The Indian Banking sector is rapidly globalizing, making it important for Indian banks to ensure their practices match those of the best banks in the world. Several Indian banks are pursuing global strategies, as Indian companies globalize and people of Indian origin increase their investments in India. It s observed that n surface level all Indian banks have same profitability but there are dramatic differences in underlying economics. Indian banks have historically had access to superior talent relative to other global banks leading to superior organizational performance on average.
The Asset Liability management survey shows that treasury is significant contributor to bank earnings in India. The treasury divisions at Indian banks are integrated profit centers that manage capital market businesses and credit and market risk. It is encouraging to see that several attackers have leapfrogged on this front and are using sophisticated risk management techniques on par with those implemented by global banks. However, risk management practices in public sector banks are at a nascent stage and simply conform to regulatory and compliance measures.
McKinsey’s survey on banking shows that Indian leading banks have done remarkably good in increasing shareholder’s value, allocating capital effectively, and contributing to GDP growth. However, in comparison to international peers, Indian banks could do more to foster financial inclusion and manage intermediation costs. Measuring Asset Liability Management Performance: The Asset Liability Management performance can be evaluated using six key parameters. Following figure shows these parameters. Future of Indian Banking System:
The optimism about Indian economic growth portends well for Indian banks. There are, however, challenges in retaining profitability and growth in the next decade. The industry has to live up to high expectations from several quarters. This report highlights ten major trends that will shape Indian banking over next decade. It identifies two critical and complex challenges thrown at the industry for which solution has to be found with urgency. The report outlines potential solutions and articulates key imperatives for government and regulation.
The ten major trends to watch out for are: 1. Retail banking will be immensely benefited from the Indian demographic dividend. Mortgages to grow fast and will cross Rs 40 trillion by 2020. 2. Rapid accumulation of wealth in rich households will drive wealth management to 10X size. 3. “The Next Billion” consumer segment will emerge as the largest in numbers and will accentuate the demand for low cost banking solutions. 4. Branches and ATMs will need to grow 2X and 5X respectively to serve the huge addition to bankable population.
Low cost branch network with smaller sized branches will be adopted. 5. Mobile banking will come of age with widespread access to internet on mobile. 6. Banks will adopt CRM and data warehousing in a major way to reduce customer acquisition costs and improve risk management. 7. Margins will see downward pressure both on retail and corporate banking spurring banks to generate more fees and improve operating efficiency. 8. Banks will discover the importance of the SME segment for profitability and growth and new models to serve SME segment profitably will be found.
9. Investment banking will grow 10X, driven by demand from corporate for transaction support and capital market access. 10. Infrastructure debt will surpass Rs 45 trillion — half of which will be on bank’s books. It will touch the ALM limits of banks and will require a significant upgrade of banks’ risk management systems. The industry is under spotlight to find solutions for two complex challenges thrown at it. One challenge comes from the democratic polity of the nation — to find an economically viable solution for financial inclusion.
The second challenge comes from within the public sector banks — to streamline HR in light of rapid loss of talent due to retirements and to energize the workforce for the challenges ahead. This report offers suggestions on possible approaches for banks. Banks may not succeed in meeting all expectations. NBFCs will play a very crucial role on the extreme ends of the spectrum where there is an innovation challenge — infrastructure finance, rural and agricultural finance, SME finance, and financial inclusion. The role of DFIs will be crucial to bridge market failures in rural infrastructure.
Among other things, the government needs to accord the highest priority to the development of a deeper wholesale debt market. Positive regulations are needed to enable NBFC and DFI to supplement banks. Money Management powers of the treasury and federal reserve banks: A brief of historical times Treasury Cash Funds: The ability of the Treasury to expand or to contract bank reserves arises out of its cash position and potential changes in cash and borrowings. The general fund balance as on August 15, 1936 in US Treasury was 2 billion dollars, but a more detailed analysis of the statement is revealing.
On the face of the statement, the general fund contained cash consisting of 422 million dollars in gold and silver certificates, 387 million dollars of deposits in Federal Reserve Banks, and 1,134 million dollars of deposits in special depository banks. To these should be added the amount in the separate stabilization fund, carried on the books at 1,800 million dollars, which is money available for money market release at the discretion of the Treasury. Unless extended by new legislation, the gold segregated in this fund will revert to the general fund early in 1937.
