sensitive Sensitive
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7 8
Borrowings - Floating
Borrowings - Zero Coupon Other Liabilities and Provisions i) Bills Payable ii) Inter-Office Adjustment
Sensitive
Sensitive Non-Sensitive Non-Sensitive
iii) Provisions Non-Sensitive Treasury Management in Banks Presented by Namrata Padhye, Ritu Madan & Anand Iyer
Classification Assets Cash
of Assets as Risk Sensitive

Rate Sensitivity Non-Sensitive Sensitive - (only the Interest earning portion) Non-Sensitive Sensitive
1 2 3
Balances with RBI Balances with other Banks i) Current Account ii) Money at call and Short Notice, Term Deposits and other placements
Investments I) Fixed Rate / Zero Coupon ii) Floating Sensitive Sensitive Non-Sensitive Sensitive Non-Sensitive
Shares / Units of Mutual Funds
Advances & Investments

I) Bills Purchased and Discounted ii) Fixed Assets
iii) Leased Assets Sensitive Treasury Management in Banks Presented by Namrata Padhye, Ritu Madan & Anand Iyer
Income GAP - Net Interest Income (NII)

GAP = RSA RSL NII = RSA*I RSL*I NII = GAP I
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Example GAP Statement of Bank A

RSL maturing during 1 yr bucket Call Money Borrowings from LAF Fixed Deposit 5 20 35 RSA maturing during 1 yr bucket Investment in G-Secs Loans and Advances Commercial papers 30 55 15
RSA = Rs. 100 Cr (Within 1 yr Maturity and earning 15% p.a.) RSL = Rs. 60 Cr. (Within 1 yr Maturity and raised at 9% p.a.)
Current Level RSA RSL
Amount Rs. 100 Cr Rs. 60 Cr.
Rate of Interest Interest earnings / Cost 15% 9% Rs. 15 Cr Rs. 5.4 Cr
RSA > RSL GAP is +ve Cumulative GAP = RSA RSL = Rs. 40 Cr 103 NII = 15 Cr 5.4 Cr = 9.6 Cr Treasury Management in Banks Presented by Namrata Padhye, Ritu Madan & Anand Iyer
Example contd.
If interest rate increase by 1%
Position at Repricing RSA

RSL
Amount
Rs. 100 Cr Rs. 60 Cr.
Rate of Interest 16%

10%
Interest earnings / Cost Rs. 16 Cr

Rs. 6 Cr
NII = 16 Cr 6 Cr = Rs. 10 Cr NII increased by 0.4 Cr with 1% rise in Interest rate Income = GAP I = Rs. 40 Cr * 0.01 = Rs. 0.4 Cr
104
Example contd.
If interest rate decrease by 1%
Position at Repricing RSA

RSL
Amount
Rs. 100 Cr
Rate of Interest 14%
Interest earnings / Cost Rs. 14 Cr
Rs. 60 8% Rs. 4.8 Cr Cr. NII = 14 Cr 4.8 Cr = Rs. 9.2 Cr NII decreased by 0.4 Cr with 1% rise in Interest rate Income = GAP I = Rs. 40 Cr * 0.01 = Rs. 0.4 Cr
105
Summary of Impact of interest rate movement

GAP Position in Interest rate Increase s in Interest income Increase s
>
in Interest expense Increases
+VE +VE
in Net Interest Income(NII ) Increases
> Decreases Decreases Decrease Decreas s es -VE Increase Increase < Increases Decreases s s < Decreases Increases -VE Decrease Decreas s es Zero Increase Increase = Increases Neutral 106 Treasury Management in Banks Presented by Namrata Padhye, Ritu Madan & Anand Iyer s s
GAP Analysis - Pitfalls

