ibf assignmnet
TRANSCRIPT
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Treasury Departmentof a Commercial Bank
2013
Submitted To:
Sir Imran Baloch
Submitted By:
Muhammad Ameen (0911119)
Maria Ali (0911229)
Sadia Ali (0911244)
Sidra Abbasi (0911247)
BBA VIII-D
26thMarch 2013
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Table Of Contents
1. INTRODUCTION: ............................................................................................................................... 2
2. DEPARTMENTS IN A COMMERCIAL BANK................................................................................ 2
2.1. TREASURY: ................................................................................................................................ 3
2.1.1. Desks in Treasury: .................................................................................................................... 3
2.1.1.1. Fixed Income or Money Market Desk:............................................................................. 4
2.1.1.2. Cash Reserve Requirement: .......................................................................................... 4
2.1.1.3. Statutory Liquidity Requirement: ................................................................................. 4
2.1.1.4. Auctions: ....................................................................................................................... 5
2.1.1.5. Open Market Operations (OMO):................................................................................. 5
2.1.1.6. Call/Term lending/borrowing: ...................................................................................... 72.1.1.7. REPOS/ Reverse REPOS:............................................................................................. 7
2.1.1.8. Outright sale/purchase of securities:............................................................................. 8
2.1.2. Forex Desk: ........................................................................................................................... 8
2.1.2.1. Nostro Account: ............................................................................................................ 9
2.1.2.2. Vostro Account: .......................................................................................................... 10
2.1.3. Equities Desk: ..................................................................................................................... 10
2.1.4. Asset Liability Management Desk:..................................................................................... 11
2.1.4.1. ALM Information Systems ......................................................................................... 12
2.1.4.2. ALM Organizations .................................................................................................... 12
2.1.4.3. ALM Process............................................................................................................... 13
2.1.4.4. Mismatch Management & Performance Measurement............................................... 13
2.1.4.5. Funds Transfer Pricing (Ftp)....................................................................................... 14
2.1.4.6. Liquidity Management ................................................................................................ 15
2.1.4.7. Summary of ALM Functions: ..................................................................................... 16
2.1.5. Propriety desks: ................................................................................................................... 17
2.2. Differences between Islamic bank treasury and Commercial bank treasury.............................. 18
Bibliography ............................................................................................................................................... 22
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1. INTRODUCTION:A bank is a financial intermediary that accepts deposits and advances them as loans. It acts as an
agent between surplus units (lenders) and deficit units (borrowers). Banking Companies
Ordinance defines Banking as banking means the accepting, for the purpose of lending or
investment, of deposits of money from the public, repayable on demand or otherwise, and
withdraw able by cheque, draft, order or otherwise; and banking company means any company
which transacts the business of banking in Pakistan and includes their branches and subsidiaries
functioning outside Pakistan of banking companies incorporated in Pakistan
Pakistans financial sector consists of Scheduled Commercial Banks which includes
nationalized, foreign, and private banks; and Non-banking Financial Institutions (NBFIs) which
include Development Finance Institutions (DFIs), Investment Banks, Mutual Funds and Pensionfunds. The Scheduled commercial banks are regulated by State Bank of Pakistans prudential
regulations and have to abide by various rules of capital and reserve requirements.
2. DEPARTMENTS IN A COMMERCIAL BANKWith growing economies, increasing globalization and industrialization, the number of banks
and their roles has increased. Most banks divide their activities into Consumer banking and
Corporate banking. The Consumer Banking is similar to B2C while Corporate Banking is similar
to B2B. These activities are divided among the different bank departments. In general, basic
departmental structure of a bank is depicted in the following diagram
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Treasu
ryDivision Money Market Desk
Forex Desk
Equities Desk
Derivative Market Desk
ALM Desk
Proprietary Desk
2.1.TREASURY:The treasury department in a bank has the main objective of managing the banks liquidity and
risk management. It mainly administers the cash requirement of a bank and invests in equity and
debt instruments accordingly. It is also responsible to invest excess cash (net of assets and
liabilities) for earning markup. The functioning has to abide by and follow the requirements of
State Bank of Pakistan.
