Treasury Management: Core Concepts, Scope & Nepalese Banking Context

TAKEAWAYS:

• Treasury management is the strategic oversight of a bank’s liquidity, interest rate risk, and capital adequacy to ensure profitability and compliance.
• The Asset-Liability Committee (ALCO) acts as the bank’s risk governance body, balancing assets and liabilities to optimize returns while mitigating risks.
• Nepal’s tight regulatory framework (e.g., RBI directives, Basel III) shapes treasury operations, requiring banks to maintain liquidity buffers and stress-test portfolios.
• Money market instruments (e.g., call deposits, repo agreements) are critical tools for short-term liquidity management and interbank transactions.
• Challenges in Nepal include high interest rate volatility, limited derivative markets, and currency risks from USD/NPR fluctuations.
• Effective treasury management reduces operational risks, improves capital efficiency, and aligns banking strategies with central bank policies.

1. Definition and Objectives of Treasury Management

Treasury management in commercial banks refers to the systematic management of a bank’s liquidity, interest rate risk, and capital to maximize shareholder value while complying with regulatory requirements. It involves:

• Asset optimization: Ensuring loans, investments, and trading portfolios generate optimal returns.
• Liability management: Balancing deposits, borrowings, and capital to meet liquidity needs.
• Risk mitigation: Hedging against interest rate fluctuations, credit defaults, and foreign exchange risks.

Key Objectives

2. The Role of the Asset-Liability Committee (ALCO)

The ALCO is the decision-making body responsible for:

• Strategic asset-liability matching: Ensuring assets and liabilities are aligned in terms of maturity, interest rate sensitivity, and currency.
• Risk appetite setting: Defining tolerance levels for interest rate risk, credit risk, and liquidity risk.
• Policy formulation: Developing guidelines for investment portfolios, borrowing limits, and hedging strategies.
• Performance monitoring: Regularly reviewing the bank’s balance sheet to identify gaps and adjust strategies.

Visual: ALCO’s Decision-Making Process

flowchart TD
    A["Market Conditions & Regulatory Changes"] --> B["ALCO Reviews Balance Sheet"]
    B --> C["Identifies Gaps in Liquidity/Risk"]
    C --> D["Formulates Strategies"]
    D --> E["Approves Investment/Borrowing Limits"]
    E --> F["Monitors Execution by Treasury Team"]
    F --> G["Adjusts Policies Quarterly/Annually"]

3. Treasury Management in Nepal: Opportunities and Challenges

Opportunities

• Growing digital banking: Platforms like eSewa, Khalti, and Ncell increase transaction volumes, creating demand for efficient liquidity management.
• Interbank transactions: The Nepal Clearing House (NCH) facilitates real-time gross settlement (RTGS), reducing settlement risks.
• Foreign exchange hedging: With Nepal Rastra Bank (NRB) allowing limited derivatives, banks can hedge against USD/NPR volatility (e.g., for importers/exporters).
• Regulatory incentives: NRB’s Basel III implementation encourages banks to adopt advanced risk management tools.

Challenges

4. Real-World Applications: How Banks Use Treasury Management

Example 1: NMB Bank’s Call Deposit Strategy

• Scenario: During Dashain, customer withdrawals surge, but loan demand remains steady.
• Treasury Action:
  • NMB issues short-term call deposits (e.g., 7-day, 14-day) to raise liquidity.
  • Uses repo agreements with other banks to borrow funds temporarily.
  • Result: Maintains liquidity without over-borrowing long-term, optimizing interest costs.

Example 2: Global IME Bank’s Foreign Exchange Hedging

• Scenario: A Kathmandu exporter (e.g., Nepal Tea Exporters’ Association) needs USD for payments.
• Treasury Action:
  • Global IME offers a forward contract to lock in the USD/NPR exchange rate (e.g., 1 USD = NPR 130 for 3 months).
  • Result: The exporter avoids currency risk, while the bank earns a small premium.

Example 3: Standard Chartered Nepal’s ALM for Retail Deposits

• Scenario: Most deposits are savings/current accounts (highly sticky but low interest).
• Treasury Action:
  • Matches short-term deposits with short-term loans (e.g., personal loans, overdrafts).
  • Uses liquidity coverage ratio (LCR) buffers to handle unexpected withdrawals.
  • Result: Maintains profitability while ensuring depositor confidence.

5. The Accounting Perspective: Ledger and Journal Entries

Treasury transactions are recorded in general ledger accounts with debit (Dr) and credit (Cr) entries. Below is a worked example for Standard Chartered Nepal Bank issuing a 7-day call deposit of NPR 50,000,000 at 8% annual interest.

