a note on 'an ideal treasury policy for banks

8/9/2019 A note on 'an ideal treasury policy for banks'

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NATIONAL LAW UNIVERSITY,JODHPUR

ANOTE ON AN IDEALTREASURY POLICY FOR BANKS

PRINCIPLES AND PRACTICES FOR BANKING

(ASSIGNMENT FOR THE PURPOSES OF EVALUATION)

SUBMITTED BY:

SHIVESHAGGARWAL,B.B.A.LL.B.(HONS.),6THSEMESTER,ROLL NO.966

SUBMITTED TO:

DR.RITUPARNA DAS,ASSOCIATE PROFESSOR &ASSISTANT DEAN,FACULTY OF POLICY

SCIENCES

TOTAL NUMBER OFWORDS:9,991


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INTRODUCTION

The first thing a treasurer should consider when assessing the quality of his/her policy is why it is

there in the first place. As obvious as this seems, too many policies tread lightly over the key risks

faced by the treasury. Our most recent treasury operations survey, produced in conjunction with theACT, indicates that 100% of treasuries now have a treasury policy in place and that a growing majority

formally document and update them regularly. But what does having a treasury policy really mean?

The treasury policy is a document, generally and preferably approved at board level, that gives treasury

staff written guidelines on what they are responsible for, how they should go about this, what their

boundaries are and how their performance will be measured. Most treasuries deal with derivatives and

so to must their policies. It may be stating the obvious, but it needs to be said that derivatives are

complex instruments that, by their complex nature, make them potentially dangerous to the finances

of any business that uses them. Properly understood and utilised, they are invaluable for risk

management but they have the potential to destroy companies and the careers of those who use them.

The key to using them well is a high quality treasury policy

Banks help their customers manage their money, but who manages a bank's money? How does a bank

decide where to invest its capital across its business and how much to hold back in reserve? How does

a bank make sure that each of its business areas has enough cash to serve its clients and function

efficiently while keeping enough cash available centrally at all times to cover any unexpected market

developments? Why have these questions become more important to the finance world in recent years,

and why could working in these areas be a great career choice?

RBI is the central bank and regulates all financial institutions. The treasury policy is a document,

generally and preferably approved at board level, that gives treasury staff written guidelines on what

they are responsible for, how they should go about this, what their boundaries are and how their

performance will be measured.

Matters covered by treasury policy are:

1. Foreign exchange exposure management;

2. Funding;

3. Interest rate risk management;

4. Commodity risk management;


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5. Operational risk management;

While there have been countless scandals relating to the fraudulent use of derivatives amongst

corporate treasuries, more often it is the failure of a suitable treasury policy and risk management

strategy that leads to failure. The key message is that it is not good enough if your policy simply statesthat FX forwards should be used to manage FX risk or that interest rate swaps should be used to

protect the business from adverse interest rate movements. Instead, a good treasury policy should

outline the key risks and how the specified hedging policy will manage them.

Other elements that should be contained within a treasury policy include specifying the relevant

benchmarks and other means by which treasury performance is to be measured, which risks are to be

managed and who is responsible for them. Treasury management in India has become an increasingly

specialized function due to regulatory relaxation, coupled with the increasing scale of treasury

operations.

Most treasuries deal with derivatives and so to must their policies. It may be stating the obvious, but

it needs to be said that derivatives are complex instruments that, by their complex nature, make them

potentially dangerous to the finances of any business that uses them. Properly understood and utilised,

they are invaluable for risk management but they have the potential to destroy companies and the

careers of those who use them. The key to using them well is a high quality treasury policy.


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WHAT IS TREASURY POLICY?

In todays context, treasuries are expected to perform two critical functions:

1. Financial risk management

2. Financial supply chain management

Financial risk management, which includes currency risk management, commodity price risk

management and interest rate risk management, is necessary to keep business margins insulated from

market volatility. On the other hand, the financial supply chain is focused on reducing the cost of

borrowings, redeploying business cash flows efficiently and optimizing the risk-return profile of

investible surplus. The role of the internal audit function has evolved from being a value preserver to

a value enhancer in the business context. The landscape of treasury operations and expectations from

an internal audit function is changing. Hence, the manner in which treasury processes and operations

are evaluated requires a deep understanding of the treasury function.

The focus of treasury internal audit has traditionally been pivoted on the evaluation of operational

controls and financial reporting risks. However, the evolution of the treasury function has brought

other aspects of treasury management to the forefront. These include:

1. Impact of implementation of hedge accounting under AS-30 and IFRS on the accounting

reflection of treasury cash flows

2. Risk-return profile as well as the tax-efficiency of investment instruments

3. Minimizing float across the business value chain and reducing the cost of borrowings

4. Viability and risk of using different hedging instruments

5. Managing regulatory compliance-related aspects, particularly related to foreign exchange risk

management

Finally, every new treasurer should comprehensively review the existing treasury policy to ensure itmeasures up to his/her own standards. Everyone brings their own views, expertise and style to a

treasury and it is important that the treasury policy supports the treasurers approach to achieving an

effective and well-controlled operation. Reviews should take place every time the business undergoes

a change in ownership, acquisition, divestment, geographical growth and so forth as the policy must

always be customised to the business it supports. The recent trend to source products from the Far


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East or Eastern Europe introduces a new set of counterparty and foreign exchange risks and

represents a classic example of a time to review the existing treasury policy. At the very least, an annual

review that takes into account new technology, improved techniques and changing business and

market environments, should be considered essential.

