Pillai Institute of Management Studies and

Research (PIMSR),
New Panvel

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Master of Management Studies (MMS)
Semester - IV
Subject (Finance - Elective) :
Commercial Banking

Lesson-9 : Treasury Operations in Banks

Lecture date : 27.2.2018

by
Prof. K.G.S. MANI

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Lecture date : 27.2.2018
Lesson- 9 : Treasury Operations in Banks
(1) Concept of Integrated Treasury :
Treasury functions were confined to funds management –
maintaining adequate cash balances to meet day-to-day
requirements, deploying surplus funds generated in the operations,
and sourcing funds to bridge occasional gaps in cash flow. In
addition, Treasury Department is also responsible to meet reserve
requirements namely, holding with Reserve Bank of India
minimum cash balances required as per Cash Reserve Ratio (CRR)
(currently 4% of Net Demand and Time Deposits of the Bank) and
investing funds in approved securities to the extent under
Statutory Liquidity Ratio (SLR) (currently it is 19.5% of NDTL).
Thus Treasury function is essentially liquidity management .
However, the scope treasury function has expanded considerably
and it has since evolved as a ‘profit centre’ for the bank. The profit
generated by the Treasury Department of the bank accounts for
substantial amount nowadays.

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Earlier Treasury operations were primarily intended to attend
to cash flow requirements of the bank, and hence operated
only in money market. Merchant business was attended
through the Foreign Exchange Department, while bank’s
investment of assets were managed through a separate
department called Investment Management Department.
Earlier there were effectively three ‘treasuries’ operating in
three different markets, which have been integrated into one .
In other words, Integrated Treasury would mean that all
market activities are integrated in one Treasury Department
which will cater to the requirements of the customers such as
foreign exchange transactions, portfolio management services,
money market operations, and derivatives transactions. Also,
the process of integrating domestic market with global markets,
characterised by free capital flows and minimum regulatory
intervention. The large corporate customers can directly deal
with the Treasury Department of the Bank instead of going

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 through their respective branches. Treasury activities
encompasses funds management, investment, foreign
exchange operations, trading, dealing, and risk management
services. The driving force of Integrated Treasury are as under:
(i) Integrated Cash Flow Management;
(ii) Interest Arbitrage;
(iii) Access to global resources;
(iv) Corporate demand for high-end services; and
(v) Risk Management.

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(2) Objectives of Integrated Treasury:
(i) To take advantage of trading and arbitrage opportunities in
bond and foreign exchange markets.
(ii) To invest internal generation of surplus cash flows for
maximum returns.
(iii) To maintain statutory reserves – CRR (4%) and SLR(19.5%) as
per RBI guidelines
(iv) To provide for sufficient liquidity for the bank by way of
borrowings from the markets.
(v) To fund balance sheet on current and forward basis.
(vi) To manage forex assets and liabilities efficiently and effectively.
(vii) To offer comprehensive value-added treasury and related
services to customers.
(viii)To adopt best practices in dealing, clearing, settlement and risk
management.
(ix) To act as a ‘profit centre’ for the bank.
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(3) Functions of Integrated Treasury Department:
(i) Meeting the reserve requirements (CRR and SLR);
(ii) Global Cash Management;
(iii)Efficient merchant services, which include foreign exchange (forex)
and advisory services (Portfolio Management Services) for High
Networth Individuals (HNI customers);
(iv) Optimising profit by exploiting market opportunities foreign
exchange market, money market and securities market (equity,
debt and derivatives markets);
(v) Assisting the bank management in Asset-Liability Management;
(vi) Risk Management (Market Risk)
(a) Price Risk (Equity price risk and commodity price risk)
(b) Interest Rate Risk (reinvestment risk)
(c) Liquidity Risk (Mismatch risk, funding risk)
(d) Foreign Exchange Risk (currency risk, settlement risk,
transaction risk, and translation risk).

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(4) Treasury Structure :
(a) Responsibility:
(i) Overall responsibility rests with the top management
(ii) Headed by the Chief General Manager or General Manager
(iii) Segmental Heads – Deputy General Manager (Share market),
DGM (Money Market), DGM (Foreign Exchange Market), DGM
(Derivatives), DGM (Portfolio Management Services)

(b) Segments :
(i) Treasury Front Office (Dealing room)
(ii) Back Office ( Accounting, Settlement and Reconciliation)
(iii) Middle Office (Market Risk Management, Liquidity Risk
Management, Interest Risk Management, Foreign Exchange
Risk Management, Derivatives Risk Management).

