Internal Audit for Treasury Market Risk Management

Treasury Dealing Room

• Authorized by the bank’s risk management committee.

• Interface to international and domestic financial markets.

• Clearing house for matching.

• Managing and controlling market risk.

• Provide funding, liquidity, investment support

Organizational Structure of Bank’s Treasury• Dealing

– Risk taking– Performed by front office

• Risk management– Performed by mid office

• Management Information– Performed by mid office

• Verification– Confirmation of deals– Settlement of deals– Accounting and reconciliation– Back office

Internal Control System

• Functional separation of trading, settlement, monitoring , control and accounting.

• Functional separation of trading and back office functions such as investment accounts of banks, client’s portfolio management scheme, broker’s accounts.

• External audit of portfolio management scheme of clients.

Internal Control System

• Dealing slip for each transaction by the trading desk

– Nature of deal

– Number of counter parties

– Direct deal or deal through a broker

– Amount of securities traded

– Price of securities traded

– Contract date and time

System of Treasury Deal

• No substitution of counter party once trading has been conducted.

• No substitution of security purchased or sold once trading has been conducted.

• Maintenance of independent books of accounts by the accounts section.

• Maintenance of Subsidiary General Ledger (SGL) account and Bank Receipt records.

• Reconciliation of bank’s books with balances in the books of public debt office at quarterly intervals

Reporting to Top Management

• Reports on a weekly basis.

• Details of transactions in securities.

• Details of SGL transfer forms issued by other banks that have bounced.

• Bank receipts outstanding for more than one month.

• Review of investment transactions.

Monitoring by the Audit Committee

• Total exposure of the bank to capital market (fund based and non fund based).

• Ensuring the compliance of RBI guidelines.

• Monitoring of risk management system.

• Monitoring of internal control system.

• Ensure that stock brokers as directors in the bank Board do not take part in investment committee decisions.

Treasury Risk

• Market risk

– Risk to the bank’s earnings and capital through

changes in market rates, security prices, foreign

exchange and equity instruments

• Liquidity risk

– Ability of banks to meet its liabilities

– Funding risk

– Time risk

– Call risk

Treasury Risk

• Interest rate risk

– Possibility that interest rates adversely affects the

bank’s financial position

– Bank’s earnings measured through net interest

margin

– Economic valuation of banks

Treasury Risk

• Foreign exchange rate risk

– Loss suffered by banks due to adverse movement of

exchange rate

• Credit Risk

– Possible loss of principal and or interest

• Operational risk

– Risk of direct or indirect loss from inadequate internal

processes, people, systems, external events

Market Risk Limit

• Past performance of the trading unit

• Experience and expertise of the traders

• Quality of internal control

• Pricing, valuation and measurement systems in place

• Projected level of trading activity

• Liquidity of products and markets

• Efficiency of systems in place to settle trades

Market Risk Limits

• Notional or volume limit

• Stop loss limit

• Gap or maturity band limit

• Value-at-risk limit

• Options limit– Delta limit– Gamma limit– Vega limit– Theta limit– Rho limit

Guidelines on Internal Control System

• Risk identification processes

• Control environment

• Reliability and integrity of management information system

• Statutory compliance of internal regulator

• Budgetary control

• Verification of investment trades

• Compliance with the internal audit report

Risk Based Internal Audit

• Review of risk systems

• Compliance with money laundering regulations

• Identification of potential internal business risks

• Identification of measures and systems to control risks

• Establishment of corrective parameters

• Follow up of review reports by the internal audit committee

Stages of Internal Audit

Checklist for Internal Audit

I. General

• Policies for all treasury activities.

• Policies in tune with the nature of operations.

• Responsible persons are associated with the policies.

Checklist for Internal Audit

I. General

• Policy specifies types and purposes of the financial instruments.

• Policy specifies frequency of reporting and reporting authority.

• Maintenance of cash reserve ratio and statutory liquidity ratio requirements.

