MODULE C REVISION_25901052_2024_07_08_07_36

BFM MODULE C
COMPLETE
REVISION PDF
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Traditional Role: Managed cash, surplus funds, and ensured
compliance.
Profit Center Shift: Reforms in '90s made Treasury a profit center
with trading.
Market Connection: Links bank activities with financial markets.
Risk Management: Handles market risk for the entire bank.
ALM Participation: Actively involved in Asset-Liability Management.
Integrated Functions: Securities and forex integrated into a single
Treasury.
Funds Focus: Primarily deals with short-term funds, with SLR
exceptions.
Comprehensive Risk: Manages risk across short, medium, and long-
term.
Indian Context: Integrated Treasury in India from financial sector
reforms.

1. Currency Convertibility: Rupee is freely convertible on current and
largely on capital accounts due to RBI relaxations.
2. Global Market Access: Banks leverage RBI allowances for FDI, ECB,
and ODI, gaining access to foreign currency funds.
3. Integrated Cash Flow: Banks no longer distinguish between Rupee
and foreign currency cash flows in treasury operations.
4. Market Integration: Globalization and domestic market
developments enable easy transfer of funds across sectors and
currencies.
5. Risk Management: Integrated Treasury actively manages market
risks, including currency and interest rate risks, using derivatives.
6. Derivative Usage: Growing link between domestic and global
markets leads to increased use of derivatives for risk management.
7. Direct Customer Interaction: Treasury directly serves large corporate
clients for services like hedging, loans, and overseas investments.
8. Merchant Business: Treasury transactions with customers, termed as
merchant business, involve providing integrated services.

9. Driving Forces: Integrated Treasury is driven by cash flow
management, interest arbitrage, and access to global resources.
1. Integrated Treasury Functions:
 Compliance with CRR and SLR.
 Global cash management.
 Efficient merchant services.
 Profit optimization in forex, money, and securities markets.
 Risk management assistance.
 ALM and funds transfer pricing.
2. Distinct Treasury Roles:

 Liquidity Management: Handles funds across currencies.
 Proprietary Positions: Trades for bank profits.
 Risk Management: Aids in ALM and manages risks.
3. Book Management:
 ALM Book: Internal risk and liquidity management.
 Merchant Book: Client-related transactions.
 Trading Book: Manages proprietary positions.

4. Globalization's Impact:
 Integrates domestic with global markets.
 Free capital flows, minimal regulation.
 Includes additional capital flows beyond regular trade-related
transactions.
1. Capital Flows Impact:
 Countries regulate uneven capital flows through central banks.
 Emerging markets embrace free capital flows for growth and
resource exchange.
2. Multi-dimensional Flows:
 Portfolio and direct investments, commercial borrowings, global
issuance, mergers.
 Payments for technology, royalties, and services.
3. Impact & Regulation:

 Affects money supply, interest rates, and systemic risks.
 Governments regulate cross-border capital for stability.
4. Indian Reforms:

 RBI and FEMA relax controls since '90s.
 Current account fully liberalized, cautious approach to capital
account convertibility.
 Global interest rates influence treasury activities.
 Cautious regulatory intervention due to risks.
 Full capital account convertibility not yet permitted by RBI.
1. Exchange Rates:
 Managed regime, Rupee effectively free-float.
 Influenced by inflation, interest rates, GDP, and global markets.
2. Institutional Evolution:
 SEBI, IRDA, CCIL, NSDL, CIBIL support markets.
 Primary dealers, mutual funds deepen debt and equity markets.
3. Payment System:
 RBI, CCIL create global-level settlement system.
 Facilitates forex, money market, and securities transactions.
4. Product Range Expansion:

 Phased introduction of Rupee derivatives.
 Swaps, forwards, options widely used.
 Introduction of Currency and IRFs, CDS.
5. Market Developments:
 Currency futures trade with good liquidity.
 IRFs trade on stock exchanges.
 Single-name CDS introduced for corporate bonds.
 Cross Currency Futures, Options for direct hedging and
strategies.
1. RBI Relaxation:
 Banks can borrow in foreign currency via overseas
correspondents.
 Limited to 100% of unimpaired tier-1 capital or USD 10 million.
 Treasury's scope expands globally, accessible to global currency
markets.

 Impact not limited to banks with overseas branches; all in
foreign transactions feel it.
3. Treasury as Profit Center:
 Evolves from a service center to a profit center.
 Integrated to generate surpluses, supplement core banking
profits.
4. Profit Generation in Treasury:
 Operates in low credit risk inter-bank markets.
 Highly leveraged with a high return on capital.
 Low operational costs compared to branch banking.
5. Treasury Profit Sources:

 Major income from conventional foreign exchange business.
 Profit generated through 'spread' in buying and selling foreign
currency.
 Minimizes overnight open positions to mitigate exchange risk.
1. Money Market Operations:

 Conventional banking involves lending and borrowing in money
market.
 Transfer Pricing Mechanism used to determine cost of funds
from branches.
2. Investment Activity:
 Traditionally invested in government securities for SLR.
 Corporate debt market developed post-RBI restrictions removal
in the late '90s.

3. Treasury Profit Sources:
 Primary income from foreign exchange and interest on
investments.
 Increasingly, profits come from market operations for profit
generation, not specific requirements.

4. Interest Arbitrage:
 Treasury exploits interest differentials across currency and
security markets.
 Borrows in one market, lends in another for profit.

 Arbitrage opportunities also arise from OTC and futures market
disparities.
5. Arbitrage Operation Example:
 Integrated Treasury example: Lend Rupee @ 3.50% or do a
Buy/Sell Swap @ 4.32%.

 Forex Treasury places USD Deposit abroad @ 0.15%.
 Total Return for Forex Treasury = 4.32% (Arbitrage Gain =
0.82%).
1. Arbitrage Process:
 Identify surplus Rupee.
 Execute Buy/Sell swap at 4.17% premium.
 Place Dollar funds abroad at 0.15%.
 Total return: 4.32%, arbitrage gain: 0.82% for seven days.
2. Money Market Instruments:

 Use various instruments for optimizing fund returns.

3. Trading Activities:
 Banks with AD 1 license trade currencies within set limits.
 Engage in speculative trading for profit.
4. Securities Trading:
 Actively trade G-secs, corporate bonds, and participate in equity
markets.
5. Credit Instruments Trading:
 Trade securitized credit receivables and participation notes.
 Market liquidity is a challenge, but banks actively engage for
profit.
1. Securitisation Guidelines:
 RBI issues guidelines for securitisation and introduces single
name credit default swaps on corporate bonds.

2. Market Risk Management:
 Treasuries manage market risk in currency and securities trading
to minimize potential losses.

3. Derivative Products:

 Banks permitted to trade in derivatives, enhancing the range of
products for both trading and risk management.
4. Treasury Products for Corporates:
 Treasury sells derivatives and structured products to corporates
for hedging currency and interest rate risks.

5. Treasury as Profit Center:
 Treasury income constitutes a significant part of the gross
income of scheduled commercial banks in India.

6. Transfer Pricing Role:
 Treasury plays a crucial role in transfer pricing, considering the
cost of funds, interest rate risk, and maturity mismatches.