Equal Size gaps in different buckets are treated equally. Equity classified as Non-sensitive. Fixed assets as Non-sensitive. Effective maturity of Demand & Savings Deposit is Uncertain. Difficult to assess Overall Risk on the basis of gaps in various time buckets.
107
Duration Analysis
It is used to measure Interest Rate Sensitivity of an Asset / Liability It is the Weighted Avg. Maturity of all the cash flows. Formula:
108
Example
Five Year Bond Par Value = Rs. 10,000 , Coupon rate = 8%, YTM = 10%, Maturity = 5 Years
Time Cash Flow PV Multiplier 1 2 3 800 800 800 0.909091 0.826446 0.751315 PV 727.27 661.16 601.05 Weighted PV 727.27 1,322.31 1,803.16
4
5
800
10800
0.683013
0.620921
546.41
6,705.95 9,241.84
2,185.64
33,529.75 39,568.14
Duration = 39,568.14 / 9,241.84 = 4.2814 Yrs 109 Treasury Management in Banks Presented by Namrata Padhye, Ritu Madan & Anand Iyer
Duration GAP Summary

DGA P Interest Rates Change in Assets Mark et Value Liabiliti es Decrea se Increas e Decrea se Increas e Decrea se NII +ve +ve -ve -ve Zero Zero Increas Decreas e e Decrea Increase se Increas Decreas e e Decrea Increase se Increas Decreas e e > > < < = Decreas e Increas e Increas e Decreas e None
Decrea Increase = Increas None 110 se e Static Gap Analysis Duration Gap Analysis Treasury Management in Banks Presented by Namrata Padhye, Ritu Madan & Anand Iyer
Limits and Triggers
Market Risks
Cap on inter-bank borrowings Purchased funds vis--vis liquid assets Core deposits vis--vis Core Assets Duration of liabilities and investment portfolio
111
All of life is the management of Risk, not its elimination.

- Walter Wriston Former Chairman of Citicorp
112
Consider an Example
Assets Liabilities
100 Crores, 5 years, Fixed rate loan@10%
90 Crores, 30 days deposit @6%
Equity 10 Crores
Total
100 Crores
Total
100 Crores
NII = 10 Crores 5.4 Crores = 4.6 Crores NIM = (10 crores-5.4 crores)/100 Crores = 4.6%
113
Interest Rates Increase by 2%

Assets
100 Crores, 5 years, Fixed rate loans@10%
Liabilities
90 Crores, 30 days deposits @8% Equity 10 Crores
Total
100 Crores
Total
100 Crores
NII = 10 Cr 7.2 Cr = 2.8 Cr NIM = (10 Cr-7.2 Cr)/100 Cr = 2.8% Change In NII &NIM = 1.6Cr, -1.6%
114
Some Sample Strategies by Banks

115
Money Market Instrument

Exporter expecting a payment of $1000 (in 30 days) Current rate Rs. 44/ $1 Payment after conversion is Rs. 44000
Borrow $1000 from US Market Interest rate 3%(30 days) Convert into Rupees i.e. Rs. 44000
Invest the Rs. 44000 in Indian Money market instrument interest rate 2% (30 days)
116
Example contd
After 30 days Exchange rate Rs 42/$1
After 30 days Receive the payment of $1000, and use it to pay off the Principal.
Interest to be paid - $1000 * 0.03 = $30 = Rs 30 *42 = Rs 1260 Interest earned Rs 44000 * 0.02 = Rs. 880 Cost of the Hedge = 1260 880 = Rs 380 Loss if not hedged = (44-42) * 1000 = Rs. 2000
117
Interest Rate Swaps (IRS)

Bank A has Investment of Rs 1000 in a Bond with a coupon rate of 10% and maturity 5 years. It wants to hedge the entire Rs.1000 against Interest Rate Risk.
It gets into an IRS with Bank B.
118
IRS Example Contd.

Fixed Rate 10%
Bank A
Bank B
Floating Rate
119
IRS Example Contd.