2.1.1. Desks in Treasury:The work treasury division is divided over a
number of desks. Following are the desks in
Treasury department
Fixed Income or Money Market Desk Foreign exchange or Forex Desk Capital Markets or Equities Desk Derivative Market Desk Asset Liability Management Desk Proprietary trading Desk
Chairman, BOD,
President
BusinessDivision
SupportDivision
Retail
Bankin
Corporate
Banking
Operations
Finance
IT Services
Human Resource
Legal Consultancy
TREASURY
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2.1.1.1. Fixed Income or Money Market Desk:Basically, the need for a money market desk at a commercial bank is primarily driven by
the State Banks requirement for commercial banks to maintain the statutory and cash
reserves. According to this requirement, it is mandatory for to maintain a certain amount
of reserves with the State Bank of Pakistan.
2.1.1.2. Cash Reserve Requi rement:Cash Reserve Requirement or CRR is the amount of money that banks have to keep with
the State Bank of Pakistan as part of reserves. It is a portion of depositors money that the
bank holds, to be kept safe to ensure the banks have certain amount of secured liquidity at
all times. The State Bank also uses this tool to control the lending pool of banks. At present,
the Cash Reserve Ratio fixed by the SBP is 5 per cent on weekly average basis subject to
daily minimum of 3 per cent of time and demand liabilities1. (State Bank of Pakistan, 2012)
2.1.1.3. Statutory L iquidity Requirement:Commercial banks are required to keep some fraction of their assets in the form of cash,
Treasury Bills (T-Bills) or other approved securities. This fraction is called Statutory
Liquidity Ratio. Its main objective is to ensure that banks have sufficient funds in the form
of liquid assets. Currently this ratio (excluding Cash Reserve Requirement) is 15 percent oftime and demand liabilities. The form of eligible liquid includes T-Bills, PIBs (not more
than 5% of TDL), cash or foreign currency (State Bank of Pakistan, 2012). The State Bank
of Pakistan has decided SLR is determined on fortnightly basis on Friday (the close of
business) (The Daily Dawn, 2012)
1Demand Liabilities: deposits of the customers which are payable on demand e.g current deposits, savings deposits,
short term deposits etc
Time Liabilities: Fixed deposits, cash certificates, cumulative and recurring deposits, time liabilities portion of
savings bank deposits, staff security deposits, margin held against letters of credit, if not payable on demand, &
deposits held as securities for advances which are not payable on demand and Gold deposits (Institute of Banking
and Finance)
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2.1.1.4. Auctions:Money market desk is also responsible to take part in auctions of T-bill, as T-bill is also a
money market instrument (government bond with maturity of less than a year). This desk
could participate in money market transactions either through the primary or the
secondary market. However, only approved financial institutions, known as Primary
Dealers, can participate in the primary market via the auction of T-Bills and PIBs.
Currently there are 12 PDs in Pakistan, namely National Bank, HBL, United Bank,
Citibank, Faysal Bank, Standard Chartered Bank, JS Bank, Pak Oman Investment
Company, MCB Bank Ltd, NIB Bank and Bank Alfalah. For example, HBL can place its
cash in T-Bills by participating in State Banks fortnightly auction of T-Bills through
competitive bidding. Lets suppose if HBL bids at a price of 97.96 for a 3 month T -Bill at a
value of 200 million. If this bid is accepted, HBL would be able to earn a yield of:
The non-PD commercial banks can only deal in T-Bills and PIBs in the secondary market by
trading with these PDs. Banks can also bid their investment in Non-Competitive bidding, in this
case they surely get their bid accepted, however the yield in non-competitive bids is the weighted
average of all the competitive bids.
2.1.1.5. Open Market Operations (OMO):OMO is a tool used by central bank to inject or to with draw excess liquidity from Money
Market. State Bank of Pakistan sells/buys government securities (PIBs , T-Bills, Ijara
Sukuk etc) to withdraw/inject liquidity or control the money supply. The money market
desk takes part in OMO, it earns yield when SBP sells securities and earns margin when
SBP buys back securities, while on SBPs end - OMO is a tool to manage the economys
money supply
Example: State Bank of Pakistan conducted its Open Market Operations i.e.; Sale of Government
of Pakistan Market Treasury Bills /Pakistan Investment Bonds to State Bank of Pakistan through
Reverse Repo OMO (Injection) contract on March 22, 2013. The Reverse - Repo Agreement was
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for 7 days, the total amount offered was 485,700 million and amount accepted was 444,700
million. The accepted yield was 8.98% (State Bank of Pakistan, 2013)
SBP, monitors the daily liquidity position on the market, and conducts OMO when desired.
