‭•‬‭Risk management, i.e.

managing the market‬

‭BFM MODULE - C‬ ‭risk of the bank/entity‬
‭➢‬‭The three distinct roles Treasury is expected‬
‭Chapter 19: INTRODUCTION TO TREASURY‬ ‭to‬ ‭play:‬
‭MANAGEMENT‬
(‭ a) Liquidity Management:‬‭Treasury is responsible‬
‭for managing short-, medium- and long-term‬
‭funds across currencies, and also, for complying‬
‭➢‬‭Treasury connects the core activity of a bank‬ ‭with reserve requirements (CRR and SLR).‬
‭(deposit taking and lending) with the financial‬
‭markets - which is also true of the corporate‬ (‭ b) Proprietary Positions:‬‭Treasury may trade‬
‭treasuries in non-banking companies – by‬ ‭in currencies, securities and other financial‬
‭continuously accessing the markets for‬ ‭instruments, including derivatives, in order to‬
‭lending, borrowing, investing and trading in‬ ‭contribute to Bank's profits.‬
‭financial assets.‬
‭➢‬‭The Treasury plays an active role in‬ (‭ c) Risk Management:‬‭Treasury will aid‬
‭Asset Liability Management (ALM)‬ ‭Management in bridging asset-liability miss‬
‭➢‬‭FUNCTIONS OF INTEGRATED TREASURY‬‭:‬ ‭matches (ALM), will provide derivative tools to‬
‭manage risks in client's business, and will also‬
I‭ntegrated Treasury,‬‭in a banking set-up, refers‬ ‭manage risks inherent in its proprietary‬
‭to integration of money market, securities‬ ‭positions.‬
‭market and foreign exchange operations.‬
‭ ill study functions of Treasury in detail in‬
w
‭➢‬‭We may state the driving force of‬ ‭the following chapters.‬
‭Integrated‬ ‭Treasury as:‬ ‭➢‬‭THE PROCESS OF GLOBALISATION‬‭:‬
‭•‬‭Integrated Cash Flow Management‬ ‭Globalization‬‭refers to the process of‬
‭•‬‭Interest Arbitrage‬ ‭integrating domestic market with global‬
‭•‬‭Access to Global Resources‬ ‭markets,‬
‭•‬‭Corporate Demand for High-end Services, and‬ ‭characterized by free capital flows and‬
‭•‬‭Risk Management‬ ‭minimum regulatory intervention.‬
‭➢‬‭We may summaries the functions of‬
‭Integrated‬ ‭Treasury as:‬ ‭➢‬‭Funds flow on capital account may take one‬
‭•‬‭Meeting reserve requirements (CRR and SLR)‬ ‭or‬ ‭more of the following routes:‬
‭•‬‭Global cash management‬ ‭•‬‭Portfolio investment‬
‭•‬‭Efficient merchant services, which include‬ ‭•‬‭Direct investment‬
‭foreign exchange (forex) and advisory services‬ ‭•‬ ‭•‬‭External commercial borrowings‬
‭Optimizing profit by encasing market‬ ‭•‬‭Issue of equity/debt in global markets‬‭•‬
‭opportunities in‬ ‭Mergers & acquisitions - involving domestic‬
‭•‬‭Forex market‬ ‭and foreign entities‬
‭•‬‭Money market‬ ‭•‬‭Payment for technology transfer, royalties,‬
‭•‬‭securities market (debt, equity and credit‬ ‭financial services etc.‬
‭derivative markets)‬
 ‭ as afforded banks an opportunity to generate‬
h
‭➢‬‭The immediate impact of globalization is‬ ‭surpluses, to supplement profits from its core‬
‭three fold‬‭:‬ ‭banking activity.‬
‭➢‬‭Treasury profits have become attractive‬
F‭ irstly,‬‭the interest rates which are central to‬
‭for‬ ‭following reasons‬‭:‬
‭treasury activity - whether it is lending,‬
‭borrowing or investment - are influenced by‬ F‭ irstly‬‭, Treasury largely operates in inter-bank‬
‭global interest rate trends, owing to cross‬ ‭markets which are almost free of credit risk,‬
‭border capital flows, which in turn also‬ ‭and hence requires very little capital‬
‭influence exchange rates.‬ ‭allocation.‬

S‭ econdly‬‭, since the domestic markets need to‬ S‭ econdly‬‭, the treasury activity is highly‬
‭compete with global markets, new institutional‬ ‭leveraged and hence, the return on capital may‬
‭structure, consisting of regulatory agencies like‬ ‭be quite high.‬
‭SEBI and IRDA on one hand, and public/private‬
T‭ hirdly‬‭, operational costs in Treasury are low‬
‭institutions like Clearing Corporation of India‬
‭as compared to branch banking, whether‬
‭Ltd. (CCIL), National Securities Depository Ltd.‬
‭retail or wholesale.‬
‭etc. on the other hand, have come in to‬
‭existence to support financial markets.‬ ‭➢‬‭Treasury profits are generated from‬
‭the‬ ‭following sources:‬
T‭ hirdly‬‭, with RBI allowing Rupee derivatives in a‬
‭phased manner, the range of products offered‬ ‭ . Foreign Exchange Business:‬‭Buying and selling‬
1
‭by treasury has widened, with innovative‬ ‭foreign currency to customers constitutes a‬
‭product structures.‬ ‭major source of ‘other income' for the banks.‬
‭The difference between 'buy' 'sell' rates –‬
I‭n December, 2013, RBI allowed IRFs,‬
‭known as ‘spread' – is the profit for the bank.‬
‭deriving value from the following‬
‭underlying, on the recognized stock‬ ‭ . Money Market Deals:‬‭Interest on funds lent‬
2
‭exchanges:‬ ‭in the market is a source of income.‬

‭(i) 91-Day Treasury Bills;‬ ‭ . Investment Activity:‬‭Income from risk-free‬

3
‭investments was not considered to be significant.‬
‭(ii) 2-year, 5-year and 10-year coupon‬
‭Banks have also been investing in strategic assets‬
‭bearing notional Government of India‬
‭- such as subsidiary and associate companies -‬
‭security; and‬
‭where returns on investment were only of‬
‭(iii) Coupon bearing Government of India security.‬ ‭secondary importance.‬

‭➢‬‭EVOLVING ROLE OF TREASURY AS PROFIT‬ ‭4. Profits for Contemporary Treasury‬

‭CENTRE‬‭:‬
‭ uying and selling foreign exchange from/to‬
B
‭Treasury was a service center, primarily‬
‭customers and interest on investments and‬
‭intended to attend to cash flow requirements‬
‭money market lending, continue to be the‬
‭of the bank, and hence operated only in money‬
‭primary sources of income for bank treasuries.‬
‭market. The wider scope of integrated treasury‬
 r‭ ate, so that the customer no longer‬
‭➢‬‭The Treasury profits arise mainly from‬ ‭has currency risk or interest rate risk.‬
‭the‬ ‭following sources:‬ ‭•‬‭The rates offered by Treasury for such products‬
‭always have a built-in profit margin, or 'a buy‬
I‭nterest Arbitrage:‬‭As the futures market‬
‭sell spread' in bank's favour.‬
‭continues to develop, Treasury also has the‬
‭•‬‭Treasury also plays an important role in‬
‭opportunity to arbitrage between OTC‬
‭transfer pricing - i.e. allocation of costs to‬
‭(over-the counter) and futures markets.‬
‭various departments/ branches of the bank‬
‭ typical arbitrage operation in an‬
A ‭on a rational basis.‬
‭Integrated Treasury is tabulated below:‬ ‭➢‬‭ORGANISATION OF TREASURY‬‭:‬
‭The Treasury is organized either‬‭as a‬
‭ omestic Treasury - Has‬
D ‭3.50%‬
‭department of the bank, or as a Specialized‬
‭opportunity to lend‬
‭Branch under direct control of the bank's‬
‭surplus Rupee for 7‬
‭head office.‬‭In either case, the Treasury‬
‭days @‬
‭functions with a degree of autonomy, with its‬
I‭nstead, Forex Treasury uses‬ ‭75.00/75.06‬ ‭own accounting system.‬
‭Rupee to do Buy/Sell Swap‬ ‭⇨‬‭The Treasury is headed by a senior‬
‭for 7 days‬ ‭management person - a General Manager,‬
‭Chief Treasury Officer (CTO), Vice-President‬
‭ nnualized Yield‬
A ‭4.17%‬
‭or any other official with a similar‬
‭(0.06/75) x (365/7)‬
‭designation.‬
F‭ x Treasury places USD‬ ‭0.15%‬ ‭➢‬‭The Treasury is segregated into three main‬
‭Deposit abroad for 7‬ ‭divisions:‬‭The Dealing Room (or, Front‬
‭Office), the Back Office (or, Treasury‬
‭days@, say‬
‭Administration) and the Mid-office (Risk‬
T‭ otal Return for Forex‬ ‭4.32%‬ ‭Management).‬
‭Treasury = 4.17 + 0.15‬ ‭ . The dealing room‬‭is headed by Chief Dealer,‬
1
‭who is in charge of the front office. The‬
‭ rbitrage Gain for Bank =‬
A ‭0.82%‬
‭Dealers working under him, buy and sell in‬
‭4.32- 3.50‬
‭the markets.‬