7. RAROC-based Pricing Models:
 Banks use RAROC-based pricing models to compute capital
requirements under Basel III guidelines.

8. Organisation of Treasury:
 Treasury is organized as either a department or a specialized
branch, maintaining autonomy with its own accounting system.

1. Treasury Leadership:
 Headed by a senior executive reporting to CFO or CEO,
overseeing three main divisions.

2. Divisions:
 Dealing Room (Front Office), Back Office (Settlements), Mid-
office (Risk Management).

3. Dealing Room:
 Chief Dealer manages front office, specialized dealers handle
forex, money market, securities, and corporate deals.

4. ALM Desk:
 Manages Asset and Liability Management (ALM) risks in larger
banks.
5. Securities Market:
 Split into primary and secondary markets, with a dedicated
equity dealer for stocks.

6. Primary Market Issues:
 Handled by the Investment Department within the Treasury.

7. Front Office Role:
 Focuses on deal execution without involvement in settlement
processes.
8. Back Office:
 Verifies, settles deals, confirms transactions, handles
bookkeeping, and maintains various accounts.

9. CCIL:
 Ensures margin requirements for settlements, contributing to
the Settlement Guarantee Fund.

1. Foreign Exchange Market (Forex):
 Most liquid market for major fully convertible currencies (USD,
EUR, GBP, JPY, CHF).

2. Currency Convertibility:
 Fully convertible currencies traded actively, partially convertible
currencies may still have high liquidity.

3. Market Features:

 Transparent, virtual, and boundaryless with fast information
dissemination through electronic media.
4. Liquidity and Trading Hours:
 Highly liquid, operates 24/7, allowing traders to buy/sell
currencies anytime globally.

5. Price Discovery:
 Efficient price discovery with two-way quotes, indicating
liquidity and transparency.

6. Spot Market:
 Primary for currency trading, settlement occurs two working
days from the trade date.

7. Same Day Settlement:
 Some currencies can be traded with settlement on the same day.
1. Spot Market:
 Immediate currency transactions with settlement in two working
days (T+2).

 TOD (Cash) and TOM (Next day) rates may be quoted at a
discount to the spot rate.
2. Forward Market:
 Involves future currency transactions with rates quoted today.
 Rates determined by interest rate differentials, reflecting risk-
free rates.
3. Non-Deliverable Forwards (NDF):
 Traded offshore for non-convertible currencies.
 Cash-settled contracts, allowing hedging in regulatory-restricted
environments.
1. NDF Market:
 (i) Foreign investors hedge in controlled markets.
 (ii) Hedge funds and banks speculate.
 (iii) Participants leverage exchange rate differentials.
2. Futures:
 Exchange-traded, standardized contracts.
 Minimal physical delivery; closed by opposite trades.

3. Options:
 Contracts for buying/selling assets.
 American: exercise anytime; European: only on expiration.
4. Swaps:
 Combo of spot/forward transactions.
 Involves cash flow exchange.
1. Swap Use:
 Fund requirements and profit from interest rate differences.
2. Interest Arbitrage:
 USD/INR swap for profit.
 Earn from higher Rupee interest than USD cost.
3. Currency Swaps:
 Manage currency and interest mismatches.
 Convert loan cash flows between currencies.
4. FX Surpluses:
 From treasury and overseas activities.
 Invested in inter-bank

1. Sweep Facility: Treasury earns interest on idle funds in Nostro
accounts.
2. Loans and Advances: Treasury clears foreign currency funds before
sanctioning advances.
3. Working Capital in Foreign Currency: Banks use FCNR loans, PCFC,
and bill discounts for foreign currency working capital.
4. Short-Term Funding: Treasury actively manages short-term funds.
5. Rediscounting of Bills: Treasury refinances foreign bills purchased by
other banks.
6. Money Market Products: Short-term resources with maturity under
one year.
7. Inter-Bank Market: Includes call, notice, and term money markets.
8. Call Money Market: Overnight placements, indicating inter-bank
liquidity.
9. O/N MIBOR: Benchmark rate for overnight interest rate swaps.

10. Participants: Commercial banks, primary dealers, co-operative
banks, payment banks, small finance banks, and regional rural banks
in the call money market.
11. Non-Bank Players: Financial institutions and mutual funds
phased out from call money market since August 6, 2005.
1. Notice Money Market: 2-14 day transactions, distinct from
overnight call money market.
2. Term Money Market: Funds placed for over 14 days up to 1 year.
3. Prudential Limits: Participant-determined, approved by boards,
following RBI norms.
4. Scheduled Commercial Banks: Limits based on capital funds for call,
notice, and internal limit for term.
5. Payment Banks, RRBs: Similar limits based on capital funds.
6. Co-operative Banks: Limit set at 2.0% of aggregate deposits.
7. Primary Dealers: Limits tied to Net Owned Fund for call, notice, and
term money.

8. Inter-Bank Markets: Forefront in signaling changes in money supply
and system liquidity.
9. Risk Perception: Inter-bank market seen as low risk, though carrying
counterparty risk.
10. Benchmark Rates: Inter-bank rates serve as benchmarks.
11. Call Money Rate: Overnight MIBOR reflects daily system
liquidity.
1. O/N MIBOR: Key benchmark for floating rate debt and overnight
interest rate swaps.
2. CRR and SLR: RBI tools affecting liquidity, CRR doesn't earn interest,
explained later.
3. Treasury Investments: Surplus cash invested post CRR and SLR
compliance.
4. Short-Term Papers: Treasury deals in government, financial, and
company short-term instruments.
5. T-Bills: Government-issued, 91/182/364-day maturities, priced at a
discount.

6. Implicit Yield: Interest calculated from discount, auctioned with
various participants.
7. Issuance Schedule: Weekly for 91-day, fortnightly for 182-day and
364-day T-bills.
8. Borrower Range: Banks, primary dealers, financial institutions,
corporates, individuals participate.
9. Convenience for Banks: T-bills offer risk-free, liquid investment with
higher yields.
10. Secondary Market: Electronic trading, settled through Clearing
Corporation of India Ltd. (CCIL).
11. Redemption: T-bills mature on the previous working day if the
maturity date falls on a holiday, redeemed at par.
1. Cash Management Bills (CMBs):
 Introduced in 2010 for short-term Govt. cash needs, <91-day
maturities.
 Features: Flexible tenure, discount issuance, tradable, SLR
eligible.

 Auction announced a day prior, settlement on T+1 basis.
2. Commercial Paper (CP):
 Short-term corporate debt, 7 days to 1 year maturity.
 Eligible issuers: Corporates, NBFCs, AIFIs, LLPs, Trusts,
Cooperative Societies, Govt. Entities.

 Requirements: 'A3' credit rating, standard asset classification for
fund-based facilities.
 Issued for minimum Rs. 5 lakhs, in demat form through an
issuing and paying agent (IPA).

 Banks use working capital limits to enhance credit for corporate
customers issuing CP.

1. Commercial Paper (CP):
 Low credit risk, short-term, issued at a discount, in demat form.
 Used for working capital, banks invest for low credit risk and
higher yields.
 Active secondary market, OTC trades reported in 15 mins,
buyback after 30 days.