OMO is conducted through Reuters and bids are received through fax by the PDs.
The Money Market Dealer at the start of the day needs to update a money market blotter.
Blotter is a record of all transactions over a span of period (usually one trading day), in which all
details of the trade including the size of transaction, the type of order (buy order or sell order),
the price of order, etc are recorded (Investopedia, no date). The dealer hence has a clear picture
of all inflows and outflows of the day, and is able to manage the assets and liabilities and
equalize both sides of the equation.
(Orchestr Trade, 2011)
Based on the net position of the bank (net lender or net borrower), bank needs money to balance
its position (squaring the position).
Besides placing funds in Government or other low risk fixed income securities, the money
market desk participates in a number of activities to use the excess funds at the end of the day to
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earn markup or to borrow funds to square its position. These include clean lending, Outright
purchase of securities, Repo, Reverse Repo Etc.
2.1.1.6. Call/Term lending/borr owing:This refers to clean lending or borrowing among banks. Such form of transactions is done
without the use of any security as collateral. Clean lending is not highly present in the market
due to the availability of REPO and Reverse REPO. However, banks do get involved in such
transactions usually for overnight borrowing in order to meet their short term requirements
(Squaring their positions). For instance, if HBL is short by 200 million on Thursday 20th
March,
and expects to get enough inflows next day to cover the shortage, the money market desk could
square this position by borrowing 200 million from UBL on an overnight basis. In such
transaction, HBL would pay interest for one day only and this interest would be based on theKIBOR. But if this transaction had occurred on Friday, HBL would have had to pay the interest
for 3 days as the transaction would then mature on Monday. HBL in this transaction does not
give any collateral to UBL; hence it is called clean borrowing.
2.1.1.7. REPOS/ Reverse REPOS:Repo and reverse repo refers to purchase and repurchase of short term securities. The term of the
transaction may vary as per the mutual contract between the parties. Basically, it is a form of
collateralized borrowing. In Repo transactions, the borrower of cash sells its securities to the
lender with an agreement to buy back the same security at a stated maturity. Repos can be done n
the basis of several securities, however, T-Bills are the most common security used in these
transactions. The lender of cash makes money by earning the differential on the discounted price
of the security over the period of transaction. For example, if HBL needs to fulfill its short term
liquidity requirements of PKR 300 million for a week, it may borrow from another commercial
bank through repo. HBL has various marketable securities which includes T-Bills with days to
maturity of 60 days. ABL agrees to get in to a repo transaction with HBL at 9.7%. The face value
of the security is 350 million. HBL would receive an amount of
(
)
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by selling the T-Bills. On maturity, HBL would buy back the same security at a price of
(
)
Hence the amount of interest that HBL paid is
One of the benefits of a repo transaction is that the security used in the transaction is
exchangeable. This means that the HBL desk can request ABL desk to switch the underlying
security with another comparable security. This is beneficial in the sense that if HBL attracts a
large client who wants to place his fund in a T-Bill of 55 days maturity; HBL can cater to this
corporate client by placing another security with ABL and getting the previously placed security.
Reverse Repo works in the same way, here at maturity the repo transaction becomes a reverse
repo when the securities are bough back and cash is given. In the above transaction, at maturity
of Repo, when HBL buys back the security and gives cash, is a reverse repo transaction.
2.1.1.8. Outr ight sale/purchase of secur i ties:Money market desks also perform the function of portfolio manager for the bank by the purchase
and sale of government securities such as T-Bills and Pakistan Investment Bonds. The desk may
decide this on the basis of banks own strategy and market conditions. For instance if HBL
perceives that the policy rates would increase from 9.5% to 10.5% as a consequence of IMF
policies, the money market desk may sell its short term securities to gain benefit later on when
the interest rate rises.