Journal Entry for Call Deposit Issuance

| **Date**       | **Particulars**                          | **Dr (NPR)** | **Cr (NPR)** |
|----------------|------------------------------------------|-------------|-------------|
| 2024-03-01    | Call Deposit A/c Dr.                     | 50,000,000  |             |
|                | To Bank (Liability) Cr.                 |             | 50,000,000  |

Interest Accrual After 7 Days (Daily Rate = 8%/365)

| **Date**       | **Particulars**                          | **Dr (NPR)** | **Cr (NPR)** |
|----------------|------------------------------------------|-------------|-------------|
| 2024-03-08    | Interest on Call Deposit A/c Dr.        | 9,863       |             |
|                | To Interest Income A/c Cr.              |             | 9,863       |

Calculation: $\text{Interest}=\frac{50,000,000\times 8\%\times 7}{365}=9,863\text{ NPR}$

T-Account for Call Deposits

Note: The balance shows the net liability after interest accrual.

6. The Treasury Management Cycle: A Step-by-Step Flowchart

flowchart LR
    A["1. Assess Market Conditions"] --> B["2. Review ALCO Policies"]
    B --> C["3. Execute Transactions"]
    C --> D["4. Monitor Liquidity & Risks"]
    D --> E["5. Report to ALCO"]
    E --> F["6. Adjust Strategies"]
    F --> A

Key Steps Explained

1. Market Assessment: Analyze interbank rates, NRB policy rates, and customer demand.
2. Policy Review: ALCO approves investment limits, borrowing ceilings, and hedging strategies.
3. Transaction Execution: Treasury team trades in money markets, issues call deposits, or hedges FX.
4. Monitoring: Track daily liquidity, interest rate movements, and regulatory changes.
5. Reporting: Submit monthly ALM reports to ALCO and NRB.
6. Adjustment: Modify strategies based on performance and external shocks.

7. Money Market Instruments in Treasury Portfolios

Treasury departments use short-term instruments to manage liquidity. Below is a comparison of key tools:

8. Regulatory Framework in Nepal

Nepal Rastra Bank (NRB) governs treasury operations through:

• Basel III Implementation: Mandates liquidity coverage ratio (LCR) ≥ 100% and net stable funding ratio (NSFR) ≥ 100%.
• Interest Rate Risk (IRR) Regulations: Banks must stress-test portfolios under ±200 bps rate shocks.
• Foreign Exchange (FX) Rules: Limits on forward contracts and hedging instruments to control speculation.
• Capital Adequacy: Minimum Tier 1 capital of 8% (higher for systemically important banks).

NRB’s Liquidity Coverage Ratio (LCR) Formula

$$\text{LCR}=\frac{\text{High-Quality Liquid Assets (HQLA)}}{\text{Total Net Cash Outflows Over 30 Days}}\ge 100\%$$ Example: If a bank has NPR 200 million in HQLA and NPR 180 million in 30-day outflows, its LCR is 111.1%.

Exam Tip: How to Score Full Marks

1. Define Clearly: Start with precise definitions (e.g., "Treasury management is the strategic oversight of a bank’s liquidity, interest rate risk, and capital to optimize returns while complying with NRB regulations.").
2. Use Nepal Context: Always relate answers to Nepal Rastra Bank (NRB), Basel III, or local banks (NMB, Global IME, Standard Chartered Nepal).
3. Visuals = Extra Marks: Draw T-accounts, ALCO flowcharts, or balance sheet snapshots to illustrate points.
4. Numerical Examples: Solve one worked problem (e.g., call deposit interest, LCR calculation) with realistic NPR figures.
5. Opportunities vs. Challenges: For essay questions, structure answers as:
   • Opportunities: Digital banking, interbank transactions, regulatory incentives.
   • Challenges: Interest rate volatility, limited derivatives, currency risks.
6. ALCO’s Role: Always mention ALCO’s decision-making process when discussing risk management.
7. Regulatory Compliance: End with NRB’s key directives (e.g., LCR, NSFR, stress testing).

Practice Question with Model Answer

Question: "Explain how a commercial bank in Nepal uses call deposits and repo agreements to manage liquidity during Dashain season. Provide a numerical example with Standard Chartered Nepal."

Model Answer: During Dashain, customer withdrawals surge due to gift purchases and festival expenses, while loan demand remains stable. Standard Chartered Nepal uses:

1. Call Deposits:

   • Issues 7-day call deposits at 9% annual interest to raise NPR 100,000,000.
   • Journal Entry:

     | Date       | Particulars               | Dr (NPR) | Cr (NPR) |
     |------------|---------------------------|----------|----------|
     | 2024-10-10 | Call Deposit A/c Dr.      | 100,000,000 |          |
     |            | To Bank (Liability) Cr.   |          | 100,000,000 |
     

   • Interest for 7 days: $\frac{100,000,000\times 9\%\times 7}{365}=17,260$ NPR.

2. Repo Agreements:

   • Borrows NPR 50,000,000 via repo by pledging NRB treasury bills (yield: 8%).
   • Repo Rate: 7% (lower than call deposit cost).
   • Net Gain: Saves 2% on NPR 50,000,000 = NPR 82,192 over 7 days.

Result: The bank meets liquidity needs cost-effectively while maintaining profitability.