The pace of the change in the regulatory framework of an international economy has increased since 2008 so that stability can be attained in it. As a result, the treasurers of the banks are required to tackle challenges in an effective and timely manner.
The international challenges have made the concept of treasury management more dynamic. Various macro factors, such as cost pressure, modification in regulations and shift in the markets are seen as emerging trends to be considered carefully by a treasurer.
Table of Content
Objectives of Treasury Management at International Level
In order to tap the international market, the treasury management of a bank should focus on the objectives that are:
Funding
A bank has to make improvements in its planning so that the long-term funding plan can be supported. The treasury management starts with and ends on funding. If the international wholesale market faces a liquidity crunch, then the banking industry would face a credit crisis. Therefore, the planning of funding plays a pivotal role in treasury management. It becomes more dynamic in nature when the operation of a bank spreads across the globe.
The following challenges are faced by banks while they plan for the treasury at the international level:
- Banks need to ensure that the proportion of short-term wholesale financing is as minimal as it can bear the market volatility.
- The funding operation of the bank’s treasury should adhere to the policy made by its management for the funding requirements.
Liquidity Management
It aims to facilitate the liquidity of funds of a bank. The latest regulations, such as Basel III, Dodd-Frank and European Market Infrastructure Regulation (EMIR) are going to impact the strategies of banks for managing liquidity risk.
The following challenges are faced by banks while adhering to these regulatory norms at the international level:
- Banks have to ensure to hold large volumes of high-quality contingent assets due to new provisions, such as maintaining Net Stable Funding Ratio and Liquidity Coverage Ratio.
- China and India have adopted new regulatory changes in the recent past that would lead to restrict the movement of funds. This would further lead to mismatches prevailing in the two different markets.
In addition, it is also important to note that the reporting guidelines of liquidity among the banks are becoming crucial in the ever-changing global market. The following challenges are faced by banks when reporting their liquidity measures:
- Banks may face difficulty in incorporating minute details in the liquidity stress test reports. For example, difficulty in providing more accurate information related to Funds Transfer Pricing (FTP) and contingent funding plans.
- The liquidity report should include non-financial indicators while preparing MI reports by considering market sentiment on potential future impact on liquidity. For example, media coverage, internet search hit rates and changes to withdrawal payment by customers.
- Banks across the globe have to adopt the standard definition of collateral instruments.
Capital Management
It refers to building a capital structure that earns the maximum returns by adhering to the regulatory framework. For instance, the shortfall of EUR 354 bn was faced by the European banks to adhere with the capital requirement as per Basel III. According to Basel III, banks are required to maintain the minimum 7 per cent Tier-1 capital and banks having a shortfall are needed to raise funds to close the gap. As a result, this borrowing affected the balance sheets of banks.
Banks are required to modify their current capital management models so that these models can be better aligned with risk management, stress testing requirements and enhanced granularity of capital reporting as required by the new regulations and long-term volatility of an international market.
Banks have to ensure that they are complying with the regional regulations of each country. For instance, Dodd-Frank and EMIR are the recent regional regulatory changes that resulted in the requirement of significant re-investment by the bank so that they can adhere with new compliance. As a result, the treasury management is required to have highly flexible operating models for adapting to this challenge.
Risk-centric Culture
After the global meltdown in 2007–08, the financial institutions, banks and all the regulatory bodies have attached greater emphasis on the risk management practices. It is expected that the treasury department will become a partner of the bank in implementing regulations and adhering to new regulatory reforms. It is required that the treasury practices today surpass the traditional treasury risks.
For this, it is required that the treasury functions develop internal risk capabilities in order to meet the regulatory demands. The treasury department would also be required to develop a risk culture that is less dependent on quantitative position-based models (models using historical data) such as VaR, stress tests, etc.
Instead, the treasury must develop better methodologies to measure and manage interest rate risks, such as Net Interest Income (NII) stress and scenario testing. These methodologies are better than the quantitative models as they consider current economic environment.