2.1.2.Forex Desk:The basic function of the foreign exchange desk of a commercial bank is to facilitate large
corporate clients who are involved in international trade. They facilitate importers and exporters
to settle their transactions that involve foreign currency e.g. PSO needs to makes its payments in
US Dollars to oil companies and Nishat Mills receive payments in US Dollars from its
international customers which need to be transferred into PKR. The foreign exchange desk helps
the bank earn profits through the spread between bids and ask price. Lets suppose that PSO is a
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client of HBL and needs to make a payment of USD 20 million on March 21st. PSO would
approach HBL to get a quote for the exchange rate. If the deal between the two parties strikes at
Rs. 99.5 per USD, HBL would make the payment to PSOs supplier and debit PSOs account
with the equivalent amount. HBL would then cover its USD short position by asking for quotes
from forex brokers. The forex desk would aim to get the best rates in order to maximize their
profits. In order to do so, the forex desk would start buying USD in smaller quantities to get
better quotes. For instance, if they are able to get USD 5 million at Rs. 99.2, another 5 million at
Rs.99, and 10 million at Rs. 99.25; they would be making a profit of
This is an example of spot transaction where the client approached the bank on the day of
payment.
Besides spot transactions, forex desk also participates in forward currency contracts. Taking the
same example, PSO approaches the bank a month before the actual day of payment. PSO
perceives that the PKR would depreciate and hence they might face a higher cost, therefore they
want to enter into a forward contract with HBL so that they can lock the forex rate. Assuming
that the USD is trading at PKR 98 during this time, HBL would quote a higher rate to PSO as the
forex desk also perceives the Dollar to appreciate over a period of the month. So if the deal
strikes at Rs. 99.10 per USD, the forex desk would start accumulating dollars from that day
onward to buy it over the minimum cost possible and thus make profit by the wider spreads.
However these trades are subject to State Banks regulation on foreign currency exposure limits.
These trades are carried out through Nostro and Vostro accounts
2.1.2.1. Nostro Account:A Nostro Account is and account is a Domestic Banks Account is a foreign country, example
UBLs account in New York Bank is a Nostro Account.
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2.1.2.2. Vostro Account:A Vostro Account is a foreign countrys account in a Domestic Bank; example Ney work Banks account
in UBL is a Vostro account.
The trades through these accounts are subject to exposure limits imposed by State Bank of Pakistan to
control the foreign currency (usually dollar) inflow and outflow in the economy. If a Bank requires more
dollars then its exposure limit then the Bank has to syndicate with other bank to fill the order. (State Bank
of Pakistan, 2002)
2.1.3.Equities Desk:An equity desk in treasury department of a bank is responsible for managing banks equity
portfolio. It searches for different opportunities where the bank can invest and gain maximum
return, thereby, increasing the shareholders worth. An equity desk dealer usually deals in shares
listed on the stock exchange.
Banks in Pakistan may or may not have an equity desk; however, some other desk maybe
performing this function for the bank. In UBL, the equity desk is responsible looking after
banks CFS portfolio,badla and trading. They deal in various products from structured products
to customer specific products. Structured products usually include plain vanilla derivatives.
Moreover, they trade in different stocks listed on the Karachi stock exchange. The trading is
extended to transactions such as future buy/sell contracts, future short sell and leverage products.
The crucial aspect for equity desk workers is the performance of the economy which sets the
price of the stocks and influences their transactions immensely. Hence, correct view and
prediction regarding the economy is important for the equity desk workers. At UBL, equity desk
workers use their expertise to trade on those stocks on KSE which has a potential return and can
be of great benefit to the stockholders of the business.
An equity desk worker goes through the following cycle .
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2.1.4.Asset Liability Management Desk:One of the most significant desks operating in a banks treasury department is the Asset and
Liability Management desk. This desk is mainly responsible for overseeing various asset and
liability related activities including the establishment of the guidelines for the banks risk
tolerance levels. ALM is a strategic tool which is required for the management of profit rate risk,
credit risk and liquidity risk faced by the banks. This desk is further responsible for the banks
overall treasury and money market activities. Also, after monitoring and evaluating the various
types of risks a bank is exposed to due to its provision of financial services, the ALM desk
provides the bank an insight by helping formulate strategies for risk management. In short this is
the practice of managing risks which are a product of mismatches between the assets and
liabilities of a bank. This mismatch management help manage risk by matching the assets and
liabilities according to the maturity pattern, by matching the duration or by hedging or
securitization (Choudhry, n.d.)
