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Treasury Operations

Why Treasury Operations in Banks?...
 To meet Statutory requirements
 SLR @23% of Net Demand & Time Liabilities
 CRR @4.25% of NDTL
 To Deploy Surplus funds profitably.
 To raise resources at competitive rates from domestic
& global markets.
 To remove asset-liability mismatches
 To gain from daily fluctuations in financial market
through trading activities
 To hedge open positions (for mitigating interest rate/
exchange rate risks)


Derivatives Investments

Forex Treasury Management

Bulk Deposits

Broad Constituents of Treasury
• SLR Securities
• Non SLR Securities
• Raising Tier I/ Tier II Bonds

• Merchant Transactions
• Trading (Currencies & Gold)
• Currency Futures
• Trading
• Back to Back Deals for Corporates (Swaps/ Options)
• Hedging of Bank’s Balance Sheet
• Interest Rate Futures

• Cash Reserve Ratio maintenance
• Inter bank Money Market Transactions
• Bulk Deposits including Certificate of Deposits Treasury
The Treasury Structure

Mid Office Back Office

(Settlement &
(Risk Mngment)
of Deals)

Front Office
(Strikes Deals)

Typical Functional Structure of the Division
DGM Risk Management Division

-Head Office
-Central Treasury FEOs (2)* (Extended Arms)-(CMs)

Front Office Back-Office Mid Office


SLR securities Settlement Risk Management
Non SLR Bonds Accounts - Domestic
Funds Audit - Forex
Equity Dealers Back office Integration ALM
CHIEF DEALER – FOREX/ Establishment

Derivative Dealers CHIEF MANAGER

Forex Dealers Computer Systems/ RTGS
Investment Committee:
 The Investment Committee is constituted in terms
of Board approved Investment Policy every year.
 The Committee is headed by the Executive
Director. Other members are GM (Credit), GM
(Treasury), GM (MASD), GM (RMD), DGM
(Treasury) and AGM/ CMs (Front Office,
 The Committee discusses/ reviews the prevailing
market conditions, likely trends in the financial
markets, economic scenario, interest rate /
liquidity scenario etc. and accordingly formulates
broad investment strategy every day.
 The decisions taken by Investment Committee
are properly recorded and meticulously complied
with. Treasury
Statutory Liquidity Ratio (SLR)
 Sec 24 of BR Act
 Till recently could be stipulated to minimum of
23% of NDTL
Recent Amendment to BR Act has removed the
lower ceiling for maintenance of SLR
 In Central/ State G.Secs and Other approved
Secs, Cash balances with RBI, SBI, & identified
banks, cash in hand & Gold
 Approved Secs- as mentioned in Sec 5 of BR
 Other Approved Secs- Also known as Trustee
 SLR can be kept more than required
Cash Reserve Ratio (CRR)
 Under RBI Act Sec 42.
 Till recently could be stipulated to 4.00% of NDTL
Recent Amendment to RBI Act has removed the lower and
upper ceilings for maintenance of CRR
 Presently stipulated at 4.25% of NDTL

