Presentation on Treasury, Investment and Risk Management in banks

Reshma Soni (201127) Rohit Bhartiya (201133) Samridhi Madan ( 201142) Abhishek Kumar (053060)

Introduction

What are the Functions of Banks?

Banking involves

Trading Operation

Banking operations

Proprietary Services Direct Exposure Risk on their own Behalf)

Consumer services

Among Primary Functions of Bank(Lending)

Most loans are ILLIQUID

Riskiest Business Assets Weakens the quality of earning capacity

Another Major Categories of Earning Assets

Government Bonds & Notes Investments in Securities Other forms of Debt securities(CDs, CPs) Stocks Permitted by Law( Corporate Bonds & Notes

What are the functions of bank security portfolio?

Stabilize the banks income

Offset Credit risk exposure in the banks loan portfolio

Help hedge bank against losses due to interest rates

Functions of Bank Security Portfolio

Makes banks balance sheet look financially stronger

Provide geographic diversification

Back up source of liquidity

Investment stands between cash, loans & deposits. How?

Investment stands between cash, loans & deposits

Cash low -- Investment sold to raise more cash Cash high -- Cash placed in investment securities
Loan demand weak -- investment securities rises in bank to provide more earning asset Loan demand strong Investment will be sold to accumulate heavy loan demand

If deposits not growing in banks, investment securities again used as collateral

Thus, Investments has a critical intersection position in the balance sheet

Crossroads account on a banks balance sheet Assets Cash

Add to investment when cash is In excess Sell investments when cash is low

Liabilities Deposits
When deposits are low, use investment as collateral for more non-deposit borrowings

Investments
Sell investments when loan demand high Add to investments when loan demand weak

Non- Deposit Borrowings Return investment pledge as collateral to the investment portfolio when deposit growth is strong

Loans

Expected return and risk

Pledging requirementSecurities be pledged as collateral for public fund deposits

Tax exposure

The ladder or space maturity policy

25

20

15 % of the value of all securities held

Strategy: Divide investment portfolio equally among all maturities acceptable to the bank

10

Advantages: Reduces investment income fluctuations/require little managing expertise

0 1 yr 2 yr 3 yr 4 yr 5 yr

Front end loaded maturity policies

% in value of all securities held
80 70

60

50

Strategy: All security investment are short terms

40

30

20

Advantages: strengthens the banks liquidity position and avoids large capital losses if interest rates rise

10

0
1 yr 2 yr 3 yr 4 yr 5 yr

Back end loaded maturity policies

35 30
25 20 15 10 5 0 1 yr 2 yr 3 yr 4 yr 5 yr 6 yr 7 yr 8 yr 9 yr 10 yr

% in value of all securities held

Strategy: All security investments are long term

Advantages: maximize the banks income potential from security investment if interest rates fall

Barbell investment portfolio strategy

1 0.9

% in value of all securities held

0.8
0.7 0.6 0.5 0.4 0.3
30%

Strategy: security holdings are divided between short terms and long term

0.2 0.1
20%

30%
20%

Advantages: Helps to meet banks liquidity need with short term and achieve earning goals due to higher potential earnings from long term portfolio

0
1 yr 2 yr 3 yr 4 yr 5 yr 6 yr 7 yr 8 yr 9 yr 10 yr

A treasury is any place where currency or items of high monetary value are kept

government which manages all money and revenue

government department responsible for collecting, managing and spending public revenues

Various Forms of treasury

funds of a government or institution

center of financial operations within an organisation

A depository where wealth and precious objects can be kept

 The management of an organization's liquidity to ensure that the right amount of cash resources are available at the right place in the right currency and at the right time using right instrument It maximizes the return on surplus funds, minimizes the financing cost of the business control interest rate risk and currency exposure to an acceptable level.

Goals
Maturity range and degree of marketability Risk Exposure

The goals sought by the bank from its investment portfolio The desired maturity range and degree of marketability (turn into cash immediately) sought for all securities purchased

The quality or degree of default risk exposure the bank is willing to accept.

Portfolio diversification

The degree of portfolio diversification to reduce risk the bank wishes to achieve with its portfolio

Centralisation of management control

LIMITED SERVICE GLOBAL

LIMITED SERVICE LOCAL

FULL SERVICE GLOBAL

FULL SERVICE LOCAL

Range of services

Full service Global

1. Undertakes most of the Activities 2. Operates as the one treasury for all markets 3. Ultimately combines: a. Pooling risks and b. Policies or strategies

Full Service Local

1. Self-sustained local unit
2. Full range of activities undertaken 3. Guided by the needs of the local business

Models of Treasury Organisation

Limited Service Global
1. Range of services limited.

Limited Service Local 1. Very small decentralized treasury 2. Virtually little or no treasury activity.

Scale or Spread
Focus

Complexity

Core functions of treasury department-the dealing room, the middle office and the back-office.

Core Functions of Treasury Department

Front-office Mid-office

Dealing Risk taking

Risk Management Management Information

Back-office

Confirmations, Settlements, Accounting and Reconciliation.

