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1. Introduction
Treasury department of a Bank or Financial Institution
(FI) bears the responsibility of managing substantial assets
and liabilities and plays an important role in improving the
bottom line of their organisation (IASBC, 2010). Treasury
operations normally consist of activities related to
investment and funds management with ultimate goal of
optimising performance as per the business objectives of
the organisation and in consonance with the regulatory
framework as well. In banking parlance, the classical role of
treasury and investment activities include meeting
regulatory requirements, managing liquidity, identifying and
hedging foreign exchange exposures, mitigating
counterparty risk etc.
In India, in addition to performing their prime duty of
statutory responsibilities, treasury department of a
bank’s/FI’s is expected to generate regular and consistent
income and that too at a minimum operational cost. In the
last few years, bank’s/FI’s expectations and dependency on
generating income from investment banking activities have
increased manifold because of, inter-alia, reduction in
traditional remittances and collection based fee income. For
example, after starting of Real Time Gross Settlement
(RTGS) of funds facility under core banking solutions, fee
based income from remittances and collections have
disappeared virtually from the banking scenario. Similarly
there is a drastic reduction in the income from issuance of
guarantees and letter of credit because of stiff price
competition among the increasing number of branches of
old, new, public, private and foreign banks. In the scenario,
banks have been compelled to concentrate on generating a
part of their income from their treasury and investment
banking activities which is a herculean task. Experts believe
that treasury operations are the most vulnerable banking
activities and exposed potentially to a wide range of risks
22 The Indian Banker
Electronic copy available at: http://ssrn.com/abstract=2728161
Treasury Operations
in Indian Banks
Challenges in
Operational Risk Management
Arya Kumar and Akhilesh Tripathi
and challenges arising from various financial, business and
operational risks, where
Financial risks include market risk, liquidity risk, and
credit risk;
Business risks include risk arising from macro-economic
changes such as interest rates, inflation, GDP rate,
implementation of government programmes/directives
(such as loan waiver scheme) and any other factors affecting
banking environment; and
Operational risks include a range of threats from loss of
key personnel, settlement failure, and compliance failure, to
theft, systems failure and building damage etc.
2. Operational risks in treasury operations
The banking industry has been facing a challenging
environment for the past few years. In the aftermath of the
financial crisis of 2008, banking business has become far
more sophisticated and complex and simultaneously risky
also. Banks are in the business of risk and perform a very
critical function of risk transformation which results in
warehousing of risks (Sinha 2012). The risk taking
behaviour of banks contribute and amplify systemic risk
which have severe repercussions in financial and economic
fragility which was witnessed during and in the aftermath of
the latest global financial crisis.
For treasury, the categories of risks, such as market risk
(exchange rate and interest rate risk), liquidity risk, and
credit risk are relatively well known, operational risk is not.
Post Liberalisation, Privatisation and Globalisation (LPG),
operational risk has increasingly been considered as an
important financial risk and thanks to Basel Committee on
Banking Supervision, popularly known as Basel Accord, it
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has also gained cognizance similar to or more than market
risk and credit risk (Dutta et al, 2006).
Operational risk has been defined by Basel Committee on
Banking Supervision (2004) as ‘the risk of loss resulting from
inadequate or failed internal processes, people and systems or from
external events, including legal risk, but excluding strategic and
reputational risk’.
Process related risk factors emanate from absence or
deficiencies in the existing systems and procedures and/or
Table-1-Perceived Operational Risks in Treasury Operations
Vol VIII No. 5 - May 2013
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ARTICLE
unintentional failure in adhering important stipulation,
procedure, related to the functioning of treasury and
investment operations.
Systems related risk control factors arise from
technological, networking and other systems related
activities because of eg unintentional break down of
computer systems / networking etc.
People related risks are considered as the large, existing,
potential and most important source of risk as these arise
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from violation, manipulation and bypassing of internal
policy guidelines, systems & procedures by the concerned
staff members intentionally for personal benefits and gains.
External events related risks include natural (earthquake,
storms, flood) mayhems and/ or humans’ actions (sudden
change in government/ government policies, market
scenarios, etc).