Checklist for Internal Audit

II. Organisation Structure

• Treasury activities are supervised by an officer independent of day-to-day activities.

• Effective segregation of key duties (treasury dealing, settlement of accounting, reconciliation of accounts).

• Policies and procedures are documented and easily accessible to all staff.

Checklist for Internal Audit

II. Organisation Structure

• Defined job descriptions and delegations for key treasury positions.

• Availability of sufficient resources to operate the treasury effectively.

• Segregation between functions of authorization, execution and recording of transactions.

Checklist for Internal Audit

III. Personnel: Training, Compliance and Performance

• Trained personnel.

• Verification of employees’ references.

• Verification of documents signed by employees at the time of joining.

Checklist for Internal Audit

IV. Deal Execution Process

• Confirmation of transactions concluded by the dealing room with the back office manager.

• Systematic filing of procedure.

• Examine third party payment.

• Outward confirmations are recorded in a register.

Checklist for Internal Audit

V. Limits

• Counterparty exposure limit for all brokers, lenders, etc.

• Dealing limits (maximum amount, a person can transact without seeking higher level approval).

• Product limits (maximum exposure in a particular instrument or product).

• Sector limits (maximum investment in a particular sector).

Checklist for Internal Audit

VI. Recording Control

i) Control over Documents

• Timely and accurate execution of money market deals and recordings.

• Receipt of all documents and statements from concerned parties (brokers, bankers, lenders, etc.).

• Numbering and filing of copies for ease reference.

Checklist for Internal Audit

VI. Recording Control

ii) Control over Accounting Procedures

• Adequate systems to track all matured investments.

• Accurate recording and accounting of positions.

• Counter checking of records by an independent person.

Checklist for Internal Audit

VI. Recording Control

ii) Control over Accounting Procedures

• All deals are recorded in the General Ledger.

• Account reconciliation has been done and time frame has been set for clearing all outstanding items.

• Inspection of source documents.

Checklist for Internal Audit

VII. Reconciliation of Bank Accounts and Treasury Records with the General Ledger

• Bank balance with bank statement.

• Reconciliation of treasury records with the general ledger.

Checklist for Internal Audit

VIII. Cash Management

• Effective procedure for monitoring the daily cash position.

• Planning of the liquidity needs for normal operating conditions and emergency situations by management.

• Trend analysis of cash forecasting.

• Bank statements.

• Review of liquidity position.

Checklist for Internal Audit

IX. Investment

• Review and follow up of investment strategy.

• Authority level and monetary limits set for investment in different instrument.

• Documentation of list of investments.

• Analyse of investment portfolio statements.

• Holding of investments in the bank’s name.

• Documents with regard to ownership of investments.

Checklist for Internal Audit

IX. Investment

• Bank utilises third party investment managers.

• Control of the investment managers’ activities.

• Appraisal of investment managers

• Compliance of investment policies by investment managers.

• Evaluation of internal / external investment managers’ performance.

Checklist for Internal Audit

X. Documentation for Derivative Transactions

(i) Usage of International Swaps and Derivatives Association (ISDA) documentation, with suitable modifications.

(ii) Confirmation for each derivative transaction with details of the terms of the contract such as gross amount, rate, value date, etc.

Checklist for Internal Audit

X. Documentation for Derivative Transactions

(iii) Individual transaction confirmation.

(iv) Evaluation of legal capacity, power and authority of the counterparty to enter into derivative transactions.

(v) Documentation of the agreement with the counterparty prior to undertaking any derivatives business with them.

(vi) Documentation regarding customer suitability, appropriateness, etc.

Checklist for Internal Audit

XI. Investment in Debt Securities

• Frequency of interest payments.

• Information about the issuer and the credit rating.

• Terms of issue such as use of issue proceeds, monitoring

agency, formation of trustees, secured or unsecured nature of

bonds, assets underlying the security and credit-worthiness of

the organisation.

• Comparison of the Yield To Maturity (YTM) of the debt

security with the YTMs of other comparable debt securities of

the same class and features.