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(c) Functions:
(1) Treasury Front Office:
(i) Dealers are responsible for dealing and trading activities with
their limits.
(ii) Maintaining CRR and SLR requirements as per RBI.
(iii) Providing for funds for liquidity requirements through
Collateralised Borrowing and Lending Obligation facility (CBLO)
and Liquidity Adjustment Facility (LAF) ( through Repo and
Reverse Repo transactions with RBI).
(iv) Money Market operations (purchase and sale of Treasury Bills,
Government Securities, Corporate Securities, etc).
(v) Borrowing and Lending surplus funds profitably (through
Clearing Corporation of India Limited (CCIL platform)
(vi) Obtaining/maintaining deal agreements/documents relating to
all dealings and trading activities.
(vii) Generate profit through trading and dealing activities.
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(2) Back Office Functions:
(i) Deal slip verification, trade confirmation from customers and
banks.
(ii) Settlement through CCIL platform or direct through NOSTRO
account.
(iii) Management of Nostro funds and Reconciliation of Nostro
accounts.
(iv) Submission of Statutory reports to RBI.
(v) Reconciling periodically, the Subsidiary General Ledger (SGL)
(securities held with RBI for SLR and other borrowings),
Current account maintained with RBI (for CRR purpose).
(vi) Accounting (Trading Book (HFT – Held for trading) and Banking
Book (HTM – Held to Maturity), valuation of contracts as per
Foreign Exchange Dealers Association of India (FEDAI) and
Accounting Standards of the ICAI (Institute of Chartered
Accountants of India).

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(3) Middle Office (Mid Office):
(i) Preparation of Policies and Procedure documents (for Treasury,
Market Dealings, Market Risk, etc).
(ii) Setting and monitoring various Treasury limits (Dealer limit,
Day light limit, Overnight Open Position limit, other Banks deals
limit, Borrowings limits.
(iii) Marking to market open trading positions.
(iv) Calculating, monitoring and Reporting Value at Risk (VaR) at
the end of every day.
(v) Stress Testing, Back Testing of investments and trading
portfolios.
(vi) Limits control, procedures control and breach of limits control.
(vii) Reporting to top management regarding various investment
positions, risk analysis under Management Information System,
(MIS) to facilitate the top management to take immediate
decisions.

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(d) Various Markets instruments:
(i) Capital market : Shares trading, Arbitrage operations.
(ii) Money market : Treasury Bills, Repos, Call Money (overnight),
Notice Money (1 to 14 days), Term Money (more than 14 days),
Certificate of Deposits, Corporate Bonds, Commercial Papers.
(iii) Securities Market : Central Government securities and State
Government securities trading.
(iv) Foreign Exchange Market : Spot deals, Forward deals, Swaps,
Arbitrage operations, Cross currency trading.
(v) Derivative Market : Futures (Current Futures, Interest Rate
Futures), and Options.
(e) Operating System in Treasury Department:
NDS – OM (Govt. securities), e-Kuber (RBI auctions for Treasury
bills), CCIL FX Clear, CCIL CBLO, Reuters Trading & Messaging
System, Bloomberg Trading system, SWIFT, RTGS and Customised
operating system (Kondor, etc), Automated Data Flow System
(without manual intervention).

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(5) Evolving role of Treasury as ‘Profit Centre’ :
The integrated treasury has afforded the banks an opportunity to
generate surpluses, to supplement profits from its core banking
activities. Treasury profits have become attractive for the following
reasons.
(i) Treasury largely operations in inter-bank markets which are almost
free of credit risk and hence requires very little capital allocation as
compared to lending activities of the bank.
(ii) Treasury activities are highly leveraged – the risk capital allocated
to Treasury may range between 2% to % of the size of
transactions handled, hence the return on capital is quite high.
(iii) Operational costs in Treasury are low as compared to branch
banking, whether retail or wholesale. The Treasury Department is
run by a few specialist officers engaged in high-value transactions.
Each transaction is generally being Rs 5 million (Rs 50 lakhs).
Treasury also trades in narrow spreads, hence profit is generally
from high volumes of business.

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(6) Sources of Treasury Profits:
Treasury profits are generated from the following sources.
(i) Foreign Exchange Business:
Buying and selling of foreign currencies from/to customers
(exporters and importers) through forward transactions.
(forward contracts). These transactions are executed by the
banks with profit margins. Banks are also buying and selling
foreign currencies under currency trading (proprietary trading)
activity and make profit.
(ii) Money Market Deals:
Banks lend money and borrow money from the Call Money
market or inter-bank market. Interest on funds lent in the
market is a source of income (profit) for the banks.
(iii) Investment activities:
Banks have always been investing in government securities to
satisfy the SLR requirements and also as a part of investment