It may be added here that, in India, external events do not
influence treasury operations, as much as in the other
countries because most of the treasury operations are
supervised and monitored by the regulatory bodies, Reserve
Bank of India (RBI), Securities and Exchange Board of
India (SEBI) whose meticulous compliance for adhering to
various norms and directives, save treasuries from internal
and global market implications, particularly negative
implications. This apart, the geographical location of India
also plays an important role in preventing implications of
external events, especially from natural calamities and
havocs, as India is better located from her many Asian,
American and European counterparts. Against this
backdrop, the discussions on external events have been
repudiated in our paper and we have concentrated only on
the remaining three major risk factors- people, process and
systems.
In Table-1 we furnish an overview of such major risks,
challenges and incidents, embedded into day-to-day
treasury operations.
Understanding of above major perceived operational risks
in treasury operations is necessary to develop risk
understanding and risk culture within treasury. Across the
globe, experts are realising that many losses earlier occurred
due to failed operational or internal processes and wrongly
accredited to credit risk or market risk failure, were in fact
operational risk faults (Wei, 2006, Cummins et al, 2006).
Samad Ali Khan et al (2009) go a step further and opine
that during the past 20-25 years, every catastrophic financial
loss2 eg of Barings Bank, Long Term Capital Management,
Allied Irish Bank-All First, Société Générale, Bear Stearns,
Lehman Brothers, American Insurance Group,National
Australia Bank,WorldCom, Enron, etc. should
unquestionably be attributed to operational risks failures
and mismanagement. Mehra (2010) supplements, stating
the root cause for all such incidences being not ‘new’ or so-
called ‘unknown risks’ arising from derivatives or
collateralised debt obligations etc but meltdown in core
ethical values across the banking and financial institutions.
Experts analyse a few prominent reasons behind these
financial losses and crisis as –
• Inappropriate use of Investment Research
24 The Indian Banker
• Preferential allocations of shares in the new Initial
Public Offerings (IPO), so-called ‘spinning’
• Inappropriate pricing of Mutual Funds
• Inappropriate behaviour in interest rate auctions
• introduction of new products and technologies into the
financial system eg derivatives
• Fraudulent/improper activity on the part of one
person or group – primarily to protect bonuses
• Trading in derivative securities – in particular ‘selling’
options in volatile markets
• Non-adherence to critical policies and procedures, in
particular trade confirmation and
• an aberrant ‘corporate culture’ which not only failed to
encourage questioning the concerned persons about the
risks being taken, but encouraged imprudent risk taking
behaviour and that too for making higher profits.
Experts believe that many similar unethical practices,
wrongdoings, if not downright illegal, inherited from greed,
misdeeds, moral meltdown and rogue trading are still
persisting albeit unearthed and managed efficiently. The
persons attached with the treasury and investment business
line of various banks and financial institutions across the
globe are aware and realise that there are black sheep who
manipulate the systems and procedures for their personal
benefits and gains in the cote of technological
advancement, complex banking and financial products,
intrigue risk modelling etc. Despite stringent actions and
strict guidelines from the regulators of respective countries,
‘these rouge traders’ still by pass and manipulate the
process easily and perpetrate damage to their organisations.
Major operational risk contributing factors, attached to the
functioning of treasury and investment activities are given
in the following Figure-1.
3. Dimensions in treasury operations
A treasury is involved in many activities. A brief overview
of its various operations is detailed in the Figure-2.
Functioning of treasury operations necessitates clear and
transparent functional distinction, demarcation and
separation of duties/responsibilities of various
functionaries attached to it. In India, various regulatory and
statutory bodies, RBI, SEBI, FEDAI (Foreign Exchange
Dealers Association of India), and FIMMDA (Fixed
Income Money Market and Derivatives Association) put
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Figure -1- Operational risk factors affecting
treasury operations
forth guidelines in three layers/stages/phases for
demarcation of treasury activities–
a. Front Office activities,
b. Mid Office activities, and
c. Back Office activities
A banking organisation/financial institution mitigate
operational risks of its treasury operations by implementing
procedures that separate clearly and visibly the front office
(trading), middle office, and back office activities.