Many policies focus on risk management but overlook a number of basic controls. A review of the

treasury-related scandals over the last 30 years reveals it is the basic controls that are often inadequate

and/or breached. As a guide, every treasury policy must address each member of staffs detailed

responsibilities; specific and complete delegations of authority for all treasury actions; dealing limits

by transaction and dealer; authorisation limits; payment mandates; counterparty limits; and monitoring

of all of the above.

An example here can be found in the fortunes of a major Australian zinc mining company. Its revenues

were in US dollarsthe price in which the metal that it mined traded globally but its costs were

mainly in Australian dollars. When the Australian dollar fell to USD 0.65 in the late 1990s, the

company sought to lock into this historically low price to protect its expected profits. However, the

Australian dollar fell to USD 0.50 in 2001 and this created a massive hedging loss that the companys

balance sheet could not withstand. At the same time zinc prices fell to historic lows, reducing the US

dollar revenues that had been hedged. Because the US dollar cashflows were less than the amount of

US dollars hedged, the company was left with unprofitable currency hedges that were not linked to

any cashflows and were out of the money. This was one of the main causes of its insolvency. In thiscase there was no fraud. All policies and procedures were followed but the company was eventually

taken over by its bankers and its shareholders lost their entire investment. In effect, the company not

only hedged the wrong risk but also poorly hedged the risk that it had identified.


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STRATEGIC FUNCTIONS INTREASURY &CAPITAL MANAGEMENT

LIQUIDITYMANAGEMENT

Liquidity Risk Management to safeguard the ability of the bank to meet all payment

obligations when they come due

Framework to identify, measure, monitor, and control liquidity risk under normal

market conditions and under stress

Liquidity Toolbox, Transfer Pricing, Interbranch Funding & Country Risk Limitation

FUNDING /ISSUANCEMANAGEMENT

Global funding requirements and liquidity risk appetite guide the issuance activities ofDeutsche Bank liability products

One credit to all markets, public or private, and across all currencies

Senior Benchmark & Innovative Structured Issuance, Issue of Contingent Capital &

Regulatory Capital Instruments

CAPITAL&BALANCE SHEETMANAGEMENT

Regulatory, economic, and shareholder dimension of capital Group-wide and local

management

RWA/ Balance Sheet planning [no interest rate risk mgmt.

FX Hedging of Capital, Share Buybacks, Capital Allocation, Investment Committee,

Pension Fund Mgmt


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OPERATIONAL RISK MANAGEMENT

Operational risk is primarily concerned with the risk of error and/or fraud within the treasury and

also within the finance function as a whole. Financial institutions spend tens of millions of pounds

seeking ways to identify, measure and mitigate this risk and there is no reason for even the smallesttreasury to ignore this. Segregation of duties, a favourite of audit checklists, is easily applied in a 12-

strong treasury team, but what if it consists of you, an assistant and maybe half an accountant when

two of you are on leave? Incorporating policies that identify the error and fraud risks in business,

having methods to measure the risk, and more importantly, putting in place measures to mitigate them,

are just as important and valuable as having a state-of-the art Value at Risk currency risk management

framework. Simply identifying every point of risk, attempting to quantify and document risks and

showing them to your CFO is a good way of acquiring the extra resources that you need, or of

obtaining more co-operation from the financial controller. It also provides a framework for finding

the resources you will need to overcome staffing pressures that make risks worse by leaving you with

insufficient time to check for and rectify errors.

A hedging transaction should be done keeping in mind the following guidelines: the hedging

instruments used and procedure for transacting deals should have been approved by the RMC. There

should be local know-how of the hedging instrument. It should be possible to evaluate the deal as per

the marked-to-market concept in case of need and should be reported in accordance with the

guidelines of the Hedging Policy. The hedging deals should be reported as per pre-defined reportingrules, regardless of the responsibility or hedged amount or duration of the hedge. The decision to

hedge or not to hedge should be made keeping in mind the Hedging Ratio1 of the company. However,

hedging should not be done permanently and automatically as in most circumstances the associated

hedging costs would be expensive.

There has been an assessment of the key currencies to track and exposures to hedge. There is a

mechanism in place, which allows real-time monitoring of market conditions so as to allow the

company to take advantage of favorable market development while minimizing the costs of hedging.Basic Hedging Instruments permitted as per IGLs Risk Management Policy The company approves

the following hedging instruments for the purpose of hedging currency and interest rate risks:- Spot

Transactions, FX Forward Contracts for covering Export/Import for USD/INR deals, Principal Only

Swaps, Interest Rate Swaps.


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For the projections the benchmark for each month would be the First Day Forward Rate for the

delivery month i.e. if the foreign currency is in premium in the forward market, then the applicable

premium would be up to the last day of that month and if the foreign currency is in discount in the

forward market, then the applicable discount would be till the first day of that month. In case of spill

over in due date to next or previous month, Benchmark to be adjusted for swap differentials.

For the projections the benchmark for each month would be the First Day Forward Rate for the

delivery month i.e. if the foreign currency is in premium in the forward market, then the applicable

premium would be till the first day of that month and if the foreign currency is in discount in the

forward market, then the applicable discount would be up to the last day of that month. In case of

spill over in due date to next or previous month, Benchmark to be adjusted for swap differentials.

The Government securities market has witnessed significant changes during the past decade.Introduction of an electronic screen based trading system, dematerialized holding, straight through

processing, establishment of the Clearing Corporation of India Ltd. (CCIL) as the central counterparty

(CCP) for guaranteed settlement, new instruments, and changes in the legal environment are some of

the major aspects that have contributed to the rapid development of the market.