2. Certificates of Deposit (CD):
 Unsecured debt by banks or FIs against funds, negotiable, higher
interest.
 Bank-issued matures 7 days to 1 year, FI-issued 1 to 3 years.
 Issued in demat form, not for loans or premature closure.
 Secondary market less active, attractive for banks in tight
liquidity.
 CDs may be issued at a discount, subject to CRR and SLR.
 OTC trades reported within 15 mins to Clear Corp Dealing
System (F-TRAC).
1. Certificates of Deposit (CD):
 Secondary market settled on DvP basis.
 Issued to all Indian residents.
 Buyback after seven days, not for resale.
2. Market Repo:
 Securities transaction for lending/borrowing (1 day to 1 year).
 Involves purchase and resale of securities.

 RBI allows repo in government and corporate debt securities.
 Counterparty buys, agrees to resell after a set period.
 Repurchase price includes interest and adjustments.
 Uniform accounting rules maintain book value.
 Haircut (about 5%) covers price risk.
 Governed by RBI Repo Directions (RBI/2018-19/24).
 Borrowings in corporate bonds are CRR/SLR liabilities.
 Can be transacted in government securities, corporate bonds,
with specific conditions.
1. Repo Transactions:
 Include various securities, traded on exchanges, ETPs, or OTC.
 Reporting on F-TRAC or Clearcorp Repo Order Matching System.
 Settlement through CCIL for government and corporate
securities.
2. Corporate Debt Repo:
 Introduced in 2010, limited participation due to added credit
risk.

 Exchange-traded repo follows recognized exchange or SEBI
regulations.
3. Tripartite Repo Trades (TREPS):
 Third entity (Tri-Party Agent) facilitates collateral and
settlement.
 CCIL replaced CBLO with TREPS, acting as tri-party agent.
 Members need CCIL and CCDS membership for TREPS deals.
 CCIL provides novation, net settlement, and collects initial
margin.
1. Tri-Party Repo (TREP):
 CCIL demands MTM margin on price fall.
 Eligible participants: regulated entities, listed corporates, and
unlisted companies for special securities.

 Tenors: One day to one year. Eligible agents: scheduled
commercial banks, recognized stock exchanges, clearing

corporations.
2. Repo under LAF:

 RBI tool for monetary policy and liquidity management.
 Banks sell to RBI in shortage, buy in surplus.
 Interest difference determines rates.
 Present rates: Reverse Repo 3.35%, Repo 5.40%. Intention for a
205 bps corridor.

3. Revised Liquidity Management Framework:
 RBI conducts 14-days Variable Rate Repo and Reverse Repo on
reporting Fridays.
 Surplus funds parked with RBI under reverse repo window.
 Ongoing review for refinements.
1. Repo and Reverse Repo:

 Auctions for 1 to 13 days, Fixed Rate Reverse Repo open 5:30
PM to 11:59 PM.
 RBI discretion for Long Term Variable Rate Repo beyond 14
days.
2. Standing Deposit Facility (SDF):

 Operational since April 8, 2022, replacing Fixed Rate Reverse
Repo.
 Available 17:30 to 23:59 on all days.
 Interest rate: 25 bps below policy repo rate (5.15% as of August
2022).
 Deposits not part of CRR but eligible for SLR.
 Minimum bid size: INR 1 crore, multiples thereof.
3. Marginal Standing Facility (MSF):

 Introduced May 9, 2011, allowing overnight funds up to 2% of
NDTL.
 Interest rate: 0.25% over Repo rate (4.25% as of date).
 Enhanced limit of 3% withdrawn on January 1, 2022, restored to
2% of NDTL.
1. Bill Rediscounting:
 Short-term bill rediscounting boosts liquidity.
 Lending bank gains term money rates.

 Borrowing bank improves capital adequacy.
 Risk lies with the borrowing bank.
2. Securities Market:
 Government Securities:
 Issued by RBI, actively traded.
 Auctions determine bond prices.
 Yield differs from coupon rate.
 Used in open market operations (OMO).
1. SLR Control:
 Capped at 40%, now 18%.
 Allows alternatives like priority sector bonds.
2. SLR Fulfillment:
 Banks prefer government securities.
 Cash, gold, or branch-level cash balances also qualify.
3. Investment Categories:

 Banks categorize investments as HTM, AFS, HFT.
 AFS securities marked quarterly.
4. G-Sec Market:
 Banks trade G-secs based on economic indicators.
 G-sec yields guide corporate bonds.
5. Corporate Debt Paper:

 Non-SLR securities for banks.
 Tradable, demat form, active secondary market.
1. Floating Rate Bonds:

 Coupons linked to benchmarks, reset periodically.
2. Deep Discount Bonds:

 Sold at a discount, interest paid at maturity.
3. Step Up Coupons:
 Instruments with increasing interest rates.
4. Period Bonds:
 Redemption in installments or with a premium.
5. Collateralised Obligations:
 Bonds secured by stocks or other collateral.
6. Put Call Option Bonds:
 Offers call option and step-up coupons.
7. Legal Protection:
 Trustees safeguard bondholders' interests.
 Can take legal action in case of default.
8. Regulation:
 Governed by Companies Act and SEBI guidelines.
 Private placements have limited SEBI regulation.
9. Convertible Bonds:
 Mix of debt and equity.
 Bondholders can convert debt to equity at a predetermined
price.
 Benefits include no debt repayment and strengthened equity
base.
 Dilution of existing shareholders' equity if conversion occurs.
10. Equities Investment:

 Banks can invest in equities within capital market limits.
1. Capital Types:
 Equity: With/without voting rights.
 Preference: Cumulative/non-cumulative,
redeemable/irredeemable, participating/non-participating,
convertible/non-convertible.
2. Equity Trading:
 Influenced by fundamentals, macro factors.
 Bank treasuries cautious due to volatility.
3. Indian Stock Market:

 Regulated by SEBI.
 BSE, NSE major exchanges.
 Derivatives popular for risk management.
4. Investors:
 FIIs, mutual funds, insurance.

 Bank treasuries cautious, prudential ceilings by RBI.
5. Ceilings:
 Bank exposure capped at 30% of investee's capital or 30% of
bank's own capital + reserves (lower).

 Portfolio-level exposure capped at 40% of net worth, direct
investments at 20%.
6. Domestic-Global Interaction:
 Overlapping markets.
 Interaction where funds can be freely swapped.
1. Regulation:
 FEMA governs foreign investment.
 Classifications: FDI, FPI, FPI (Former FII).
2. FDI Basics:
 Unlisted or 10%+ in listed Indian companies.
 Equity below 10% still treated as FDI.
3. Dilution Consideration:
 Fully Diluted Basis includes all potential conversions.

4. FPI Highlights:
 Investment below 10% in listed Indian firms.
 SEBI (FPI) Regulations, 2014 govern FPI.
5. FPI Status:
 Former FIIs deemed FPI till 2017.
6. Foreign Investment Scope:

 Involves capital instruments on a repatriable basis.
 Covers Indian companies and LLPs.
7. Prohibitions:
 Restricted sectors: lottery, gambling, and certain chit funds.
 Exceptions for NRIs and OCIs in non-repatriable chit funds.
1. Prohibited Sectors:
 Restrictions on Nidhi companies, TDR trading, Real Estate, and
Tobacco-related manufacturing.
2. Sector-Specific Limits:
 FEMA 20(R) sectoral restrictions and limitations on atomic
energy and railway operations.