Bank’s/FI’s segregate treasury functions by assigning
specific job role to the respective functionaries and ensure
non-overlapping of their assignments/activities. This
demarcation of activities/job roles in these three separate
layers/compartment/cells ensures, inter-alia, avoidance of
interrelated clashes of functions. We detail hereunder a
brief overview on these functional segregations and
demarcations:
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ARTICLE
A) Front office activities are undertaken by the
traders and dealers to conduct three component of
treasury operations in a banking organisation-
domestic, which cover inland treasury operations to
meet statutory requirements viz maintaining
Statutory Liquidity Ratio (SLR), Cash Reserve Ratio
(CRR), and liquidity management- borrowing and
lending money in call money market etc. In Forex
category of business activities, deals are undertaken,
in other than domestic currency, to meet
organisation’s proprietary and its customers’
requirements as well. Trading segment of treasury
activities include both domestic and foreign
exchange segment of treasury operations and are
undertaken by the traders to meet proprietary as
well as customers’ demands and normally with a
short term horizon in both domestic capital and
money markets and foreign exchange market as well.
Brief overview of these functional segregations and
demarcations are given in Figure-3.
Challenges associated with front office
activities3
Primarily, front office undertakes deals in domestic
market in local currency and in Forex market in
foreign currency. Normally an organisation has
different dealers for undertaking these activities. For
example, in a mid-sized treasury of a banking
organisation/financial institution, have separate
dealers for call money market, fixed income
securities, equity trading and investment, derivatives
(options, futures) etc. These dealers may undertake
deals according to the bank’s/FI’s investment policy,
Figure-2- Dimensions in Treasury Operations
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Figure-3- Front Office Activities
guidelines, systems and procedures and ensure meticulous
adherence to the various statutory and regulatory
guidelines. A few challenges related to these activities are -
(i) Price discovery-which is the process by which
buyers and sellers interact to determine the fair
market price of an asset. Trading in the financial
markets is about obtaining prices. In efficient
financial market, prices reflect the future risk and the
return associated with a security. Trading decisions
also impact how prices will move and trading
activities continuously feed new information into
market prices.
(ii) Rate reasonability which relates to a mechanism or
process for checking that the rate entered by a dealer
that is likely and reasonable, based on the expected
daily fluctuations possibilities in that rate. For
example under normal circumstances interest rates
and exchange rates will move within a certain daily
range and a rate reasonability check will flag any rates
that are outside that boundary.
26 The Indian Banker
(iii) Proprietary trading and customers’ trading - In
proprietary trading a bank/FI trades stocks, bonds,
options, commodities, derivatives or similar financial
instruments for its own account ie for its own profit
rather than trading on behalf of its customers. In
simple terms, in a proprietary trading, the trading desk
of bank/FI, carries out trades in various instruments
using its own funds. It involves taking active position
with a view to capital gain. Proprietary trading entails
substantial risks as securities are bought, held and sold
in the expectation of profits from changes in market
prices. Banks involved in this form of trading with
the aim to directly benefit from the market rather
than through the commissions they might earn from
processing trades on behalf of their customers. There
are a number of ways in which proprietary trading
can create conflicts of interest between a trader's
interests and those of customers of their
organisation. One such activity is ‘front running’ of a
customers’ order- where the proprietary desk trader
knowingly purchases shares ahead of the customers’
trades, so as to benefit from the price increases that
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could result when the customers’ deals are processed. to day monitoring of various front and back office
This results in profits for the proprietary desk at the operations of a treasury department, mid office personnel
cost of the banks’ customers who end up paying are normally based either at the treasury department itself
higher prices for their trades. Similar example may be or near to the treasury department, which is headed by a
bank staff encouraging customers to buy particular functionary, responsible for front office and back office
securities, performing poorly, after the proprietary functions also. This proximity of location and the
traders have bought them for the bank. So the ownership interest of head of the department, influence,
challenge is how to avoid conflicts of interest or sometimes, mid office functionaries’ decisions. Hence the
situations where the proprietary desk’s trades could most important challenge for mid office people is how to
harm the bank’s customers’ interests.as well as how to function effectively without being influenced by the
ensure that proprietary trading desks function in powerful dealers and senior functionaries of the treasury
isolation from those processing trades on behalf of department. A few similar challenges are associated with –
the banks clients