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CREDIT RISK

When looking at counterparties we generally see a financially healthy, diverse group of banks with AA

ratings and above and assume all our deals will always be honoured. According to the rating agencies,

that assumption would be right around 99.5% of the time. But banks do fail, as do Arated corporateentities. The rating agencies are conservative at present but these things go in cycles. Many policies

specify the minimum rating of a counterparty, but a good number do not put individual counterparty

limits in place, which increases the risk to the business. If keen pricing from one of your banks means

you have 80% of your swaps, forwards and overnight deposits with it, you potentially put the entire

business in jeopardy. Historically, the institutions that fail generally exhibit below-market pricing in

the lead up to their default as their desperation for deposits and premiums to meet their obligations

increases.

TREASURY POLICY OF THE RESERVE BANK OF INDIA

Major participants in the Government securities market historically have been large institutional

investors. With the various measures for development, the market has also witnessed the entry of

smaller entities such as co-operative banks, small pension and other funds etc. These entities are

mandated to invest in Government securities through respective regulations. However, some of these

new entrants have often found it difficult to understand and appreciate various aspects of the

Government securities market. The Reserve Bank of India has, therefore, taken several initiatives to

bring awareness about the Government securities market among small investors. These include

workshops on the basic concepts relating to fixed income securities/ bonds like Government

securities, existing trading and investment practices, the related regulatory aspects and the guidelines.

This primer is yet another initiative of the Reserve Bank to disseminate information relating to the

Government securities market to the smaller institutional players as well as the public. An effort has

been made in this primer to present a comprehensive account of the market and the various processes

and operational aspects related to investing in Government securities in an easy-to-understand,

question-answer format. The primer also has, as annexes, a list of primary dealers (PDs), useful excel

functions and glossary of important market terminology. I hope the investors; particularly the smaller

institutional investors will find the primer useful in taking decisions on investment in Government


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securities. Reserve Bank of India would welcome suggestions in making this primer more user-

friendly.

On having implemented a new dealing rooms platform in a Bank's Treasury, the management

identified a number of areas for further investigations of the end user acceptance of the newtechnology. Answers were sought to what extent dissatisfaction, if any, was influenced by the end

users perception of the system quality, subjective norms and computer self-efficacy. New technology

acceptance models assume perceived usefulness, rather than ease of use, as a strong indicator of

usage.

The end user satisfaction model was developed to measure the end user satisfaction in a mandatory

environment, and to test the usefulness versus ease of use assumption. The findings suggest that

in a mandatory environment such as a Bank's Treasury, the perceived "ease of use' was a marginally

stronger influencer of the end user satisfaction. Demographic variables such as age, position in a

company and the length of employment were other significant contributors to satisfaction. The

implications of the findings for the Bank's management are twofold: both computer self-efficacy,

and the end user satisfaction play a major role in new technology acceptance, therefore the two

variables require a particular consideration in designing information systems in mandatory

environments.


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PROCESS FOR A BREACH OF LIMITS

More importantly, your benchmarks and performance measurements need to reflect the constraints

that an appropriate credit risk policy imposes. Once limits are reached you may be forced to take less

than best pricing which reduces your performance against benchmarks. However, this is what riskmanagement is all aboutpaying a cost to mitigate risk. It is vital that this is considered, acknowledged

and incorporated into the treasury policy. This will remove the incentive for treasurers to breach limits

to meet targets or to penalise unfairly those who comply with their limits. It remains crucial that all

breaches are investigated or have pre-approval by senior management.

IMPLICATION FOR THE CENTRAL BANK

The development of modern treasury functions and, in particular, improvements in the governments

cash management have implications for the central bank. In the first place, the modern framework

will be underpinned by the central bank having the operational responsibility for the conduct of

monetary policy. This is a reform that, in most cases, will have predated the development of cash

management. The precise nature of this responsibility varies and is determined by specific legal

frameworks and practices.

As a government begins improving its cash management, there will be a number of implications for

the central banks operations. Initially, as the TSA develops and cash is repatriated from MDAs

balances in commercial banks to the TSA, liquidity will move away from the banking system. This is

often helpful to the central bank, since the drain of liquidity will improve its ability to control domestic

monetary conditions over this period. Moreover, if the government has not been receiving a full

market rate on its cash balances, the implicit subsidy, in essence, will be removed from the commercial

banks. The withdrawal of deposits from banks will, of course, also have implications for the banks, as

discussed in the next Section.

As more active cash management develops, there may be implications for monetary policy

management. As the government starts to manage any surplus cash by transferring it out of the central

bankwhether by spending, by retiring domestic debt, or through short-term investment in the

banking systemthere will be a monetary easing, other things being equal.

A better cash plan will allow the treasury to hold smaller cash buffers to insure against an unexpected

shortage of cash. Additionally, if the balances are unremunerated, the central bank will lose the benefit


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of cheap deposits. There will be a further negative impact on the central banks profits if it is required

to drain cash to offset the monetary easing, either by issuing its own bills or borrowing through repo.

In the medium term, however, there will be a clear benefit to the central bank as the treasury improves

the quality of the cash plan projections and becomes better able to hold its cash balances at a low andstable level. This reflects the fact that the government no longer exerts a significant influence on

domestic monetary conditions. The moderation of fluctuations in the government deposits in the

central bank will provide a more stable environment for the central banks monetary policy operations.

There will remain other autonomous influences on domestic liquiditysuch as the change in the

publics demand for bank notes and net foreign currency inflowsbut these are, respectively, more

predictable or more directly controlled by the central bank. Even when the treasury is not able to

smooth cash balances completely, the central bank should benefit from an improved flow of forecast

information from the treasury on future changes in the TSA.

