Welcome to Banking Quest

Introduction

• Structure of Treasury? 
• Front Office 
• Back Office 
• Mid Office 
• Integrated Treasury Mechanism 

 INVESTMENT BANKING

• FRONT OFFICE
• MIDDLE OFFICE
• BACK OFFICE

 Structure of Treasury

• Normally, the Treasury of a Public Sector Bank is headed by an executive in the cadre of General Manager. 
• After merger of Union Bank, Corporation Bank and Andhra Bank, presently the merged entity is headed by Chief General Manager (CGM)
• The three offices, that is Dealing Room, Back Office and Mid Office are headed either in the rank of Chief Manager or Assistant General Manager. 
• Originally, the Government used to manage its treasury or funds management work.
• Later, the Government handed over this function to the RBI.
• RBI used to look after the funds management or treasury management of the Government. 
• Wherever RBI is not there, this work is delegated to State Bank of India initially.
• Presently, many banks and more particularly PSBs (Public Sector Banks) take care of the funds management work of the Government. 
• When the country adopted the liberalization policies, the funds management work for the banks became more important and hence every bank started to have their own independent treasury branch to look after the treasury or funds management work. 
• In the liberalized situation, the funds management work has become more important for corporates too.  Hence, big corporates like Reliance, Adani, L&T have opened their own treasuries. 
• Treasury Branch/Department of a Bank consist of three Sub-Department under it:
  • 1. Front Office or also called as dealing room
  • 2. Mid Office (Middle Office) or also called as Risk Management department for Treasury
  • 3. Back Office or also called as Accounts Section, which takes care of accounting, settlement, reconciliations, deal confirmations and preparation of balance sheet and other documents for the treasury.

Dealing Room

Description of Front Office:

• Front Office is the place where all transactions or deals are concluded. So, the transactions concluded are called as Deals.
• The persons sitting in the front office and carry out the deals are called as Dealers. 
• Once the transaction or deal is concluded, the dealer should prepare a deal slip and hand it over to the back office either manually or through the system. 
• Since deals are taking place in the front office, it is also called the Dealing Room.
• Since deals are concluded by the Officers posted in the front office, they are called as dealers. 

Description of Front Office (contd.):

• All the dealers would be working under the control and guidance of a Chief Dealer who is normally the senior most dealer in the group and a person having obtained a degree or diploma in this line, that is, his or her educational background is good.  Sometimes, Banks source Chief Dealers and Dealers from the other banks also.
• Deals can be carried out through the system or over phone. 
• For the deals concluded over phone, the dealing room should have a voice recording system to capture the talk between the dealers as to how the deals were concluded over phone. 
• That is why, CGM, Canara Bank in his opening remark said the dealers enjoy more power than the Managing Director in concluding the deal. 
• Every Bank should have Board mandated Treasury Policy. Hence, compliance to Treasury Policy is MUST by the Dealers. 
• Any dealer violating the norms or exceeding the limits falls under the scope of Operational Risk and the punishments are normally very high and may go to the extent of termination of the job. 
• To sum-up, the risk is getting opened for the Treasury through the Front Office. 

Back Office

Description of back office:

• Once the deals are concluded by the dealer, a deal slip has to be prepared and sent to the Back Office.
• In the dealing room, most of the deals are undertaken with counterparty banks (interbank transactions), RBI and customers subject to adhering to the limit discipline fixed as per Treasury Policy. 
• The transaction or deals carried out with another counterparty banks have to be first confirmed over phone. 
• Both the Dealing room and Back Office will work in tandem under the control of the Treasury head.  

Deal Confirmation:

• Let us take for example, how a deal concludes in a Dealing Room.
• Bank X lends Rs. 100 crores to Bank Y in call money for one day at an interest rate of 6%.
• The above deal is concluded by the dealer in the dealing room. The dealer will prepare a deal slip and hand it over to the back office.
• So, once the deal slip is received at the back office, the back-office official has to contact the back office of Bank Y and confirm the deal over phone.
• Thereafter, the officer generates the deal confirmation and sends the same through courier for the confirmation of the counterparty bank. 
• Nowadays, System support is also leveraged but the process should be the same. 
• Once a deal is confirmed by the counterparty bank, the deal confirmation will be kept in a file for the verification of the auditors. 
• As per RBI norms, Treasury of a Bank should be under a Concurrent Audit System, that is, subjected to daily audit either internally or by external auditors. 

Settlement:

• Once the deal is confirmed over phone, the office has to send a RTGS for Rs. 100 crores to Bank Y.
• The officer will write in the diary when Bank Y will send the money back.
• Next day, the officer will ensure that the money has come from Bank Y, that is, Rs. 100 crore + interest, since the deal is for one day.