Notional amount = 1000 Years A Payin (Fixed 10%) B Payin (Floati ng) Current Interest rate Duration 5 Yrs Diff ere nce A B Pay- PayOut Out Payout from Bond 100 Total Rate pay- of out retur n 100 10
1
2 3 4 5
10
10 10 10 10
10
11 10.5 10 9.5
10
11 10.5 10 9.5
0
1 0.5 0 0.5
0
10 5 0 -5
0
-10 -5 0 5
100
100
110
105
11
10.5
100
100
0
95
0
9.5
120
Risk management through derivatives Without Hedging
With Hedging
121
Main types of strategy

Buying an option Selling an option Dealing a firm product Defensive strategy Offensive strategy Neutral strategy
122
Hedging techniques for an Fx.risk

View of Currency Very Bullish Very Bullish Bullish Bullish Flat Market Flat Market No View No View Bearish Bearish Very Bearish Very Bearish View of Risk Risk Averse Risk Tolerant Risk Averse Risk Tolerant Risk Averse Risk Tolerant Risk Averse Risk Tolerant Risk Averse Risk Tolerant Risk Averse Risk Tolerant Action Buy Currency Forward Buy Currency Forward Buy Currency Forward Buy ATM call Do Nothing or Buy OTM Call Do nothiing Buy ATM call Do nothing or Buy ATM call Buy OTM Call Do Nothing Do nothing or Buy FAR OTM Call 123 Do Nothing
Can you beat that !!

In India, we have 88 commercial banks, which account for about 82% (total assets of the financial sector) over 2000 cooperative banks, which account for about 5%; and 133 Regional Rural Banks, which account for about 3%.
124
Taking into account the -- size, complexity of operations, relevance to the financial sector, need to ensure less risk and the need for having an efficient delivery mechanism
We need constant changes to make it more competitive !!
125
APPROACH OF RBI
With the commencement of the banking sector reforms in the early 1990s, RBI has been consistently upgrading the Indian banking sector by adopting international best practices. The approach to reforms is by having clarity about the destination, deciding on the sequence and modulating the pace of reforms to suit Indian conditions
BASEL I
The current risk-based capital adequacy rules, adopted in 1989, are based on the International Basel Capital Accord of 1988 (Basel I). Basel I requires all banks to maintain a minimum total risk-based capital ratio of 8 percent.
India implemented the Basel I framework with effect from 1992-93 which was, however, spread over 3 years
127
Limitations of Basel I
Insufficiently sensitive to risk (broad categories)
Very limited account of risk mitigation To lend to poorer quality credits No incentive structure to improve risk measurement and risk management practice
128
WHY TO SHIFT TO BASEL II ?

it is more risk sensitive; it recognizes developments in risk measurement and risk management techniques Basel II takes the regulatory framework closer to the business models employed in banks Further, the Basel I framework can be seen as a one size fits all model
129
Basel II the Three Pillars

Capital Adequacy
PILLAR 1 PILLAR 2 PILLAR 3
Minimum Capital Requirement

Rules To Calculate Required Capital
Supervisory Review Process

Increased Supervisory Power
Market Discipline Requirements

Increased Disclosure Requirements
Keeping in mind following risk -- Credit risk , Market risk & Operational risk
implementing Basel II with effect from March 31, 2007
130
The Risk Categories in Basel II

Credit risk the risk that a borrower or counterparty might not honour its contractual obligations Market risk the risk of adverse price movements such as exchange rates, the value of securities, and interest rates Operational risk the risk of loss resulting from inadequate or failed internal processes, people, and systems, or from 131 external events Treasury Management in Banks Presented by Namrata Padhye, Ritu Madan & Anand Iyer
Credit Risk
Basel II places emphasis on improving the management and measurement of credit risk The measurement of credit risk implies assessing the borrowers creditworthiness. A loan should, therefore, be priced to reflect how much risk it involves.
132
Components of Credit Risk