T‭ he securities dealer deals only with secondary‬

‭➢‬‭Trading:‬‭Trading is a speculative activity,‬ ‭market, i.e., buying and selling of securities‬
‭where profits arise out of favourable price‬ ‭already available in the market. On behalf of‬
‭movements during the interval between‬ ‭the bank, the dealer may also participate in‬
‭buying and selling, or vice versa in the case‬ ‭primary auction of government securities and‬
‭of short selling.‬ ‭T-bills, conducted periodically by RBI.‬
‭➢‬‭Treasury Products:‬‭The Treasury may offer a‬
‭ . The Front Office‬‭only handles execution of‬
2
‭currency or interest rate swap to a corporate‬
‭customer to convert their floating rate USD‬ ‭deals and is in no way involved in the settlement‬
‭loan into Rupee loan carrying fixed interest‬ ‭process of the deals executed by them.‬
 ‭limits‬
‭ .The back-office‬‭is responsible for‬
3 ‭of Treasury and reports to the management‬
‭verification and settlement of the deals‬ ‭on key parameters of performance.‬
‭concluded by the dealers.‬
‭ . Investment department‬‭, as stated earlier, will‬
5
‭➢‬‭Settlement‬‭refers to receipt and payment of‬ ‭deal with primary issues. Whenever a suitable‬
‭amounts following deals made by dealers‬ ‭offer is received, the Department would put up‬
‭(i.e., sale and purchase of foreign currency,‬ ‭an investment proposal and obtain approval at‬
‭lending and borrowing, sale and purchase of‬ ‭appropriate level. Minimum marketable‬
‭securities etc.). Settlement is a key function‬ ‭investment being Rs. 5 crores.‬
‭of Back office, as all payments and receipts‬
‭must take place on value date.‬ ‭6. The other departments in Treasury Viz.‬

‭ . Middle office (Mid-office)‬‭is created exclusively‬

4 ‭ ccounts and Administration, Systems‬
A
‭to provide information to the management (MIS)‬ ‭Administration, Remittances (swift/RTGS, etc.)‬
‭and to implement risk management systems. Mid‬ ‭would be mainly administrative in nature.‬
‭office monitors exposure limits and stop loss‬

‭BFM MODULE - C‬
‭Chapter 20: TREASURY PRODUCTS‬

S‭ ome of the features of Foreign Exchange Market‬

‭take‬ ‭place‬ ‭'on-line'‬ ‭across‬ ‭the‬ ‭time‬ ‭zones‬ ‭in‬
‭P RODUCTS OF FOREIGN EXCHANGE MARKET‬‭:‬ ‭electronic‬ ‭medium‬ ‭and‬ ‭the‬ ‭exchange‬ ‭rate‬
‭Foreign‬ ‭exchange‬ ‭(forex)‬ ‭market‬ ‭is‬ ‭the‬ ‭most‬ ‭movements‬ ‭are‬ ‭reflected‬ ‭on‬ ‭the‬ ‭screen‬ ‭from‬
‭liquid‬ ‭market‬‭as‬‭free‬‭currencies‬‭(major‬‭currencies‬ ‭moment‬ ‭to‬ ‭moment,‬ ‭even‬ ‭when‬ ‭the‬ ‭trades‬‭take‬
‭which‬ ‭are‬ ‭fully‬ ‭convertible,‬ ‭e.g.,‬ ‭USD,‬‭EUR,‬‭GBP,‬ ‭place in far-off markets, say in New York or Tokyo.‬
‭JPY,‬ ‭CHF,‬ ‭etc.)‬ ‭can‬ ‭be‬ ‭readily‬ ‭bought‬ ‭and‬ ‭sold‬ ‭2.‬ ‭Virtual‬‭market,‬‭having‬‭no‬‭physical‬‭boundaries,‬
‭here.‬ ‭the‬ ‭only‬ ‭limitation‬ ‭for‬ ‭currency‬ ‭trades‬ ‭being‬
F‭ ree‬‭currencies‬‭belong‬‭to‬‭those‬‭countries,‬‭whose‬ d ‭ omestic regulation or convertibility.‬
‭markets‬ ‭are‬ ‭highly‬ ‭developed‬ ‭and‬ ‭where‬ ‭3.‬ ‭Information‬ ‭dissemination‬ ‭is‬ ‭very‬‭fast‬‭through‬
‭exchange controls are practically dispensed with.‬ ‭electronic‬‭media‬‭most‬‭common‬‭being‬‭the‬‭screens‬
‭are:‬ ‭of‬ i‭nformation‬ ‭vendors,‬ ‭such‬ ‭as‬ ‭Reuters‬ ‭and‬
‭1.‬‭Transparent‬‭market‬‭as‬‭most‬‭of‬‭the‬‭transactions‬ ‭Bloomberg, who also provide dealing screens‬
 ‭ ffer‬ ‭two-way‬ ‭quotes‬ ‭(simultaneously‬ ‭for‬
o
‭ here‬ ‭the‬ ‭buy/sell‬ ‭transactions‬ ‭can‬ ‭take‬ ‭place.‬
w ‭purchase‬ ‭and‬‭sale‬‭of‬‭currency),‬‭lending‬‭liquidity‬
‭There‬ ‭are‬ ‭also‬ ‭internet‬ ‭sites‬ ‭which‬ ‭provide‬ ‭and‬ ‭transparency‬ ‭to‬ ‭the‬ ‭market.‬ ‭The‬ ‭narrower‬
‭trading‬ ‭platforms.‬ ‭Several‬‭banks‬‭have‬‭their‬‭own‬ ‭the buy‬
‭sites‬ ‭where‬ ‭customers‬ ‭can‬ ‭deal‬ ‭in‬ ‭foreign‬ ‭sell spread; the more liquid is the currency market.‬
‭exchange‬ ‭on‬ ‭line.‬ ‭Worldwide‬ ‭networks‬ ‭of‬ ‭forex‬ ‭Spot Market‬
‭brokers also use‬
‭ urrencies are mostly bought and sold in spot‬
C
t‭ elecommunications for instant transmission of‬ ‭trades.‬
‭information.‬
T‭ he spot refers to settlement - payment and‬
‭ .‬ ‭An‬ ‭easily‬ ‭liquefiable‬ ‭market‬ ‭as‬ ‭forex‬ ‭markets‬
4 ‭receipt of funds in respective currencies.‬
‭are‬ ‭open‬ ‭24‬ ‭by‬ ‭7.‬ ‭Traders‬ ‭can‬ ‭easily‬ ‭buy‬ ‭or‬‭sell‬
S‭ pot‬ ‭settlement‬ ‭takes‬ ‭place‬ ‭two‬ ‭working‬ ‭days‬
‭currencies‬ ‭at‬ ‭any‬ ‭time‬ ‭as‬ ‭per‬ ‭their‬ ‭own‬ ‭choice,‬
‭from‬ ‭the‬‭trade‬‭date,‬‭i.e.,‬‭on‬‭the‬‭second‬‭working‬
‭thus‬ ‭having‬ ‭the‬ ‭largest‬ ‭trading‬ ‭volume‬ ‭in‬ ‭the‬
‭day.‬ C
‭ urrency‬‭may‬‭also‬‭be‬‭bought‬‭and‬‭sold,‬‭with‬
‭world.‬
‭settlement on the same day‬
‭For‬ ‭most‬ ‭currencies,‬ ‭dealers‬ ‭in‬ ‭the‬ ‭forex‬ ‭market‬