In addition, the treasury held in the general fund as silver bullion, carried at cost, 332 million dollars which, when and if “coined” into silver dollars and issued in the form of silver certificates, would produce about double or 664 million dollars, assuming the original cost to average one-half the coinage value of about $1. 29 per ounce. Summarizing, the present cash funds readily available for manipulation total nearly 4. 5 billion dollars. Treasury Expansion: If the treasury wishes to expand bank reserves generally throughout the US, it can check out its present and potential balances in the Federal Reserve Banks.
Whenever the treasury draws its checks in payment of expenses or redeem bonds, member and nonmember banks must per-force receive such checks on deposit from their customers. In the regular course of business, the checks are forwarded, for collection to correspondent banks who give credit therefore finally, directly or indirectly, on books of the federal reserve banks. By this method, treasury deposits in Federal Reserve Banks are converted readily into member bank reserve deposits as Federal Reserve Banks.
The treasury’s balance of 387 million dollars at federal reserve banks could be augmented by 10 billion dollars; that is to say, the Treasury could deposit its present holdings of gold and silver certificates, its silver bullion after conversion into certificates, the balance in the stabilization fund, and the potential cash arising from the use of the extraordinary powers to revalue gold and silver and issue greenbacks. Therefore, the aggregate expansibility if the member bank reserves by treasury action totals more than 10 billion dollars. Incidentally, Federal reserve bank reserves would be increased by these new treasury deposits.
Bank’s Treasury Performance Measurement In recent years we have seen increased volatility in interest rates, forex rates and asset prices. The financial markets have also become more sophisticated and complex. These developments have resulted in the treasury playing more critical role in banking operations. The treasury function, which includes foreign exchange and money market operations, provides a supporting role to the major banking operations. In a typical bank, the major operations would include corporate banking, private banking, retail banking, investment banking, fund management and international banking.
Besides providing a supporting role to the other major operations in a bank, the treasury is also an important profit center in many banks. Role and Structure of Treasury: Different banks have different structure and roles of a treasury. Some banks makes it as a part of international banking and some do not make it specific to any department. Centralized treasury function of a bank is normally involved in the following areas: •Risk exposure management •Asset and liability management •Nostro account management •Capital debt raising •Trades in foreign currency notes •Prevention of frauds and instigation of controls
Treasury can be set as a service center providing functions to various departments or it can be set up as an individual department working as a profit center. Risks in Treasury Operations: Treasury faces following risks: 1. Credit Risk Credit risk in the money market is the risk that the borrower is unable to replay the funds when due. Establishing lines for placements with each borrower can control this risk. Lines of credit should also be established by industry. Credit risk in foreign exchange market comprises either the 20% or the 100% risk, depending on whether the other party to the contract defaults before or at the maturity date.
Exposure to sovereign risk or cross-border risk should be controlled. A system should be developed to measure the total amount of funds including money market and exchange transactions exposed to sovereign risk for each country. There should be sovereign limits on the total contracts outstanding as well on the amounts outstanding for one day. 2. Market Risk Volatility in interest rates would affect the profitability of money market operations and swap exchange positions. The risk can be controlled by imposing limits on the net position and negative case positions allowed to develop during given periods of time.
The time gap position limits are used to control the exposure for mismatching of maturity dates. These limits also serve to control the liquidity risk in treasury operations. 3. Liquidity Risk Liquidity risk is the risk of not being able to obtain funds when they are needed. A large net exchange position may represent a substantial liquidity risk if the currencies involved are not very marketable. Imposing cash-flow limits can control the risk 4. Volume Risk It is well known that in many reported cases, difficulties in treasury operations were preceded by an unusual increase in the dealing activity of the particular bank.
A bank’s own unauthorized increase in trading volume should provide an early warning of possible overtrading dangers. Trading volume limits on total outstanding, near date outstanding and forward date outstanding should be established. Bank Treasury and Cash Management Services The financial crisis has put tremendous pressure on CPAs to make the most of very limited resources. One resource in particular, banking establishments, must compete to attract CPA clients. Technology has opened the door for many finance and treasury functions to be more efficiently handled by the bank than by a company.