• Establishment of effective interaction with the front
B) Mid office activities – play an important role in office, back office and other department functionaries
establishing effective interaction with the front office
and back office. It ensures that treasury operations are • Examining roles of key treasury personnel attached
in control with reference to decisions strategy, with front office, back office, and other treasury
execution, delivery, counterparties, business process, operations and ensuring non-overlapping
reporting and accounting. Mid office activities are
undertaken for ensuring performance monitoring and • Acquaintance with the knowledge and techniques
conducting review exercise of treasury operations. required to effectively support and supervise the risk
Mid office activities ensure risk control through profile of dealers’ positions, in line with internal and
adherence of various tolerance limits viz stop loss external risk management and regulatory guidelines
limits, currency limits, broker limits, exposure limits
etc. All these activities are undertaken through various • Monitoring deal life cycle - from consummation to
risk management exercises such as Liquidity Risk post-settlement reconciliation
Analysis, Interest Rate Risk Analysis, Scenario
Analysis, VaR, Duration, Modified Duration etc. The • Monitoring and updating the benchmarks used in
following Figure -4 depict interrelationship among pricing etc.
these assessment tools
Figure-4- Mid Office Activities Assessment Tools
As may be observed, all these risk
monitoring and management
exercises are inter related and
attract many challenges in their
smooth functioning and
monitoring. A few of these are
detailed hereunder.

Challenges associated with mid

office activities

A mid-office ought to report

independently to the risk
management department of the
organisation, which in turn is
responsible to its risk committee.
Ideally a mid-office should
function as an independent,
separate unit and not be linked to
any profitability targets. But
practically it does not happen.
Since most of the mid offices
activities are attached with the day

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• Measuring exposures on daily basis or Mark to Market
(MTM)
• Monitoring and controlling of risk limits and reporting
credit exposures and excesses to the higher
management without any biasness
• Introduction, support and systematic approach to risk
control for all products of new products
• Application of best practice techniques for mitigating
market, credit, and operational risk management
• Conducting VaR, stress testing, and scenario analysis
and putting up their results in non-technical language to
the higher management
• Implementation of necessary legal, documentary and
regulatory framework and effective accounting and
reporting MIS
Challenges associated with back office activities
Back office activities include mainly transaction and
settlement related issues, emanating from front office and
effectively leading to making of an actual payment/receipt.
Settlement related challenges arise when after having sent
the payment/receipt instructions, there is a delay in
receiving the payment or the payment is not made at all, ie
there is a default. A few related challenges include -
execution error, product complexity, booking error,
commodity delivery risk, documentary/ contract risk.
Similar others are-
Systems related challenges which include- Programming
error, model/methodology error, IT systems failure,
telecommunications failure
Figure-5- Back Office Activities Challenges
28 The Indian Banker
Business events related challenges which include -
Currency convertibility risk, shift in credit rating, reputation
risk, legal risk, taxation risk, disaster risk, wars, collapse/
suspension of market
Regulatory related challenges which include - Breaching
capital requirements, regulatory changes etc.
In a nut shell, challenges associated with back office
activities are shown in the following Figure-5
Operational risks management
Importance of segregation of duties
Based on these statures, organisations ensure segregation of
various treasury activities and assign specific job role to the
respective functionaries. The demarcation of activities/job
roles in these three front office, mid office and back office,
separate layers/compartment/cells also ensures, inter-alia,
avoidance of interrelated clashes of functions/deals along
with real time risk control and risk monitoring as well. For
example, front office activities, mainly consisting of buying
and selling of securities, are checked by back office and
mid office which ensure that in case a front office person
commits a mistake to the extent of blunder (advertently or
inadvertently) or manipulate prices of securities, exchange
rates, dealing positions, mismatches etc. for his own benefit
(eg Nick Leeson- Barings Bank), (s)he will be caught hold
of by the Back Office. Back office ensures correctness of
deals, their follow-up with counter parties, settlement,
reconciliation, and accounting, recording and reporting to
higher authorities. Mid office plays its role as of a checker
and risk manager and ensures adherence to various
procedures and systems, accounting policies through
management information systems (MIS), risk management
and other control systems tools. However, the major and
foremast risk attached to the treasury operations is its
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conduct of operations and management by a small group
of persons, who possess powers, by dint of their job role
and hierarchy, to influence the situations for their own
gains and repeat the subprime type aftermaths any time.