‭Chapter:21 INTERNATIONAL EQUITY AND DEBT PRODUCTS‬

‭⇨‬‭Fully diluted basis‬‭means the total number of‬

s‭ hares that would be outstanding if all possible‬
‭➢‬‭REGULATORY ENVIRONMENT‬ ‭sources of conversion are exercised.‬
‭Foreign Direct Investment' (FDI) is the investment‬ ‭⇨‬‭'Foreign Portfolio Investment'‬‭is any investment‬
t‭ hrough capital instruments by a person resident‬ ‭made by a person resident outside India in capital‬
‭outside India‬ ‭instruments where such investment is (a) less than‬
‭10 percent of the post issue paid-up equity capital‬
‭(a) in an unlisted Indian company; or‬ ‭on a fully diluted basis of a listed Indian company‬
‭or (b) less than 10 percent of the paid up value of‬
‭(b) in 10 percent or more of the post issue paid-up‬
‭ quity capital on a fully diluted basis of a listed Indian‬
e ‭each series of capital instruments of‬‭a listed‬
‭company.‬ ‭Indian company.‬
 ‭USD 5‬
‭⇨‬‭'Foreign Portfolio Investor (FPI)'‬‭is a person‬ ‭billion for raising of capital by issuance of IDRS‬
‭registered in accordance with the provisions‬ ‭by eligible foreign companies in Indian markets.‬
‭of Securities Exchange Board of India‬
‭(Foreign Portfolio Investors) Regulations,‬ ‭➢‬‭Transfer, Redemption and Two-Way‬
‭2014.‬ ‭Fungibility‬ ‭of IDRS‬
‭⇨‬‭'Foreign Investment'‬‭is any investment made‬ I‭DRS shall not be redeemable into underlying‬
‭by a person resident outside India on a‬ ‭equity shares before the expiry of one year‬
‭reparable basis in capital instruments of an‬ ‭from the date of issue.‬
‭Indian company or to the capital of an LLP.‬‭➢‬
‭P rohibited Sectors/Persons‬ ‭➢‬‭Limited two-way fungibility of IDRS‬
‭is‬ ‭permissible.‬
‭1.‬‭Lottery Business including Government/‬
‭private lottery, online lotteries.‬ (‭ a) Listed Indian companies may either sell or‬
‭2.‬‭Gambling and betting including casinos.‬ ‭3.‬ ‭continue to hold the underlying shares subject‬
‭Chit funds (except for investment made by‬ ‭to compliance with the Foreign Exchange‬
‭NRIs and OCIs on a non-repatriation basis).‬‭4.‬ ‭Management Regulations, 2004.‬
‭Nidhi company.‬
(‭ b) Indian Mutual Funds, registered with SEBI‬
‭5.‬‭Trading in Transferable Development Rights‬
‭may either sell or continue to hold the‬
‭(TDRs), etc.‬
‭underlying shares subject to compliance with‬
‭➢‬‭GLOBAL DEPOSITORY RECEIPTS (GDRs)‬‭:‬‭GDRs‬
‭the Foreign Exchange Management Regulations,‬
‭represent Receipts that entitle the holder to‬
‭2004.‬
‭convert into specified number of equity shares‬
‭of Indian Company.‬ (‭ c) Other persons resident in India including‬
‭resident individuals are allowed to hold the‬
‭ ‬‭INDIAN DEPOSITORY RECEIPTS (IDRS)‬‭:‬
➢
‭underlying shares only for the purpose of‬
‭⇨‬‭Issue of IDRS‬
‭sale within a period of 30 days from the‬
‭•‬‭The issue of IDRs should comply with the‬ ‭date of conversion of the IDRS into‬
‭Companies (Registration of Foreign‬ ‭underlying shares.‬
‭Companies) Rules, 2014 and the Securities‬
‭and Exchange Board of India (Issue of Capital‬ ‭ ‬‭EXTERNAL COMMERCIAL BORROWINGS‬‭:‬
➢
‭and Disclosure Requirements) Regulations,‬ ‭External Commercial Borrowings‬‭are commercial‬
‭2009;‬ ‭loans raised by eligible resident entities from‬
‭•‬‭IDRS shall be denominated in Indian Rupees‬ ‭recognized non-resident entities and should‬
‭only;‬ ‭conform to parameters such as minimum‬
‭•‬‭The proceeds of the issue of IDRS shall be‬ ‭maturity, permitted and non- permitted‬
‭immediately repatriated outside India by‬ ‭end-uses, maximum all-in-cost ceiling, etc.‬
‭the companies issuing such IDRs.‬ ‭➢‬‭Limit and leverage:‬‭Under the aforesaid‬
‭➢‬‭P urchase/Sale of IDRS‬ ‭framework, all eligible borrowers can raise‬
‭ECB up to‬‭USD 750 million‬‭or equivalent per‬
‭ n FPI or an NRI or an OCI may purchase, hold‬
A
‭financial year under the automatic route.‬
‭or sell IDRS. There would be an overall cap of‬
 ‭ BFCs) shall not invest in FCCBs/ FCEBs in any‬
N
‭⇨‬‭Further, in case of FCY denominated ECB raised‬ ‭manner whatsoever.‬
‭from direct foreign equity holder, ECB liability‬ ‭➢‬‭TRADE CREDITS‬‭:‬
‭equity ratio for ECB raised under the‬
T‭ rade Credits (TC) refer to the credits extended‬
‭automatic route cannot exceed 7:1.‬
‭by the overseas supplier, bank, financial‬
‭⇨‬‭The automatic route limit stands increased‬
‭institution and other permitted recognized‬
‭from USD 750 million or equivalent to USD‬
‭lenders for maturity, as prescribed in this‬
‭1.5 billion or equivalent.‬
‭framework, for imports of capital/ non-capital‬
‭➢‬‭Issuance of Guarantee, etc. by Indian banks‬
‭goods permissible under the Foreign Trade‬
‭and‬ ‭Financial Institutions:‬ ‭Policy of the Government of India.‬
I‭ssuance of any type of guarantee by Indian‬ ‭⇨‬‭TC for imports into India can be raised in any‬
‭banks, All India Financial Institutions and NBFCs‬ ‭freely convertible foreign currency (FCY‬
‭relating to ECB is not permitted.‬ ‭denominated TC) or Indian Rupee (INR‬
F‭ urther, financial intermediaries (viz., Indian‬ ‭denominated TC), as per the framework‬
‭banks, All India Financial Institutions, or‬ ‭given in the table ahead‬

S‭ r.‬ ‭Parameters‬ ‭FCY denominated TC‬ ‭INR denominated TC‬

‭no.‬

‭i‬ ‭Forms of TC‬ ‭Buyers' Credit and Suppliers' Credit.‬

‭ii‬ E‭ ligible‬ ‭Person resident in India acting as an importer.‬

‭borrower‬
‭ p to USD 150 million or equivalent per import transaction for oil/gas refining‬
U
‭iii‬ ‭ mount‬
A ‭& marketing, airline and shipping companies. For others, up to USD 50 million‬
‭under‬ ‭or equivalent per import transaction.‬
‭automatic‬
‭route‬

‭iv‬ ‭ ecognized‬
R ‭ . For suppliers' credit: Supplier of goods located outside India. 2. For buyers' credit:‬
1
‭lenders‬ ‭Banks, financial institutions, foreign equityholder(s) located outside India and financial‬
‭institutions in IFSCs located in India. Note: Participation of Indian banks and‬
‭non-banking financial companies (operating from IFSCs) as lenders will be subject to‬
‭the prudential guidelines issued by the concerned regulatory departments of the‬
‭Reserve Bank. Further, foreign branches/subsidiaries of Indian banks are permitted as‬
‭recognized lenders only for FCY TC.‬

‭v‬ ‭Period of TC‬ T‭ he period of TC, reckoned from the date of shipment, shall be up to three years for‬
‭import of capital goods. For non-capital goods, this period shall be up to one year or‬
‭the‬
 ‭ perating cycle whichever less is. For shipyards / shipbuilders, the period of TC‬
o
‭for import of non-capital goods can be up to three years.‬

‭12‬
‭vi‬ ‭ ll-in-cost‬
A ‭ enchmark Rate plus 350 bps spread:‬
B ‭Benchmark rate plus 250 bps spread.‬
‭ceiling per‬ ‭For existing TCs linked to LIBOR whose‬
‭annum‬ ‭benchmarks are changed to ARR.‬

‭ enchmark rate plus 300 bps spread: For‬

B
‭new TCs.‬

‭vii‬ ‭Exchange rate‬ ‭ hange of currency of FCY TC into INR TC‬

C F‭ or conversion to Rupee, exchange‬
‭can be at the exchange rate prevailing on‬ ‭rate shall be the rate prevailing on‬
‭the date of the agreement between the‬ ‭the date of settlement.‬
‭parties concerned for such change or at an‬
‭exchange rate, which is less than the rate‬
‭prevailing on the date of agreement, if‬
‭consented to by the TC lender.‬

‭viii‬ ‭ edging‬
H T‭ he entities raising TC are required to‬ T‭ he overseas investors are eligible to‬
‭provision‬ ‭follow the guidelines for hedging, if any,‬ ‭hedge their exposure in Rupee through‬
‭issued by the concerned sectoral or‬ ‭permitted derivative products with AD‬
‭prudential regulator in respect of foreign‬ ‭Category I banks in India. The investors‬
‭currency exposure. Such entities shall‬ ‭can also access the domestic market‬
‭have a board approved risk management‬ ‭through branches / subsidiaries of‬
‭policy.‬ ‭Indian banks abroad or branches of‬
‭foreign banks with Indian presence on‬
‭a back-to back basis.‬

‭ix‬ ‭ hange of‬

C ‭ hange of currency of TC from one freely‬
C ‭ hange of currency from INR to any‬
C
‭currency of‬ ‭convertible foreign currency to any other‬ ‭freely convertible foreign currency is‬
‭borrowing‬ ‭freely convertible foreign currency as well‬ ‭not permitted.‬
‭as to INR is freely permitted.‬