Although there has been a recent effort from banks to raise fees, competition keeps the fees that banks charge for treasury services relatively low. Banks’ treasury and cash management services have evolved over the years and now provide a roster of benefits. Finance and treasury professionals can reduce costs and add value to an organization by determining if their current banking relationship offers a broad enough range of technology-based treasury services. Treasury Workstations: Although not a treasury service provided by a bank, treasury workstations can simplify and accelerate the tasks involved in treasury management.
These workstations are computer systems that handle corporate treasury functions. This option is usually cost- prohibitive for smaller bank customers, but it should be considered as an option in any complete review of treasury systems. Treasury Best Practices: Banking Structures •Optimal number of providers •Optimal number of accounts •Effective services and technology •Competitive pricing Bank Relationship Management: •Good balance of credit and cash management services maintained •Effective communications •Quality and fees are monitored •Services are re-bid periodically.
Collection/Concentration •High percentage of electronic versus paper payments •Effective use of lockbox and technology to accelerate cash collection •Automatic, daily consolidation of funds to one, or few accounts •Use check conversion Disbursement •Controlled disbursement accounts •Full reconciliation services •Positive pay services: traditional, payee match, imaging •Comprehensive payable services •Few (or no) manual checks Treasury Single Account Government banking arrangements are an important factor in managing and controlling government’s cash resources.
They are critical for ensuring that (i) all tax and non-tax revenues are collected and payments are made correctly in a timely manner; and (ii) government cash balances are optimally managed to reduce borrowing costs (or to maximize returns on surplus cash). This is achieved by establishing a unified structure of government bank accounts via a treasury single account (TSA) system. A TSA is a prerequisite for modern cash management and is an effective tool for the ministry of finance/treasury to establish oversight and centralized control over government’s cash resources.
It provides a number of other benefits and thereby enhances the overall effective- ness of a public financial management (PFM) system. The establishment of a TSA should, therefore, receive priority in any PFM reform agenda. Fragmented government banking arrangements hinder effective cash management. The primary objective of a TSA is to ensure effective aggregate control over government cash balances. The consolidation of cash resources through a TSA helps to avoid borrowing and paying additional interest charges to finance the expenditures of some agencies while other agencies keep idle balances in their bank accounts.
Effective aggregate control of cash is also a key element in monetary, debt, and budget management. A TSA system should embody the following principles: (i) the government banking arrangement should be unified to ensure the fungibility of the government’s cash resources; (ii) no other government agency should be allowed to operate bank accounts without the over- sight of the treasury; and (iii) the coverage of the TSA should be comprehensive, encompassing all government cash, both budgetary and extra budgetary.
The design of a TSA in a particular country depends on the stage of development of the public institutions and financial management systems and the degree of maturity of its banking system, including the technology used for the interbank settlements and clearing systems. In countries with well developed PFM systems and an advanced banking network, best practice implies creating a TSA in the central bank, while a well developed accounting system records all transactions of different entities that may have transaction accounts in commercial banks on a zero-balance basis.
Issues related to consolidation of cash in a TSA for cash management purposes should not be confused with issues related to the distribution of responsibilities for accounting control and processing of receipts and payments. A TSA can operate with both centralized and decentralized transaction processing and accounting control systems. Technology in Treasury Management: Technology is a key success factor in the treasury management business. It helps banks attract lucrative corporate customers and develop better service offerings to provide customers more value.
It also helps banks and customers save time and money. Many market forces are impacting banks in the quest to stay competitive in the lucrative treasury management services business. For example •Customers dissatisfied or frustrated with the quality of their banking services are defecting to rival institutions. One contributing factor to poor quality of service is inadequate integration of back-end systems that have been nrought into the same environment due to mergers and acquisitions •Revenue opportunities in traditional arenas such as check-payments processing are declining.
Thus many banks are outsourcing this service, and are instead pursuing operations with healthier growth rates, such as electronic payment processing. •Banks face new competition from non-traditional competitors. For example, technology vendors have offered electronic bill and invoice presentment and settlement solutions for years, offering businesses an alternative to using a traditional bank for such services.
The banks recently improved their own service offerings, but continue to lag behind non-bank technology providers in areas such as connectivity and integration with customer’s back-end systems, leading enterprise resource planning and existing treasury management systems •New regulations are forcing banks to change how they deliver certain services. For example, the Check Truncation Act, a Federal Reserve regulation, would force banks to hold checks at the place of deposit or somewhere along the check collections chain, providing paper images of the checks back to the customer only on request.
