Dean's Office Official Model Question Paper

Treasury Management

Treasury management is the specialized banking function responsible for managing a bank’s cash liquidity, capital allocation, domestic money market borrowing/lending, foreign exchange exposures, and asset-liability management (ALM) to maximize net interest income while mitigating financial risks.

Treasury Structural Division

• Front Office (Dealing Room): Executes financial market trades (money market borrowing/lending, forex dealing, government securities trading).
• Mid Office (Risk Management): Monitors risk exposures, enforces VaR and counterparty dealer limits, and ensures regulatory compliance.
• Back Office (Settlement & Accounting): Confirms trade tickets, processes payment settlements, reconciles bank Nostro accounts, and maintains general ledgers.

Asset-Liability Committee (ALCO)

ALCO is an executive-level management committee comprising the CEO, Treasury Head, Chief Risk Officer, and Chief Financial Officer. Its mandate is strategically managing the bank’s balance sheet structure, interest rate spreads, and liquidity risks within regulatory limits.

Repricing Gap

The repricing gap measures the difference between Rate Sensitive Assets (RSA) and Rate Sensitive Liabilities (RSL) that reprice within a given maturity bucket:

$$\text{Repricing Gap } (GAP) = \text{RSA} - \text{RSL}$$

Liquidity Coverage Ratio (LCR)

LCR mandates that commercial banks must hold sufficient unencumbered High-Quality Liquid Assets (HQLA—cash, central bank reserves, government bonds) to survive a severe 30-day stressed liquidity scenario:

$$\text{LCR} = \left(\frac{\text{Total Stock of HQLA}}{\text{Total Net Cash Outflows over 30 Days}}\right) \ge 100\%$$

Integrated Treasury Management Architecture

Integrated treasury unites traditional cash management with domestic money markets, foreign exchange, and debt securities operations:

+----------------------------------------------------------------------+
|                 INTEGRATED TREASURY OPERATIONS                       |
+-------------------+--------------------+-----------------------------+
| 1. Domestic Money | 2. Foreign Exchange| 3. Government Securities    |
|    Market Desk    |    (Forex) Desk    |    & Investment Desk        |
| - Interbank Call  | - Merchant Forex   | - Treasury Bills (91/364d)  |
| - Term Money Lines| - Interbank Forex  | - Development Bonds         |
| - Repos / SLF     | - FX Swaps/Forwards| - Statutory SLR Maintenance |
+-------------------+--------------------+-----------------------------+

1. Domestic Money Market Desk

• Function: Manages daily intraday cash flows, ensuring compliance with Nepal Rastra Bank’s 4% Cash Reserve Ratio (CRR).
• Instruments: Interbank Call Money, Overnight Repos, Reverse Repos, and the Standing Liquidity Facility (SLF) accessed from NRB during temporary clearing deficits.

2. Foreign Exchange (Forex) Desk

• Function: Manages cross-currency exposures and facilitates customer trade financing (import LCs and export remittances).
• Operations: Quotes competitive spot and forward exchange rates to corporate clients; manages Nostro account balances held in international correspondent banks; executes interbank cover deals to keep the bank’s Net Open Position (NOP) within NRB statutory limits.

3. Government Securities and Investment Desk

• Function: Manages the bank’s statutory investment portfolio to satisfy the 12% Statutory Liquidity Ratio (SLR) requirement.
• Instruments: Bids in primary NRB auctions for 28-day, 91-day, and 364-day Treasury Bills and long-term Government Development Bonds (Bikas Rinpatra), generating interest yields while maintaining a secondary trading book.

Numerical Problem: Repricing Gap Analysis

1. Given Data

• Rate Sensitive Assets (RSA) = $\text{Rs. } 40\text{ Billion}$
• Rate Sensitive Liabilities (RSL) = $\text{Rs. } 50\text{ Billion}$

2. (a) Repricing Gap Calculation

$$\text{GAP} = \text{RSA} - \text{RSL} = 40\text{ Billion} - 50\text{ Billion} = \mathbf{-Rs.\ 10\ Billion\ (Negative\ Gap)}$$

3. (b) Gap Ratio Calculation

$$\text{Gap Ratio} = \frac{\text{RSA}}{\text{RSL}} = \frac{40}{50} = \mathbf{0.80}$$

• Asset/Liability Classification: Because $\text{GAP} < 0$ (and $\text{Gap Ratio} < 1.0$), the bank is Liability-Sensitive (more liabilities reprice than assets over the 90-day horizon).