‭•‬‭Perpetual Debt Instruments (PDI) qualifying for‬

‭the extant Basel III Capital Regulations‬
‭➢‬‭RUPEE DENOMINATED BONDS‬
‭•‬‭Debt capital instruments qualifying for‬
‭ BI, vide circular dated November 3, 2016,‬
R ‭inclusion as Tier 2 capital under the‬
‭permitted banks to issue Rupee‬ ‭extant Basel III Capital Regulations‬
‭Denominated Bonds overseas for the‬ ‭•‬‭Financing of infrastructure and affordable‬
‭following purposes :‬ ‭housing‬
‭inclusion as Additional Tier 1 capital under‬
‭—------------------------------‬‭b. Total Additional Tier 1 capital‬
‭⇨‬‭The "eligible amount" for purpose of issue of‬ ‭amount" can be issued in foreign currency‬
‭P DIS in foreign currency shall be, as on March‬ ‭and/or in rupee denominated bonds‬
‭31 of the previous financial year, the higher of:‬ ‭overseas.‬
‭a. 1.5% of Risk Weighted Assets (RWAs) and‬
‭⇨‬‭Not more than 49% of the "eligible‬

‭Chapter:22 FUNDING AND REGULATORY ASPECTS‬

‭ ere prescribed at 25% and 40% of DTL‬
w
‭respectively, under Banking Regulation Act‬
‭ ‬‭RESERVE ASSETS: CRR AND SLR‬‭:‬
➢ ‭of 1949. An amendment to the Act has‬
‭⇨‬‭As per Section 42(1) of RBI Act 1934 and‬ ‭removed the minimum requirement we f‬
‭Section 18(1) of BR Act, 1949, Cash Reserve‬ ‭January 2007, allowing greater flexibility to‬
‭Ratio (CRR) is the amount of funds that all‬ ‭RBI.‬
‭Scheduled Commercial Banks (SCBs) are‬
‭•‬‭Currently, the CRR is 4.50% of NDTL and SLR is‬
‭required to maintain with RBI. Cash‬
‭18% of NDTL of banks, calculated as of the‬
‭Reserve Ratio (CRR) is the mandatory‬
‭last‬
‭deposit to be held by Banks with the‬
‭Central Bank. It is a percentage of their‬
‭•‬‭Friday of the second preceding fortnight for‬
‭Net Demand and Time Liabilities.‬
‭CRR and SLR. Detailed instructions for‬
‭⇨‬‭As per Section 24 of BR Act, 1949,‬
‭calculating the DTL are contained in RBI's‬
‭Statutory Liquidity Ratio (SLR) is the‬
‭Master Direction 2021-22/80 dated 20th‬
‭prescribed‬
‭July 2021 (updated 6th April 2022).‬
‭percentage of Net Demand and Time‬
‭Liabilities of a bank to be held in prescribed‬
‭ ‬‭Components of Demand Liability‬
➢
‭securities, mostly government securities.‬
‭are:‬‭a. Current deposits,‬
‭•‬‭The minimum and maximum levels of CRR were‬
‭b. Demand liabilities portion of savings bank‬
‭prescribed at 3% and 20% of demand and‬
‭deposits,‬
‭c. Margins held against letters of‬
‭•‬‭time liabilities (DTL) of the bank, respectively,‬
‭credit/guarantees,‬
‭under Reserve Bank of India Act of 1934.‬
‭d. balances in overdue fixed deposits, cash‬
‭However, an amendment to the Act in 2006‬
‭certificates and cumulative/recurring deposits,‬
‭removed the floor and ceiling limits wef‬
‭e. Outstanding Telegraphic Transfers (TTS), Mail‬
‭April 2007, enabling RBI to stipulate the CRR‬
‭Transfers (MTs), Demand Drafts (DDs),‬
‭at its discretion.‬
‭•‬‭Similarly, the minimum and maximum SLR‬
 ‭⇨‬‭The SLR requirement is to be computed‬
f‭ . Unclaimed deposits‬ ‭similarly, as of the last Friday of the‬
‭g. Credit balances in the Cash Credit account, h.‬ ‭second preceding fortnight.‬
‭Deposits held as security for advances which‬ ‭⇨‬‭The SLR is to be maintained in the form of‬
‭are payable on demand.‬ ‭the following assets:‬
‭➢‬‭Components of Time Liabilities are‬ ‭•‬‭Cash balances (excluding balances maintained‬
T‭ ime Liabilities‬‭of a bank shall include those‬ ‭for CRR).‬
‭liabilities which are payable otherwise than‬ ‭•‬‭Gold (valued at price not exceeding current‬
‭on demand and shall include the following:‬ ‭market price).‬
‭•‬‭Approved securities valued as per norms‬
‭(a) Fixed deposits,‬ ‭prescribed by RBI.‬
‭(b) Cash certificates,‬ ‭ ny default in maintaining the daily CRR balance,‬
A
‭(c) Cumulative and recurring deposits,‬ ‭the bank is liable to pay a penal interest of 3%‬
‭p.a. above the Bank Rate on the shortfall‬
(‭ d) Time liabilities portion of savings‬ ‭amount for that day and if the shortfall‬
‭bank deposits,‬ ‭continues on the next succeeding day/s, penal‬
‭(e) Staff security deposits,‬ ‭interest shall be recovered at the rate of 5% p.a.‬
‭above the Bank Rate.‬
‭➢‬‭The following liabilities are excluded from‬
‭➢‬‭An illustrative table of CRR and SLR to be‬
‭the CRR stipulation:‬
‭maintained by a Bank on NDTL as at end of‬
‭•‬‭Paid-up capital, reserves, retained profits,‬
‭second preceding fortnight, with one‬
‭refinance availed from RBI, and apex‬
‭fortnights lag is given below.‬
‭financial institutions like NABARD and SIDBI.‬
•‭ ‬‭Net income tax provision.‬ F‭ ORTNIGHT‬ ‭ ates‬
D ‭ ates‬
D ‭ ates‬
D
‭•‬‭Claims received from DICGC, ECGC, Insurance‬ ‭(Year 2021)‬ ‭25/09 -‬ ‭09/10 -‬ ‭23/10-‬
‭Company (Towards ad-hoc settlement), and‬ ‭08/10‬ ‭22/10‬ ‭05/11‬
‭Court Receiver etc.‬ ‭NDTL‬ ‭ s.1,20,0‬
R ‭ s. 1,‬
R
‭•‬‭Liabilities arising on account of utilization of‬ ‭00 crores‬ ‭30,000‬
‭limits under Bankers' Acceptance Facility.‬ ‭•‬ ‭crores‬
‭District Rural Development Agency (DRDA)‬
‭subsidy of Rs. 10,000/- kept in Subsidy Reserve‬ ‭ RR to be‬
C ‭Rs. 120000 x 4.5% =‬ ‭ s. 5400‬
R
‭Fund account in the name of Self Help Groups.‬ ‭maintained‬ ‭crores‬