3. Technology Collaboration:
 Prohibited for Lottery, Gambling, Betting.
 Special approval needed for investments from Bangladesh or
Pakistan.
4. Global Depository Receipts (GDRs):
 Convertible to specific equity shares.
 Issued abroad, traded internationally, with exchange risk borne
by overseas investors.
5. American Depository Receipts (ADRs):
 Exclusively traded in the US.
 Solicitation allowed only in the US.
 Compliance with US GAAP standards required.
1. IDRs Issuance:
 Foreign companies can issue IDRs.
 Compliance with Rules and SEBI Regulations.
 Financial firms need regulator approval.
 IDRs in Indian Rupees.

 Proceeds repatriated outside India.
2. IDRs Trading:
 FPIs, NRIs, and OCIs can trade.
 NRIs/OCIs use NRE/FCNR(B) accounts.
 Overall cap: USD 5 billion, SEBI-monitored.
3. Transfer, Redemption, Fungibility:

 Redemption after a year under FEMA.
 Limited two-way fungibility.
 Specific conditions for listed firms, mutual funds, and residents
holding/selling underlying shares.

 FEMA provisions exclude FPIs holding underlying shares.
5. Lender Restrictions:
 Multilateral institutions and foreign bank branches for FCY ECB.
 Individuals as lenders only if foreign equity holders or
subscribing to bonds.
 Compliance with FATF or IOSCO standards.
6. Borrower's End-use:

 Broadly permitted end-uses.
 Special restrictions for real estate, investment in capital market,
equity investment, working capital, repayment of Rupee loans.

7. All-in-cost Ceiling:
 Limit on overall cost includes interest, fees, expenses.
 Linked to benchmark rates in the case of Rupee-denominated
ECB.
8. Security and Guarantee:
 Mandatory for ECB above $5 million.
 No corporate or personal guarantee for FCY ECB by eligible
borrowers.
9. Minimum Average Maturity:
 Varies based on amount and purpose.
 3 years for all end-uses except working capital.
10. Reporting and Compliance:

 Reporting to RBI through AD banks.
 Compliance with ECB guidelines and provisions.

11. ECB in Indian Rupee Issued Overseas:
 Plain vanilla Rupee-denominated bonds.
 Private placement or listed on foreign exchanges.
 Compliance with host country regulations.
12. ECB Limits and Monitoring:
 Overall cap for eligible foreign companies: $5 billion.
 Monitoring by SEBI.
 FEMA provisions not applicable to FPI holding underlying shares
on IDR redemption.
13. Two-way Fungibility for IDRs:
 Limited two-way fungibility.
 Listed Indian companies, Indian mutual funds, and other
residents with a 30-day sale option.
14. ECB Framework Relevance:
 Governs commercial loans from recognized non-residents.
 Ensures compliance with various parameters and guidelines.
 Facilitates external borrowings for eligible entities in India.

1. ECB Types:
 Foreign Currency ECB.
 Indian Rupee-denominated ECB.
2. Lender Restrictions:
 Recognized lenders from FATF or IOSCO compliant countries.
 Special provisions for multilateral institutions, individuals, and
foreign bank branches.

3. Borrower's Maturity Period:
 Minimum Average Maturity Period (MAMP) of 3 years.
 Specific MAMPs for different categories, e.g., 1 year for certain
manufacturing companies, 5 years for working capital ECB from

foreign equity holders.
4. All-in-Cost Ceiling:
 Linked to benchmark rates (e.g., ARR).
 Spread of 500 bps for new ECBs, 550 bps for existing ECBs linked
to LIBOR.
5. Underwriting Restrictions:

 Foreign branches/subsidiaries of Indian banks can't underwrite
issuances by Indian banks.
 Prudential norms apply for participation as
arrangers/underwriters/market makers/traders in Rupee-

denominated bonds overseas.
6. Call and Put Options:
 Not exercisable before completion of MAMP.
 Exceptions for specific categories with prescribed MAMPs.
7. MAMP Categories and Periods:

 Categories (a) to (e) with specific MAMPs ranging from 1 to 10
years.
 Restrictions on raising ECBs from foreign branches/subsidiaries
of Indian banks for certain categories.

8. All-in-Cost Ceiling Calculation:
 Based on benchmark rates plus specified spreads.
 Differentiated spreads for existing and new ECBs.
9. Compliance Requirements:

 Strict adherence to MAMP for specific categories.
 Reporting and compliance with ECB framework and guidelines.
1. Currency Control:
 RBI controls currency in circulation.
 Money multiplier effect involves lending and deposits.
2. Broad Money (M3):

 Includes currency, demand, and time deposits.
 Sources: public credit, government, and foreign currency assets.
3. Money Multiplier:
 Reduces importance of currency.
 RBI's role shifts to utility function.
4. Monetary Policy:
 Objectives: control inflation, ensure market stability.
 Full M3 control is crucial.
5. Reserve Money:
 RBI's impounded money through CRR.
 Aims to reduce money multiplier effect.

6. Reserve Assets:
 Cash by banks (CRR).
 Investments in government securities for SLR.
7. CRR (Cash Reserve Ratio):

 Mandatory deposit by banks.
 Percentage of Net Demand and Time Liabilities.
8. SLR (Statutory Liquidity Ratio):

 Prescribed percentage in securities.
 Includes government securities.
1. Liquidity Tools:
 SLR: Maintains liquid assets.
 CRR: Mandatory deposit, decided by RBI.
2. RBI's Role:
 Lender of Last Resort for distressed banks.
 Manages exchange rate volatility.
3. Quantitative Control:
 CRR and SLR adjust money supply.

 Increase for liquidity absorption, decrease for infusion.
4. Treasury Responsibility:
 Ensure full CRR and SLR compliance.
 Timely submission of Form A to RBI.
5. Current Ratios:
 CRR: 4.50% of NDTL.
 SLR: 18% of NDTL.
 Computed per RBI guidelines.
6. Penalties and Reputation:

 Default leads to RBI penalties.
 Affects bank viability and reputation.
1. Liability Components:
 Margins, overdue deposits, outstanding drafts.
 Excludes certain paid-up capital and reserves.
2. Time Liabilities:
 Covers fixed deposits, cash certificates, etc.

 Exemptions for specific items like tax provision.
3. CRR Exemptions:
 ACU (US$) accounts and Offshore Banking Units.
 Exceptions for specific liabilities.
4. Excluded from CRR:

 Unrealized gains/losses, subsidies, claims.
 Bill rediscounts, advance income, etc.
5. CRR Calculation:
 Lagging DTL basis, fortnightly reporting.
 Ensures adherence to RBI guidelines.
1. CRR Requirement:
 Banks maintain daily CRR above 90%.
2. Interest on CRR:
 RBI doesn't pay interest on CRR, raising deposit costs.
3. SLR Calculation:
 Computed similarly to CRR.
4. SLR Assets:
 Includes cash, gold, approved securities.
5. Penalties for Default:
 Default attracts penal interest.
6. Liquidity Management:
 CRR and SLR changes impact liquidity.
7. Economic Impact:
 CRR/SLR adjustments influence money supply.
8. Reserve Ratios:
 Tools for RBI to control economic conditions.
1. Liquidity Adjustment Facility (LAF):

 Principal tool for daily liquidity monitoring.
 Involves RBI lending and accepting funds through Repo.
2. Repo Transactions:
 Banks bid in multiples of Rs. 5 crore.
 RBI acts as a lender of last resort.
3. Reverse Repo:
 Banks lend to RBI in case of excess liquidity.