FRONT OFFICE
Buy, sell and trade in money market instruments, securities, forex, equity, derivatives and precious metal

Restructuring, reorganizing, pre payment

Keep track of and develop their views on different asset class, securities, currencies, derivative products

FRONT OFFICE
Significant interaction with various trading and delivery teams Liquidity Management ALM implementation

Striking of Deals (trading) and earning profits from trading

Maintenance of CRR and SLR

Middle Office
Risk Management and Management Information
Market risk which arises on account of: Liquidity risk Country risk

- Interest rate movement

Independent market risk

- Foreign exchange rate movement

Formation of Investment policy for banks treasury Formation of ALM policy for the bank.

- Commodity prices

- Equity prices

Back office

Co-ordination with frontoffice

Ensuring compliance with stated treasury procedures and stipulations

Internal control and check and accounting

Monitoring of SLR/CRR

Other functions of back office

Risk management Systems and Telecommunications BACK-OFFICE OPERATIONS Treasury Accounting

Regulatory reporting
Financials, analysis, budgets

Documentation

 Treasury operates in financial market directly

Investment committee

Risk committee

Treasury products are marketable and liquid

Treasury can monitor FX movements

Treasury

Money market business unit

Cash reconciliation

Asset Liability

Management Committee

Meeting SLR requirements!

Sample work flow model in Treasury Division- Standard Chartered.

The International Swaps and Derivatives Association

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market and credit risk management.

Asset - Liability Management (ALM)

Asset Liability Management

Assessment of various types of risks and altering the asset liability-portfolio in a dynamic way to manage risks.

Keeping cost of liability as low as possible and yield on asset as high as possible.

Mis-matches between liability and asset should be reduced to minimum.

Components of ALM

Assets Management Liability Management

Risk Management

NEED?
Monitor Interest margin spread

Manage Interest Rate Risk

Manage Liquidity Risk

Capital Adequacy Risk

Profit planning and growth projection

1. Monitoring Interest Rate Spreads

Spread= Earning on assets Cost of liability

Interest Rate is market driven.

Cannot try to give less interest to depositors to keep the cost low

Cannot Charge more than 4% above Prime Lending Rate.

Cost analysis
Particulars
Owned Funds Borrowings Current Deposits Savings Deposits Term

Yield- Cost = Spread

Particulars
Cash in hand Balance with RBI Investments Advances upto Rs. 25000 Advances upto Rs. 2 lacs

As % of total
8 12 5.4 17.6 54

Rate
9 4.5 10

Cost
1.080 0.792 5.4

As % of total
4.5 8 36 4.2 11.5

Rate
4 11 11 13.5 16.75

Yield
.224 3.96 .462 1.552 2.362

Advances 14.1 above Rs. 2 lacs Exports 4.7

0.423

N.P.A.
Other Assets Total 100 7.272 Total

13.1
2.5 100

9.039

2. Managing Interest Rate Risk

Interest Rate is market sensitive.
If savings interest rates fall then people invest in 15 or 30 days deposits.

If interest rate of long term deposits rise, investment in short term would fall. Yield on advances will go down with fall in interest rates. As interest rates go up, old deposits will be withdrawn (if premature penalty is not imposed), and re-invested as per the new rates. It will effect the spread. Similarly, with securities or investments, rates going up, means new securities will be issued with higher coupon and price of existing securities will go down

Thus.
Matching of borrowings and lending is the solution.
Match Fixed rate liabilities with fixed rate assets. Match Floating rate liabilities with floating rate assets. Any mismatch will create a gap. Positive gap exists when, Assets > Liabilities. Negative gap exists when, Liabilities > Assets.

3. Managing Liquidity Risk

Difficult to have perfect match between assets and liability.

Larger the number of transactions, larger is the risk.

100 Crores of C.D. @10%

Try to create an asset like L.C.

The net return would be 2-3% However, if not able to create an asset- it invests that amount in call money market.
It will give 5-6% return. If it creates asset after some time, then at the time of maturity of C.D. amount would be outstanding. It will have to go to call money market.

Managing Liquidity is an issue!!

ALM classifies the securities on the basis of their maturity by Gap Analysis.

Gap Analysis
Liabilities
Rs. 2500 (Matched) Rs. 5000 ( Short term maturity) Rs. 2500 ( Long term maturity)

Asset
Rs. 2500 (Matched) Rs. 6000 ( Short term maturity) Rs. 1500 ( Long term maturity)

Gap
Zero +1000

-1000

4. Capital Adequacy Risk

Assets carry Risk Weightage.

Growth of assets depends on growth of capital.

Bank suffering from capital constraints may not be able raise further capital from market as its performance parameters may not be good.

Growth in Long term deposits have a negative impact on profit if capital constraints exist as money has to be deployed in Zero Risk Govt. Securities (low yield).

Global best practices and key performance indicators of bank treasury department.

you cant manage anything unless you measure it

Revenue growth

Revenue mix

Cost efficiency

Return on average invested capital

Dividends per share growth

Basics earning per share

1)Finance Structure is centralized Improved cash visibility Greater control Improved efficiency

2)Roles and responsibilities are clearly defined, with management reporting focused on consistent format and KPIs.
3)Develop efficient ways to bring companys cash into investible balance

Best practices in International Treasury Management,1999

4) Minimize expenses in making payments

5) No rookies work in the department

6) Reasonable risk factors are identified and mitigated 7)Partnering with other components of the bank 8)Seeking constant improvement 9) Treasury workstations

THANK YOU