Technology-effective Treasury Systems
It involves deployment of improved technology systems in the treasury of a bank. It is important because the spread of the treasury management across the globe needs effective technology. For example, improved technology systems could include development of tools to facilitate on-demand risk data (i.e. intraday risk runs). Such data can be useful in allowing management to take action more swiftly.
The following challenges are faced by banks while making the use of effective technology:
- Banks have to ensure the centralised control of their treasury functions.
- Banks should have an accurate projection of exposures and risks so that they can succeed in difficult times. For example, the recent credit crisis and the ongoing Eurozone market fluctuations show the importance of an accurate projection of exposures and risks for banks functioning on an international level.
Best Practices for International Treasury Management
The world economy has undergone through numerous economic transformations from the established markets in Europe and North America to the developing ones in Africa, Asia and Latin America. As a result, the bank needs to pay due diligence while operating treasury management in the international market. It is because the international market is more prone to volatility as compared to the volatility of domestic market.
The five best practices that help a bank effectively managing its treasury operations are:
Centralise the treasury function globally
A bank working globally needs to ensure that its treasury functions are centralised. A function repetitive in nature is not performed more than once. As a result, the duplication of same task is avoided and it results into the optimum utilisation of scarce resources. The centralised model of treasury management would ensure the integration of policies with decision-making across the global functioning.
The treasury function consolidating in nature helps the manager of a bank in strategic decision-making by having aggregate view of its cash flow and risk positions that include optimising debt and investment portfolios by ensuring minimised taxes and financial risks.
Strengthen governance
The efficiency of the treasury management is based on the governance framework prevailing in internal environment of a bank. The internal governance framework includes thorough review of policies and processes for core activities that are followed by testing so that their effective functioning can be ensured. Therefore, the treasurer needs to test the existing process under the difficult situations, such as financial or credit crisis.
Manage working capital in the developing markets
Managing working capital in the volatile market is considered one of the most challenging tasks for a bank. This challenge gets tougher when a bank works in the developing markets characterised by various business cultures. For instance, the payment terms can be of 30 days in many developed markets as compared to South American and African countries where payment terms usually are of 360 days. In addition, the lack of automated processing mechanism for accounts payable and receivable also leads to increased complexity.
Increase the accuracy of cash flow forecasting
The cash flow forecasting plays a pivotal role in treasury management. To improve the accuracy of forecasts, a bank should analyse cash flow forecasts, different cash scenarios and run currency “what if” scenarios.
An effective programme lets the treasury anticipate about the potential liquidity gaps that lead to financial risk, especially in emerging markets. A bank performs liquidity forecasts by measuring liquid assets and credit sources so that they can predict the banks’ financial position of paying off its debts and obligations. In addition, it helps a bank in managing cash by testing stress scenarios under various dynamic and crucial market conditions.
The effective treasury management of a bank requires the monitoring of cash in different time periods, such as the daily, weekly and monthly monitoring of cash so that the progress can be tracked. In addition, it contributes to the measurement of the impact of various efforts for improving cash flow performance.
Enhance treasury management systems
The advent of technology and communication technology has resulted into useful software to facilitate the treasury function. It is important to note that advanced technology comes along with the huge cost. For instance, the implementation of integrated management system and enterprise resource planning (ERP) modules costs around $1 million.
In addition, the company should perform a cost-benefit analysis to find out if the technology used for treasury management is worth the cost. The integration of all the technology devices and software is another challenge that has to be performed with due diligence so that the incurred cost can be justified. Even a minor error can cause a big loss that could be bigger than the cost incurred to make a sophisticated treasury management system.
Challenges in International Treasury Management
A treasurer is a person who is responsible for the financial risk management of the organisation/bank. Risks faced by banks or organisations arise from various sources. Therefore, the treasurer must possess the ability to communicate with various financial professionals. Various challenges related to international treasury management are explained as follows:
Risk management
Organisations and banks have to face multiple risks, such as risks related to changes in interest rates, credit, currency, commodities and operations. All these constitute the major financial risks and the treasury department must address these risks, which are discussed as follows:
- Liquidity risk: Managing liquidity is the most important task of a treasurer. The treasurer has to manage liquidity by ensuring sufficient revenues, maintaining expenditure at optimum levels, accessing funds from other banks, RBI and other sources. In case the treasurer is not able to maintain sufficient liquidity when required for meeting the payment obligations, creditors may sell off the organisation’s assets to pay the debt.