4. (c) Change in Net Interest Income when Rates Rise by +1.50% ($\Delta r = +0.015$)

$$\Delta\text{NII} = \text{GAP} \times \Delta r$$

$$\Delta\text{NII} = (-\text{Rs. } 10\text{ Billion}) \times (+0.015) = \mathbf{-Rs.\ 150,000,000\ (-Rs.\ 150\ Million)}$$

• Interpretation: Because liabilities reprice faster than assets, funding interest costs increase more than asset revenues, shrinking Net Interest Income by Rs. 150 Million.

5. (d) Change in Net Interest Income when Rates Fall by -1.00% ($\Delta r = -0.010$)

$$\Delta\text{NII} = (-\text{Rs. } 10\text{ Billion}) \times (-0.010) = \mathbf{+Rs.\ 100,000,000\ (+Rs.\ 100\ Million)}$$

• Interpretation: Falling interest rates benefit a liability-sensitive bank, expanding Net Interest Income by Rs. 100 Million as deposit interest costs drop faster than loan yields.

Duration Gap Analysis & Balance Sheet Immunization

While Repricing Gap analysis measures the short-term impact of interest rate changes on annual Net Interest Income, Duration Gap Analysis measures the long-term impact on the Economic Value of Equity (EVE) / net worth.

1. Macaulay Duration & Duration Gap ($DGAP$)

• Macaulay Duration ($D$): The weighted average maturity of an asset’s or liability’s cash flows, measuring its price sensitivity to interest rate movements.
• Duration Gap Formula:
  $$DGAP = D_A - \left(\frac{L}{A}\right) D_L$$
  Where $D_A$ is average asset duration, $D_L$ is average liability duration, $A$ is total assets, and $L$ is total liabilities.

2. Impact on Market Value of Equity ($\Delta E$)

$$\Delta E \approx - \left[D_A - \left(\frac{L}{A}\right) D_L\right] \times A \times \left(\frac{\Delta r}{1 + r}\right)$$

$$\Delta E \approx - DGAP \times A \times \left(\frac{\Delta r}{1 + r}\right)$$

+-------------------------------------------------------------+
|                 DURATION GAP EXPOSURE PROFILE               |
+-------------------+--------------------+--------------------+
| Condition         | If Rates Rise (^)  | If Rates Fall (v)  |
+-------------------+--------------------+--------------------+
| DGAP > 0 (Pos)    | Equity Value Falls | Equity Value Rises |
| DGAP < 0 (Neg)    | Equity Value Rises | Equity Value Falls |
| DGAP = 0 (Zero)   | EQUITY PROTECTED   | EQUITY PROTECTED   |
+-------------------+--------------------+--------------------+

3. Balance Sheet Immunization

• A bank achieves immunization against interest rate volatility by structuring its portfolio such that $DGAP = 0$:
  $$D_A = \left(\frac{L}{A}\right) D_L$$
• When $DGAP = 0$, any percentage change in the market value of assets is exactly offset by an equal percentage change in the market value of liabilities, insulating the bank’s net worth from interest rate swings.

Regulatory Liquidity Risk Management in Nepal

Nepal Rastra Bank enforces quantitative liquidity metrics to ensure banks maintain adequate cash buffers against depositor runs:

1. Structural Liquidity Maturity Ladders

• NRB mandates banks to map all asset cash inflows and liability outflows into standard time buckets: (1-7 days, 8-14 days, 15-28 days, 29-90 days, 91-180 days, 181-365 days, 1-3 years, and over 3 years).
• Regulatory Rule: Net cumulative negative liquidity mismatches in the 1–28 day short-term buckets cannot exceed 15% to 20% of total deposit liabilities.

2. Credit-Deposit (CD) Ratio Framework

• NRB enforces a statutory CD Ratio ceiling of 90%:
  $$\text{CD Ratio} = \frac{\text{Total Local Currency Loans}}{\text{Total Deposits} + \text{Core Capital}} \le 90\%$$
• Impact: Acts as an automated brake against aggressive over-lending, ensuring banks retain at least 10% of funding in liquid cash, government securities, and central bank reserves.

3. Net Stable Funding Ratio (NSFR)

• Requires banks to maintain a stable funding profile in relation to the composition of their assets and off-balance sheet activities:
  $$\text{NSFR} = \frac{\text{Available Amount of Stable Funding (ASF)}}{\text{Required Amount of Stable Funding (RSF)}} \ge 100\%$$
• Strategic Value: Discourages banks from funding long-term 20-year infrastructure loans with volatile 3-month corporate wholesale deposits.