For a banks ALM desk to be most effective the activities pursued for risk management must aim
to manage the volume, mix, maturity, rate sensitivity, quality and liquidity of assets and
liabilities on the overall basis so as to enable the bank to achieve the predetermined risk ratio.
Three major aims of an ALM desk in a bank are to stabilize short-term profits, to alleviate long-
The dealer asks forquotes from the broker
or dealing systems
He buys/sells thesecurity at the givenrates and records the
information
If the deal is executed,it is recorded on the
equity blotter
Transaction limits, varlimites etc are checked
Upon limit clearance,the transaction is sentto the back office for
validation and
confirmation
At the end of the day,equity desk generates asingle deal ticket for all
buy deals and otherdeal tickets for all sell
transactions
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term earnings and to maintain long-term substance of the bank. These goals enable the bank to
stabilize its ALM system and the bank does this by considering three main parameters; Net
Interest Income (NII), Net Interest Margin (NIM) and Economic Equity Ratio (EER)
(khabyadilip, 2011)
According to traditional approach, the major function of a treasury depa rtments ALM desk has
been the management of risk associated with the banking book. In addition to this main function
and the other functions which will be elaborated on later, the following are the tools which are
used by an ALM desk in a banks treasury (Barone-Adesi, 1994).
2.1.4.1. ALM I nformation SystemsThese are the information systems used to collect Real time information about the maturity and
behavior of loans and advances made by the bank and all its branches. For this data collection
process, in order to help the ALM process to proceed, ABC approach is used by banks. This
approach helps analyze the behavior of the asset and liability products which mainly reside in the
top branches of the bank thus accounting for the most significant part of the business. This
further deal with making use of this information collected to make assumptions as to how the
assets and liabilities in other branches of the bank would behave. The data and assumptions
extracted from the information gathered ultimately transforms or is refined with time and
experience of banks management within the ALM framework. This data collection has further
been facilitated by the spread of computerization (rbi.org.in, 2013).
2.1.4.2. ALM OrganizationsThe major responsibility of risk management lies with the management which decides the risk
management policy of the bank including the decision about setting limits for liquidity, interest
rate, foreign exchange and equity price risks. Also, an Asset-Liability Committee (ALCO) is
formed which consists of senior management including the CEO. The ALM desk, which is our
main focus and mainly consists of operating staff, is responsible for analyzing, evaluating and
reporting the risk profiles to ALCO. The staff in ALM desk prepares forecasts pertaining to the
possible changes to the banks risk appetite due to external market conditions related to balance
sheet and recommend what actions could be taken considering the banks limitations (rbi.org.in,
2013).
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2.1.4.3. ALM ProcessThe ALM process or the scope of the ALM function could be described by considering the
following steps involved in the process (Baid, 2012);
Identifying risk parameters. Identifying types of risk the banks ALM desk or the overall bank is subject to. Measurement of the risks identified based on the risk parameters worked upon. Strategies employed for the management of the risks identified. Risk policies established and risk tolerance level of the firm evaluated and identified.
The entire ALM process defines the scope of the ALM functions performed by the ALM desk.
This mainly includes the following elements or criterion judging the ALM functions
effectiveness (Baid, 2012);
Liquidity risk management, which it does by overseeing the money market activities. Management of Market risk, which includes the interest rate risk. Funding and capital planning, which includes taking care of transactions like asset
purchased or sold and liability taken or repaid with respect to the banks funding
requirement.
Profit planning and growth projection, which the desk does so by evaluating the cost ofthe risks involved along with the evaluation of the banks profitability position and past
and present growth rates.
Trading risk management which involves risks expected to be experienced in the tradingactivities of the bank, especially in case of international trading.
Considering these tools used by the ALM desk of the treasury department of bank, following
activities are carried out (Report, 2008);
2.1.4.4.
Mismatch Management & Perf ormance Measurement
The first activity that an ALM desk performs is the mismatch management between the assets
and the liabilities. This is sometimes also known as the mismatch position of the balance sheet.