Accounting:

• The back office is responsible for passing the entries in the books of the treasury. 
• The back office is responsible for preparing the P & L account, Balance Sheet of the Treasury.
• Normally, Treasury Books are closed every quarter to synchronize with Bank financials (June, September, December & March). 

Reconciliation: 

• There are a number of transactions taking place in the treasury.  All these transactions have to be matched properly with RBI account, Foreign Bank Accounts (Nostro Accounts) etc. 
• Reconciliation of accounts is the big responsibility of the Back Office. One of the reasons for the Nirav Mody Scam was that the reconciliation  was not done or carried out properly. 
• The entries of inward and outward remittances have to be recorded in the books of the India bank (a NOSTRO mirror account). Assuming that this did not happen, an audit process, which requires reconciliation of the two accounts, should  throw up anomalies.
• According to the guidance note on bank audits, the auditor has to consider whether a system of periodical reconciliation was in place and whether confirmations from the foreign banks are obtained on a periodic basis, either through physical confirmations, SWIFT messages, emails, etc. 
• The above areas of checking, it seems, were not carried out properly for several years in this scam.

Meaning of Nostro Account

• A nostro account refers to an account that a bank holds in a foreign currency in another bank. Nostros, a term derived from the Latin word for "ours," are frequently used to facilitate foreign exchange and trade transactions. (Our account with you)
• Bank’s customers such as exporters and importers carry out a number of transactions through the Bank, called as Authorized Dealer.
• Any export proceeds of the exporters would be credited to the Nostro account of the bank and any importer who pays in foreign currency for the import, the Nostro account of the bank would get debited. 
• Hence, every bank requires the Nostro account for carrying out such varied and numerous forex transactions. 
• For example, Canara Bank, Treasury, Mumbai opening a Current Account with CitiBank, New York in US $ is the example of a Nostro account.

Concept of Mid Office

• In the year 1994, a big scam took place in Singapore.
• This is called the Nick Leeson Scam. This scam had taken place in a bank called Barings Bank, Singapore. 
• Nick Leeson being the head of Derivatives was suppressing the losses made in a number of ways. 
• When one fine morning he admitted the losses, the losses exceeded the capital of the bank and due to this, the bank had to be closed. 
• Nick Leeson was punished by Singapore Court and had to undergo 7 years imprisonment. 
• Subsequently, he migrated to Ireland and settled there. 
• Nick Leeson has written a book by the name ' ‘Rogue Trader’’, one of the best-selling books even today. Movies have come in this book.
• This scam has opened the eyes of the Supervisors, Regulators.
• Out of this BCBS came out with its guidance note in the year 1996 recognizing Market Risk as one more potential threat for the bank in addition to credit risk. 
• This guidance note also recommended that every bank having treasury should set-up a Mid Office. 
• So, Mid Office is created to take care of the risk management of the treasury. 
• By virtue of carrying out the deals, the dealing room opens the risk for the treasury. 
• This risk has to be quantified and mid-office should have its risk management views on the deals concluded by the dealing room.
• Mid office is the watchdog of the Dealing room. 
• Whatever the deals taking place in the dealing room, mid office should watch them from a risk angle. 
• Even though mid office people sit in treasury, they will report to the Risk Management head and not to the head of Treasury. 
  • In case, the mid office is kept under the control of the Treasury Head, he may influence the mid office people not to report the high-risk transactions to the management.  To avoid such consequences, the Mid office is kept under the control of the Risk Management department or any other departments such as audit, vigilance or money-laundering departments. 
  • However, the Mid office should not stifle/interfere with the functioning of the dealing room.
  • Mid office will study the deals carried out by the dealing room, once the deals are concluded from a risk angle. 

 Short recipe of Nick Leeson Scam

• Nick Leeson is a former derivatives trader who became notorious for bankrupting Barings Bank, the United Kingdom's oldest merchant bank.
• After moving to Singapore to execute and clear transactions on the Singapore Exchange (SGX) in 1992, Leeson began making unauthorized trades, which initially made large profits for Barings.
• Although Leeson was supposed to be managing a cash-neutral business, he was actually using the bank’s money to make bets on the market in an attempt to recoup his trading losses.
• Leeson's losses accounted for £827 million, twice Barings's available trading capital, and after a failed bailout attempt the bank declared bankruptcy in February 1995.

 Role of Investment Committee

• At the Head Office level, the Investment Committee composed of Senior Executives of the Bank meet daily around 9 am in the morning. 
• Normally, the Convenor of this meeting is the Treasury Head. It is headed by the Managing Director of the Bank supported by Executive Directors. 
• Treasury Head will apprise the Committee about the summary of transactions that took place in Treasury previous day, how expects the market to behave today and what actions dealing room intend taking today. 
• Thereafter, the Risk Head will give his opinion on the deals concluded on the previous day from a risk management point of view. 
• Based on the reports given by the Treasury Head and Risk Head, the MD will give his opinion, advice and directions for safeguarding the interest of the Bank.  