 Securities held in the SGL account, no physical transfer.
4. Auctions and Frequency:
 Daily Repo/Reverse Repo auctions.
 Multiple auctions based on banks' liquidity needs.
5. Measures on Liquidity Constraints (2015):

 RBI takes steps to address banks' liquidity challenges.
6. Purpose of LAF:
 Manages day-to-day liquidity.
 Supports effective functioning of payment systems.
● Liquidity Measures (2015):

 Overnight repos at 0.25% of NDTL.
 Variable Rate Repo introduced.
2. Export Credit Refinance (ECR):

 Phased out from 6th Feb 2015.
3. New Liquidity Products (2020):

 14-day variable-rate repo/reverse repo.

 Variable Rate Term Repo.
 Fixed Rate Reverse Repo.
 MSF, FX Swaps, SDF.
4. MSF (Marginal Standing Facility):

 Banks draw funds up to Excess SLR + 2%.
5. FX Swaps and SDF:

 Amount decided by RBI.
 SDF replaces fixed rate reverse repo.
1. Payment and Settlement Systems (PSS):

 Vital for financial market development.
 Reforms include instant securities transfer and reduced delays in
payments.
2. SDF (Standing Deposit Facility):
 All LAF participants eligible.
 Allows overnight deposits with RBI.
 Replaced Fixed Rate Reverse Repo.
3. Monetary Policy Objective:

 Narrow policy rate corridor for finer alignment of WACR with
repo rate.
 SDF as the floor (4.15%) and MSF as the upper limit (4.65%).
4. Repo Rate and Market Operations:

 Repo used as a market-based instrument.
 RBI issues Master Directions for Call, Notice, and Term Money
Operations.

 RTGS (Real Time Gross Settlement System):

 Launched in October 2004.
 Enables instant gross settlements.
 Requires banks to maintain sufficient funds with RBI throughout
the day.
2. INFINET and SFMS (Structured Financial Messaging System):
 INFINET: Secure communication for banking.

 SFMS facilitates domestic fund transfers and authenticated
messages.
3. Negotiated Dealing System (NDS):
 Introduced in February 2002 for electronic government
securities dealing.
 Offers electronic reporting, settlement, and trading.
 Membership open to various financial institutions.
4. FX Clear and Depository Institutions:

 CCIL's FX Clear manages forex transactions.
 NSDL and CSDL provide DVP for secondary market equity and
debt deals.
 Simultaneous funds and securities transfer eliminates settlement
risk.
 .
1. Treasury Risk Management Importance:
 Arises from market opportunities and risks.
 Involves balance sheet and market risk management.

2. Concern for Treasury Risks:
 Highly sensitive due to high leverage.
 Greater loss potential compared to credit risk.
3. Management Sensitivity:
 Low funding, high leverage allows substantial transactions.
 Treasurer's decisions involve significant amounts without
specific approval.
 Quick and irrevocable losses in treasury.
4. Market Risk Source:

 From variations in currency or security prices.
 Tied to the gap between buy and sell legs of a transaction.
 Known as market risk due to potential price changes.
1. Exposure Ceilings:
 Limits on exposure to counterparty risk.
 Back office ensures compliance with exposure limits.
 Obtains independent confirmations for settlement.

2. Limits on Trading Positions:
 Controls on trading book activities.
 Front office adheres to position limits.
 Prevents excessive risk-taking.
3. Stop-Loss Limits:
 Implemented to curb potential losses.
 Predefined limits for various types of transactions.
 A proactive measure for risk management.
4. Mid Office Oversight:

 Monitors risk management processes.
 Ensures adherence to risk policies.
 Collaborates with front and back offices.
5. Preventive Measures:
 Organizational controls, exposure ceilings, and trading limits act
as preventive steps.
 Aimed at avoiding excessive risk and ensuring compliance.
1. Middle Office Functions:

 Manages risk and MIS.
 Ensures compliance with policies.
2. Responsibilities:
 Validates product pricing.
 Conducts daily valuation.
 Monitors overall risk and liquidity.
3. Internal Controls:
 Position Limits: Prevents excessive risk.
 Stop-Loss Limits: Limits losses.
 Deal Size Limits: Caps transaction values.
4. Open Positions:
 Daylight Limits: Intraday positions.
 Overnight Limits: Positions held overnight.
 Aggregate Limits: Currency-wise and in Rupees.
5. Aggregation:
 Net positions in USD and Rupees.
 Ensures regulatory compliance.

1. Market Risk Components:
 Liquidity: Gaps impacting solvency.
 Interest Rate: Erosion of profits.
 Currency: Exchange rate fluctuations.
2. Liquidity Risk:
 Arises from cash flow gaps.
 Can lead to higher borrowing costs.
 Requires contingency planning.
3. Interest Rate Risk:

 Mismatched assets and liabilities.
 Affects interest-sensitive assets.
 Impacts net earnings.
4. Currency Risk:
 Linked to interest rate dynamics.
 Influenced by global factors.
 Connected to economic trends.
5. Market Risk (BIS):

 Adverse effects from market movements.
1. Interest Rate vs. Exchange Rate:
 Interest rate: Domestic cost of currency.
 Exchange rate: External cost of currency.
 Forward rates reflect interest differentials.
2. Equity Market Impact:

 Stock prices influence markets.
 Reflects liquidity, interest rates, and exchange rates.
 Vital for attracting foreign investment.
3. Commodity Market Linkages:

 Commodity prices influenced by economic factors.
 Treasury observes gold prices and exchange rates.
 Limited commodity exposure in Indian Treasury.
4. Market Vulnerability to Speculation:

 Perception of future changes drives markets.
 Treasury's trading involves speculation.
 Market risks impact transaction values and profits.

5. Treasury's Role in Risk Management:
 Treasury linked with asset-liability management (ALM).
 Provides inputs to ALM and implements risk solutions.
6. Risk Measures - VaR and Duration:

 VaR:
 Indicates worst possible rate movement.
 Defined confidence level and time period.
 Example: Overnight VaR of 45 paise for USD/INR at 95%.
 Duration:
 Measures bond price sensitivity to rate changes.
 Reflects time for investment to recover its price.
 Key for managing interest rate risk in bonds.
1. VaR Calculation:
 Measures worst market rate movement.
 Example: Overnight VaR for 1-year G-Sec yield at 0.35%.
 95% confidence, 5% chance of exceeding VaR.
2. VaR Approaches:
 Parametric, Monte Carlo, Historical Data.
3. VaR Utility:
 Easy concept, single loss figure.
 Used in Treasury for risk assessment.
 Additive across asset classes.
4. VaR Limitations:
 Most accurate for short periods.
 Back-testing assesses model.
5. Duration Concept:
 For interest rate risk.
 Linked to YTM of a bond.
 Widely used in investments.
6. Yield to Maturity (YTM):

