Integrated Treasury: Meaning,

Functions and Structure

Integrated treasury is a holistic approach to funding the balance sheet and
deployment of funds across the domestic as well as global money and forex
markets. This approach enables the bank to optimize its asset-liability
management and also capitalize on arbitrage opportunities.

Traditionally, the forex dealing room of a bank managed the foreign exchange
dealings mainly arising out of merchant transactions (forex buying from and
selling to customers) and consequent cover operations in interbank market.
The domestic treasury/investment operations were independent of forex
dealings of a bank.

The treasury operations were treated as a cost center, specifically devoted to

reserve management (CRR and SLR) and consequent fund management.
The treasury also undertook investment in Government and non-government
securities.

Needs of integration of the bank treasury

Presently except couple-of treasuries, almost all the treasuries of the public sectors banks are
operating in isolations. For example, forex treasury and domestic treasury of many of the banks
are operating independently. There may be times that the forex and domestic treasury of these
banks might have worked on different directions there by neutralizing an advantageous position
or even adversely affecting the banks financial position. This is because the forex treasure may
not know the position of the domestic treasury or that
the perceptions of both the treasuries may be different or in opposite directions =.Communicatio
n/information gap between these two treasuries also may lead to such detrimental position for the
banks. This may even lead to the goodwill of the bank. There may be instance when the
integrated treasuries of the other banks may take arbitraging opportunities on its
unrelated/opposite levels/positions of the banks May be lending funds to other banks, which
may, in turn deploy in foreign currency deposit with the former. There are few banks where even
the funds management (money market treasury) and investment management (capital and debt
market treasury) are functioning independently.

The need for integration of forex dealings and domestic treasury operations
has arisen on account of interest rate deregulations, liberalization of exchange
control, development of forex market, introduction of derivative products and
technological advancement in settlement systems and dealing environment.

The integrated treasury performs not only the traditional roles of forex dealing
room and treasury unit but also many other functions.

Functions of Integrated Treasury:

(a) Reserve Management and Investment:
It involves:
(i) Meeting CRR/SLR obligations,

(ii) Having an approximate mix of investment portfolio to optimize yield and

duration.

Duration analysis is used as a tool to monitor the price sensitivity of an

investment instrument to interest rate changes.

(b) Liquidity and Funds Management:

It involves:
(i) Analysing of major cash flows arising out of asset-liability transactions,

(ii) Providing a balanced and well-diversified liability base to fund the various
assets in the balance sheet of the bank, and
(iii) Providing policy inputs to the strategic planning group of the bank on
funding mix (currency, tenor and cost) and yield expected in credit and
investment.

(c) Asset Liability Management:

ALM calls for determining the optimal size and growth rate of the balance
sheet and also price the assets and liabilities in accordance with prescribed
guidelines.

(d) Risk Management:

Integrated treasury manages all market risks associated with a bank’s
liabilities and assets. The market risk of liabilities pertains to floating interest
rate risks and asset and liability mismatches.

Market risk for assets can arise from:

(i) Unfavourable change in interest rates,

(ii) Increasing levels of disintermediation,

(iii) Securitization of assets, and

(iv) Emergence of credit derivatives, etc.

While the credit risk assessment continues to be in the domain of Credit

Department, the treasury would monitor the cash inflow impact from changes
in asset prices due to interest rate changes by adhering to prudential
exposure limits.

(e) Transfer Pricing:

The treasury has to ensure that the funds of the bank are deployed optimally,
without sacrificing yield or liquidity. An integrated treasury unit has an idea of
the bank/s overall funding needs as well as direct access to various markets
(like money market, capital market, forex market, credit market).

Hence, ideally the treasury should provide benchmark rates, after assuming
market risk, to various business groups and product categories about the
correct business strategy to adopt.

(f) Derivative Products:

The treasury can develop Interest Rate Swap (IRS) and other rupee
based/cross-currency derivative products for hedging bank’s own exposures
and also sell such products to customers/other banks.

(g) Arbitrage:
Treasury units of banks undertake arbitrage by simultaneous buying and
selling of the same type of assets in two different markets in order to make
profit less risk/y.

(h) Capital Adequacy:

This function focuses on quality of assets, with Return on Assets (ROA) being
a key criterion for measuring the efficiency of deployed fund.

An integrated treasury is a major profit center. It has its own P and L

measurement. It undertakes exposures through proprietary trading (deals
done to make profits out of movements in market interest/exchange rates) that
may not be required for general banking.

Nature of Integration:
To start with, there is geographical and infrastructural integration. The forex
dealing rooms are merged and located in the same premises along with the
domestic treasury unit. Under horizontal integration the dealing/trading rooms
engaged in the same trading activity are brought under the same policies,
hierarchy, technological and accounting platform.

In vertical integration all existing and diverse trading and arbitrage activities
are brought under one control with common pool of funding and contributions.
The impact of transactions of all units on rupee funds is merged. There is
computerized linking of transactions.

Benefits of Integration:
The basic objective of integration is to improve portfolio profitability, risk-
insulation and synergize banking assets with trading assets. Banking assets
are held basically for client relationship/ steady income/statutory obligations
and are generally held till maturity, whereas trading assets are held primarily
for generating profits on short-term differences in prices/yields.

The purpose is achieved through efficient utilization of funds, cost effective

sourcing of liability, proper transfer pricing, availing arbitrage opportunities,
on-line and off-line exchange of information between the money and forex
dealers, single window service to customers, effective MIS, improved internal
control, minimization of risks and better regulatory compliance.