 CRR kept in Current A/c with RBI at 18 Designated Centers

 Daily minimum balance required to be maintained is 70% of
average fortnightly requirement. (e.g. if total CRR balance
required to be maintained is Rs.100 cr per day, then on a
cumulative product basis, banks have to maintain at least
Rs.1400 cr during a reporting fortnight, but on any particular
day the balance should not be less than Rs. 70 cr. )
 RBI is not paying any interest on balances maintained as CRR .
 Equity / Preference Shares
 Units of Mutual Funds
 Commercial Papers
 Corporate Bonds and Debentures
 Spl. Central Govt. bonds like UTI bonds and
Oil Bonds.
 Bonds and debentures of PSUs, Government/
Semi Government autonomous bodies
 Investments abroad in the shape of equity
participation, subscribing to shares, etc.
Money Market Instruments
 Call Money
 Notice Money
 Certificate of Deposits
 Inter Bank Participation Certificates
 Term Money
 Commercial Papers
 Repo and Reverse Repos –with RBI/Market
 Rediscounting of Bills
 Collateralised Borrowing & Lending Obligations
I B/S disclosure:
 Government securities
 Other approved securities
 Shares
 Debentures & Bonds
 Subsidiaries/ joint ventures and
 Others (CP, Mutual Fund Units, etc.).
II Investment portfolio also classified under three
categories: Held To Maturity (HTM), Held For Trading
(HFT) and Available For Sale (AFS)
 Banks to decide category of investment on acquisition
Classification into HTM, HFT & AFS
 Securities intended to be kept in p’folio till their maturity
can be categorised in Held To Maturity (HTM) p’folio.
 Securities purchased with the intention to trade and gain
from market yields to be classified under Held For Trading
 The securities which do not fall under HTM or HFT will
be classified under Available for Sale (AFS).
 Banks can decide holdings under HFT and AFS
considering aspects such as basis of intent, trading
strategies, risk management capabilities, tax planning,
manpower skills, capital position.
 HFT Securities to be sold within 90 days
Valuation of Investment Portfolio:
 HTM securities not required to be marked to
market, hence no depreciation loss on HTM p’folio.
 AFS and HFT securities are to be marked to market
at regular intervals and if need be depreciation
needs to be provided on the same.
 Hence in firming interest rate scenario makes sense
to shift securities to HTM category to limit interest
rate risk.
 Banks, vide RBI guidelines of Sep’04, permitted to
keep 25% of NDTL in HTM category.
Shifting among categories:
 May shift investments to/from HTM category
with approval of Board of Directors once a
 Such shifting will normally be allowed at the
beginning of the accounting year.
 Transfer from one category to another has to
be done at the acquisition cost/ book value/
market value on the date of transfer,
whichever is the least, and the depreciation, if
any, on such transfer should be fully provided
Derivative Portfolio
(excluding Exchange Traded Currency/ Interest Rate Futures)

Swaps Options Structured Products

Swaps with embedded options

Single currency Cross currency

FX- INR Option FC-FC Option

CHF/INR Treasury
Why Derivatives ?
The existence of derivatives is because of uncertainty about
the future movement of financial markets. Derivatives
are tools to reduce uncertainties arising due to the
following factors:
1. Dynamic nature of interest rates. The interest rates
change over a period of time but the quantum of change
is not predictable.
2. Uncertain movement of interest rates not only in the
local economy but also across globally because of,
inter-alia, central banks’ moves on growth vs. stability.
3. Movement in exchange rates between different
currency pairs.
All above three factors expose the related parties to interest
rate/ exchange rate risks. Use of derivatives enables the
exposed parties in risk mitigation by resorting to interest
rate / exchange rate hedging by using derivatives.
Scenario 1:
 Corporate A has raised Rs. 100 crores Term Loan for 5 years
at fixed rate of interest of 12% pa. The corporate holds the view
that tracking business cycle, the interest rates are going to
 Repaying its present high cost borrowings and raising fresh
borrowing on floating rate is the right answer to this situation.
 But given the ‘on balance sheet’ rigidities it may not be
practically feasible to repay the fixed rate loan and raise a fresh
low floating rate loan.
 Corporate A would like to convert its ‘fixed rate liabilities’ to
‘floating rate liabilities’, without touching its original ‘underlying’
term loan. Division
Solution 1: Interest Rate Exposure Management
 Corporate approaches the Interest Rate swap market where
market makers are quoting fixed/ floating rates.
 Corporate can receive fixed rate of interest on a notional
amount equal to the underlying fixed rate term liability i.e. on
Rs. 100 crs. and pay floating rate of interest, based on a
quoted benchmark,.
 This exchange of interest rate i.e fixed vs floating is called
Interest Rate Swap, a Derivative Transaction.
 Effectively Corporate’s fixed rate loan payout on loan will get
cancelled out by receiving fixed rate of interest in swap
transactions and it will be paying the floating rate. Hence, the
fixed rate term liability has been converted into floating rate
liability as desired by corporate.

