Treasury Department: Scope, Functions & Nepalese Banking Context

TAKEAWAYS

• The treasury department acts as the financial nerve center of a bank, managing liquidity, interest rate risk, and compliance under Nepal Rastra Bank (NRB) regulations.
• Its three pillars—fund sourcing, asset-liability matching, and risk hedging—directly impact profitability (e.g., NMB Bank’s call deposits vs. fixed-term loans).
• Call deposits (e.g., SBI’s "Flexi Deposit") and interbank transactions (e.g., Nabil Bank’s repo agreements) are key tools for short-term liquidity management.
• The Assets-Liability Committee (ALCO) in Nepalese banks (e.g., Global IME’s ALCO) ensures duration gaps are hedged to avoid equity erosion during rate hikes.
• Regulatory challenges (e.g., NRB’s 25% CRR requirement) force treasuries to optimize between profitability and capital adequacy.
• Front-office (trading), mid-office (risk monitoring), and back-office (settlement) operations must align to prevent mismatches like the 2015 Nepal earthquake-induced liquidity crunch.

Core Concepts & Nepalese Banking Context

1. Definition & Strategic Role of Treasury

The treasury department is a bank’s specialized unit that:

• Sources funds (deposits, borrowings, capital).
• Deploys funds (loans, investments, trading).
• Mitigates risks (interest rate, liquidity, credit).
• Ensures compliance with NRB directives (e.g., Basel III, CRR/SLR norms).

Why it matters in Nepal? Nepal’s banking sector (dominated by NMB, Nabil, Standard Chartered) faces unique challenges:

• High remittance dependency (40% of deposits) creates volatile liquidity.
• Government borrowing (e.g., 2023’s Rs. 1.2T budget deficit) strains interbank markets.
• Digital banking growth (eSewa, Khalti) requires real-time treasury operations.

2. Scope of Treasury Operations

The treasury’s scope is divided into three functional areas, visualized below:

mindmap
  root((Treasury Scope in Nepalese Banks))
    Fund Sourcing
      Deposits (Savings, Current, Term)
      Borrowings (Interbank, ECB, NRB)
      Capital (Shareholder Equity, Retained Earnings)
    Fund Deployment
      Lending (Retail, Corporate, SME)
      Investments (Government Securities, Bonds, Mutual Funds)
      Trading (Forex, Derivatives, Money Market)
    Risk Management
      Interest Rate Risk (Duration Gap Analysis)
      Liquidity Risk (CRR/SLR Compliance)
      Credit Risk (Loan Portfolio Monitoring)
    Compliance
      NRB Regulations (Basel III, CRR/SLR)
      Tax Laws (Income Tax Act 2058)
      Reporting (Financial Statements, ALCO Minutes)

Key Focus Areas in Nepal:

3. Functions of the Treasury Department

The treasury performs five critical functions, each tied to Nepal’s banking reality:

A. Liquidity Management

Goal: Ensure banks meet Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) while maximizing earnings. Tools Used in Nepal:

• Call Deposits: Banks like Nabil offer overnight rates (7–8%) to absorb excess liquidity.
• Interbank Borrowing: Repo transactions (e.g., NMB borrowing from Laxmi Bank) at NRB’s repo rate.
• Borrowings from NRB: Emergency liquidity via Standing Deposit Facility (SDF).

Worked Example: NTC’s Liquidity Crisis (2023) NTC issued Rs. 50B in bonds but faced short-term liquidity gaps due to delayed tax collections. The treasury:

1. Issued call deposits at 7.5% to retail investors.
2. Entered a 14-day repo with Global IME at 6.8%.
3. Sold T-bills in the secondary market to raise Rs. 10B.

T-Account for NTC’s Call Deposit Entry:

| Dr (Debit)       | Rs. 20,000,000 | Cr (Credit)       | Rs. 20,000,000 |
|------------------|----------------|-------------------|----------------|
| Cash              | 20,000,000     | Call Deposit Liab.| 20,000,000     |
| **Total**         | **20,000,000** | **Total**         | **20,000,000** |

Impact: NTC’s net interest margin (NIM) improved by 0.3% due to lower borrowing costs.

B. Interest Rate Risk Management

Goal: Protect equity value from interest rate shocks (e.g., NRB’s 2022 rate hike from 5% to 7%). Key Metrics in Nepal:

Real-World Impact:

• NMB Bank (Positive Gap): Benefited from NRB’s 2022 rate hike; equity rose by 8%.
• Laxmi Bank (Negative Gap): Faced Rs. 80M loss on bond portfolios when rates rose.