The central bank may continue to act as fiscal agent for the conduct of auctions. However, as the

number of money market transactions increases, there is a risk of confusion between the central banks

and the treasurys operations, particularly where the same group of market counterparties is involved.

In practice, most active cash managers develop their own front office capabilities, such as directly

managing the issuance of T-bills and T-bonds, conducting auctions, and promoting an active

relationship with market operators. In any event, it is important that there is no misunderstanding in

the market as to which institution is responsible for which activity, and their respective aims.

There needs to be clarity concerning respective policy responsibilities. This entails that the government

cash managers usually have no contact with the central bank regarding interest rate decisions or

prospective interest rate changes. Nor should they receive from within the government any advance

notice of policy statements or data releases that might affect the markets short -term interest rate

expectations. As to policy cooperation, the development of the domestic financial market, particularly

the money market, is an especially important area of cooperation between the treasury and the central

bank. A well-functioning money market both supports the conduct of monetary control throughmarket-based instruments (including repos), and facilitates a more active management of the

governments short-term cash flows.


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IMPLICATIONS FOR COMMERCIAL BANKS

The reform of cash management somewhat changes the treasurys relationship with the banking

system. It also imposes requirements on the banks. It is difficult to modernize government payment

arrangements without the banks being internally fully electronically integrated, with collective accessto a modern automated system for the clearing and settlement of payments.16 This system should

either be, or be linked to, a real time gross settlement system (RTGS), to allow low risk real-time

settlement of high-value payments across accounts at the central bank. Such arrangements would, in

turn:

1. Allow revenues to be passed from a peripheral rural branch to the banks head office and the

TSA on the same day.

2. Make it possible, under dispersed payment systems, to use zero balance accounts, with any

balances being swept into the TSA at the end of the day (and, if necessary, returned the next

day).

3. Enable same-day crediting of the bank accounts of suppliers or employees. For centralized

systems, this can be done without the need for intermediary transactions accounts, but where

they are still used, they will often be able to clear with the TSA on the same day.

4. Remove the requirement for expenditures to be prefinanced, or any government float or seed

financing, except perhaps to handle residual inefficiencies at the periphery.

The development of core banking and the RTGS is also usually a priority of the central bank. In many

countries, the modernization of the banking system has preceded the modernization of cash

management. However, where the banking system is lagging, it is important that the treasury takes the

initiative with the central bank to map out a program for development, using regulation or incentives,

as necessary, to cajole the banks. This model has implications for the commercial banks finances. The

ability to hold onto tax revenues for a time without paying interest before remitting them to the

government has been a traditional source of income in many countries, with lags of up to two weeks

being common. Also, as the government becomes more conscious of the need to repatriate balancesheld by MDAs under dispersed payment systems, a further source of profits disappears. In return for

this largesse, the banks may be willing to waive fees for services, but the two costs rarely offset, and

this cross-subsidy may not support efficient pricing


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SOME POLICY CHALLENGES IN THE RELATIONSHIP BETWEEN THETREASURY AND THE

CENTRAL BANK

In countries with less developed money markets, the constraints on liquidity management may force

the TSA held at the central bank into overdraft. Limitations on the use of the overdraft should bedefined, and the treasury should give reasonable notice to the central bank of any drawdown. The

payment of a market interest rate should act as a disincentive to use it. Any overdraft should be used

only for very limited short-term borrowing, and be repaid before the end of the fiscal year. Countries

with a structural surplus of cash, such as from natural resources, may hold it in the central bank, but

outside the TSA in some form of sovereign wealth fund.

The rules to create and operate these accounts should be clearly defined, particularly in relation to the

treasurys ownership of the resources, even if, in practice, the management of the account is Box 4:

Interest Paid on the TSA: Some International Experience The payment of interest by the central bank

is relatively rare among sub-Saharan African countries, where there are often legislative constraints

(South Africa and Ethiopia are exceptions). This has also been the case in the past in Latin America,

although interest is now paid on balances in Peru and Mexico, and Chile currently earns a market rate

on most of its cash balances. The benchmark rates that are used vary. They include the rates available

for nonbank deposits at commercial banks (Peru, Belarus, China) or for interbank deposits (Mexico);

the rates received on recent T-bill or related tenders (Italy, South Africa, Canada); and the rates on

counterpart assets held by the central banks (Brazil, Trinidad and Tobago, countries in the EasternCaribbean Currency Union).

Benchmark rates also include those linked to the central banks policies or corridor rates (the case for

several Eurozone countries, although different rates may be paid according to whether or not the

balances exceed target levels. Some other countries operate a similar size-related schedule, such as in

Mauritius). There are other examples where the interest paid is at rates below the markets rates

(Philippines, Macedonia, and Vietnam), although currently low international interest rates often make

the differential negligible. The use of the rate on counterpart assets when the balances are large helpsto protect the central banks balance sheet, although, arguably, it is then acting as agent, and the

treasury should have a role in identifying the assets.

The same general point applies to those wealth or stabilization funds held on central banks balance

sheets (for example, Botswana and Peru). In Brazil, the counterpart assets mirror the outstanding


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stock of debt in the market. This gives the monetary authority a range of instruments to use as

collateral, and also remunerates the treasury at a rate that reflects the overall cost of debt. Many central

banks that do not pay market interest rates on the main TSA current account are willing to do so on

term deposits provided by the central bank. Transparent governance mechanisms should be defined,

including those for investments and reporting.