 Sections Working in Dealing Room

• Predominantly, there are three sections that work in Dealing Room:
  • Domestic Section
  • Forex Section
  • Derivative Section
• Domestic Section: Under this Section, there are several desks attached to it:
  • RBI – LAF desk (Liquidity Adjustment Facility)
  • CRR and SLR desk
  • CBLO desk (Collateralized Borrowing & Lending Obligations)
  • Call Money desk
  • G. Sec desk.
  • Corporate bond desk
  • Equity desk
• Forex Section: Under Forex Section, there are several desks attached to it:
  • $/rupee spot market desk
  • Forwards desk
  • Cross-Currency desk
  • $/rupee option desk
  • Merchant desk
• Derivative Section: Under derivative section, there are several desks attached to it:
  • Interest rate derivatives:
    • OTC (over the counter products)
    • Exchange traded
  • Currency Futures
  • Currency Swaps
  • Cross-Currency Options
  • Structured Derivatives

 Concept of Integrated Treasury

• Under the liberalized environment, the three sections of the dealing room should not work in silos.
• All the three sections, Domestic, Forex and Derivatives should work in tandem to safeguard the interest of the bank. 
• When all the above sections are working together, it is called an Integrated Treasury.
• In the integrated treasury, the rupee will move between the desks in such a way it earns more income for the treasury as well as for the bank. 
• Banks with good credit standing, may borrow large amounts in the money market and lend to other banks/ highly rated corporates and other institutions, using market instruments, at marginally higher rates and can earn profit in the process.

 Example for Integrated Treasury:

• Forex dealers purchases $ 1 million at the rate of Rs. 76/- today.
  • When the dealer buys $ from a counter-party bank, it has to sell rupees to the same bank. 
  • X Bank Dealer buy $ 1 million from Y Bank at the rate of Rs. 76/- per $ (Function of Forex Section)
  • So, X Bank has to give or sell rupees worth Rs. 7.60 crores to Bank Y ($ 1000,000 x 76). This is the function of the Domestic Section.
• Let us assume that the forex dealer keeps the position today and sells the same tomorrow at a price of Rs. 76.05 to Bank A. In the process, Bank X has made a profit of $ 1000,000 x 0.05 = Rs. 50,000/-.

What is the annualized yield, Bank X has got on this deal?

• Rs. 76 invested today for 1 earns a return of 0.05
• If it is Rs. 100 for 365, what is the yield?
• (100 x 365 x 0.05)/ (76 x 1) = 24%.
• In case, the above $ purchased was funded by the Domestic Section with a call money borrowing of say 25% on that day:
• The deal may be on profit for the forex section.
• But the overall deal is a loss making proposition for the bank. 
• So, in the Integrated Treasury Set-up, the dealer should keep in mind that he should make profit and at the same time, the Bank should also make profit.
• In case, there is a conflict of interest between the dealer and the bank, Bank’s interest is more superior to Dealer’s individual interest. 

 Let us do a small problem:

• Dealer has purchased $ 500th at the rate of Rs. 76.10 per $.  He has kept the position for 2 days and sells the $ on 3rd day at the rate of Rs. 76.13 per $.  Arrive at the earnings in absolute amount and in annualized yield.

Answer:

• • $ 500,000 x 0.03 = Rs. 15,000/-
  • (100 x 365 x 0.03)/ (76.10 x 2) = 7.19%.

Next Problem:

• • Dealer has bought $ 800th at the rate of Rs. 76.13 per $.  He has kept the position for 3 days and sells the $ on 4th day at the rate of Rs. 76.15 per $.
  • The Call money desk has funded the $ purchase by borrowing rupees from Call Money market at the rate of 4%.

Questions:

• • 1. Arrive at the profit made by the forex dealer in absolute amount and also in % terms.
  • 2. Also, arrive at the profit or loss made by the bank in the above deal.

Solution:

• • $ 800,000 x 0.02 = Rs. 16,000/- profit made by a forex dealer.
  • (100 x 365 x 0.02) / (76.13 x 3) = 3.20% - income in % term.
  • Bank has to pay 4% in call money.
  • Bank has made a profit of 3.20% in forex.
  • Net Bank has made a loss of 0.80%.
  • (76.13 x 3 x 4) / (100 x 365) = 0.0250290 per $ x 8,00,000 = 20,023/- (Expenditure)
  • Less Income on forex:  Rs. 16,000/-
  • Loss for the bank is Rs. 4,023/-.