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 activities. Banks are also investing in share market and earn
profit.
(iv) Arbitrage activity :
The Treasury operates across the currency and security
markets, hence is in a position to find where the interest
differentials are in its favour. The Treasury may borrow in USD
and lend in Rupee in inter-bank market or vice versa,
depending on the domestic and foreign interest rates (LIBOR
rate). Treasury may also borrow in the money market and
invest in short-term commercial paper or Treasury Bills,
Treasury may also buy shares in one market and sell in another
market, or buy in NSE and sell in BSE and book profit taking
advantage of intra-day volatility in the market.
(v) Trading Activities :
Trading is a speculative activity, where the profit arises out of
favourable price movements during the interval between

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 buying and selling. Banks with Authorised Dealer (No1) licence
from RBI, are permitted to trade in currency trading with pre-
set limits, in the foreign exchange market. Treasury may go
long (buy currency) or short(sell currency) on currencies to
profit from exchange rate movements. They may also swap
currencies, buying and selling currencies at different points of
time, to benefit from changes in forward rate movements
(which reflect changes in interest rates). Till the position is
squared, the dealer has an ‘open position’ value of which
changes as per movement of exchange rates. Treasury may so
proprietary trading in securities, where, in a rising market
(interest rate rises) securities are bought (at low price) and
sold with profit when the yields fall (at higher price) (since
interest yield and price of bond have inverse relationship)
(vi) Portfolio Management Services (PMS): Treasury Department
offer their products and services to the HNI customers. The

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 bank invests the funds received from HNI (High Networth
Individuals) and receives fees for and/or margin of profit on
trades.
(vii) Investment Banking Activities: Treasury is also involved
in investment banking where their responsibility covers trade
execution on behalf of the bank’s customers in the cash or
derivatives markets. These transactions may generate profits,
depending on the complexity and skill required to design and
put through the customised derivative products in the market.

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(7) Bank’s Treasury Products :
(a) Domestic Treasury Department:
(i) Asset Products / Investments:
(1) Call/Notice Money Lending,
(2) Term Money Lending / Inter-bank Deposits,
(3) Investment in Certificate of Deposits,
(4) Investment in Commercial Papers,
(5) Reverse Repos/CBLO (back lending through CCIL),
(6) Inter-bank participation Certificates,
(7) Derivative Usance Promissory Notes/ Bankers’ or Corporate
Acceptances
(8) SLR Bonds (notified as such by the RBI)
(i) Issued by the Government of India as securities and Treasury
Bills,
(ii) Issued by State Governments,

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(iii) Guaranteed by Government of India,
(iv) Guaranteed by State Governments.
(9) Non-SLR Bonds issued by –
(i) Financial Institutions,
(ii) Banks/NBFCs (Tier-II capital),
(iii) Corporates,
(iv) State-level Enterprises,
(v) Infrastructure Projects.
(10) Asset-back securities (Pass Through Certificates)
(11) Private Placements,
(12) Floating Rate Bonds,
(13) Tax-free Bonds,
(14) Preference Shares,
(15) Listed/Unlisted equity shares,
(16) Mutual Funds schemes.
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(ii)Liability Products / Instruments :
(1) Call/Notice Money Borrowings,
(2) Term Money Borrowings,
(3) Certificate of Deposits,
(4) Inter-bank Participating Certificates,
(5) Repos/CBLO – backed borrowings through CCIL,
(6) Refinance (RBI, SIDBI, NABARD, Exim Bank, National Housing
Bank)
(7) Tier-II Bonds (issued by the bank)

(b) Foreign Exchange:

(i) Inter-Bank:
(1) Spot Currencies,
(2) Cash Transactions, (immediate delivery)
(3) Tom (Tomorrow transactions)
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(4) Forward Transactions,
(5) Foreign Currency Placements, Investments and Borrowings (as
per guidelines of RBI),

(ii) Merchant (initiated in branches arranged by Foreign Exchange

Treasury Department)
(1) Preshipment Foreign Credit (PCFC) (Packing Credit facilities),
(2) Foreign Exchange Bills Purchased (FCBP),
(3) Foreign Exchange Loans (FCLs)/ FCNR(B) Loans,
(4) Postshipment Foreign Credit (PSFC) (Bills Discounting facilities)
(5) External Commercial Borrowings (ECB)

(iii) Derivative Products / Transactions:

(1) Interest Rate Swaps (IRSs),
(2) Forward Rate Agreements (FRAs),

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(3) Interest Rate Futures,
(4) Interest Rate Options,
(5) Currency Futures,
(6) Currency Options.

(8) Assignment :
Write a detailed note on the following, relating to a bank:
(i) Functions of Treasury Department,
(ii) Products handled, Dealing and Trading in Treasury
Department,
(iii) Roles of Front Office (Dealing Room), Back Office, and Middle
Office,
(iv) Various risks relating to Treasury Operations,
(v) Risk Management System for treasury operations.

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THANK YOU

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