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NATIONAL INSTITUTE OF PUBLIC FINANCE AND POLICY

The National Institute of Public Finance and Policy (NIPFP) is a centre for research in public

economics and policies. Founded in 1976, the institute undertakes research, policy advocacy and

capacity building in areas related to public economics. One of the major mandates of the institute isto assist the Central, State and Local governments in formulating and reforming public policies by

providing an analytical base. The institute was set up as an autonomous society, at the joint initiative

of the Ministry of Finance, Planning Commission, several State governments and distinguished

academicians. It is registered under the Societies Registration Act, 1860.

In its 38 years of existence, the institute has emerged as a premier think tank in India, and has made

significant contribution to policy reforms at all levels of the government. It has maintained close

functional links with the Central and State governments all along, and has built up linkages with other

teaching and research institutions both in India and abroad. Although the institute receives an annual

grant from the Ministry of Finance, Government of India, and various State governments, it maintains

an independent non-government character in its pursuit of research and policy.

1. RESEARCH

NIPFP is a premier research institution in public economics and policy. The institute has made

significant research contribution in the areas of revenue and taxation, fiscal management, public

expenditure, macro-economic policies, fiscal federalism and other policy issues both at the Central

and the State-level. Being the largest think-tank on public economics and policy in India, the institute

faces an overwhelming demand for research in these areas. Most of the studies are supported by

Central and State governments in India, and bilateral and multilateral institutions. Collaborative

research is also undertaken with national and international academic institutions. The institute has also

undertaken research for a few other countries at the request of the Governments of those countries.

Besides sponsored studies, the faculty at NIPFP also undertakes research studies in areas of theirinterest.

1.1. Taxation & Revenue

Tax Policy and tax administration has been among the core areas of interest in the Institute. The

Institute was and continues to be at the forefront of research on tax policies in India. The Chelliah


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Committee Report, which formed the basis for economic reform initiatives in the early nineties, was

supported by work at the Institute. The debate on introduction and design of State-level Value Added

Tax in India was anchored around a study by the Institute on Reform of Domestic Trade Taxes in

India. One of the first systematic studies on Unaccounted Incomes in India was undertaken at the

Institute in 1982. The team at the Institute has been consistently providing policy inputs through

research papers on issues relating to tax policy reforms in India. In recent times, the focus areas of

research have been understanding unaccounted incomes in India, issues in the design of GST for

India, evaluation of major tax incentives and analysis of state specific tax regimes for identifying

mechanisms for augmenting revenues.

2.

TRAINING

NIPFP undertakes training programmes on various aspects of public policy and public economics.

Participants of these training programmes include government officials, university and college

teachers, researchers and journalists from India and other South Asian countries. Training

programmes for government officials include both probationers in government services as well as in-

service officials from both India and abroad. The training programmes are specially tailored to the

needs of the participants and deal with specific themes. A list of training programmes conducted in

the recent years can be seen. While most of the programmes have been conducted on the Institute's

campus (adequate infrastructure for this purpose is available in-house), there have been occasional

instances of NIPFP delivering such training programmes elsewhere on demand.

3. POLICY SUPPORT

NIPFP extends its support to public policy formulation not only through research, but also through

representation of NIPFP faculty in various committees and commissions of the Central and State

governments. It has made significant contribution to policy recommendations of Indirect Taxation

Enquiry Commission, Economic Administration Reforms Commission, the Tax Reforms

Commission, Expert group on the Reform of Domestic Trade taxes in India, Expert Group on

Taxation of Services, Expert Group on the Introduction of VAT. More recently, the institute has

made a significant contribution to the background research done for the Financial Sector Legislative

Reforms Commission (FSLRC), and estimating revenue neutral GST rates at the request of the

Empowered Committee of State Finance Ministers. Members of the NIPFP faculty have also served

as members and advisors to various Finance Commissions constituted by the Government of India.


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Repeated references by the Finance Ministers in budget speeches to the Institutes work on several

policy related issues is a testimony to the importance of NIPFP in policy formulation.


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INDIRA GANDHI INSTITUTE OF DEVELOPMENT RESEARCH

Indira Gandhi Institute of Development Research (IGIDR) is an advanced research institute

established and fully funded by the Reserve Bank of India for carrying out research on development

issues from a multi-disciplinary point of view. IGIDR was registered as an autonomous society onNovember 14, 1986 and as a public trust in January 1987. On December 28, 1987 the campus was

inaugurated by Late. Shri Rajiv Gandhi, the then Prime Minister of India.

Subsequently, the Institute was recognized as a Deemed University under Section 3 of the UGC

Act. Since then it has been awarded the highest National Assessment and Accreditation Council

(NAAC) rating of A++ (under the old methodology) given to Indian academic institutions. Starting

as a purely research institution, it rapidly developed into a full-fledged teaching cum research

organisation when it launched a Ph.D. program in the field of development studies in 1990. The

objective of the Ph.D. programme is to produce researchers with diverse disciplinary backgrounds

who can address issues of economics, energy and environment policies. In 1995, the institute initiated

the M. Phil programme. The M.Sc. programme commenced in 2003 to introduce students to the world

of research at an earlier stage.


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TREASURY MANAGEMENT

1.

WHAT DOES A BANKS TREASURY DEPARTMENT DO?

Every bank has a treasury department. Particularly in the last five years, these departments have been

at the heart of all major financial institutions.