Case Analysis: Koshi Commercial Bank Limited

(a) Credit-Deposit (CD) Ratio Calculation & Compliance (5 Marks)

1. Formula under NRB Directives:

$$\text{CD Ratio} = \frac{\text{Total Loans}}{\text{Total Deposits} + \text{Core Capital}}$$

2. Inputs:

• Total Loans = $\text{Rs. } 100\text{ Billion}$
• Total Deposits = $\text{Rs. } 100\text{ Billion}$
• Core Capital = $\text{Rs. } 12\text{ Billion}$
• Total Available Funding Base = $100\text{B} + 12\text{B} = \text{Rs. } 112\text{ Billion}$

3. Calculation:

$$\text{CD Ratio} = \left(\frac{100\text{ Billion}}{112\text{ Billion}}\right) \times 100 = \mathbf{89.29\%}$$

• Compliance Evaluation: The bank’s CD Ratio is 89.29%, which complies with NRB’s regulatory ceiling of 90.0%. However, the margin of safety is razor-thin (only 0.71% headroom, representing approximately Rs. 800 Million in lending capacity). Any further deposit withdrawals will breach the 90% cap, triggering NRB penalties.

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(b) Duration Gap ($DGAP$) & Equity Value Impact (7 Marks)

1. Duration Gap Computation:

$$DGAP = D_A - \left(\frac{L}{A}\right) D_L$$

Where:

• $D_A = 4.5\text{ years}$
• $D_L = 1.8\text{ years}$
• $A = \text{Rs. } 120\text{ Billion}$
• $L = \text{Rs. } 108\text{ Billion}$
• $\frac{L}{A} = \frac{108}{120} = 0.90$$DGAP = 4.5 - (0.90 \times 1.8) = 4.5 - 1.62 = \mathbf{+2.88\text{ years}}$$
• Interpretation: The bank has a large positive duration gap (+2.88 years). The average maturity of its assets is substantially longer than its liabilities.

2. Estimated Impact on Market Value of Equity ($\Delta E$) for a 200 bps Rate Hike ($\Delta r = +0.02$, $r = 0.095$):

$$\Delta E \approx - DGAP \times A \times \left(\frac{\Delta r}{1 + r}\right)$$

$$\Delta E \approx - (2.88) \times (120\text{ Billion}) \times \left(\frac{0.02}{1 + 0.095}\right)$$

$$\Delta E \approx - 345.6\text{ Billion} \times \left(\frac{0.02}{1.095}\right) = - 345.6\text{ Billion} \times 0.018265 = \mathbf{-Rs.\ 6,312,384,000}$$

• Result: A 2.0% increase in interest rates causes an estimated Rs. 6.31 Billion decline in the market value of the bank’s equity (eroding over 50% of the bank’s Rs. 12 Billion core capital buffer).

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(c) Emergency ALCO Liquidity Contingency Plan (8 Marks)

To bridge the Rs. 8 Billion short-term cash outflow in the 1–30 day bucket, ALCO must execute a multi-tier liquidity plan:

Standing Liquidity Facility (SLF) -> Interbank Repo -> CASA Deposit Campaign -> Asset Securitization

1. Utilization of Central Bank Standing Liquidity Facility (SLF):
   • Pledge unencumbered government bonds and treasury bills with Nepal Rastra Bank to access the 7-day SLF at the prevailing Bank Rate, providing immediate liquidity of Rs. 4 Billion to settle immediate clearing obligations.
2. Short-Term Institutional Term Deposit Tie-Ups:
   • Approach institutional fund providers (Citizen Investment Trust, Employees Provident Fund, Nepal Army Welfare Fund) offering competitive fixed deposit rates within NRB interest rate caps to roll over Rs. 3 Billion in maturing term deposits.
3. Interbank Repo Borrowing:
   • Execute 14-day bilateral repo transactions with liquid commercial banks against the bank’s government bond portfolio.
4. Loan Disbursement Moratorium & Asset Reduction:
   • Impose an immediate temporary freeze on fresh non-essential loan disbursements, using recurring EMI and loan amortization inflows (~Rs. 1.5 Billion monthly) to build cash reserves.
5. Structural Duration Rebalancing (Long-Term):
   • Issue 7-year subordinated corporate debentures to lengthen liability duration ($D_L$), and shift fresh lending toward short-term floating-rate working capital loans, reducing $D_A$ and immunizing the balance sheet.