Mismatch balance sheet represents a bank probable to experience an interest rate and liquidity
risk profile. This mainly involves the ALM desk working towards managing the regulatory
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capital with the active positioning of balance sheet in a way so as to enable the bank to earn
maximum profits. The management of this mismatch is essential for a bank owing to its need of
meeting the clients demand and maximizes the return on capital. The bank does this through gap
management. This term describes the situation where the practices of varying assets and
liabilities lead to the gap in response to the expectations about the future interest rate course and
the shape of the yield curve. This is the difference between the floating-rate assets and liabilities.
In order to manage this mismatch through gap management, the ALM desk conducts various
analyses which are mainly designed to identify the reasons behind this mismanagement, see if
the mismatch is static or dynamic (stable or continuously changing), and check the sensitivity of
net interest income and market-value under multiple scenarios. All these integrated together help
the banks ALM desk reduce the mismatch between assets and liabilities. In case of mismatch
management, the bank also decides on whether taking a neutral approach to dealing with ALM
risks or will it go for a more aggressive approach. After considering this, the bank makes the
decision of the resources to be allocated to the measures taken for the management of this
mismatch (Report, 2008).
Performance measurement is one other activity conducted by the ALM desk of treasury. The
desk does this by using the three parameters of Net Interest Income (NII), Net Interest Margin
(NIM) and Economic Equity Ratio (EER). Majority banks make use of NII as the main measure
for the performance measurement. While some advanced banks make use of market or economic
value as the secondary measure of performance. The process involves the bank making various
assumptions which must be realistic and align with the market situation as well as the current
scenario the bank is operating in. lastly, the access to timely and accurate data of the ALM desk
from other desks of the treasury department would help the desk in risk management and other
activities (Barone-Adesi, 1994).
2.1.4.5. Funds Transfer Pri cing (Ftp)Funds Transfer Pricing system or FTP is the fundamental tool that is used by banks for risk
management and asset and liability management. The tool mainly involves the ability to the
bank to become immune to the risks that it might face as has been discussed before and provide
the bank with economic and product transparency. The main purpose of this process is to identify
the interest rate margins and using those margins curtails the interest rate and funding risk or the
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liquidity risk. The process involves locking the margins on loans and deposits by assigning them
a transfer rate that reflects the re-pricing and the cash flow profile of each item on the balance
sheet. The system also helps in the centralization and management of the interest rate mismatch
by isolating the business performance of each of its portfolios into different discrete portfolios,
each assigned an individual metrics for measurement (Report, 2008).
In many banks, FTP is also used as a tool for the management of the balance sheet structure
which is done through an analytical process which in turn helps in the identification and
understanding of the competitive advantage of the bank, helping in the allocation of assets and
protection of the franchise. The FTP rates are structures to include interest rate risk and funding
liquidity risks which are derived from the transfer yield curve constructed from the appropriated
premiums (Knowledge Base, 2011).
2.1.4.6. L iqui dity ManagementThe liquidity management function of the ALM desk mainly involves the management of the
funded liquidity risk which is embedded in the balance sheet of a bank. This process involves the
funding of the long-term loan mortgages and other securitized assets with short-term liabilities.
The ALM process helps the ALM desk assess the resilience of funding and liquidity sources.
Maturity transformation is another function of the ALM desk which it carries out, owing to the
need to meet the customers requirements and liquidity, interest rate and currency mismatches
management. According to the traditional approach, the ALM desk analyzes and manages
liquidity within the pre-set limits defined by the bank (Report, 2008).
The liquidity management also includes the ALM desks responsibility to recognize the liquidity
risk, properly articulate the risk tolerance level of the bank and using this tolerance level
scrutinize the balance sheet on regular basis. ALM desk follows five principles for the
governance of the liquidity risk, which includes diversifying sources and terms of funding,
identifying, measuring, monitoring and controlling risk, understanding the relationship of
liquidity and other risks, establishing tactical and strategic liquidity management platforms and
preparing contingency plans for implementation under various probable scenarios (Report,
2008).