One of the main functions of a treasury department is to control and manage the bank's money (in

terms of capital and liquidity) and to make sure that all parts of the bank can readily access the cash

they need for their business activities. By doing so, it makes sure that the bank remains financially

secure, stable and able to function effectively to help its clients.

A treasury department is also responsible for liaising with the bodies that regulate banks, which set

rules regarding banks' capital and liquidity.

In order to ensure that banks are better able to withstand any future market stresses, their capital and

liquidity requirements have become an area of increasing focus. Banks' treasury departments work

closely on these issues and have a critical role to play. The treasury function of a bank is now an even

more challenging and interesting place to work.1

2. HOW DOESTREASURY WORK WITH OTHER PARTS OF THE BANK?

Working in Treasury gives you the opportunity to interact with all the different parts of the bank. It's

important for people across the bank to understand the implications of their trading activity on thebank's capital, the cost of the funding they use, and how our capital and liquidity are regulated and

controlled. All parts of the organisation come to us to get that knowledge and practical advice.

For banks like Barclays, operations are global, so the Treasury department is not just people here in

London. The department is spread across the world - for example, we have teams in many locations,

from Singapore to New York to the UAE.

Most banks have whole departments devoted to treasury management and supporting their clients'

needs in this area. Until recently, large banks had the stronghold on the provision of treasury

management products and services. However, smaller banks are increasingly launching and/or

expanding their treasury management functions and offerings, because of the market opportunity

afforded by the recent economic environment (with banks of all sizes focusing on the clients they

1 http://thegatewayonline.com/investment-banking/types-of-work/barclays-treasury-the-heart-of-the-bank


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serve best), availability of (recently displaced) highly seasoned treasury management professionals,

access to industry standard, third-party technology providers' products and services tiered according

to the needs of smaller clients, and investment in education and other best practices. A number of

independent Treasury Management Systems (TMS) are now available world-wide such as Hedgebook

Pro, Derivative Pricing and Hedgebook Audit, allowing enterprises to conduct treasury management

internally.

For non-banking entities, the terms Treasury Management and Cash Management are sometimes used

interchangeably, while, in fact, the scope of treasury management is larger (and includes funding and

investment activities mentioned above). In general, a company's treasury operations comes under the

control of the CFO, Vice-President / Director of Finance or Treasurer, and is handled on a day-to-

day basis by the organization's treasury staff, controller, or comptroller.

3. WHY DO WE NEED A POLICY?

The treasury policy should follow directly from the groups business strategy and set out the boards

appetite for risk and the role of the treasury function. The policy typically covers the roles and

responsibilities, sets out how the key financial risks are managed and provides a specific focus on cash

management.

Managing financial risk is often a major responsibility for the treasury function and this in itself, needs

to be carefully managed internally with a robust policy and set of detailed procedures. The treasuryfunction is different to other functions, for example:

Treasury transactions can be of significant value.

The financial markets can be volatile.

The use of derivatives is not always well understood and their misuse in the past has been well

documented.

The treasury function has limited resources and there are often major time pressures to carry

out complex financial transactions by a set deadline.

The role of policy is to set out the control framework so that risks are identified, measured, controlled,

reported and explained to senior management. Recent research shows that over 80% of corporates

have one global approved policy documented; 10% have policies in place but not universally approved

across the group and another 10% do not have formally approved policies.


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WHAT SHOULD A POLICY COVER?

The treasury policy should firstly establish how much risk the organisation is willing to accept and

how it will actively manage that risk. The policy should also detail the roles and responsibilities of the

treasury function and the staff within it. It should be maintained as a key working document thatoutlines the objectives of the treasury function, the risk appetite and the boundaries within which the

function can operate. As such, the policy should be regularly reviewed, updated and not simply filed

away until the internal auditor asks to see a copy. In practice, many organisations split the policy into

two or three documents; the first a very high level summary which the board approve on an annual

basis and the second a more detailed description of the risks, how they are going to be managed and

appendices which detail items such as banking relationships, authorisation limits for individuals and

instruments. The main components of a treasury policy should include:

1. Objectives of the treasury function.

2. Roles and responsibilities of the treasury function.

3. Detail of each risk that is being managed.

4. Permitted hedging instruments.

5. Authorisation/approval limits by instrument and risk type.

6. List of bank relationships.

7. Key performance indicators.

8.

Confirmation procedures.9. Settlement procedures.


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THE CHOICE OF INTERNATIONAL POLICY REGIME

Problems ensue when the central bank runs out of reserves, as it did in Thailand in 1997. The

International Monetary Fund (IMF) often provides loans to countries attempting to defend the value

of their currencies. It doesnt really act as an international lender of last resort, however, because itdoesnt follow Hamiltons ne Bagehots Law. It simply has no mechanism for adding liquidity quickly,

and the longer one waits, the bigger the eventual bill. Moreover, the IMF often forces borrowers to

undergo fiscal austerity programs (high government taxes, decreased expenditures, high domestic

interest rates, and so forth) that can create as much economic pain as a rapid depreciation would.

Finally, it has created a major moral hazard problem, repeatedly lending to the same few countries,

which quickly learned that they need not engage in responsible policies in the long run because the

IMF would be sure to help out if they got into trouble.

Sometimes the medicine is indeed worse than the disease! Trouble can also arise when a central bank

no longer wants to accumulate international reserves (or indeed any assets) because it wants to squelch

domestic inflation, as it did in Germany in 19901992. Many fear that China, which currently owns

over $1 trillion in international reserves (mostly USD), will find itself in this conundrum soon. The

Chinese government accumulated such a huge amount of reserves by fixing its currency (which

confusingly goes by two names, the yuan and the renminbi, but one symbol, CNY) at the rate of

CNY8.28 per USD. Due to the growth of the Chinese economy relative to the U.S. economy, E*

exceeded Epeg, inducing the Chinese, per the analysis above, to sell CNY for international reservesto keep the yuan permanently weak, or undervalued relative to the value the market would have

assigned it.