S‭ LR to be‬ ‭Rs. 120000 x 18% =‬ ‭ s. 21600‬

R
‭⇨‬‭Banks have to maintain cash balances with RBI‬
‭maintained‬ ‭crores‬
‭to meet the prescribed CRR on average during‬
‭the fortnight, subject to daily cash balances‬
‭not falling below 90% of the amount required‬
‭for CRR.‬
 ‭➢‬‭The important developments in this regard‬
‭ ‬‭THE LIQUIDITY ADJUSTMENT FACILITY (LAF)‬‭:‬
➢ ‭are‬ ‭as under:‬
‭The Liquidity Adjustment Facility is the principal‬ ‭•‬‭Real Time Gross Settlement System (RTGS)‬‭has‬
‭operating instrument of Reserve bank's‬ ‭been fully activated by RBI from October‬
‭monetary policy. It refers to RBI lending funds‬ ‭2004.‬ ‭RTGS‬‭is a paperless clearing system,‬
‭to banking sector through Repo instrument and‬ ‭where settlements are on gross basis, rather‬
‭is used to monitor day-to-day liquidity in the‬ ‭than day end net settlement of cheque in a‬
‭market.‬ ‭clearing house.‬
‭ ‬‭In order to help banks, to wade through‬
➢ ‭•‬‭All inter-bank payments and customer‬
‭the liquidity constraints, RBI has taken the‬ ‭remittances (currently minimum Rs. 2‬
‭following measures on February, 3, 2015:‬ ‭lakhs) are settled instantly under the‬
‭•‬‭Continue to provide liquidity under overnight‬ ‭RTGS.‬
‭repos (fixed rate repo) of 0.25% of‬ ‭•‬‭The IDRBT has developed the Indian Financial‬
‭bank-wise NDTL at the LAF repo rate.‬ ‭Net Work (INFINET) as a secure‬
‭•‬‭Introduced a new window called Variable Rate‬ ‭communication backbone for the banking‬
‭and financial sectors and it has helped in‬
‭Repo. Under this window liquidity would be‬
‭introduction of Structured Financial‬
‭provided for 7 days, 14 days and 28 days. This‬
‭Messaging System (SFMS) which facilitates‬
‭is also called as Term Repos.‬
‭domestic transfer of funds and authenticated‬
•‭ ‬‭The limit fixed by RBI, is under this window,‬
‭messages, similar to the SWIFT used by banks‬
‭and is 0.75% of NDTL of the banking system.‬ ‭•‬
‭for international messaging.‬
‭RBI has also phased out the Export Credit‬
‭•‬‭Negotiated Dealing System is an electronic‬
‭Refinance facility from 6th February 2015.‬
‭platform for facilitating dealing in‬
‭government securities and money market‬
‭ ‬‭PAYMENT AND SETTLEMENT SYSTEMS‬‭:‬
➢
‭instruments.‬ ‭RBI had introduced the NDS in‬
‭The important reforms relevant to‬
‭February 2002, in order to achieve‬
‭treasury operations include the following:‬
‭a. automatic electronic reporting and‬
‭⇨‬‭Payments‬‭refer to inter-bank payments as also‬ ‭settlement process‬
‭payments on behalf of customers.‬ ‭b. auctions on electronic platform and‬
‭⇨‬‭Settlement‬‭refers to payment/receipt in‬ ‭c. a trading platform for trading in‬
‭exchange of securities or foreign‬ ‭Government securities on a negotiated‬
‭exchange.‬ ‭basis‬ ‭➢‬‭RBI launched in August 2005, NDS - OM‬
‭or anonymous order matching system, as an‬
I‭n the past, payments needed to be cleared in 1‬
‭improvement over NDS.‬‭The NDS - OM coexists‬
‭to 3 days, and even longer if it is outstation‬
‭with telephone based trading mechanism on‬
‭payment, giving rise to expensive delays and‬
‭NDS.‬
‭counterparty risks. Operational costs were also‬
‭•‬ ‭The‬ ‭system‬ ‭allows‬‭straight-through‬‭processing‬
‭high in paper based (cheque) clearing.‬
‭(STP)‬ ‭and‬ ‭trades‬ ‭executed‬ ‭will‬ ‭flow‬ ‭straight‬
‭to CCIL for settlement.‬
 t‭ he same day by electronic funds transfer‬
‭ ll dealings in Govt securities now take place‬
A ‭using the National Electronic Funds Transfer‬
‭on NDS through screen-based trading.‬ ‭•‬‭FX Clear‬ ‭system introduced by RBI.‬
‭is a forex dealing system developed by CCIL for‬ ‭➢‬‭Banks, who have implemented core banking‬
‭foreign exchange transactions (USD/ INR as well‬ ‭solutions, facilitate any time - anywhere‬
‭as cross currencies).‬ ‭funds transfer, and internal transfer of funds‬
‭•‬‭Depository Institutions‬‭like NSDL (National‬ ‭from one account to another account‬
‭Securities Depository Ltd.) and CSDL (Central‬ ‭within the bank can be effected instantly,‬
‭Securities Depository Ltd.) provide delivery‬ ‭irrespective of the branch location.‬
‭vs. payment (DVP) for secondary market‬ ‭➢‬‭In view of the growing complexities in‬
‭deals in equity and debt paper.‬ ‭payment systems, the RBI has constituted‬
‭The securities and funds are cleared by‬ ‭Board for Regulation and Supervision of‬
‭their respective clearing houses.‬ ‭Payment and Settlement Systems at the‬
‭•‬‭NEFT and on-line Payments:‬‭All inter-bank and‬ ‭highest level, as a sub-committee of its‬
‭intra-bank remittances can now be affected‬ ‭Central Board.‬
‭on‬

‭BFM MODULE - C‬

‭Chapter 23: TREASURY RISK MANAGEMENT‬

‭treasury risk.‬

‭ ‬‭SUPERVISION AND CONTROL OF‬

➢ a‭ .‬‭Firstly, Treasury has a very low funding‬
‭TREASURY‬‭:‬‭➢‬‭Treasury Risk Management‬ ‭requirement, which we call as high leverage.‬ ‭b.‬
‭A second reason for management concern is‬
T‭ reasury risk management assumes‬ ‭the large size of transactions done at the sole‬
‭importance for two reasons:‬ ‭discretion of the Treasurer.‬

(‭ a) the nature of treasury activity is such that‬

‭c.‬ ‭A‬ ‭third‬ ‭factor‬ ‭closely‬ ‭connected‬‭to‬‭the‬‭above‬
‭profits are generated out of market‬
‭is‬ ‭that‬ ‭the‬ ‭losses‬ ‭in‬ ‭treasury‬ ‭business‬
‭opportunities and market risk is present at‬
‭materialize‬ ‭in‬ ‭very‬ ‭short-term,‬ ‭and‬ ‭the‬
‭every step‬
‭transactions, once‬
(‭ b) Treasury is also responsible for balance sheet‬
‭management, i.e., market risk generated by‬
‭other operational departments. We will deal‬
‭with the first aspect a little more elaborately.‬
‭➢‬‭Concern for Treasury Risks‬

‭Bank management is highly sensitive to‬

 ‭risk management and management information‬
c‭ onfirmed, are irrevocable - hence no‬ ‭system (MIS). Mid-office would ensure treasury's‬
‭corrective action is possible.‬ ‭compliance with Board approved policies‬
‭➢‬‭Systematic risk‬‭is the risk associated with the‬ ‭bearing upon FX risk management, investment‬
‭entire market or segment thereof while‬ ‭management and liquidity management.‬
‭Unsystematic risk is the risk associated with‬
‭a particular investment.‬ ‭➢‬‭Internal Controls‬

T‭ reasury also faces funding risk, or liquidity risk,‬ T‭ he most important of the internal controls in‬
‭as all 'settlements' need to be funded.‬ ‭the context of foreign exchange are of three‬
‭kinds:‬
T‭ reasury risks are primarily managed by‬
‭conventional control and supervisory‬ ‭(i) limits on deal size‬
‭measures which may be divided into three‬ ‭(ii) limits on open positions and‬
‭parts:‬
‭(iii) stop-loss limits.‬
•‭ ‬‭Organizational Controls‬
‭•‬‭Exposure Ceiling‬ ‭ . Limits on deal size‬‭prescribe the maximum‬
1
‭•‬‭Limits on trading positions and stop-loss‬ ‭value for a buy/sell transaction.‬
‭limits‬‭➢‬‭Organizational Controls‬
‭ . Open positions‬‭refer to the trading positions,‬
2
T‭ he organizational controls‬‭refer to the checks‬ ‭where the buy/sell positions are not matched.‬
‭and balances within the system. Treasury is‬ ‭Position limits‬‭are prescribed currency-wise as‬
‭divided into three parts:‬ ‭also for aggregate position expressed in Rupees.‬

‭ . The front office‬‭executes deals with counter‬

1 ‭ . Stop-loss‬‭limits represent the final stage of‬
3
‭party banks (purchase and sale of foreign‬ ‭controlling trading operations. When the‬
‭exchange, securities etc. & lending and‬ ‭market moves adversely, the open positions will‬
‭borrowing operations).‬ ‭result in loss.‬

F‭ ront office is headed by Chief Dealer, assisted‬ ‭➢‬‭Exposure Ceiling Limits‬

‭by other dealers in foreign exchange, securities‬
E‭ xposure limits‬‭are kept in place to protect the‬
‭market and money market.‬
‭bank from credit risk/counter-party risk. Credit‬
‭ . The back office‬‭has the responsibility for‬
2 ‭risk in Treasury may be split into default risk‬
‭compliance with exposure limits and position‬ ‭and settlement risk.‬
‭limits imposed by the Management and RBI,‬
‭•‬‭The limits also take into account the size of‬
‭as well as for accuracy and objectivity of the‬
‭treasury's operations, so that the business is‬
‭transaction detail.‬
‭spread over several counterparties and there‬
‭3. Middle Office (mid-office)‬‭is responsible for‬ ‭is no concentration of risk.‬
 t‭ he sake of clarity, it is identified as a‬
‭•‬‭The exposure limits are also fixed for foreign‬ ‭component of market risk.‬
‭exchange and money market brokers, in‬
‭order to avoid business concentration.‬ ‭ ‬‭RISK MEASURES: VaR AND DURATION‬‭:‬
➢
‭➢‬‭MARKET RISK‬‭:‬ ‭⇨‬‭Value at Risk (VaR)‬

‭ arket Risk‬‭is where the price of a security,‬

M ‭ aR is a statistical measure indicating the worst‬
V
‭interest rates or exchange rates move in such a‬ ‭possible movement of a market rate, over a‬
‭way that the value of an asset diminishes or‬ ‭given period of time, under normal market‬
‭the liability under an existing obligation‬ ‭conditions, at a defined confidence level.‬