 Total return on a bond.
 Includes interest, gains, and losses.
 Duration measures rate sensitivity.
7. Duration Calculation:

 Weighted average recovery time.
 Reflects interest rate sensitivity.
 Manages bond interest rate risk.
1. Securities Overview:
 Treasury invests in gov. and non-gov. securities.
 Bonds may trade at a discount or premium.
 Yield reflects effective return on investment.
2. Yield to Maturity (YTM):

 Reflects present value of bond's cash flows.
 Internal rate of return on the investment.
3. Yield and Bond Prices:

 Inverse relationship: rising yield, falling price.
 Falling yield, rising price.
4. Yield Limitations:
 Same YTM doesn't imply similar price volatility.
 Doesn't indicate how prices respond to rate changes.
5. Duration Concept:
 Weighted average life of a bond.
 Considers periodicity of coupon flows.
6. Macaulay Duration Calculation:

 Multiply each cash flow period by its present value.
 Aggregate results divided by total present value.
 Reflects bond's sensitivity to interest rate changes.
1. Derivatives in Treasury:
 Used for risk management, client needs, and trading.
 Value derived from underlying markets like forex, bonds, and
commodities.
2. Derivative Basics:
 Financial contracts tied to an underlying (price, rate, or index).
 Derivatives refer to future prices, influenced by spot market
values.
3. OTC vs. Exchange-Traded:
 OTC: Customized products for individual clients.
 Exchange-traded: Standardized contracts on futures exchanges.

4. Futures Contracts:
 Forward contracts on futures exchanges known as futures
contracts.
 Examples: CME, Eurex, NSE, MCX.
5. Regulation and RBI:

 RBI regulates Rupee derivatives.
 Derivatives cover various markets and events like weather
conditions.
1. OTC vs. Exchange-Traded:
 OTC: Customized, bank-offered, counter-party risk, often
physical settlement, mainly for hedging.

 Exchange-Traded: Standardized, transparent pricing, no counter-
party risk, mostly cash settlement, used for trading.

2. Derivative Types:
 Forward Contracts: OTC, future delivery at fixed rate.
 Options: Right to buy/sell at set price.
 Swaps: Exchange cash flows or financial instruments.

3. Usage in India:
 Hedging: Banks and corporates use for risk mitigation.
 Trading: Larger banks trade, individuals in futures market.
4. Futures Contracts:
 Subset of forwards, fixed rate through exchange.
 Open to individuals, corporates, and entities.
5. Derivative Focus:
 Currency and Interest Rate Derivatives: Main types in India, used
for hedging risks.

1. Forward Contracts:
 Protects exporters (importers) from currency appreciation
(depreciation).
 Delivery must occur on the expiry date; otherwise, the contract
is canceled.
 Forward rate reflects interest rate differentials and may be at a
premium or discount.
2. Forward Options:
 Allows delivery within a month before the contract expiry.
 Forward premium (discount) is quoted for the option period,
based on the start or end date.

3. Opportunity Cost:
 Forward contracts fix the rate, eliminating market movement
benefits.
 Ideal for achieving zero risk but lacks the advantage of favorable
market rates.
4. Options Overview:
 Call options allow buying at a predetermined rate.
 Put options permit selling at a predetermined rate.
 Strike price and expiry date are key components.
5. Option Types:
 American options can be exercised anytime (mostly prohibited
post-2008).
 European options can only be exercised on the expiry date, used
in India.

1. Currency Options:
 Call (buy) or put (sell) at a fixed rate on expiry.
 Settlement based on rate difference.
2. ITM, ATM, OTM:

 ITM (better), ATM (same), OTM (worse).
3. Option Premium:
 Intrinsic value (ITM) or zero.
 Time value (extrinsic value), highest for ATM.
4. Option Features:
 Buyer's right, seller's obligation.
 Small upfront premium; high leverage.
 Influenced by volatility, maturity, rates, strike.
1. Option Pricing:
 Intrinsic value and time value determine premium.
 ITM options cost more; time value linked to maturity.
2. Currency Options:
 Two legs: USD put or JPY call.

 Used for hedging price fluctuations.
3. Underlying Products:
 Options relate to currency, bonds, or equity.
 Used for risk transfer and mitigation.
4. Stock Options:
 Right to buy/sell equity at a strike price.
 Available for individual stocks or stock indices.
5. Plain Vanilla and Structured Options:

 Plain vanilla is a simple, unconditional option.
 Structured options include zero-cost and barrier options.
6. Exotic Options:
 Complex, risky products bundling various risks.
 Not suitable for hedging market risk.
7. Comparison with Forwards:

 Both hedge exchange risk, but differences exist.
 Options offer flexibility; forwards lack opportunity benefits.
1. Option Execution:
 Executed at contracted rate on expiry.
 Holder has the right, no obligation.
2. Choosing Rates:
 Holder selects better rate (strike or market).
 Quoted rate includes bank margin.
3. Option Premium Determinants:

 Determined by factors like strike, volatility, and rates.
 Paid upfront by the holder.
4. Forward Contracts:
 Simple contracts, executed at contracted rate.
5. Types of Options:
 Various options, simple to complex structures.
 Risk exposure varies with option types.
6. Counter-Party and Market Risk:

 Counter-party risk exists; no market risk if liquid.
 Plain vanilla options have no market risk.
7. Option Buyer vs. Seller:

 Seller has unlimited risk; buyer has full upside.
 No market risk in plain vanilla options.
8. Structured Credit Products:

 Options used in structuring credit products.
 Embedded options impact bond pricing.
9. Futures Basics:
 Traded on futures exchanges.
 Seller delivers specified asset at a fixed price.
10. Financial and Commodity Futures:

 Financial futures for currencies, rates, and equities.
 Standard sizes, prefixed settlement dates.
11. Currency Futures:

 Traded for major currencies.
 EURO, GBP, JPY, CHF, AUD, CAD included.
1. Futures Basics:
 Exchange-traded contracts.
 Fixed future delivery and price.

2. Differences from Forwards:
 Exchange acts as a counterparty.
 Daily mark-to-market settlements.
 Active daily trading on exchanges.
3. Indian Currency Futures:

 USD/INR since Aug 2008.
 Cross-currency contracts (Euro, GBP, JPY) from late 2009.
 2020–21 daily turnover: Rs. 45,334 crores.
4. Interest Rate Futures:

 Tied to fixed income securities.
 Hedge against interest rate risk.
 Prices respond to rate expectations.
5. Hedging with Interest Rate Futures:

 Inverse rate and bond price relationship.
 Short selling T-bill futures hedges against rate increase.
 Futures profits offset higher loan interest.
6. Alternative Reference Rates:

 Euro Dollar bonds use alternative rates.
 Varying contract terms and practices.
 Hedge based on rate and bond price relationship.
1. Rupee IRF in India:
 Launched 2003, relaunched Aug 2009.
 Contract: Rs. 2 lakhs.
 Based on 6, 10, 13-year govt. securities.
 2016–17 daily turnover: Rs. 1,801 cr.
2. Basis Risk in Futures:

 Standard contract sizes.
 Example: Hedging USD 560,700 needs 561 contracts.
 Basis risk: Small diff. between contract face value and exposure.
3. Interest Rate Swaps (IRS):

 Exchange of interest flows on asset/liability.
 Notional amount represents swap value.
 Shifts rate calculation basis (fixed to floating, vice versa).
 Exchange of cash flows representing interest payments.

