The treasury management (or treasury operations) can be explained as the management of the best possible use of surplus funds, maintain liquidity, reduce the overall cost of funds, and mitigate operational and financial risk.
Traditionally, banks used to have two separate departments for treasury operations of a bank namely the domestic treasury/investment operations of a bank and foreign exchange treasury operations. Fundamentally they used deal with arranging the funds whenever the bank needs the funds and to deploy the surplus funds for profit. The treasury dealings are normally short-term funds-flow of the bank. However, in case of SLR requirement, investment in some securities is held to maturity exceeding one year. As a risk management function, they cover underlying assets and liabilities across short, medium and long-term maturities.
The domestic treasury operations were essentially meant for management of reserve ratios, i.e., CRR and SLR (which are basically the govt. securities) and Fund Management. Over the period, the treasury operations evolved as independent profit centres of the banks as these operations indirectly contributes to revenue generation of the banks. Every bank would have designated certain portion of the investment into held to maturity and a part as held for trading portfolio to exploit profit from trading. Raising funds by issuing several liability instruments and investing them by taking up different items of asset products are the other activities of the treasury.
When the bank lends at money market or bond market, those assets become treasury assets of the bank. On the other hand, once a bank borrows money from the money market or bond market, it is said to have undertaken a treasury liability. We have to remember that the deposits received from bank customers are not treated as treasury liability as deposits accepted by the banks are not market borrowing. Similarly loans and advances made to customers are not treasury assets. In the other words, when a particular asset or liability is created through a transaction in the inter-bank market and if it can be negotiated or sold in the market, it becomes a part of the treasury portfolio of the bank.
The treasury (foreign exchange division) dealing in funding and managing foreign currency assets and liabilities. Their main task is to provide a ‘cover’ to the customers of the bank in respect of their foreign currency exposure on account of their merchant transactions, viz., exports, imports, remittances, etc. In addition to that the dealing room of the banks engages in providing different hedging and derivatives products to manage the-interest rates and exchange risks of the customers of the bank and accordingly they do cover operations in the inter-bank market. They also exploit profit through arbitrage operations such as buying currency on the spot market and sell the same currency in the futures market if there is a beneficial pricing discrepancy.
Integration of domestic and foreign treasury divisions:
Integrated Treasury, in a banking set-up, refers to integration of domestic and foreign exchange operations. Prior to the integration of two departments, these departments work independently and without any communication between them. For example, banks borrow and lend money among them on the interbank market in order to maintain appropriate, liquidity levels, and to meet reserve requirements placed on them by the banking regulator. Under the traditional system, the staff working in one department was not aware of what the other department was doing. For example, ‘say’ the Forex treasury was placing its surplus funds for one month at interbank (Libor) rate 0.19% interest while domestic treasury was borrowing equivalent amount for one month at interbank (MIBOR) 4.32% interest. Here one department was borrowing money at a higher rate of interest and the other department of the same bank was lending money to other banks at a much cheaper rate of interest. The integration of the forex dealing and domestic treasury has helped the bank to overcome this unwanted situation as they consolidate outflow and inflow of money both from domestic and foreign exchange operations. In the integrated scenario, banks no longer distinguish between Rupee cash flows and foreign currency cash flows. Further, the integrated treasury has direct access to the various segments of the market, viz., money market, capital market, forex market, etc. and it has an overview of the bank’s total funding needs. They have multiple accesses to foreign currency funds through their off-shore operations, FCNR (B), RFC, and EEFC and float funds from external commercial borrowings (ECB) of corporate customers for funding needs. Further, banks look for interest arbitrage across the currency markets and are in a position to move quickly. Banks can also source funds in global market and swap the funds into domestic currency, or vice versa, depending on the market opportunities. For example, banks can make placement of Rupee denominated commercial paper to lending in USD in global interbank market.
Integrated Treasury therefore is in a position to operate across the sectors and across the currency markets, either in search of higher returns, or in order to mobilize low-cost funds for liquidity needs. Integrated Treasury is also fully involved in risk management, in particular, management of market risk, often using derivative products. To know various terminologies used by banks in their dealing rooms in their day to day operations read below post.