Introduction to Treasury Management

Treasury Function Foundations: Front, Middle, and Back Office Architecture

Asset Liability Committee (ALCO)

The senior executive committee of a bank (comprising CEO, Head of Treasury, Chief Risk Officer, and Chief Financial Officer) responsible for strategically managing balance sheet risk, liquidity profiles, interest rate gaps, and capital adequacy.

Traditional vs Modern Treasury

• Traditional Treasury: Service center focused strictly on managing cash reserve compliance (CRR/SLR), settling checks, and funding branch liquidity deficits.
• Modern Treasury: Strategic profit-center actively managing market risk, balance sheet duration gaps, foreign exchange derivatives, and arbitrage trading opportunities.

Stop-Loss Limit

A mandatory risk boundary set by the Middle Office capping the maximum permissible cumulative loss a dealer or trading desk can incur before positions must be immediately liquidated.

Integrated Treasury Management and Strategic Balance Sheet Optimization

Treasury Office Architecture

Statutory Responsibilities of ALCO

1. Setting Interest Rate Policy: Deciding deposit and lending rate revisions based on Cost of Funds and competitors.
2. Liquidity Gap Monitoring: Reviewing time-bucket maturity mismatch reports to prevent short-term funding squeezes.
3. Transfer Pricing (FTP): Operating the Funds Transfer Pricing mechanism between liability-mobilizing branches and asset-deploying branches.
4. Capital Allocation: Ensuring risk-weighted assets stay within Basel III capital conservation buffers.

Comparative Treasury Desks: Money Market vs Forex vs Fixed Income Desk

Treasury Yield Curves, Funding Cost, and Profit Center Optimization

Applied Problem: Treasury Funds Transfer Pricing (FTP)

Branch Alpha mobilizes Rs. 100,000,000 in retail deposits at an average cost of $4.50\%$. Branch Beta identifies high-grade commercial borrowers and disburses Rs. 100,000,000 in term loans at $10.50\%$. The Central Treasury establishes an internal Funds Transfer Pricing (FTP) benchmark rate of $7.00\%$.

1. Compute the net profit earned by Branch Alpha under the FTP mechanism.
2. Compute the net profit earned by Branch Beta under FTP.
3. Verify that total bank operating profit is preserved.

Solution:

1. Branch Alpha (Deposit Mobilizer):
   • Sells funds to Treasury at FTP rate ($7.00\%$).
   • Incurs deposit cost ($4.50\%$).

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     $$\text{Alpha Profit Margin} = 7.00\% - 4.50\% = 2.50\%$$

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     $$\text{Alpha Net FTP Profit} = 100,000,000 \times 0.025 = \text{Rs. } 2,500,000$$
2. Branch Beta (Lender):
   • Buys funds from Treasury at FTP rate ($7.00\%$).
   • Lends to commercial borrowers at $10.50\%$.

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     $$\text{Beta Profit Margin} = 10.50\% - 7.00\% = 3.50\%$$

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     $$\text{Beta Net FTP Profit} = 100,000,000 \times 0.035 = \text{Rs. } 3,500,000$$
3. Total Bank Operating Profit:

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   $$\text{Consolidated Profit} = 2,500,000 + 3,500,000 = \text{Rs. } 6,000,000$$
   (Notice: Total Loan Interest Rs. 10.5M minus Deposit Interest Rs. 4.5M = Rs. 6.0M. FTP equitably rewards both deposit-raising and lending branches).

A common analytical mistake is confusing the roles of Front Office (trading execution) and Middle Office (independent risk monitoring), allowing dealers to verify their own trades.