Assessment issues in treasury operations
For the past 2-3 decades, organisations across the globe,
particularly banks/financial institutions are facing teething
problems in managing operational risks. For successful
Operational Risk Management (ORM), proper analysis,
assessment and measurement are a must. But this is not
easy because of, inter-alia, unavailability of proper and
appropriate tools. Compared to Market Risk Management
(MRM) and Credit Risk Management (CRM), ORM is a
new concept. Experts generally apply MR/CR assessment
tools for OR analysis because of their familiarity and
acquaintance with such tools. But these tools fail to capture
the unique characteristics of operational risks and do not
show results in the desired manner (Scandizzo, 2005).
Analysis of MR and CR is data based where
quantitative/statistical tools help in understanding the rules
of the past trend to predict the future.
Most of the market and credit risk assessment tools, such
as Betas, VaR for market risk and Credit Rating method
and Vasicek model for credit risk are based on quantitative
and statistical analysis and involve huge data. On the other
hand, operational risks contain many qualitative and
subjective factors such as human aspects, training,
Figure-6- A MODELORM FRAMEWORK
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ARTICLE
professional experience, severity of processes, controls,
technology lacunae etc which cannot be captured by
traditional quantitative statistical tools (Scandizzo, 2005).
Data based analysis does not help much in predicting the
humans behaviour. Unlike market and credit risks, there is
no direct and clear link between the exposure and the
likelihood or size of losses in OR assessment. For example,
two banks with identical assets and liabilities portfolios,
counterparties and instruments, will exhibit exactly the
same Market Risk (MR) and Credit Risk (CR) but may
differ significantly in their Operational Risk assessment
(Holmes 2003). Similarly loss data exercises undertaken to
ascertain OR exposure state only the reasons for OR
failures not the real sources of such incidences (Holmes
2003). Buchelt and Unteregger (2004) argue that whether a
loss event is to be classified as an operational loss event or
not, since OR is determined by the causes rather than the
consequences of the event. Imad A Moosa (2007) argues
that the factor between pure market and credit losses and
those linked to operational risk must be the cause. In fact,
as pointed out by Scandizzo (2005), there is no
mathematical model that can rigorously link the
occurrence of a particular OR factor to the market value of
a financial institution or with the amount of loss which
actually took place.
For each area of risk, an assessment is to be made as to the
likelihood of the risk occurring, the potential
consequences, and the approaches to manage the risks.
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A model framework for treasury operations
Banks operate on the foundation of public confidence and
any small breach in that confidence can lead to a run on
the bank and to its eventual failure (Sinha 2012). Hence
consistent and continuous evaluation of risk contributing
factors is necessary. Risk management is a process and a
business model for sound risk management system is
essential for successful and fruitful assessment,
measurement and management of risks in treasury and
investment activities.
An ideal ORM framework should be appropriate to the
range, nature and its operating environment of treasury
operations in an organisation. The framework should lay
down the principles of how operational risks are to be
identified, assessed, monitored, and controlled or mitigated.
Senior management in treasury should own the
responsibility of implementing the ORM framework. The
framework should be consistently implemented throughout
all treasury operations, and all levels of staff should
understand their responsibilities with respect to ORM.
Senior management should also ensure that before new
activities, processes, and systems are introduced or
undertaken, the operational risks inherent in them is
subject to adequate assessment and managed appropriately.
An ideal ORM framework for treasury operations should
follow a five step process as outlines in Figure - 6.
