Treasury department play an important role in managing the bank’s funds. Two (2) important funds that the Treasury department normally manage are (a) the shareholders’ funds, and (b) the depositors’ deposits such as current account deposits, saving account deposits, general or unrestricted (special) investment deposits and specific or restricted investment deposit, Wakalah deposits and Commodity Murabahah deposits. Excess funds not use for financing activities purposes will be re-invested by the Treasury department in various Shariah compliant instruments that can yield additional income to the Bank.
What are the functions of Treasury Department?
In banking, two very important requirements that the Treasury Department must observes is the maintenance of the minimum statutory reserve imposed by Central Bank (Bank Negara Malaysia) and the Bank’s liquidity requirements. If the Bank failed to observe the above requirements (especially statutory reserve), it will be reprimand and fine by the Central Bank.
Other equally important functions of the Treasury Department is monitoring and controlling risks relating to overall short and long term return to the Bank thus it is important that the Treasury Department able to advise on the type of deposits that the Bank should market and the type of financing assets (including type of pricing) that the Bank should focus to avoid unexpected impact to the Bank’s income especially when Islamic banks are operating in business environment where 80% of the banking assets comprised conventional assets where “interest rate” play very important tools in determining the country monetary policy. In Malaysia, particularly since most of the Islamic banks’ assets (more than 80%) are fixed profit rate, the Islamic banks shall be exposed to commercial displacement risk due to movements of deposits from Islamic banks to the conventional banks or vice versa. Somehow, in Malaysia, most of the public and corporations are still indifference when it comes to “riba” investment instruments. To maximize return, depositors will move their money from one bank to another or move from conventional to Islamic system and vice versa. To reduce the impact of commercial displacement risk, maintenance of profit equalisation reserve was allowed in Islamic banks. Why this is allowed has been explained under Topic 27 on Profit Equalisation Reserve.
The actual level of involvement of a treasury department in profit rate risk management varies by institution, but generally speaking, the department would forecast net profit income and measure the sensitivity of the potential income to changes in profit rates and particularly, which we cannot deny, using conventional interest rate as benchmark. Typically the department would employ a variety of standard and proprietary models to measure this risk.
Result from their analysis will be reported to ALCO (Asset & Liability Management Committee) responsible for overseeing a variety of asset and liability (ALM) activities including the establishment of guidelines for the bank's risk tolerance levels.
The treasury department may further be tasked with ensuring risk management is within the guidelines set by ALCO by entering into a variety of financial transactions, such as profit rate swaps and so on.
Note: It should be noted that there are Shariah issues relating to profit rate swaps (one of our topics for discussion later) but as the Writer mentioned earlier, we shall discuss all the various Islamic banking products first and perhaps later once all the topics have been discussed, then only we shall revisit the Shariah issues (inclusive international arguments) and hopefully, we can derive one standard features which are acceptable by all Shariah Committee in the world. Probably by then, we may move away from certain products that are not acceptable internationally.
Internally within the various divisions in the banks, when each Division or Department is measured as whether it is a cost or profit centre, the Treasury also handles funds transfer pricing (FTP). At a high-level, the FTP process centrally manages the funding requirements of the entire bank in lieu of having each division fund its own balance sheet.
How effective is the Treasury Department would depend a lot on the Treasury Management System. If the Bank is operating under a window or Islamic subsidiary, the treasury management system need to support both the Conventional and Islamic treasury but importantly the transactions are not comingled (this might be one of the many reasons why Qatar Central Bank instructed conventional banks operating window operations to close down or sell-off their Islamic banking businesses) to ensure its meets strict Shariah requirement. The system should provide straight through, end-to-end processing, parameter-driven system to allow users to configure any money market, capital market and foreign exchange products that are currently traded in the marketplace.
The Treasury Management System should have the following modules:
- The Front Office applications should have suitable tools for managing the trading desk activities. Treasury dealers can monitor daily the trading activities from their respective deal blotter. Generally, the system provides real time information on dealer positions, currency exchange positions, and nostro positions as well as their daily profitability. Other tools that would help the Treasury dealers in analysing their position is that the system should have online calculators, a real time mark-to-market revaluations and the ability to provide "what-if" simulations on profit and exchange rate sensitivities enable dealers to better monitor and control their positions.
- The Middle Office module also provides real time compliances on the bank's credit, market and liquidity risks. During deal capture, positions and exposures created are validated and checked against the limits parameters set. Limits exceeded will be highlighted instantly and override commands are required to approve such breaches.
- The Back Office module performs all back office related functions of the Treasury department ranging from deal confirmation, settlement, deal maintenance and cancellation. Outward confirmations through various media such as SWIFT, Fax, Telex and e-mail are generated upon confirmation of the deal. Payment messages through SWIFT, direct debit/ credit and payment advices can be generated as well.
(Source on treasury management system: www.silverlakegroup.com/2nd/solution5.html)
Asset Liability management (ALM) is a strategic management tool to manage profit rate risk, credit risk and liquidity risk faced by the banks. Banks manage the risks of asset liability mismatch by matching the assets and liabilities according to the maturity pattern or by matching the duration, or by hedging and securitization.
The activities related to sales and trading encompass dealing in money markets (to generate and invest liquidity) and in other controversial activities such as foreign exchange markets (to trade in currency) and derivative markets (to hedge). The later two activities are still subject to arguments by Shariah’ scholars but let’s not argue on these issues first but to understand how these activities are been offered and practised in Malaysia.
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