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.

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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.

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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.

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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:

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  RBI and FEMA relax controls since '90s.
 Current account fully liberalized, cautious approach to capital

account convertibility.
5. Globalization's Impact:
 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:

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  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.

2. Globalization's Impact:
 Treasury's scope expands globally, accessible to global currency

markets.

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  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:

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  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.

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  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.

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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:

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  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.

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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.

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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:

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  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).

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  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.

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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

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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.

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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.

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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.

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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.

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  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.

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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.

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  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.

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  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:

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  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):

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  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.

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  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:

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  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:
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  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:

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  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.

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  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.

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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.

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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.

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  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:

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  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.

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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.

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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:

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  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:

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  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.

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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.

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  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.

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  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:
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  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.

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  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.

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  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:

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  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.

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  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.

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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.

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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:

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  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.

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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):

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  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.

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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:
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  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:

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  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:
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  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.

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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.

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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:
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  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.

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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.

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  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:
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  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:

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  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.

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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:

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  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.

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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.

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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.

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  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.

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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.

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  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:
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  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.

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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.

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  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.

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  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.

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  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.

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  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:
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  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.
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  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:

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  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:
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  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.

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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.

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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:

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  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:
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  Includes anti-money laundering and hedging policies.
 Excludes credit and operational risk from ALCO focus.
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