Solution 1: Interest Rate Exposure Management
 Pictorially, it can be represented as below:
 It can be seen the corporate is left paying floating rate whereas his fixed rate loan
payment has been offset.
Corporate Pays benchmark
linked floating rate to IRS

Corp. Pays Fixed rate 12% Corp. Receives fixed rate in IRS

on fixed rate term loan Corporate A for 5 years from IRS provider

Scenario 2: Interest Rate Exposure
 Corporate B has raised Rupee Term Loan for 5 years
at floating rate of interest, reset periodically. The
corporate holds the view that tracking business cycle,
the interest rates are going to harden but it is not in a
position to repay its present borrowings and raise fresh
borrowing on fixed rate.
 Here derivatives come into picture.
 Corporate B can enter into an “Interest Rate Swap” to
notionally convert its ‘floating rate liabilities’ to ‘fixed
rate liabilities’, without touching its original ‘underlying’
term loan.
Scenario 2: Management of Interest Rate Exposure
 And how it can be done? Corporate B undertakes to receive floating rate of interest in
the IRS and to pay fixed rate of interest, based on a quoted benchmark, on a notional
amount equal to the underlying floating rate term liability.
 Hence, the floating rate term liability has been converted into fixed rate liability as
desired by corporate A. Pictorially, it can be represented as below:
Corporate Pays fixed rate to
IRS provider
Corp. Pays Floating rate on Corp. Receives benchmark linked
existing term loan floating rate in IRS for 5 years
Corporate B
from IRS provider

Interest Rate Swap
 This transaction (IRS) is based on an
original ‘on balance sheet loan’ which is
referred as ‘underlying’ for entering
derivative transaction.
 The amount of loan on which swap deal
is based is called as ‘notional amount’.
 It does not represent any asset or debt.
It is used as principal for calculation of
interest amount.
Overnight Indexed Swap (OIS):
A Standard IRS Product
 An Overnight Indexed Swap (OIS) is Rupee benchmark
Interest rate swap.
 This swap is based on overnight NSE Mibor rate which is again
based on daily call money market rates.
 This is widely used and a very transparent IRS product.
 Participants quote a fixed rate for different tenor in exchange of
NSE Mibor rate.
 In other words OIS-IRS is a contractual agreement between two
counterparties, to exchange a series of cash flows Over a pre-
defined period of time to offset some existing interest rate
A typical OIS deal
Corporate receives 5 yr OIS at 6.20% for Rs 25 crore. In return, it will pay
overnight NSE Mibor rate.
 In this case the details are as follows
 Rs 25 crores is Notional principal.
 Term of the swap is 5 years.
 Rate for the receiving side is 6.20% which is called fixed leg
 Rate for the paying leg is overnight NSE Mibor rate which is called as floating
leg. It is reset daily.
 The cash flows will look as shown below
Receives 6.20%

Pays Daily O/N Mibor


Fixing Daily; Settlement every 6 months

Scenario 3: Management of Exchange Rate Exposure
1. A corporate with domestic operations is not directly affected
by the exchange rate of local currency with other currencies.
2. However, corporates with cross-border trade or borrowings/
lendings are directly affected by movement of exchange rate
of local currency with other currencies.
3. An exporter or a client with overseas investments may be
adversely affected on appreciation of local currency as it will
get lesser units of local currency for similar amount of
foreign currency that it will receive in future.
4. On the other hand, an importer or a client with overseas
borrowings may be adversely affected on depreciation of
local currency as it will have to shell out more units of local
currency for similar amount of foreign currency it will have
to pay in future.
Solution ??????
Forward Contracts
Since the future is uncertain, a corporate having
exposure to a foreign currency bears the risk of
appreciation/ depreciation of that foreign
currency vis-à-vis local currency.
To insulate itself from future uncertain exchange
rate movement, a client can “lock” the exchange
rate for a future date, which is called Forward
Currency contract.
Forwards are the basic building block for other
derivative instruments.

Forward Contracts: Tool to Manage Exchange Rate Risk
 USD/ INR Spot Rate: 48.50
 One Year Forward Premium: 1.00
Hence, One Year Forward USD/ INR Rate: 49.50

Receivable/ Investment Exposure:

By booking forward contract at 49.50, the client will be able to convert his
future receivable at assured rate of 49.50 enabling him to do his costing
accordingly. No loss if USD/ INR is below 49.50 on maturity but also no
gain if USD/ INR on maturity is above 49.50.