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The ALM desk also makes use of five liquidity management tools. Namely these are Static
funding gap, Dynamic cash-flow gap, Liquidity asset ratios, Concentration ratios and Liquidity
stress measurement. Static funding gap mainly measures the gap or deficit in the banks ability to
fund the maturing assets from maturing liabilities. This is mainly done based on the maturity
bucket basis. Dynamic cash-flow gap mainly measures the marketable asset liquidation with the
help of maturing assets and liabilities measurement. Liquidity asset ratios are the ratios of liquid
assets over liquid liabilities. Liquid in this context mainly includes cash and cash equivalents,
trading account securities, repos investments into government securities etc. Concentration ratios
are ratios helping the bank assure the funding compared to assets and liabilities or capital from a
particular source. Liquidity stress measurement is all about evaluating the banks stress situation
by seeing the multiple ratios performance in high stress and low stress situations (rbi.org.in,
2013).
2.1.4.7. Summary of ALM Functions:According to the traditional approach, ALM desk of a treasury department is responsible for the
risk management of the bank, which mainly includes the following functions or activities
conducted by the ALM desk (Global Money Markets; Asset Liability Management, 2013)
Interest rate risk management which mainly includes the management of interest rate riskfrom banking books and includes interest income sensitivity analysis, maturity gap and
duration gap analysis, sensitivity of the book to the changes in the yield curve.
Liquidity risk management which includes the measurement of the regulatoryrequirements which lead to knowing the proportion of banking assets which will be held
as short-term instruments.
Reporting on hedging of risk which involves updating senior management with thebanks risk exposure.
Setting risk limits which involves setting, implementing and enforcing the risk limits andmonitor the compliance with these limits.
Capital requirement reporting which involves compilation of the capital requirementreports and informing regulatory authorities
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After the traditional approach, various developments took place in the ALM desks function in
the treasury department. These developments added the following functions under the ALM desk
as well (Global Money Markets; Asset Liability Management, 2013);
Making use of VAR (Value-at-risk approach) tool for assessing the risk exposure. Integration of market and credit risk Usage of new risk-adjusted measures of return Optimization of portfolio return. Proactive management of the balance sheet
Thus these are the various activities and functions of the ALM desk of the treasury department.
2.1.5.Propriety desks:Proprietary desk is another function of the treasury in a bank, where traders work solely with the
aim to generate profits for the bank itself and not for customers. The money used in these
transactions is of the banks own money rather than its customers money. Trading takes place in
stocks, bonds, options, commodities, derivatives, or other financial instruments for banks own
account. The traders have a clear of capital gains on the banks money.
The trading takes place for the bank's own account and capital. These traders work in isolation
with the other processing departments so that there is no conflict of interest or situation where
the trader might want to benefit the customer than the bank. Also, the objective of these desks is
to earn profits that are above those that could be earned in their normal market-making trades.
A crucial point in propriety desk is the risk of insider trading and the outflow of non-public and
price sensitive information. An activity most commonly known as fronting running where a
propriety desk knowingly purchase shares ahead of the customers trade so as to benefit the price
increases which would be beneficial when the customers deals are processed.
The Proprietary desk holds three types of securities, Held to maturity, Held for trade and
Available for sale. The securities that are held for maturity have strict conditions of not to be
used in trade, while the prop desk traders use the other to securities to generate profits.
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Prop desk also functions to run the yield curve in a bank, as they sell securities of different
tenures on different yields, it generates a yield curve that reflects banks view on the short and
long term interest rates.
2.2.Differences between Islamic bank treasury and Commercial bank treasuryTreasury department in an Islamic bank and the one operating in a commercial bank have
slightly different operations owing to the obvious difference of Islamic banking conducting
interest free banking while commercial banks conducting interest-based banking. Although the
main function of the treasury is the same in both the banks, that is the management of the
banks funds, yet there are certain transactional differences which surface the society
(Knowledge Base, 2011).
1. Islamic banking treasury plays an important role in the management of funds in anIslamic bank. Being a Shariah complaint institution, the banking transactions are profit
based and not interest based.
2. In an Islamic bank, treasury department manages two types of funds; shareholdersfunds and depositors deposits like current account deposit, saving account deposits,
general or unrestricted investment deposits, specific and restricted investment deposits,
Wakalah deposits and Commodity Murabaha deposits.
3. Excess funds which are not used for financial activities are reinvested by the treasurydepartment in other Shariah compliant instruments. Compared to the conventional or
commercial banking, Islamic banking is more liquid, however the short-term
investments of the IFIs is limited meaning lower returns while in Commercial banks,
returns are highas the short-term investments are unlimited.