Size of Expected Loss Expected Loss
=
EL =
1.What is the probability of a counterparty going into default? 2. How much will customer owe the bank in the case of default? (Expected Exposure)
Probability of Default
PD X
Loan Equivalency (Exposure at Default)
EaD X
3. How much of that exposure is the bank going to lose?
Severity (Loss Given Default)
LGD
133
Credit Risk Approaches

For each portfolio, the banks must choose One approach from a set of Three:
Standardised Approach Ratings Based Approach
134
Standardised Approach
New risk weights (0%; 20%; 50%; 100%, 150%) used for assessing capital required. Uses External Ratings (where available) Unrated weighted at 100% 35% weight for claims secured by Residential Mortgage 100% weight for claims secured by Commercial Mortgage
135
Internal Rating (IR) Approach

This method has been further classified to Foundation IR approach Advanced IR approach
In both methods, capital is allocated based on the following 3 factors:

Exposure at default (EAD) amount that is likely to be drawn in default. Loss given at default (LGD) Measures the proportion of lost exposure in default Probability of default (PD) - chances of default in terms of percentage (Default fails to repay borrowings)
136
Advanced Internal Ratings Based Approach

- Same principles as for Foundation Approach, but all items are provided by the bank, based on internally developed models - Capital charge - subject to a floor at 90 % in 2008 and 80 % in 2009
137
Credit Risk Approaches

Expected Loss (EL)
Probability of Default (PD)
Severity of Loss (LGD)
Exposure at Default
Standardised = External Rating
x Regulatory
Imposed
Regulatory Imposed
IRB Foundation
Proprietary x Rating
Regulatory Imposed
Regulatory Imposed
IRB Advanced
Proprietary x Rating
Proprietary Severity
Proprietary Exposure
138
Some simple Calculations
139
The 3 Approaches
Standardised Approach
Foundation IRB (Internal Ratings Based) Approach Advanced IRB (Internal Ratings Based) Approach
- One size fits all - No capital incentives for better Credit Risk Management
Risk based Incentive to manage risks
Simple Low level of detail Little sensitivity to risk
Sophisticated High level of detail High sensitivity to risk
140
Operational Risk
It is defined as the risk of losses resulting from inadequate or failed internal processes, people, and systems, or external events and Banks use their own methodology for assessing exposure to operational risks.
141
Operational Risk
Operational Risk (OR) will add to banks regulatory capital requirements Operational risk is not restricted to banks, its present in all organisations including yours
142
PILLAR 1 Minimum Capital Requirement

A banks own assessment of key risk factors for a particular exposure serve as the primary inputs in the calculation of the banks risk-based capital requirements. These risk factors are then inserted into formulas specified by the Agencies to derive a specific rupee amount capital requirement for each exposure or group of exposures.
143
PILLAR 2 Supervisory Review Process

It focuses on the regulatory review that would be necessary to ensure that a bank holds sufficient capital given its overall risk profile.
Since banks are already required to hold capital sufficient to meet their risk profiles under Basel I, the new accord does not propose anything new under the second pillar. Existing rules such as the prompt corrective action rules would continue to be enforced and supplemented as necessary to ensure that an institution holds sufficient capital given its overall risk profile.
144
PILLAR 3
Market Discipline Requirements
Specific disclosure requirements would be applicable to all banks Banks would have to disclose in their public financial reports or in regulatory reports on a quarterly basis, their risk management policies for each separate risk area and their exposures to credit and other types of risks. This would allow shareholders and debt holders to assess a banks capital structure, risk exposures, risk assessment processes, and 145 capital adequacy.
Comparison of Basel Accords

1988: Basel I
Focus on Single Measure (Capital) One Size Fits All
2004: Basel II
Three Pillars
Menu of Approaches
Broad Brush
Greater Risk Sensitivity

146
Comparison ..
Basel I
Capital Minimum Regulatory = (Credit & Market) Risk adjusted assets Capital
Basel II
Minimum Regulatory = Capital Capital Credit + Operational + Market risk risk risk
147
Consolidations in the Indian Banking Industry