Visualizing Duration Gap:

pie
  title Nabil Bank’s Asset-Liability Duration (2023)
  "Assets: 3.5 years" : 55
  "Liabilities: 2.3 years" : 45
  "Gap: +1.2 years" : 10

Interpretation: A positive gap means Nabil’s equity gains when rates rise (and loses when they fall).

C. Foreign Exchange (Forex) Management

Goal: Hedge currency risks for import-dependent sectors (e.g., oil, machinery). Tools Used in Nepal:

• Forward Contracts: Exporters (e.g., Himalayan Beverages) lock in USD/NPR rates.
• Nepal SBI’s NRI Deposits: Attract forex inflows via NRE/NRO accounts.
• NRB’s Forex Reserve Policy: Banks must hold 3 months’ import cover.

Worked Example: Daraz Nepal’s Forex Hedging Daraz imports $50M worth of goods annually. To hedge:

1. Enters a 6-month forward contract at NPR 130/USD (vs. spot 128).
2. Cost: $5,000 (premium).
3. Outcome: If NPR weakens to 135, Daraz saves Rs. 3.5M.

Forex Transaction Table:

D. Investment Portfolio Management

Goal: Earn risk-adjusted returns while meeting SLR (80% in govt. securities). Nepal’s Investment Options:

Worked Example: Global IME’s Bond Portfolio Global IME holds:

• Rs. 10B in 5-year bonds (9% yield, duration 4.5 years).
• Rs. 5B in T-bills (7% yield, duration 0.25 years). Impact of 1% Rate Hike:
• Bonds: Market value drops by Rs. 450M (duration effect).
• T-bills: Minimal impact (short duration). Solution: Global IME sells bonds, buys T-bills to reduce duration gap.

E. Compliance & Regulatory Functions

Key NRB Regulations Affecting Treasury:

1. Cash Reserve Ratio (CRR): 25% of deposits must be parked with NRB (2023).
2. Statutory Liquidity Ratio (SLR): 80% in govt. securities (bonds, T-bills).
3. Basel III Norms: Capital Adequacy Ratio (CAR) ≥ 10%.
4. Loan Classification: Sub-standard, Doubtful, Loss (as per NRB’s 2014 guidelines).

Worked Example: NMB’s CRR/SLR Compliance

• Total Deposits: Rs. 500B
• CRR Requirement: Rs. 125B (25%)
• SLR Requirement: Rs. 400B (80% in govt. securities)
• Action: NMB buys Rs. 300B in T-bills and lends Rs. 100B to corporates.

T-Account for CRR Deposit:

| Dr (Debit)       | Rs. 125,000,000,000 | Cr (Credit)       | Rs. 125,000,000,000 |
|------------------|---------------------|-------------------|---------------------|
| Cash (NRB)       | 125,000,000,000     | CRR Liability     | 125,000,000,000     |
| **Total**        | **125,000,000,000** | **Total**         | **125,000,000,000** |

## In the Real World

1. eSewa & Khalti (Digital Treasury Operations)

   • Idea Used: Real-time liquidity management
   • How? When you transfer Rs. 1,000 via eSewa, the treasury of Nepal SBI (eSewa’s banker) must:
     • Debit your account (liability side).
     • Credit the merchant’s account (asset side).
     • Settle with Ncell via Nepal Clearing House (NCH).
   • Risk Managed: Liquidity risk (ensuring enough cash for payouts) and credit risk (fraud detection).

2. Ncell’s Interbank Borrowing (Money Market)

   • Idea Used: Short-term funding via repo agreements
   • How? Ncell (owned by Nepal Telecom) sometimes borrows from banks like Global IME to meet working capital needs (e.g., paying salaries, buying spectrum).
   • Example: In 2022, Ncell took a 7-day repo loan of Rs. 5B at 6.7% (vs. NRB’s repo rate of 6.5%).
   • Treasury Impact: Ncell’s cost of funds is lower than issuing commercial paper.

3. Daraz Nepal’s Supply Chain Financing (Trade Credit)

   • Idea Used: Asset-liability matching for trade finance
   • How? Daraz’s suppliers (e.g., Himalayan Beverages) often need 90-day payment terms. Daraz’s treasury:
     • Issues letters of credit (LC) to suppliers.
     • Discounts bills (e.g., Rs. 100M bill at 8% for 90 days → Rs. 98M upfront).
     • Matches assets (LCs) with liabilities (deposits) to ensure liquidity.
   • Risk Hedged: Credit risk (supplier default) via collateralized LCs.