An integrated treasury acts as a center of arbitrage and hedging activities. It

seeks to maximize its currency portfolio and free transfer of funds from one
currency to another in order to remain a proactive profit center. With phased
liberalization on capital account convertibility, there will be scope for banks
with integrated treasury to structure multi-currency balance sheets and take
advantage of strategic positioning.

Structure of Integrated Treasury:

The treasury branch is manned by the front-office, mid-office, back office and
audit group. The dealers and traders constitute the front office.

In the course of their buying and selling transactions, they are the first point of
interface with other participants in the market (dealers of other banks, brokers
and customers). They report to their department heads. They also interact
among themselves to exploit arbitrage opportunities.

A mid-office set-up, independent of the treasury unit, acts as the unit

responsible for risk monitoring, measurement and analysis and reports directly
to the top Management for control. This unit provides risk assessment to
Asset Liability Committee (ALCO) and is responsible for daily tracking of risk
exposures, individually as well as collectively.

The back-office undertakes accounting, settlement and reconciliation

operations. The audit group independently inspects/audits daily operations in
the treasury department to ensure adherence to internal/regulatory systems
and procedures.

Arbitrage Benefit to Treasury:

The price differentials between different markets of the same asset category
give rise to arbitrage opportunities.

For example, arbitrage benefit can be availed by borrowing in US dollar,

converting the same rupee, taking forward cover to hedge exchange risk and
investing in rupee. However, efficient functioning of financial markets
generates asset prices and exchange rates that preclude arbitrage.

Initiatives of Integrated Treasury:

Many banks in India have taken the initiative to set up their integrated treasury
operations supported by infrastructural facilities like
Reuters/Telerate/Bloomberg System, hotlines, Dealing Boards, Internet, etc.,
dedicated software for integrated treasury.

Payment systems like Negotiated Dealing System (NDS), Clearing

Corporation of India Ltd (CCIL) and new initiatives like Real Time Gross
Settlement System (RTGS) are already in place.

INTEGRATED TREASURY AND ITS FUNCTIONS

Introduction
The reforms set in since the past few years has brought along with it host of risks for the banks,
apart from a variety of opportunities. Now banks will have to learn to operate in a more
deregulated environment a diversified and competitive market place, which will require them to
manage risks better. Recent volatility in exchange rate movements and domestic interest rate
levels has indicated the influence of the global market within the country. Such volatilities would
precipitate substantial losses and at times irretrievable situations for several banks. These
situations warrant proactive or prompt reactive moves from the banks. It is in the context of the
urgent need of TREASURY MANAGEMENT for the banks emerge. Bank with an extensive
branch network has to establish a centralized treasury and dealing room, to counter the market
situations and contain the risk exposures at the earliest.Until the few years back, many of the
Indian banks were giving a secondary importance to treasury management. There are dangers in
giving treasury operations a secondary role. A significant proportion of the treasury related
problems are to be attended immediately for instance, loss of interest arising from surplus funds
available for the banks on day to day basis. An open currency risk which has been identified but
not acted upon for lack of time means that banks profits are at risk for possibly one or more
day‘s movement in volatile foreign exchange markets can be very expensive indeed.Therefore,
that, even in a relatively small organization, it is essential that treasury work isunder taken by at
least one individual with a sole or primary responsibilities to cover, atleast, cash , management
and currency management. A few of the banks have already set up fully functioning treasuries
and a couple of them have set up integrated treasuries with forex and domestic dealers sitting in

the same dealing room

.The word INTEGRATION means consolidation or merger or centralization. In
the present context it is the consolidation or the centralization of the segmented financialmarkets
like money market. Debt and capital market and forex market at the macro leveland integration
of the respective treasuries at the operational level at banks financial institutions. Let us discuss
this in the following.
Banking reforms which were initiated in the beginning of the 90‘s is slowly opening the
domestic economy to the global market. Opportunities are winding for the banks,financial
institutions, corporate and others, which would result in intense market/economy is integrating
with the global economy, it is needles to emphasize need for integration of the micro level units.
For example different segments within the financial markets are almost integrated. The financial
markets which were earlier segregated in different watertight compartments like money market,
debt market, capital market, forex market etc. have been almost integrated. Now money can
freely flow, of course with lesser regulations, from one market to the other market have been
given partial freedom to enter other markets. Now financial institutions which earlier wereconfin
ed to be long term market have been permitted to enter sort term in money market to lend in call
and borrow not only from the open domestic market nut also from the global market. Banks have
been permitted to enter the capital/debt market, forex market and money market with partial
freedom in certain cases, to mobilize and/or deploy resources. Bank, if not for there own needs,
are forced to enter these market very often

and render services to their clients, which have access to these markets. For example a corporate
accessing the overseas market for external commercial borrowing has to ultimately depend on
bankers for utilizing the funds it has raised or converting the fund sand bringing into the country.
Thus we can say, with liberalization of the financial system, markets are almost fully integrated.
Once the capital account convertibility(CAC) fully comes, all these markets would have
been fully integrated. The impact of the financial integration on CAC can be summarized as
follows:

a. Promotes competition resulting in better quality products and services.

b. Improves quality and number of financial assets as a result of greater liquidity anddeeper
market.
c. Reduces margin and more efficient allocation/ intermediation interest rates toalign with global
interest rates differential to reflect in foreign exchange forwardrates.

d. Avoids inducements for tax evasion and capital flight opportunities for diversion/distribution
of risk.