Lower capital levels that large banks obtain under Basel II will likely result in more acquisitions by the larger banks. Since most community banks will remain under Basel I, they will have difficulty competing against bigger Basel II banks that benefit from reduced capital requirements and higher ROEs. Basel I banks will become likely takeover targets for Basel II banks that believe they can deploy Basel I bank capital more efficiently.
Even without the compulsions of Basel, Indian banking industry is on a look out for expanding their operations to the overseas countries. The domestic markets are saturated and some of the banks have already tested the foreign waters for profitable markets. Hence there is a need for consolidation in the banking industry today in order to compete for a piece of the pie in the international markets.
148
CONCLUSION
Future presents both challenges and opportunities Enhance the financial performance and raise the visibility of treasury Increased use of automation and outsourcing and relying on a more versatile staff As all policies with respect to Basel need to be considered within the broader context of the banks own business strategy. Banks need risk management packages not only to adhere Basel II ,also for effective risk management and mitigation, gain competitive advantage, develop the robust system, transparency, and cost reduction through detailed data analysis
149
BANK ??
Basel Accord Interest Rate Risk Management Liquidity Risk Management RBI Guidelines on ALM Banks Balance Sheet NDTL What is Treasury Management? Treasury Products
Treasury Management
Dynamics of Asset Liability Management

Forex Market, Money Market Securities market Elements of Treasury Management
VaR, Price Gap & Time Gap 150 Treasury Management in Banks Presented by Namrata Padhye, Ritu Madan & Anand Iyer
THANK YOU
151

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TREASURY MANAGEMENT IN BANKS

METs Institute of Management

Dynamics of Asset Liability Management

Forex Market, Money Market Securities market Elements of Treasury Management

Bank Goals and Constraints

A Banks Balance Sheet

Other liabilities & provisions

Net Demand Time Liabilities???

letters of credit if not payable on demand, deposits held as

Net Demand and Time Liabilities

banking system assets with

Net Demand and Time Liabilities

Net Demand and Time Liabilities

Fortnightly return in Form A

a provisional return in Form 'A' within 7 days

Computation of DTL in Form A

RBI act Section 42(2)

Two responsible officers

What is Treasury Management?

Maintenance of statutory reserve requirements

Integrated Treasury- A Typical set up

Balance sheet Money Market management activities

ALM Manage ment of: Reserves Gaps ,liquidity

Swap Trading Bond Trading (gilts & corporate paper

Spot trading ,merchant cover operations

Interest rate derivatives & Forex derivatives

Equities & Commodities

Trading in equities & commodities like gold, oil etc.

FOREIGN EXCHANGE MARKET

PRODUCTS OF FOREX MARKET

REDISCOUNTING OF FOREIGN BILLS

Money Market Players & their Role

Money Market Instruments

Participants Purpose Call Rates Operation Mechanism Location

Issuer Investor Purpose Form and Size Types

Definition Issuers Investors Features Maturity

Denomination and size

Money Market Instruments

Repurchase Agreements (REPOs)

Purpose Participants Liquidity Term / Maturity

Interest Rate Swaps

Basic Interest Rate Swap

Changes in CRR Changes in SLR Open Market Operations Bank Rate

Bonds Syndicate Credits Medium Term Loans Committed underwritten facilities

Value at Risk (VaR)

Expected change Standard deviation

VaR (1%) = 10,00,000 2.33 (15,00,000)

Methods used to calculate VaR

Monte Carlo Simulation

Risk Exposure in Money Market Instruments

Asset Liability Management in Banks

Components of a Bank Balance sheet

Banks Profit & Loss Account

Assets Liability Management

Evolution of the concept of ALM

Objectives of ALM in Banks

Market Value of Banks Assets

Chief Int. Banking

Head of Technical Division

Responsibilities of ALCO Committee

Responsibilities of ALCO Committee

Strategic management of Structural