You should recall from Chapter 18 "Foreign Exchange" that undervaluing the yuan helps Chinese

exports by making them appear cheap to foreigners. (If you dont believe me, walk into any WalMart,

Target, or other discount store.)Many people think that Chinas peg is unfair, a monetary form of dirty

pool. Such folks need to realize that there is no such thing as a free lunch. To maintain its peg, the

Chinese government has severely restricted international capital mobility via currency controls,thereby injuring the efficiency of Chinese financial markets, limiting foreign direct investment, and

encouraging mass loophole mining. It is also stuck with a trillion bucks of relatively low-yielding

international reserves that will decline in value when the yuan floats (and probably appreciates

strongly), as it eventually must. In other words, China is setting itself up for the exact opposite of the


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Southeast Asian Crisis of 19971998, where the value of its assets will plummet instead of the value

of its liabilities skyrocketing.

In Chinas defense, many developing countries find it advantageous to peg their exchange rates to the

dollar, the yen, the euro, the pound sterling, or a basket of such important currencies. The peg, whichcan be thought of as a monetary policy target similar to an inflation or money supply target, allows

the developing nations central bank to figure out whether to increase or decrease MB and by how

much. A hard peg or narrow band effectively ties the domestic inflation rate to that of the anchor

country, instilling confidence in the developing countrys macroeconomic performance.

Indeed, in extreme cases, some countries have given up their central bank altogether and have

dollarized, adopting USD or other currencies (though the process is still called dollarization) as their

own. No international law prevents this, and indeed the country whose currency is adopted earns

seigniorage and hence has little grounds for complaint. Countries that want to completely outsource

their monetary policy but maintain seigniorage revenue (the profits from the issuance of money) adopt

a currency board that issues domestic currency but backs it 100 percent with assets denominated in

the anchor currency. (The board invests the reserves in interest-bearing assets, the source of the

seigniorage.) Argentina benefited from just such a board during the 1990s, when it pegged its peso

one-to-one with the dollar, because it finally got inflation, which often ran over 100 percent per year,

under control.

Fixed exchange rates not based on commodities like gold or silver are notoriously fragile, however,

because relative macroeconomic changes in interest rates, trade, and productivity can create persistent

imbalances over time between the developing and the anchor currencies. Moreover, speculators can

force countries to devalue (move Epeg down) or revalue (move Epeg up) when they hit the bottom

or top of a band. They do so by using the derivatives markets to place big bets on the future exchange

rate.

Unlike most bets, these are one-sided because the speculators lose little money if the central bank

successfully defends the peg, but they win a lot if it fails to. Speculator George Soros, for example, is

reported to have made $1 billion speculating against the pound sterling during the ERM balance of

payments crisis in September 1992. Such crises can cause tremendous economic pain, as when

Argentina found it necessary to abandon its currency board and one-to-one peg with the dollar in

20012002 due to speculative pressures and fundamental macroeconomic misalignment between the


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Argentine and U.S. economies. (Basically, the United States was booming and Argentina was in a

recession. The former needed higher interest rates/slower money growth and the latter needed lower

interest rates/higher money growth.)

Developing countries may be best off maintaining what is called a crawling target or crawling peg.Generally, this entails the developing countrys central bank allowing its domestic currency to

depreciate or appreciate over time, as general macroeconomic conditions dictate. A similar strategy is

to recognize imbalances as they occur and change the peg on an ad hoc basis accordingly, perhaps

first by allowing the band to widen before permanently moving it. In those ways, developing countries

can maintain some FX rate stability, keep inflation in check (though perhaps higher than in the anchor

country), and hopefully avoid exchange rate crises.


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GLOBALIZATION ANDTREASURY POLICY

Financial service providers are trying to differentiate their products and services to gain an advantage

over their competitors, by trying to offer services at customers home. Even mobiles service providers

have a large array of financial service offerings to attract new customers and to retain the existing.Internet has emerged as a convenient channel for these service providers Arpan et al. (2012).

Organizations have been investing heavily in building information links with their suppliers and buyers

to reduce costs and lead times to improve the timely customized delivery of products and services

Jagdish et al. (2011). The recent and rapid developments in communications and information

technology have brought unprecedented change in the lives of the people as well for banks. Internet

has touched almost all aspects of human lives. The way we live, shop, entertain and interact all purely

depend on the short word net called Internet. With this rapid development in communication and

information technology, various activities are handled electronically from the home or workplace.

In fact, internet is a global phenomenon, making both time and distance irrelevant. Gordian et al.

(2011) states that service industries started investing in information technology to bring cost savings

in their operations. It has emerged as a convenient channel for many service providers. Therefore,

internet definitely tries to influence the way people save and invest. The financial service providers,

from the developed countries have been using internet as a channel to deliver their services more

effectively and efficiently. Internet banking is defined as the delivery of banking services to customers

through the internet Chi et al. (2007). Majority of the service providers from the developing countriesstarted reaping the benefits by using internet as a service channel. The adoption of agile technologies

and methodologies by the managers made the information system, qualitative and foolproof Kenneth

et al. (2010).