In each case, technology plays an important role in helping banks respond to market pressures and stay competitive. For example, enterprise application integration technology is critical for addressing integration issues and improving quality of service for applications that may span multiple systems. New technologies for electronic payment processing and electronic bill and invoice presentment and settlement can help the banks compete in those arenas, retaining their corporate clients rather than losing them to technology vendors.
Overall banks clearly see the value of developing technology-oriented services that are different from their competitors, helping them protect their revenues while supporting client cost reduction efforts. Future of Bank Treasury Management: Following figure shows the changes in regulatory frameworks in Banking in recent years and future expected trends. As a result of business, market and regulatory challenges, the following key themes are emerging for treasury functions:
Key macro factors such as changing regulations, cost pressures, and shifting markets have led to what we see as key themes and trends emerging for he near future and post 2015 for treasury functions. Following figure shows the essentials in achieving this post-2015 vision. •Funding: Building a long term funding plan with improved funding models. •Liquidity Management: Development of ‘best in class’ liquidity capabilities such as high quality stress testing and accurate daily reporting of key liquidity metrics.
•Capital management: Developing an optimal capital structure that maximizes equity returns whilst meeting the requirements of regulators and markets. •Risk-Centric Culture: Development of holistic view of the risk across the organization, building a risk-centric culture to ensure that balance sheets are effectively managed and the implementation of an economic capital model to facilitate strategic decision making. •Technology Effectiveness: Deployment of improved flexible tools and technology to meet the changing market demands.
2013-14 is supposed to be the inflation point for the treasurers to transform and adapt, enabling them to meet the challenges and needs post 2015 Future Risk Management: Looking ahead, new regulations such as Basel III, Dodd-Frank and European Market Infrastructure Regulations (EMIR) will influence how banks define and manage liquidity risk. The effect will be far reaching in terms of banking business models, capital, technology and collateral management requirements. Following figure shows how your organization plans to address solution requirement to manage liquidity risk under the new Basel III risk management.
The following figure shows how Basel III norms will affect the capital management of organizations Conclusion: The pressures that are now facing treasury functions within banks are unprecedented. With the turbulent economic climate and constantly changing regulatory landscape, modern treasury strategy must now show that it can match the needs of the organization, fundamentally supporting the business, and meet the expectations of an increasingly wider set of external stakeholders, particularly regulators.
To address these challenges in a strategic and sustainable way, bank Treasury functions must look not only their current situation, but also at the challenges that will face them post 2015. They will need to demonstrate: •Efficiency and effectiveness in achieving results by minimizing cost of funds, maximizing capital efficiency and deleveraging balance sheets •Adherence to new regulatory requirements •Robust governance and risk management •Flexible contingency planning for stress scenarios Bibliography 1. Money Management powers of the treasury and federal reserve banks, J. Franklin Ebersole, HBR 2.
Bank’s Treasury Performance Measurement, Malik Sy and Ho Kim Wai 3. Bank Treasury and Cash Management Services, Ron Box, The CPA in industry 4. Treasury Single Account: An Essential Tool for government cash management, Sailendra Pattanayak and Israel Fainboim, Fiscal Affairs Department 5. Treasury Trends: Bank Relationships & Bank Report Cards, Daniel J Carmody 6. Indian Banking 2020 making the decade’s promise come true, Alpesh Shah Ashish Garg Bharat Poddar Neeraj Aggarwal Pranay Mehrotra Ruchin Goyal Saurabh Tripathi, FICCI BCG report 7. Indian Banking: Towards global best practices, McKinsey&Company 8.
Treasury management in India, Knowledge Management Applications 9. Future of bank treasury: A profession in focus, Deloitte 10. Treasury Management: How to improve productivity through new banking technologies, Sharon Dore 11. Bank consolidation and Interstate banking: Effect on Treasury Management, Aaron L Phillips 12. Treasury Management: Banking on Technology, Rebecca Kopf, Gaurav Varma and Christine Klima 13. How to become banana: Best practices in treasury management, Leigh Marjamaa 14. Treasury management: An Overview, Lee E. Teigen 15. Treasury management: Trends in Europe, Conor Griffin.