4. Illustration of IRS:
 Example: Swap fixed 7% debenture rate to T-bill + 2% floating.
 Savings if market rates fall.
 T-bill as risk-free benchmark.
 Notional amount not exchanged.
5. Calculation and Netting in IRS:

 Rates on notional amount.
 Bank pays fixed, company pays floating.
 Actual payment netted out.
 Negative net cash flow: Company pays.
6. IRS for Floating Rate Payment Hedging:

 Useful with existing floating rate payment.
 Example: Swap alternate reference rate loan to T-bill + 2%.
 Net cash flow adjusts based on market rate.
1. Benchmark Rates:
 Tied to risk-free rates like SOFR, O/N MIBOR.
 Common in debt and bank lending.

2. Rate Calculation:
 O/N MIBOR daily by FBIL.
 CMS, G-sec yields are used.
 FIMMDA standardizes practices.
3. MIFOR Benchmark:
 Daily Reuters rate.
 Combines alternate rate and USD/INR forward premium.
 Limited to inter-bank use.
4. Floating-to-Floating Swap:
 Shifts benchmark rates.
 Offers flexibility in rate choices.
5. IRS Variety:
 OTC from banks.
 Quanto, coupon, knock-out swaps (India permits plain vanilla).
 Tailored to client needs.
6. Client-driven IRS:
 Matches borrowing to business cycles.

 Example: Convert fixed rates for working capital.
 Aligns with specific needs and payment structures.
1. IRS in Treasury:
 Manages net position.
 Mitigates asset-liability mismatches.
2. Counterparty Risk:
 Limited to net interest payable.
 Settled at reset periods.
3. Credit Conversion Factors:

 Adjust Notional Principal for Capital Charge.
4. Forward Rate Agreement (FRA):

 Complements IRS for single future payment.
 Rates from risk-free Treasury yield curve.
5. Currency Swap Basics:

 Exchanges cash flows in different currencies.
 Covers principal, interest, or both.
 Clients choose to hedge risks together or separately.

1. Currency Mismatch:
 Issue when loan currency differs from revenue currency.
2. Scenario:
 German investor needs Rupees.
 Indian company needs Euros for a French acquisition.
3. Bank Role:
 Banks offer swaps to bridge currency demands.
4. Historical Logic:
 Domestic firms use swaps for interest rate advantage.
 Indian firms raise foreign loans, swap to Rupees.
5. Operation of Currency Swaps:

 POS (Principal Only Swap):
 Pays foreign currency interest.
 Repays principal in domestic currency.
 COS (Coupon Only Swap):
 Uses foreign currency loan.

 Swaps interest to domestic currency.
 P+I Swap:
 Eliminates currency and interest risks.
 Pays both principal and interest in domestic currency.
6. Combination Structure:
 Swaps combine forward rates and interest swap rates.
 Offers a clear structure for buyers.
1. IRS Use:
 Corporates hedge with IRS.
 Banks, MFs, and FIs use for hedging and market activities.
2. Regulation:
 RBI sets derivative capital rules.
 ISDA Master Agreement required.
3. ISDA Documentation:
 Standardized by ISDA.
 Master Agreement, Schedule, Trade Confirmation.
4. Dispute Resolution:
 Trade Confirmation > Schedule > Master Agreement.
5. RBI's Moves:
 Banks trade IRS, not just hedge.
 Initially limited benchmarks; now MIFOR allowed.
 Dual jurisdiction under ISDA for global banks.
6. MIFOR Benchmark:
 Combines LIBOR and forward premium.
 For active forex market swaps.
 Published by 5 PM, based on LIBOR.
7. Dual Jurisdiction:
 Banks under ISDA opt for Indian and common law.
 Facilitates global-Indian bank engagement.
1. Reporting (2012):
 OTC forex and interest rate derivatives on CCIL.
 Confidentiality with FEDAI, FIMMDA, PDAI.
2. USD Rupee Options (2003):

 For hedging by banks, corporates.

3. Exchange Traded Currency Options:
 Plain vanilla on recognized stock exchanges.
 AD Category - I banks as members with requirements.
4. Prudential Requirements for Banks:

 Net worth Rs. 500 crores.
 CRAR 10%, NPA < 3%.
 Net profit for 3 years.
5. Participation Criteria for Other Banks:

 Urban Co-op, State Co-op as clients.
 Reg. dept. approval required.
6. Options Usage Guidelines:

 Exporters/importers for trade.
 Eligible limit determined by turnover.
7. Rebooking Limitations:
 Cancelled options for loans can't be rebooked.
8. AD Category - I Banks as Traders:

 Board-approved.

 Own account and client trading.
 Minimum prudential requirements.
1. Bank Criteria:
 AD Category - I banks need to meet prudential standards.
 Co-op banks can join with regulatory approval.
2. Operational Limits:
 AD Category - I banks operate within NOP and AG limits.
 Options impact NOP and AG limits.
3. Marking and Policies:

 Daily marking for all positions.
 Internal policies, Board-approved, guide derivative use.
4. Structured Products (2007, Modified 2011):

 Corporates eligible with Board-approved risk policy.
 Banks must prevent mis-selling via suitability policies.
5. Cross Currency Derivatives (Extant Guidelines):

 EUR-USD, GBP-USD, USD-JPY allowed.
 Added EUR-INR, GBP-INR, JPY-INR options.

 Enables direct hedging and cross-currency strategies.
6. New Contracts Features:
 Participants can trade without underlying exposure, following
position limits.
 AD Category - I banks trade within NOPL, ensuring USD-INR
compliance.
1. Interest Rate Options (2017):
 RBI introduced on Jan 31, 2017.
 Allowed on SEBI exchanges and OTC.
 Market makers need infrastructure.
2. Types of Options:
 European call/put, caps, floors, collars.
 Exercise on predefined date.
3. Benchmark Administration (FBIL):

 Formed in 2014 by FIMMDA, FEDAI, and IBA.
 Manages money market, govt. securities, forex benchmarks.
 Aims for integrity, transparency, and precision.

 Started with FBIL-Overnight MIBOR in 2015.
4. FBIL Operations:
 Calculates Overnight MIBOR from NDS-call data.
 Announces daily rate at 10:45 AM.
 Committed to unbiased, data-driven benchmarks.
1. Banking Essence:
 Balances maturity and risk.
 Collects varied maturity deposits.
 Loans with diverse terms and risks.
2. Deposit Dynamics:
 Banks accept deposits up to 10 years.
 Prefers short-term to dodge interest risk.
3. Risk Handling:
 Manages credit risk traditionally.
 Faces market risks: liquidity and interest rates.
4. Market Risk Examples:

 Negative earnings if fixed rates clash with falling rates.