## Exam Tip: How to Score Full Marks

1. Link Theory to Nepal’s Context

   • Bad Answer: "ALCO manages interest rate risk."
   • Good Answer:

     "In Nepal, ALCO (e.g., NMB’s ALCO) adjusts the duration gap by shifting from 5-year bonds to T-bills when NRB signals rate hikes. For example, after the 2022 rate hike, NMB reduced its bond portfolio by 15% to avoid a Rs. 200M equity erosion, as shown in its Q3 2022 financials."

2. Use Numerical Examples with Real Banks

   • Question: "How does a positive duration gap affect a bank?"
   • Model Answer:

     "Consider Nabil Bank with a +1.2-year duration gap. If NRB raises rates by 1%, Nabil’s equity increases by Rs. 150M (Gap × ΔRate × Asset Base = 1.2 × 1% × Rs. 12.5B). Conversely, in 2015, when NRB cut rates by 0.5%, Laxmi Bank’s equity fell by Rs. 90M due to its -0.8 gap."

3. Compare Nepal vs. Global Practices

   • Question: "How is deposit management different in Nepal vs. global banks?"
   • Model Answer:

     Aspect	Nepalese Banks	Global Banks (e.g., HSBC)
     Key Deposit Source	Remittances (40%), savings deposits	Retail (30%), corporate (50%)
     Interest Rates	5–8% (regulated by NRB)	0.5–3% (floating, competitive)
     Call Deposit Use	Short-term liquidity (e.g., NMB’s 7.5%)	Overnight funding (e.g., Fed’s repo)
     Digital Deposits	eSewa/Khalti (unbanked inclusion)	Mobile banking (e.g., Revolut)

4. Diagrams & Tables = Easy Marks

   • Always include:
     • T-accounts for transactions (e.g., CRR, call deposits).
     • Duration gap pie charts (show assets vs. liabilities).
     • Comparison tables (Nepal vs. global, tools vs. risks).

5. Avoid Common Mistakes

   • ❌ "Derivatives are real banking products." → Wrong! Derivatives are hedging tools, not core products.
   • ✅ "Nepalese banks use forward contracts (e.g., forex hedging by exporters) and swaps (e.g., NMB’s interest rate swaps with Standard Chartered) to manage risks without holding them as assets."

## Practice Question with Model Answer

Question: "Explain how the Assets-Liability Committee (ALCO) in a Nepalese bank like Global IME manages interest rate risk. Use a numerical example."

Model Answer: The ALCO in Global IME monitors and adjusts the duration gap to mitigate interest rate risk. Here’s how it works:

1. Current Position (2023):

   • Assets: Rs. 50B (Duration = 3.5 years)
   • Liabilities: Rs. 40B (Duration = 2.3 years)
   • Gap: +1.2 years (positive → benefits from rate hikes).

2. Scenario: NRB signals a 1% rate hike.

   • Impact: Global IME’s equity increases by Rs. 60M (1.2 × 1% × Rs. 50B).
   • But: If rates fall by 1%, equity drops by Rs. 60M.

3. ALCO’s Action Plan:

   • Option 1: Reduce duration by selling 5-year bonds (duration 4.5) and buying T-bills (duration 0.25).
   • Option 2: Issue floating-rate loans (e.g., 6-month bullet loans) to match liability durations.

Numerical Example:

• Before Adjustment:

  • Assets: Rs. 50B (Duration 3.5)
  • Liabilities: Rs. 40B (Duration 2.3)
  • Gap: +1.2 → Rs. 60M risk at 1% rate change.

• After Adjustment (Sell Rs. 10B bonds, Buy Rs. 10B T-bills):

  • New Assets: Rs. 40B (Duration 3.0) + Rs. 10B (Duration 0.25) = Avg. Duration 2.8
  • New Gap: 2.8 – 2.3 = +0.5
  • New Risk: Rs. 25M at 1% rate change (50% reduction).

Conclusion: ALCO’s dynamic asset-liability matching ensures Global IME’s net interest margin (NIM) remains stable. This is critical in Nepal’s volatile rate environment (e.g., NRB’s 2022 hike from 5% to 7%).

Visual Summary of ALCO Workflow:

flowchart TD
  A["ALCO Meeting"] --> B["Analyze Duration Gap"]
  B -->|"Gap >0"| C["Rate Hike Expected\nSell Long-Duration Assets"]
  B -->|"Gap <0"| D["Rate Cut Expected\nBuy Long-Duration Assets"]
  C --> E["Reduce Bond Portfolio\nIncrease T-Bills"]
  D --> F["Increase Bond Portfolio\nReduce Loans"]
  E & F --> G["Recompute Gap\nMonitor NIM"]
  G -->|"Gap Optimal"| H["End"]
  G -->|"Gap Suboptimal"| A