‭⇨‬‭Duration‬
‭increase.‬

T‭ hus, market risk is a confluence of liquidity‬ ‭ uration is a measure widely used in‬
D
‭risk, interest rate risk, exchange rate risk,‬ ‭investment business, though the concept of‬
‭equity risk and commodity risk.‬ ‭duration is applicable to all assets and‬
‭➢‬‭The three main components of market risk‬ ‭liabilities, where interest rate risk is present.‬
‭are liquidity risk, interest rate risk and‬ ‭Duration is expressed in terms of years.‬
‭currency risk.‬
‭⇨‬‭Modified Duration‬‭(MD) is a more direct‬
‭(a)‬‭Liquidity Risk‬
‭method to measure the price sensitivity of‬
L‭ iquidity risk‬‭refers to cash flow gaps which‬ ‭a bond.‬
‭could not be bridged. Let us assume that the‬ ‭•‬‭The MD indicates price sensitivity of a bond‬
‭Treasurer has borrowed in call market and‬ ‭per unit of change in the yield levels.‬
‭purchased a 5- year government security,‬ ‭•‬‭The modified duration is valid only for small‬
‭assuming the bond prices would go up next day‬ ‭changes in the price, and is also not uniform‬
‭and he can sell the security with profit.‬ ‭at different levels of the price.‬
‭➢‬‭USE OF DERIVATIVES IN RISK MANAGEMENT‬‭:‬
‭(b)‬‭Interest Rate Risk‬
‭ erivatives‬ ‭are‬ ‭financial‬ ‭contracts‬ ‭which‬ ‭derive‬
D
I‭nterest‬ ‭rate‬ ‭risk‬ ‭refers‬ ‭to‬ ‭rise‬ ‭in‬ ‭interest‬ ‭costs‬ ‭their‬ ‭value‬ ‭based‬‭on‬‭an‬‭underlying‬‭market‬‭for‬‭a‬
‭(of‬ ‭a‬ ‭liability)‬ ‭or‬ ‭fall‬ ‭in‬ ‭interest‬ ‭earnings‬‭(from‬ ‭commodity‬ ‭or‬ ‭financial‬ ‭product.‬ ‭Derivatives‬ ‭are‬
‭assets) eroding the business profits.‬ ‭used‬ ‭to‬ ‭protect‬ ‭treasury‬ ‭transactions‬ ‭from‬
‭(c) Currency Risk‬ ‭market‬
‭risk. Derivatives are also useful in managing‬
‭ urrency risk or exchange rate risk is also a‬
C ‭balance sheet risk i.e., asset liability‬
‭manifestation of interest rate risk, although‬ ‭management.‬
‭for‬
 ‭Chapter 24: DERIVATIVE PRODUCTS‬
T‭ he derivative products that can be directly‬
‭negotiated and obtained from banks and‬
‭investment institutions are known as‬
‭➢‬‭DERIVATIVES AND THE TREASURY‬‭:‬
‭Over-the Counter (OTC) products.‬
‭ erivatives are market products widely used by‬
D
T‭ he standardized derivative contracts, for a‬
‭bank treasuries. Treasury uses derivatives chiefly:‬
‭specified sum and for specified period, which‬
‭-‬
‭are purchased or sold on an exchange are‬
•‭ ‬‭To manage risk, including ALM risks,‬ ‭•‬‭To cater‬ ‭exchange traded derivatives, traded on a‬
‭to the requirements of the clients and more‬ ‭futures exchange.‬
‭particularly the corporate customers, and‬‭•‬‭To‬
‭➢‬‭OTC products are different from‬
‭trade, i.e. to take a trading position in‬
‭exchange‬ ‭traded products in the‬
‭derivative products.‬
‭following respects:‬
‭➢‬‭OTC AND EXCHANGE TRADED PRODUCTS‬‭:‬

‭OTC‬ ‭Exchange Traded‬

‭ TC products are offered by banks and‬

O F‭ utures contracts are traded only‬
‭financial institutions (need to be authorized‬ ‭on organized futures exchanges‬
‭banks in India)‬

‭ ontract date, amount and terms as desired by‬

C S‭ ize of contract is standardized, with‬
‭the client‬ ‭pre-set set- element dates for specific‬
‭terms (e g one month, $1000 contract‬
‭settled last Wednesday of every month‬
‭against INR)‬

‭ rice is quoted by the Bank, adding a‬

P T‭ ransparent pricing, based on‬
‭margin to market quote‬ ‭screen-based order matching system‬

S‭ ecurity (cash margin, charge on assets‬ T‭ he Exchange collects daily cash‬

‭etc.), at MTM bank's discretion, based on‬ ‭margin based on value of the‬
‭client status‬ ‭contract‬

‭ ounter-party risk (bank risk is present but it‬

C ‭ o counter-party risk, as Exchange is‬
N
‭is a party remote risk.)‬ ‭the counter which manages the risk‬
‭by‬
‭margining system‬
 S‭ ettlement is mostly by physical delivery (net‬ ‭ ostly‬ ‭net‬ ‭settlement‬ ‭by‬ ‭cash‬
M
‭may settlement only in trading‬ ‭(physical‬ ‭delivery‬ ‭be‬ ‭insisted‬ ‭upon‬
‭positions/cancel lotions)‬ ‭in commodity futures)‬

‭Mostly used for hedging underlying risk‬ ‭Mostly used for trading and speculation.‬

‭➢‬‭FORWARDS, OPTIONS, FUTURES AND‬ ‭dollars, irrespective of the market movement.‬

‭SWAPS‬‭: Derivatives are basically of three‬ ‭➢‬‭Options‬
‭kinds:‬
‭ ptions refer to contracts where the buyer of an‬
O
‭•‬‭Forward Contracts;‬ ‭option has a right but no obligation to exercise‬
•‭ ‬‭Options, and‬ ‭the contract.‬
‭•‬‭Swaps‬
‭Options are either put options or call options.‬
F‭ utures‬‭are part of forwards, where execution‬
‭•‬‭Call option‬‭gives a right to the holder to buy‬
‭of contract at a fixed rate is obligatory through‬
‭an underlying product‬
‭an exchange.‬
‭(currency/bonds/commodities) at a‬
‭➢‬‭Forward Contract‬ ‭prefixed rate on a specified future date.‬
‭•‬‭P ut option‬‭gives a similar right to the holder‬
F‭ orward contract is a contract to deliver foreign‬ ‭to sell the underlying at a prefixed rate on a‬
‭currency on a future date at a fixed exchange‬ ‭specified future date or during a specified‬
‭rate.‬ ‭period.‬
F‭ orward contract is ideal as a hedging‬ ‭➢‬‭There are material differences between‬
‭instrument to achieve zero risk, as the‬ ‭options and forwards:‬
‭contracted rate fixes the value of forward‬

‭Forward Contract‬ ‭Option Contract‬

‭i. The contract must be executed at‬ ‭i. The holder has a right to exercise the option,‬
‭contracted rate on the expiry date.‬ ‭but has no obligation.‬

‭ii. The rate is fixed at current market quote.‬ ‭ii. Holder may choose strike price (contracted rate)‬
‭or market rate whichever is better for him.‬

‭iii. There is no fee payable, the quoted‬ ‭iii. Option premium is payable front-end.‬
‭rate includes bank margin.‬
 ‭iv. Forward premium is the interest rate‬ ‭iv.‬ O ‭ ption‬ ‭premium‬ ‭is‬ ‭determined‬ ‭by‬
‭differential of the two currencies‬ ‭several‬ ‭factors,‬ ‭including‬ ‭strike‬‭price,‬
‭involved.‬ ‭volatility‬ ‭of‬ ‭exchange‬ ‭rates‬ ‭and‬
‭interest rates.‬

‭v. Forward contract is a simple contract‬ ‭v. Various types of options are available,‬
‭for purchase or sale of currency -‬ ‭and simple to complex structures, with‬
‭there are no variations.‬ ‭varying elements of risk, are possible‬
‭by combining purchased and written‬
‭options.‬