Payable/ Borrowing Exposure:

By booking forward contract at 49.50, the client will be able to convert his
future payable at fixed rate of 49.50 enabling him to do his costing
accordingly. No loss if USD/ INR is above 49.50 on maturity but also no
gain if USD/ INR on maturity is below 49.50.
The same is true for all other currency pairs. Treasury
Currency Options: The improvement over
‘Forward Contracts’
 An option agreement can be compared to an Insurance
agreement which protects against probable losses, in return
for a premium.
 Unlike forwards, an option holder can have unlimited
 Buyer/ holder of option enjoys the right to purchase or sell
the designated instrument, be it a currency, commodity or
stock etc., at a specified price within a specified period of
 Seller of option receives premium for selling that type of
Option Terminology
 Call Option gives the buyer the option without the
obligation to buy the underlying asset on a certain date in
future at a certain price.
 Put Option gives the buyer the option without the
obligation to sell the underlying asset on a certain date in
future at a certain price.
 Strike Price is the price at which the asset may be brought or
sold in an option contract, also called the exercise price.
 American Option can be exercised anytime during the term
of the option contract.
 European Option can be exercised only on the maturity
date. Division

1) Right to buy/sell Right as well as Obligation

to buy/sell

2) Limited loss Unlimited opportunity loss

3) Exercise, If profitable Must deliver/ close out
4) Customer decides rate Market decides rate
5) Premium payable No premium payable
6) Unlimited gain potential No upside gain potential
Why Options are better than Forwards?
1. Provides pure right and has no obligation. Hence, in case on
maturity date, if exchange rate of currency happens to be
better than strike rate, the client may not exercise his right
and may deal at the market rate.
2. Thus he enjoys the unlimited upside unlike forward contract
where it has to buy/ sell at the strike price only, which may
result in opportunity loss.
3. Client can chose the option strike price whereas forward
contract rate is market determined. (However, upfront
premium payable will change according to strike price
4. Option contracts include payment of upfront premium
whereas no premium is involved in forward contracts.
5. Options are generally preferred over forward contracts when
the direction of movement is not clear but there is high
volatility. Treasury
Derivatives Operations in Treasury
Approach towards derivative transactions can be
classified as under:
1. Trading Portfolio:-
To do proprietary trading in Overnight Indexed Swap to
earn profit from movement in OIS rates
2. Hedging Portfolio:-
To hedge the gaps of Bank’s own balance sheet; to
protect spread/ NIM, and to reduce high cost of fixed
rate liabilities.
3. Back to Back Portfolio:-
To undertake interest rate and exchange rate hedging
transactions for Corporates and cover the same
back to back in the interbank market.
Concept of Marked To Market (MTM)
 This is an important concept as it reflects ‘market
value’ of the outstanding derivatives position at a
particular time on the prevailing market rates.
 Though it is a notional number, it is useful, both
for trading as well as for customer side trades.
 In the trading we mark to market our portfolio on
daily basis and account for the same.
 On customer side the MTM forms the basis for
arriving at the credit exposure amount which we
monitor regularly.

MTM Calculation – An Example
Assumption: PNB has received fixed @ 6% pa in 5
Year OIS deal for notional Rs. 25 Crore.

Scenario 1: Fixed rate moves to 6.25%

PNB has right to receive 6% pa whereas now the
market receiving rate is 6.25%.
It means PNB is ‘out of money’ by 0.25% pa on
notional Rs. 25 crore for remaining tenor of the
The Present Value (PV) of this 0.25% pa (on notional
Rs. 25 crore) negative cashflows over the remaining
tenor of the deal is the negative MTM of the deal
for PNB. Treasury
MTM Calculation – An Example (contd….)
Scenario 2: Fixed rate moves to 5.75%
PNB has right to receive 6% pa whereas now the market
receiving rate is 5.75%.
It means PNB is ‘in the money’ by 0.25% pa on notional
Rs. 25 crore for remaining tenor of the deal.
The Present Value (PV) of this 0.25% pa (on notional Rs.
25 crore) positive cashflows over the remaining tenor of
the deal is the positive MTM of the deal for PNB
MTM is the cost or value, as the case may be, for
unwinding the existing deal at the present market rate.
Roughly, at around 6% fixed rate, on a standard 5Y OIS
deal of Rs. 25 crore, one basis movement in fixed rate
changes the MTM by about Rs. 1 Lac.
Currency Futures
Permitted Currency Pairs
Initially, currency future contracts were allowed only in
USD/ INR pair. Subsequently, GBP/ INR, Euro/ INR
and Yen/ INR has been permitted by RBI.  
Trading Hours
The trading on currency futures is allowed from 9 a.m.
to 5 p.m. From Monday to Friday. 
Size of the contract
The minimum contract size of the currency futures
contract is USD 1000.
Tick size
Tick size is 0.0025 Rupee.
The currency futures contract is quoted in Rupee terms.
However, the outstanding positions is in foreign
currency (USD, GBP etc.) terms.
Tenor of the contract
The currency futures contract have a maximum maturity
up to 12 months.
Settlement mechanism
The currency futures contract is settled in cash in Indian
Expiry date and time
Contracts expire two working days prior to the last
business day of the month and the contracts expire at
12 noon on the expiry day at RBI reference rate of the
Trading Mechanism
 Currently, Currency Futures are being traded on
3 exchanges. ( NSE, MCX & BSE)
 Bank should have membership in MCX & NSE.
 System Based operations
 Bank can Buy or Sell on behalf of customers and
take own proprietary position as well.
 Unlike other OTC products like Forward
Contracts and Options, customers need not
have an ‘underlying’ foreign currency
exposure to deal in currency futures.
 Hedging:
Risk mitigation of existing exposures to currencies
exchange rate
 Speculation:

For trading with a view to make profit if positions

turn favourable subsequently, and vice-versa
 Arbitrage:

To locate and profit from minor rate differences

between different cash/ forward markets
Margin Requirements
The currency futures transactions are characterised by
elimination of market/ settlement risk as the parties have to
deposit the margins as under:
Initial Margin
When the position is opened, the member has to deposit the
margin with the clearing house as per the rate fixed by the
exchange. Initial margin is 1.75% on first day & thereafter 1%
in addition to 1.75%.
 Marking to Market
At the end of trading session, all the outstanding contracts are
re-priced at the settlement price of that session. It means that
all the futures contracts are daily settled, and profit and loss is
determined on each transaction.
Maintenance Margin
Member’s account are debited or credited on a daily basis.
Interest Rate Futures
 An Interest Rate Futures (IRF) contract is “an
agreement to buy or sell a debt instrument at a
specified future date at a price fixed today.”
 They are standardised exchange traded financial
products which eliminate counterparty risk and price
discovery mechanism is transparent.
 Exchange traded IRF necessitates keeping of
Margins which eliminates settlement risk.
 IRF provide avenue for ‘Margin Trading’ for
participants who do not want to block funds in
‘long’ positions. Treasury
Key Features of IRF
 Underlying: 10 Year Notional Coupon bearing GOI security
 Coupon: Notional Coupon 7% with s/a compounding
 Lot Size: Rs. 2 Lac
 Tenor: Maximum maturity 12 months
 Contract Cycle: 4 quarterly contracts with fixed expiries.
 Daily Settlement
Price: Weighted average price of the futures for last
half an hour
 Margin: Initial margin (minimum 2.33%), Extreme Loss
and Calendar Spread Margins to be maintained
 Settlement: Physical delivery of deliverable grade securities

Key Features of Interest Rate Futures (contd.)
 IRF are traded on the Currency Derivatives segment of a
recognized stock exchange. Presently NSE and MCX-SX
are the two exchanges undertaking Currency Derivatives.
 The members registered by SEBI for trading in Currency
Derivatives shall be eligible to trade in IRFs.
 Banks, PDs, Mutual Funds, Insurance Companies,
Corporate Houses, Brokers, FIIs and Retail participants
shall be the market participants.
 Banks are allowed to trade on their own account. Also,
they shall be allowed to participate in IRFs for hedging
interest rate risk inherent in their entire balance-sheet,
including both on and off balance-sheet items. However,
banks are not allowed to undertake trades on behalf of
Utility of IRF for Banks
 Managing duration gap (mis-match in interest
re-setting dates on assets/ liabilities).
 Protecting against the devaluation of Govt.
securities in AFS and HFT portfolios due to
hardening of interest rates.
 Generating trading profit from interest rate
movements by utilising their experience of
substantial statutory investments in Govt.
Operational Issues in Interest Rate
Concept of ‘Cheapest to Deliver (CTD)’ Bond:
 Bond which can be bought at cheapest price from
underlying bond market and delivered against IRF contract
is called CTD bond.
 CTD bond is the bond where difference between “Present
Quoted Price of Bond” and “IRF Settlement Price *
Conversion Factor” is the most beneficial to seller.
 Conversion Factor is the multiplication factor to be applied
to the current market price of identified deliverable grade
securities to raise/ reduce the YTM of these securities to 7%
(the notional coupon of the underlying G-sec bond on
which the IRF is based).