Once an ORM framework is firmly established, it should
be assessed and examined consistently, continuously and at
frequent intervals, by the internal as well as external
auditors and experts to identify the loopholes and vetting
the KRIs. It should also be ensured that framework
coordinates well with the bank’s corporate strategy,
regulatory directives and best global practices. Step by step
follow up of above process would lead to a better
governed organisation with effective internal control
environment. Risk keeps on changing over time.
Identification of KRIs and determination of level of risk
through performance monitoring and reporting structure
keep the situation under control.
Conclusion
For the past 2-3 decades, Operational Risk Management
(ORM) is acquiring new credibility as a roadmap to add
value to the banking business. Day by day, it is attracting
more and more attention from regulators, financial
institutions and other stakeholders. Operational risk is
embedded everywhere and its assessment, at most of the
occasions, is subjective because operational risks are mainly
entrenched to ‘work in progress’ and difficult to quantify.
Developing an ORM framework is an evolutionary process
and takes time and efforts to not only identify and
30 The Indian Banker
understand the risks but also the mitigation techniques in
an environment that is constantly changing. Addressing
operational risks in an effective manner is important for
business continuity and sustainability of an organisation, as
experts believe, these have final impact on the market value
of a firm. For the framework to succeed, it is extremely
important to develop a culture of risk awareness across
treasury and ensure that all staff is involved in developing
and implementing the framework. Treasury activities are
important and premier income generator of a bank/FI and
it is very difficult for them to produce revenue growth and
improve earnings without active and consistence positive
involvement of treasury operations.
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About the Authors

Prof Arya Kumar is presently Dean Student Welfare Division and Chief Entrepreneurship Development & IPR Unit
BITS, Pilani. He is also coordinating the activities of Technology Business Incubator and Center for Entrepreneurial
Leadership at BITS, Pilani. He is an MA (Hons.) Economics and PhD from BITS-Pilani in the area of Financial
Management of Higher Education in India. He has a diversified experience for more than 33 years of serving in
educational institutions, research organisations, banks and financial institutions. He served as chief general
manager and zonal head of Delhi Zone in Industrial Investment Bank of India till July 2003 where he was actively
involved in Corporate Planning, Project Financing, Investment Banking, and Reconstruction of Ailing Units. His basic
interests lie in Entrepreneurship, Strategic Management, Values in Management and Financial Management. He
has co-authored four books in the area of Entrepreneurship, General Management, Ethics in Management, and Grassroots
Entrepreneurship.

Prof Kumar has contributed many research articles in National Journals and Economic Dailies in the area of entrepreneurship,
management and economics. He has been serving as Guest Faculty with number of leading management institutions and colleges of
various Banks. He has presented and got published many papers in national/international conferences in India and aboard. He has
also examined and guided many PhD candidates He has delivered more than 32 invited talks/chaired sessions during last 6 years,
especially in the area of entrepreneurship, finance, banking and economic development. He has to his credit three vital research
projects that have been funded by NSTMIS, DST, Govt of India, and National Entrepreneurship Network, Wadhwani Foundation, Aditya
Birla Group. He can be reached at aryakum@gmail.com; aryakumar@bits-pilani.ac.in.

Akhilesh Tripathi, is presently chief manager in State Bank of Bikaner & Jaipur and possess a vast and varied
experience in wide spectra of banking operations and administration ranging from Branch operations, Credit
Management, Investment Management, Treasury Management, Risk Management, Change Management,
Relationship Banking to Economic Research and Equity Analysis. He is also guest faculty to staff training centre of
his bank as well to few other professional courses imparting institutions. He had conducted workshops and
seminars on change management for junior, middle and senior management cadre of officers of his bank. He has
worked as a Faculty Guide to students for carrying out Student Internship Projects. His academic credentials include
a basic degree education in commerce, an MBA, a CAIIB and a few certificate courses in the area of banking,
treasury and risk management. He is alumnus of Indian Institute of Management, Indore and Birla Institute of Technology and Science
(BITS), Pilani. He is also member of PRMIA, GARP, ISACA and Indian Institute of Banking and Finance (IIBF), Mumbai. He can be
reached at akhilesh@sbbj.co.in; aktakhil@gmail.com.

Vol VIII No. 5 - May 2013 The Indian Banker 31