‭➢‬‭Futures‬

‭ nder a futures contract, the seller agrees to‬

U
‭deliver to the buyer a specified‬ ‭➢‬‭Operationally, the three variants of‬
‭security/currency or commodity on a specified‬ ‭currency‬ ‭swap function as under:‬
‭date, at a fixed price.‬ ‭•‬‭P rincipal Only Swap (POS):‬‭The borrower‬
‭continues to pay interest in USD terms, but‬
‭ ‬‭INTEREST RATE AND CURRENCY‬
➢ ‭has the benefit of using the principal amount‬
‭SWAPS‬‭:‬‭•‬‭Interest Rate Swaps‬ ‭in home currency, without exchange risk.‬
‭The repayment takes place in domestic‬
‭ swap is an exchange of cash flow. An interest‬
A
‭currency, at a fixed rate of exchange,‬
‭rate swap is an exchange of interest flows on an‬ ‭hence there is no exchange risk.‬
‭underlying asset or liability, the value of which‬
‭•‬‭Coupon Only Swap (COS):‬‭The USD loan is‬
‭is the notional amount of the swap.‬
‭utilized in the same currency, but interest on‬
‭•‬‭Forward Rate Agreement (FRA)‬ ‭USD loan is swapped into Rupee interest - the‬
‭borrower has to pay interest in Rupees at‬
‭ product closely linked with IRS is forward rate‬
A ‭swap rate; principal repayment is as per‬
‭agreement (FRA), where the interest payable for‬ ‭original loan terms.‬
‭a future period is committed under the‬ ‭•‬ ‭P +I‬‭swap:‬‭W ithout‬‭initial‬‭exchange‬‭-‬‭where‬‭the‬
‭agreement.‬ ‭borrower‬ ‭has‬ ‭eliminated‬ ‭the‬ ‭currency‬ ‭risk‬
‭and‬ ‭interest‬ ‭rate‬ ‭risk‬ ‭completely‬ ‭(zero‬ ‭risk)‬
‭ hile IRS covers a series of periodical interest‬
W
‭and‬ ‭will‬ ‭pay‬ ‭principal‬ ‭and‬ ‭interest‬ ‭in‬
‭payments, FRA is for a single payment in‬
‭domestic‬ ‭currency‬ ‭(Rupees)‬ ‭to‬ ‭settle‬ ‭the‬
‭future.‬
‭foreign currency‬
‭•‬‭Currency Swap‬ ‭borrowing.‬
‭The swap cost is included in the rupee‬
‭ ‬‭Currency Swap‬‭is an exchange of cash flow‬
A ‭interest rate.‬
‭in one currency, with that of another‬
‭currency.‬
 ‭➢‬‭DEVELOPMENTS IN INDIAN MARKETS AND‬
‭RBIGUIDELINES ON RISK EXPOSURE‬‭:‬
‭•‬‭RBI has issued detailed guidelines for capital‬
‭adequacy requirement for derivatives.‬ ‭➢‬‭Banks authorized by the Reserve Bank under‬
‭•‬‭Banks and counterparties (other banks/clients) need‬ ‭section 10 of the Foreign Exchange‬
‭to execute ISDA Master Agreement before entering‬ ‭Management Act, 1999 as 'AD Category - I bank'‬
‭into any derivative contracts.‬ a‭ re permitted to become trading and clearing‬
‭•‬‭The Master Agreement covers all the transactions‬ ‭members of the exchange traded currency‬
‭between two counterparties globally, and there is‬ ‭options market of the recognized stock‬
‭no need for any other transaction wise agreement,‬ ‭exchanges, on their own account and on behalf of‬
‭except for the exchange of usual deal confirmation,‬ ‭their clients, subject to fulfilling the following‬
‭specifying the terms of the transaction.‬ ‭minimum prudential requirements:‬
‭➢‬‭Documentation‬ a‭ . Minimum net worth of Rs. 500 crores. b.‬
‭Minimum CRAR of 10 per cent.‬
‭The documentation is comprised of three stages.‬‭1.‬ c‭ . Net NPA should not exceed 3 per cent. d.‬
‭ISDA Master Agreement‬ ‭Made net profit for last 3 years‬

‭2. Schedule to Master Agreement‬ ‭➢‬‭The AD Category - I bank, which fulfil the prudential‬
‭requirements,‬‭should lay down detailed guidelines‬
‭3. Trade Confirmation (for each trade)‬
‭with the approval of their Boards for trading and‬
‭➢‬‭While introducing IRS, RBI has taken some bold‬ ‭clearing of the exchange traded currency options‬
‭steps to encourage the derivative market,‬ ‭contracts and management of risks.‬
‭including:‬ ‭➢‬‭AD Category - I banks, which do not meet the‬
‭a. Banks have been allowed to use the IRS not only for‬ ‭above minimum prudential requirements‬‭and AD‬
‭hedging, but also for trading (market making)‬ ‭Category - I banks, which are Urban Co operative‬
‭purpose - which provision has boosted the treasury‬ ‭banks or State Co-operative banks, can‬
‭activity.‬ ‭participate in the exchange traded currency‬
‭b. RBI allowed MIFOR as a benchmark for interest rate‬ ‭options market only as clients, subject to‬
‭swaps, but later restricted the use of MIFOR only for‬ ‭approval therefore from the respective regulatory‬
‭inter-bank dealings.‬ ‭Departments of‬‭t he Reserve Bank.‬
c‭ . As per FBIL's extant methodology, the MIFOR‬ ‭➢‬‭In order to avoid misuse of derivatives, RBI‬
‭(Mumbai Interbank Forward Outright Rate) for‬ ‭issued Comprehensive Guidelines on‬
‭Overnight, 1 month, 2 months, 3 months, 6 months and‬ ‭Derivatives, in April 2007, which were‬
‭12 months tenor is calculated using the rolling forward‬ ‭subsequently modified in 2011. RBI in‬
‭premier in percentage term and the USD LIBOR for the‬ ‭particular stipulated that‬
‭relevant tenor.‬ ‭a. Derivative products can be offered only to those‬
‭d. RBI has permitted banks under ISDA‬ ‭corporates who have clearly laid‬‭down‬
‭Agreement, to opt for dual jurisdiction.‬
 r‭ isk management policy approved at the‬
‭Board level, and‬
‭b. Banks must have a suitability &‬
‭appropriateness policy so that they‬
‭would avoid miss selling of derivative‬ ‭➢‬‭Financial Benchmarks India Pvt Ltd (FBIL)‬
‭products.‬ ‭FBIL, an independent company, is a three-way‬
‭joint venture between Fixed Income, Money‬
‭Market and Derivatives Association of India,‬
‭ ‬‭The key features of the new contracts are:‬‭a.‬
➢
‭Foreign Exchange Dealers Association of India‬
‭Market Participants, i.e. residents and foreign‬
‭and Indian Banks' Association.‬
‭portfolio investors, are allowed to take‬
‭positions in the cross-currency contracts‬ I‭t is responsible for all the aspects relating to‬
‭without having to establish underlying‬ ‭the benchmarks to be issued by it, namely,‬
‭exposure subject to the position limits as‬ ‭collection and submission of market data and‬
‭prescribed by the exchanges.‬ ‭information including polled data, formulation,‬
‭b. Authorized Dealer Category-I bank trading‬ ‭adoption and periodic review of benchmark‬
‭members may undertake trading in all‬ ‭calculation methodologies, calculation,‬
‭permitted exchange traded currency‬ ‭publication and administration of benchmarks‬
‭derivatives within their Net Open Position‬ ‭confirming to the highest standards of‬
‭Limit (NOPL) subject to limits stipulated by‬ ‭integrity, transparency and precision.‬
‭the exchanges.‬
‭c. Eligible market participants are permitted to‬ ‭➢‬‭FBIL also announces the benchmark‬
‭take positions in Interest Rate Options for‬ ‭rates/matrix of :-‬
‭their own balance sheet management and‬ ‭a. Term MIBOR for three tenors of 14-day, 1-‬
‭for market making purposes.‬ ‭month and 3-month‬
‭d. The participants, who are eligible as market‬ ‭b. FC-Rupee Options Volatilities for five tenors of‬
‭makers are required to have appropriate‬ ‭1-week, 1-month, 3-month, 6-month and 12-‬
‭infrastructure and risk management systems‬ ‭month‬
‭in place.‬ ‭c. Certificates of Deposit (FBIL-CD), and d.‬
‭e. Interest Rate Options are permitted on‬ ‭Treasury Bills (FBIL-TBILL) on a daily basis except‬
‭exchanges authorized by SEBI as well as in‬ ‭Saturdays, Sundays and public holidays.‬
‭the Over-the-Counter (OTC) market.‬
 ‭Chapter:25 TREASURY AND ASSET-LIABILITY MANAGEMENT‬