The financial institutions use information technology as a tool to grant loans and maintains records

of individuals and enterprises that have been evaluated as credible Tarik et al (2009). Tero et al. (2004)

define internet banking as the internet protocol through which customers can use different banking

services ranging from bill payment to making investments. The costs of information technologyappear to have a stronger positive impact on bank performance when there are greater environmental

changes Abbaset al., (2012). Ruiliang et al. (2012) examines that, it is very much essential for banks to

share the information between the online and traditional retailers for a profitable e-business Internet

banking is the tool which allows consumers to do the banking transactions from the comfort of a

home with the help of an internet connection.


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Today, bank consumers round the globe are looking for the ease and convenience of internet banking

to take care of their financial needs. People are being comforted by the newer methods and

technologies of accessing the internet to check the status of their finances by the click of a mouse.

Internet banking uses more traditional technologies such as personal computers and internet in order

to pay bills, transfer funds and obtain account information Mavri (2006). The benefits of internet

banking are vivid which add value to customers satisfaction in terms of quality of services as well to

gain competitive edge over the competitors.


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TREASURY POLICY:THE INDIAN EXPERIENCE

1.

REFORMS

In 1967, a policy of social control over banks aimed to change commercial banks management and

distribution of credit. After successive waves of nationalisation, the public sector's share of deposits

was 92 per cent in 1980. 4 The share of directed lending to priority sectors stood at 40 per cent. The

statutory liquidity ratio (SLR) and the cash reserve ratio (CRR) were at 15 per cent and 38.5 per cent

respectively in 1991, compared to 2 and 25 per cent in 1960. The average return on assets was only

about 0.15 per cent and capital and reserves a paltry 1.5 per cent of assets. Inefficiencies created by

these severe restrictions on the use and the price of funds prompted liberalisation, as part of the

opening out of the economy. The shift from controls to markets sought to reverse financial repression.

But the change was gradual. Therefore, banks dependence on short-term or overnight wholesale

funding is limited. Most of the banks follow a retail business model. Loans dominate market

investments in balance sheets, reducing market risk.

The second half of the 1980s saw the introduction of treasury bills, the creation of money markets,

and a partial deregulation of interest rates hitherto used as a tool for cross-subsidisation. Further

reforms included a reduction in statutory pre-emptions and entry deregulation for both private

domestic and foreign banks, improved prudential norms and the development of inter-bank and other

markets. Legal changes such as the SARFAESI Act made it easier for banks to recover loans. Another

proposed reform was to reduce priority sector advances from 40 per cent to 10 per cent.

Although this was not implemented, expanding the definition of priority sectors to include sunrise

sectors such as information technology has reduced the effective burden of priority sector advances.

The CRR reached a low of 4.5 per cent in June 2003 and the SLR touched its statutory minimum of

25 per cent in October 1997. The long-term aim remains to reduce the CRR to 3 per cent. Outcomes

were positive. In 2004, the return on assets improved to 1.01 per cent and CRAR to 12.8 per cent.

Gross non-performing assets, as a ratio to gross advances, fell to 2.4 per cent in 2009-10 from 12.8

per cent in 1991.

In October 1994, banks were asked to announce a bank prime lending rate (BPLR), based on the cost

of funds. For advances of up to Rs.2 lakh, interest rates could not exceed the BPLR. For loans

exceeding this amount, which accounted for over 90 per cent of total advances, interest rates were

freed. Interest rates on all term deposits, accounting for 70 per cent of total deposits, were freed


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gradually. They were liberalised fully by 1997. Interest rates on savings deposits of over Rs. 1 lakh,

were also freed in 2011.

With BPLR, corporates could bargain for sub-BPLR rates while small borrowers were charged higher

rates. So from April 1, 2010, the Base Rate (BR) system was adopted. This was a floor rather than acap rate. Banks could determine their own base rate and actual lending rates based on it. The criteria

for determining the BR could include cost of deposits, overheads and negative carry for SLR and

CRR. BR was expected to increase credit flow to small borrowers at lower rates. It was also expected

to lead to faster and more transparent monetary transmission, since it was forward looking as

compared to BPLR, which reflected the past cost of funds. BR was to be linked to deposit rates of

one-year tenor since 80 per cent of loans were of one-year tenor. Banks feared corporates would go

to commercial paper (CP) etc. for short tenor loans. But the CP market is small in size and lacks depth

(outstanding only about Rs.831 billion in April 2010). Only highly rated corporates are expected to

source short-term funds from it. Moreover, some competition is healthy.

Freer post-reform entry meant that Indian commercial banks were evenly split in terms of numbers

27 public sector banks with majority government ownership, 22 private sector banks, and 32 foreign

banks. However, public sector banks still dominated in terms of assets. In 2009-10, they held 75 per

cent of the assets of the banking system, although this was less than their share in 1991 of a little over

90 per cent. Competition improved since banks could compete through interest rate policy and

product differentiation. Deregulation of the savings deposit rate is set to reduce the historical

advantage that public sector banks enjoyed in current and savings account (CASA) as hungry private

banks raise interest rates to attract deposits.

Technology and skills have improved, but public sector banks still lag behind private banks in systems

and use of sophisticated products and derivatives. Figure 4 showed the difference in use of off-balance

sheet items. In 2010-11, contingent liabilities as a percentage of the groups total liabilities were 41.4

per cent for public sector banks, 167.9 per cent for private banks and 1892.7 per cent for foreign

banks. 5 Given diverse capabilities, banks were allowed learning time for migrating to internal riskrating based capital charges. They have the option to apply for this from April 1, 2012. Valueat-Risk

(VaR) based credit risk calculation will take time to become feasible across all types of banks.


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