- Credit risk: The treasurer has to ensure that the surplus cash that lies with the company is invested in those securities that are safe and earn a good rate of interest. The safety of investments can be ensured by checking the credit rating of the issuer. In addition, the treasurer must be confident that the counter-party to the financial instruments used in managing risks would perform as expected.
- Currency risk: This risk arises when an organisation/bank translates foreign currency into its own currency. A bank faces translation risk when it translates its foreign subsidiaries’ assets and liabilities into domestic currency. If the value of assets and profits is lowered, then the value of the bank’s share may also lower. The bank/organisation may also face currency risk if a bank/organisation from another country faces more favourable exchange rate translation.
- Interest rate risk: Banks and organisations both need to borrow finances in order to carry on its operations, such as buying raw materials, machinery or premises. They may decide to borrow at either a fixed rate of interest or at a variable rate of interest. If the rate of interest falls, the organisation/bank has to pay less.
However, if the of interest rate rises, the organisation/bank will have to pay more. Due to insufficient cash, it may run into liquidity crisis, which may affect the bank’s credit rating. - Operational risk: Credit risk, currency risks, etc. are the financial risks that arise as a result of external influences on a bank/ organisation. Operational risk is a type of internal risk that arises as a result of inadequate operational controls that lead to decrease in company value.
For example, a treasury dealer borrows funds for business purpose but transfers the same to his personal account. Such a practice is possible only when a treasurer handles both the dealing as well as funds transfer activities. However, in order to ensure no operational risks, the treasury must be well-managed and such roles must be segregated.
Risk policies
It is the duty of the treasurer to formulate the policies related to the treatment and management of all the risks. These policies are approved by the board of directors of the bank. The policies also define the discretionary powers of the treasurer and all the individuals who are authorised to deal in the treasury.
The policies relating to risk mitigation and management are created by each bank/organisation. It means that the risk policies vary from one organisation/bank to another. Banks, for example, maintain policies related to derivatives, and how in what conditions they can be used.
The treasury department and all its members must work in accordance with the treasury policies. To ensure this, the bank must regularly conduct internal audits. The audit must be performed by the internal audit department and a treasury committee that includes members from senior management and the treasurer.
The audit committee or the Asset Liability Committee regularly reviews and discusses financial risks facing the bank/ organisation. The committee then suggests what actions can be taken to manage and transfer the risks. Decisions related to the management of risks may involve consulting various internal and external specialists.
Professional development
The treasury in the past was considered as a secondary department and a part of accounting role. However, recently, the role and requirement of treasury management have been recognised in a new light due to an increase in the number of financial instruments and globalisation of financial markets and institutions.
Due to these reasons, the role of treasury management has become specialised, complex and time-consuming. As a result of all these developments, the field of treasury management has developed as a field distinct from the field of accountancy.
The two most important functions of the treasury manager include effective cash management and ensuring low-cost funding. Apart from the above-mentioned challenges, there are a few other challenges faced by treasurers in the context of international treasury management.
These challenges are as follows:
- Global cash forecasts are not very accurate, which make the work of treasury management even more difficult.
- Lack of global cash visibility.
- The treasury management has to be done keeping in mind various risk types.
- The treasury management of a bank has to comply with the regulatory and legal requirements of various countries.
- The treasury management departments often lack a long-term treasury strategy.
- Treasury departments in most banks have adopted technology to a very limited extent. Their uses of manual processing, spreadsheets and outdated technologies take precedence over the introduction and use of more advanced technologies.
- The treasury of a bank has to maintain multiple banking relationships.
- The treasury department uses varied Enterprise Resource Planning (ERP) systems.