‭ ence the liquidity gap arises out of mismatch‬

H
‭⇨‬‭RBI has prescribed time bands (Next day, 2 to 7‬
‭➢‬‭MEANING OF ASSET LIABILITY MANAGEMENT‬
‭days, 8 to 14 days, 15 to 30 days, etc.) for‬
‭(ALM)‬‭:‬
‭measuring and monitoring liquidity gaps.‬ ‭➢‬
‭ sset and liability management (ALM) is a‬
A ‭Interest Rate‬
‭practice used by financial institutions to‬ ‭Interest rate risk arises when interest earnings‬
‭mitigate financial risks resulting from a‬ ‭are not adequate to set off interest payments‬
‭mismatch of assets and liabilities. By‬ ‭due in a given period, even if the book value of‬
‭strategically matching of assets and liabilities,‬ ‭the asset equals that of the liability, owing to a‬
‭financial institutions can achieve greater‬ ‭change in market rates of interest.‬
‭efficiency and profitability while also reducing‬
I‭nterest rate risk may be defined as the risk‬
‭risk.‬
‭of erosion of NII, on account of interest rate‬
‭ALM is therefore defined as protection of‬
‭movements in the market.‬
‭net worth of the bank.‬
‭➢‬‭LIQUIDITY RISK AND INTEREST RATE RISK‬‭:‬ ‭ ‬‭ROLE OF TREASURY IN ALM‬‭:‬
➢
‭➢‬‭Liquidity‬ ‭The core function of Treasury is fund‬
‭management. It automatically engulfs liquidity‬
L‭ iquidity and interest rate are two sides of the‬
‭and interest rate risks, as the treasury‬
‭same coin, as the liquidity risk translates into‬
‭maintains the pool of bank's funds.‬
‭interest rate risk, when the bank has to recycle‬
‭the deposit funds or rollover a credit on market‬ ‭⇨‬‭Relationship between Treasury and ALM as‬
‭determined terms.‬ ‭under:‬
‭•‬‭It is Treasury which operates in financial‬
‭ anks are extra sensitive to liquidity risks, as‬
B
‭markets directly, establishing a link between‬
‭they cannot afford to default or delay meeting‬
‭core banking functions and market‬
‭their obligations to depositors and other‬
‭operations. Hence the market risk is‬
‭lenders.‬
‭identified and monitored through Treasury.‬
‭➢‬‭The difference between sources and uses of‬ ‭•‬‭Treasury uses derivatives and other means,‬
‭funds in specific time bands is known as‬ ‭including new product structures to bridge‬
‭liquidity gap which may be positive or‬ ‭the liquidity and rate sensitivity gaps.‬
‭negative i.e., when advances are more than‬ ‭•‬‭Treasury products are marketable and hence‬
‭deposits in a time bucket, it becomes a‬ ‭liquidity can be infused in times of need.‬ ‭•‬
‭positive gap and when deposits are more‬ ‭Treasury also monitors exchange rate and‬
‭than advances in a time bucket, it becomes‬ ‭interest rate movements in the markets, and‬
‭negative gap.‬
‭of assets and liabilities of the bank.‬
 ‭bonds‬
‭ ence it is much easier to administer such‬
h ‭(often called pass-through certificates -‬
‭risks through treasury operations.‬ ‭PTCs) that can be traded in the market.‬
‭➢‬‭USE OF DERIVATIVES IN ALM‬‭:‬ ‭⇨‬‭Credit derivatives‬‭segregate credit risk from‬
‭Derivative instruments are useful in managing‬ ‭loan/investment assets.‬
‭the liquidity and interest rate risks, as also in‬
‭ redit derivatives (CD) help the issuer diversify‬
C
‭structuring new products which help overcome‬
‭the credit risk and use the capital more‬
‭market risk to a large extent.‬
‭efficiently. The CD is a transferable instrument,‬
‭⇨‬‭Derivatives‬‭can‬‭be‬‭used‬‭to‬‭hedge‬‭high‬‭value‬ ‭though the market for CDs is not very liquid.‬
‭individual‬ ‭transactions,‬ ‭or‬ ‭aggregate‬ ‭risks‬
‭➢‬‭The eligible entities under market-makers and‬
‭as‬ ‭reflected‬ ‭in‬ ‭the‬ ‭asset-liability‬
‭users’ categories are as under:‬
‭mismatches.‬
‭⇨‬‭Treasury enables the bank in structuring new‬ ‭ arket makers:‬‭Commercial Banks, standalone‬
M
‭products which help reduce the mismatches‬ ‭P rimary Dealers (PDs), Non-Banking Financial‬
‭in the balance sheet.‬ ‭Companies (NBFCs) having sound financials and‬
‭⇨‬‭The preconditions for efficient use of‬ ‭good track record in providing credit facilities‬
‭derivatives are that the derivative market‬ ‭and any other institution specifically permitted‬
‭should be well developed; and the dealers‬ ‭by the Reserve Bank. Insurance companies and‬
‭in treasury should have adequate skills in‬ ‭Mutual Funds would be permitted if permitted‬
‭using and pricing derivatives.‬ ‭by their regulators.‬
‭➢‬‭CREDIT RISK AND CREDIT DERIVATIVES‬‭:‬
‭ sers:‬‭Commercial Banks, PDs, NBFCs, Mutual‬
U
‭Treasury and Credit Risk‬ ‭Funds, Insurance Companies, Housing Finance‬
‭Companies, Provident Funds, Listed Corporates,‬
‭ ‬‭Credit risk‬‭in treasury business is only with‬
⇨ ‭All India Financial Institutions namely, Export‬
‭respect to counterparty dealings, contained by‬ ‭Import Bank of India (EXIM), National Bank for‬
‭exposure limits and risk management norms.‬ ‭Agriculture and Rural Development (NABARD),‬
T‭ here are two ways in which Treasury may get‬ ‭National Housing Bank (NHB) and Small‬
‭intertwined with banking operations in the‬ ‭Industries Development Bank of India (SIDBI),‬
‭credit area: -‬ ‭Foreign Institutional Investors (FIIs) and any‬
‭other institution specifically permitted by the‬
‭⇨‬‭Firstly‬‭, there are several treasury products, or‬ ‭Reserve Bank.‬
‭more correctly debt-market products, such‬
‭as commercial paper and bonds, which are‬
‭credit substitutes.‬ ‭ ‬‭TRANSFER PRICING‬‭:‬
➢
‭⇨‬‭Secondly‬‭, there are new products which‬ ‭Transfer pricing refers to fixing the cost of‬
‭convert conventional credit into tradable‬ ‭resources and return on assets of the bank in a‬
‭treasury assets. The process is called‬ ‭rational manner the treasury notionally buys‬
‭securitization, whereby credit receivables of‬ ‭and‬
‭the bank can be converted into units or‬
 ‭more importantly‬
s‭ ells the deposits and loans of the bank, and‬ ‭how to improve and/or maintain the‬
‭the price at which the treasury buys and sells‬ ‭existing NIM, etc.‬
‭forms the basis for assessing profitability of‬ ‭•‬‭Liquidity Policy‬‭prescribes minimum liquidity‬
‭banking activity.‬ ‭to be maintained, funding of reserve assets,‬
‭•‬‭The treasury determines the buy/sell prices on‬ ‭limits on exposure to money market,‬
‭the basis of market rates of interest, the cost‬ ‭contingent funding, inter-bank‬
‭of hedging market risk and the cost of‬ ‭committed credit lines etc.‬
‭maintaining reserve assets of the bank.‬ ‭•‬‭Derivatives Policy‬‭prescribes norms for use of‬
‭•‬‭There are different ways of arriving at transfer‬ ‭derivatives, capital allocation, restrictions on‬
‭pricing and the bank has to formulate a‬ ‭derivative trading, valuation norms,‬
‭conscious policy in this regard.‬ ‭exposure limits etc.‬
‭•‬‭Once transfer pricing is implemented, treasury‬ ‭•‬‭Investment Policy‬‭prescribes the permissible‬
‭takes care of the liquidity and interest rate‬ ‭investments, norms re-credit rating and‬
‭risks of the entire bank, and profits of credit‬ ‭listing, SLR and Non-SLR investments, private‬
‭department reflect only the credit risk, net of‬ ‭placement, trading in securities and‬
‭all mismatches of sources and uses of funds.‬ ‭repos, classification and valuation of‬
‭•‬‭In a multi-branch environment, transfer pricing‬ ‭investments, accounting policy etc.‬
‭is particularly useful to assess the branch‬ ‭•‬‭Composite Risk Policy for Foreign Exchange and‬
‭profitability.‬ ‭Treasury‬‭prescribes norms for merchant and‬
‭➢‬‭P OLICY ENVIRONMENT‬‭:‬ ‭trading positions, securities trading, exposure‬
‭The asset-liability management will be‬ ‭limits, limits on intra-day and overnight‬
‭effective, only if there is a strong policy‬ ‭positions, stop-loss limits, periodical valuation‬
‭foundation.‬ ‭of trading positions etc.‬
‭•‬‭Transfer Pricing Policy‬‭prescribes the‬
T‭ hough in general we describe it as ALM Policy,‬ ‭methodology, spreads to be retained by‬
‭the policy should aim at aggregate risk of the‬ ‭treasury, segregation of administrative‬
‭bank and should chive coordination between‬ ‭costs and hedging costs, allocation of costs‬
‭different departments of the bank and treasury.‬ ‭to branches/other departments of the‬
‭➢‬‭An Integrated Risk Management Policy,‬ ‭bank etc.‬
‭bearing‬ ‭upon Market Risk of the Bank,‬ ‭➢‬‭Essential requirements of all the above‬
‭should ideally‬ ‭have the following‬ ‭policies are:‬
‭components:‬ ‭a.‬‭The policies are to be approved at the highest‬
‭•‬‭ALM Policy‬‭prescribes the composition of Asset‬ ‭level, either by the Board or by a Board‬
‭Liability Management Committee (ALCO) and‬ ‭committee,‬
‭operational aspects of ALM, including risk‬ ‭b.‬‭The policies should comply with the extant‬
‭measures, monitoring of risks, risk‬ ‭regulations of RBI and other regulatory‬
‭neutralization, product pricing,‬ ‭bodies such as SEBI, and‬
‭management information systems and‬
‭c.‬‭The policies should also comply with the‬
‭current market practices and code of‬
‭conduct as evolved by SROs like FIMMDA‬
‭and FEDAI.‬

‭d.‬‭There should also be a monitoring‬

‭committee, comprising of senior executives‬
‭of the bank, to ensure compliance with the‬
‭Policy provisions.‬

‭e‭.‬ All the policies should be subject to annual‬

‭review, and in most cases, there is a‬
‭requirement to file a copy of the policy‬
‭with RBI.‬