4. On the other hand, commercial banks treasury is an interest-based treasury, where themain function, as of Islamic bank is the management of funds. However the element
that differentiates an Islamic banking treasury from a commercial banking treasury is its
operations.
5. The main transactions or products of a treasury of a commercial bank include foreignexchange market products which include spot and forward transactions, which are
not the product of the Islamic banks. Spot transactions are done but not forward
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transactions. Time deposits are traded in the commercial banking treasury while are not
traded in the Islamic banking treasury.
6. Commercial bank treasury manages shareholders funds, depositors deposits like currentaccount deposit, saving account deposits, general or unrestricted investment deposits,
specific and restricted investment deposits, and other lending transactions like
commercial bonds and papers which earn interest on them (Treasury Operations in
Islamic Banking, 2011).
7. The two main requirements that an Islamic banking treasury has is the need to maintainthe minimum statutory reserve which is imposed by the central bank and the
maintenance of Banks liquidity requirements.
8. Monitoring and controllingshort and long term risks is another function carried out bythe banks treasury. The treasury is responsible to advice on the type of deposits and
financing assets, especially the type of pricing that must be marketed.
9. In an Islamic treasury, the type of risks that the bank considers mitigating does notinclude the interest rate risk, since the banking transactions are interest-free and profit-
based. An additional risk that Islamic banks may be exposed to, owing to the policy of
keeping banks assets at fixed profit rate, is the commercial displacement risk which
is the risk of movement of deposits from Islamic banks to conventional/commercial
banks.
10.In order to mitigate this type of risk, the Islamic banks are allowed to maintain a profitequalization reserve. Same are the functions of a commercial banking treasury, yet the
difference is that a commercial banking treasury also manages funds from the
commercial papers and bonds, which earn interest on them.
11.The additional risk that commercial banks suffer from is the interest rate risk which isdeemed to be mitigated by the interest rate management by the treasury. Also the treasury
department of a commercial bank overseas the long term interest rate positions and
carries out the banking activities according to this forecast, so as to earn the highest
interest on its investments (Treasury services, 2001-2013).
12.The treasury of an Islamic bank aims to manage the mismatch created in the assets andliabilities owing to the long term assets which include Sukuk, project financing and
real estate financing. While a commercial banking treasury manages the mismatch or
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gap in assets and liabilities created by assets like commercial bonds, corporate bonds,
forwards and future contracts, spot contracts, T-Bill is and many other interest-bearing
assets. Liquidity of Islamic banks and short term funding is higher than commercial
banks (Farooq, 2010).
Considering the Treasury management system of both the banks, system is similar of both banks
and includes the following players (Treasury services, 2001-2013);
Front office which includes treasury dealers. Middle office, which works upon the banks real time compliances to the banks credit,
market and liquidity risk.
Back office which is responsible for conducting the back office functions of the treasurydepartment like deal confirmation, settlement, deal maintenance and cancellations.
Apart from that, the Islamic banks being Shariah complaint banks include treasury activities like
trading which encompasses the money market deals, ALM activities like management of the
asset liability mismatch but does not include the desks of Derivatives and foreign exchange,
since these desks trade in derivative securities and foreign securities bearing interest (Farooq,
2010).
Thus these are the few differences that exist between an Islamic banking treasury and acommercial banking treasury department. This can further be briefed by considering the
following functions of the treasury (Iqbal, 2008);
Planning and operations activities which includes the management of funds, assets andother kinds of funds. Cashflow forecasts, risk forecasts, investment appraisals, tax and
pensions planning, ensuring quality service standards all come under this head in both
systems Islamic and Commercial
Cash and Liquidity management (ALM) which includes the asset and liability mismatchmanagement which is done in commercial and Islamic banks on different liquidity
instruments. In Islamic banking specifically these instruments are Repo, Murabaha,
Wakalah, Mudarabah, Sukuk and Structural deposits.
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Funding and capital markets which includes managing capital instruments portfoliowhich includes short and long term investments.
Financial Risk Management which includes interest rate risk for commercial banks apartfrom other risks and commercial displacement risk for Islamic banks.
Corporate governance which involves management of treasury transactions and policies. Stakeholdersrelations who pertain to manage banks relations with investors and other
stakeholders like customers or board of directors.
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