 Mismatch between short deposits and long loans.
5. ALM Core:
 Asset Liability Management (ALM) safeguards net worth.
 Manages balance sheet risks.
1. Liquidity and Interest Link:

 Liquidity risk leads to interest rate risk.
 Critical for banks to manage liquidity promptly.
2. Asset-Liability Mismatch:
 Cash flow mismatch results from asset-liability misalignment.
 Focus on balancing inflows and outflows.
3. Liquidity Sources:
 Involves cash surpluses, credit lines, and liquefiable securities.
 Assessing available cash against immediate liabilities is key.
4. Liquidity Gap:
 Positive or negative gap based on asset and liability variations.
 Examined in specific time bands for maturity mismatch.
5. RBI Guidelines:
 Specifies time bands for measuring liquidity gaps.
 Caps on net cumulative negative mismatches in different time
buckets.
6. Contingency Measures:
 Banks must outline measures in Liquidity Management Policy.
 Includes standby credit lines to tackle liquidity shortfalls.
1. Interest Rate Risk:

 NII risk from market interest rate changes.
2. NII Illustration:
 Example: Rs. 100 cr. deposit at 5%, invested in a 7% loan.
 NII impact with changing deposit rates.
3. Repricing Risk:
 Mismatch in assets and liabilities repricing dates.
 ALM organizes in time buckets for analysis.
4. ALM Measurement:
 Gap measurement in time buckets for rate-sensitive assets and
liabilities.
 Monitored using various metrics.
5. Risk Mitigation:
 Swapping between fixed and floating rates with derivatives.
 Key for managing interest rate risk and NII protection.
1. RBI Capital Adequacy:

 Mandates capital for market risk.
 Additional capital for derivative use.
2. Basel 3 Simplified Approach:

 Simplified capital approach under Basel 3.
 Different methods for banks with sophisticated derivatives.
3. ALM Measurement Methods:

 Gap management is one method.
 Includes VaR, Present Value, duration, and simulations.
4. Depositor Comfort:
 Indian depositors prefer fixed rates.
 MCLR introduces floating rates for advances.
5. Role of Treasury in ALM:

 Treasury manages funds, addressing liquidity and interest rate
risks.
 Connects core banking to financial markets, identifying market
risks.
1. Mismatches and Gains:
 Mismatches are inherent.
 Bank profits from them.
2. Treasury's Involvement:
 Uses derivatives for gap bridging.
 Hedges residual risks.
3. Market Risk in Treasury:

 Treasury exposed but risks often offset.
 Tracks exchange and interest rates.
4. Marketable Treasury Products:

 Treasury products replace credit.
 Boosts liquidity when needed.
5. Integrated ALM:
 ALM often part of dealing room.
 Treasury vital in ALCO for risk and policy.
6. Derivatives in ALM:
 Manage liquidity and interest rate risks.
 Effective for risk management with minimal capital.
7. Dynamic Hedge Management:

 Derivatives used for dynamic hedging.
 Adjustments made due to changing asset-liability composition.
1. Swap Protection:
 Derivative transactions separate from banking.
 Swap makes 3-month deposit act as a 3-year.
2. Interest Rate Arbitrage:

 Swap fixed loan rate to T-bill linked.
 Yields a stable spread throughout the loan.
3. Currency Arbitrage:
 Borrow in USD, lend in Rupees.
 Treasury pays forward premium for exchange risk.

4. Hedging Currency Mismatches:
 Use options for FC loan repayments.
 Protect value of foreign currency receivables.
5. New Product Structuring:

 Treasury aids in creating products.
 Floating rate deposits and loans gain popularity.
6. Limitations of Derivatives:
 Effective only with rational product pricing.
 Residual risk remains (basis risk).
 Embedded options and prepayment may escape hedging.
7. Credit Risk in Treasury:

 Mainly concerns counterparty dealings.
 Governed by exposure limits and risk norms.
1. Credit Derivatives:
 Manage credit risk.
 Include credit default notes.

2. Risk Factors:
 Counterparty risk in protection.
 Crisis exposed protection providers' credit risk.
3. Leverage Impact:
 Highly leveraged, profitable.
 Crisis led to bail-outs due to vanishing protection.
4. RBI's Caution in India:

 Careful introduction of credit derivatives.
 Allows single name Credit Default Swaps (CDS) on corporate
bonds.
5. Eligibility for Entities:
 Market makers: Banks, PDs, NBFCs.
 Users: Banks, PDs, Mutual Funds, Insurance Companies, etc.
6. RBI's Guidelines:
 Defines norms for market makers.
 Specifies operational guidelines and capital adequacy norms.
7. Transfer Pricing:

 Essential in asset-liability management.
 Treasury sets rational costs and returns for bank resources and
assets.
1. Pricing Foundation:
 Treasury sets prices based on market rates.
 Considers interest, hedging, and reserve costs.
2. Policy Role:
 Manages liquidity and interest rate risks.
 Isolates credit department profits to credit risk.
3. Branch Profitability:
 Vital in multi-branch setups.
 Assesses profit considering risks.
4. Integrated Policy:
 Covers ALM, liquidity, derivatives, investment, and composite
risk.
 Includes FX, treasury, and transfer pricing.
5. RBI Requirements:
 Includes anti-money laundering and hedging policies.
 Excludes credit and operational risk from ALCO focus.
?

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BFM MODULE C

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 Global cash management.

 Efficient merchant services.

 Profit optimization in forex, money, and securities markets.

 Risk management assistance.

 ALM and funds transfer pricing.

2. Distinct Treasury Roles:

 Proprietary Positions: Trades for bank profits.

 Risk Management: Aids in ALM and manages risks.

 Merchant Book: Client-related transactions.

 Trading Book: Manages proprietary positions.

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 Free capital flows, minimal regulation.

 Includes additional capital flows beyond regular trade-related

 Emerging markets embrace free capital flows for growth and

3. Impact & Regulation:

 Governments regulate cross-border capital for stability.

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 Cautious regulatory intervention due to risks.

 Full capital account convertibility not yet permitted by RBI.

 Influenced by inflation, interest rates, GDP, and global markets.

 Primary dealers, mutual funds deepen debt and equity markets.

 Facilitates forex, money market, and securities transactions.

4. Product Range Expansion:

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 Introduction of Currency and IRFs, CDS.

 IRFs trade on stock exchanges.

 Single-name CDS introduced for corporate bonds.

 Cross Currency Futures, Options for direct hedging and

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 Integrated to generate surpluses, supplement core banking

 Highly leveraged with a high return on capital.

 Low operational costs compared to branch banking.

5. Treasury Profit Sources:

 Profit generated through 'spread' in buying and selling foreign

1. Money Market Operations:

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 Corporate debt market developed post-RBI restrictions removal

in the late '90s.

generation, not specific requirements.

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Buy/Sell Swap @ 4.32%.

 Total Return for Forex Treasury = 4.32% (Arbitrage Gain =

 Execute Buy/Sell swap at 4.17% premium.

 Place Dollar funds abroad at 0.15%.

 Total return: 4.32%, arbitrage gain: 0.82% for seven days.

2. Money Market Instruments:

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 Engage in speculative trading for profit.

 Market liquidity is a challenge, but banks actively engage for

name credit default swaps on corporate bonds.

to minimize potential losses.

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for hedging currency and interest rate risks.

income of scheduled commercial banks in India.

cost of funds, interest rate risk, and maturity mismatches.

requirements under Basel III guidelines.

branch, maintaining autonomy with its own accounting system.

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overseeing three main divisions.

office (Risk Management).

forex, money market, securities, and corporate deals.