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<strong>Technical</strong> <strong>Guide</strong>
on Internal Audit of
Treasury Function in Banks
The Institute of Chartered Accountants of India
(Set up by an Act of Parliament)
New Delhi

<strong>Technical</strong> <strong>Guide</strong>
on Internal Audit of
Treasury Function in Banks
DISCLAIMER:
The views expressed in the <strong>Technical</strong> <strong>Guide</strong> are those of author(s). The
Institute of Chartered Accountants of India may not necessary subscribe
to the views of the author(s).
The Institute of Chartered Accountants of India
(Set up by an Act of Parliament)
New Delhi

© The Institute of Chartered Accountants of India
All rights reserved. No part of this publication may be reproduced, stored in a
retrieval system or transmitted, in any form or by any means, electronic,
mechanical, photocopying, recording or otherwise, without prior permission, in
writing, from the publisher.
Edition : January, 2010
Committee / : Internal Audit Standards Board
Department
Email : cia@icai.org
Website : www.icai.org
Price : Rs. 150/- (Including CD)
ISBN No. : 978-81-8441-296-3
Published by : The Publication Department on behalf of The Institute
of Chartered Accountants of India, ICAI Bhawan,
Post Box No. 7100, Indraprastha Marg, New
Delhi-110 002.
Printed by : Sahitya Bhawan Publications, Hospital Road, Agra-3.
May/2010/1,000 Copies (Reprint)
ii

FOREWORD
With the significant developments that have taken place in the capital, money
and foreign exchange markets in the recent years affecting volatility in
exchange rates and accentuating liquidity constraints, organisations have
started paying closer attention to the treasury management function. The
globalization of the economy with mobilization and deployment of funds
from/in other countries is also necessitating increased attention in the area of
treasury management. Banking industry has been all long focusing on
successful treasury management, which is extremely necessary for their
strong, viable and profitable existence.
In view of the complexity, volume and growth of treasury function in banks,
internal auditors have a dynamic role to play to support the banks in helping
to achieve the strategic goals. Internal auditors can strengthen the bank’s
treasury functions by reviewing critical control systems and risk management
processes and providing valuable suggestions.
I am happy to note that the Internal Audit Standards Board of the Institute is
issuing this publication “<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury
Function in Banks” containing extensive knowledge on this complex subject.
I congratulate CA. Shanti Lal Daga, Chairman, Internal Audit Standards
Board and the members of the Board on issuance of this publication. I am
confident that this comprehensive publication would help the members as
well as other readers in acquiring good knowledge of products, practices and
regulations of treasury function in banks.
January 12, 2010
New Delhi
CA. Uttam Prakash Agarwal
President
iii

PREFACE
In this financially globalized volatile world, bank’s treasury groups which are
ultimately responsible for keeping their banks in business are witnessing
tremendous changes. The change is being forced with rapid economic
developments, globalizing industries and competition, new technologies and
revolutionary changes in the regulatory environment. Apart from responding to
these changes, treasury functions of banks are under pressure to add value to
the banks through their operations and contribute to achieve strategic goals.
Internal audit helps the organisations to achieve their stated objectives. Carrying
out an internal audit of treasury functions in banks requires an in-depth
understanding of the applicable statutes, systems and processes since it
operates under a very regulated and governed atmosphere. Specialist
knowledge in certain areas of banking is also of equal importance.
In the wake of these developments in the field of treasury management in banks,
the Internal Audit Standards Board of the Institute is issuing this publication
“<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks” for the
members of the Institute as well as bankers. This publication is aimed to help the
readers in understanding the roles and responsibilities of the treasury function in
banks as well as in determining the nature of internal audit procedures to be
undertaken. The <strong>Technical</strong> <strong>Guide</strong> has been divided into various chapters
covering aspects such as treasury products and services, treasury dealing room,
organisational structure of a bank’s treasury, investment portfolio, asset liability
management, treasury risks. The guide also deals with the fundamental controls
and the internal audit procedures with special reference to treasury/ market risk
segments. It also contains detail checklist on internal audit of treasury operations,
foreign exchange operations and domestic operations of treasury. It also includes
a compilation of relevant circulars issued by the Reserve Bank of India applicable
to treasury operations of a bank. For better understanding of the readers, the
guide also contains an introduction section and also a glossary of some technical
terms used in the <strong>Guide</strong>.
At this juncture, I am grateful to CA. Rajkumar S. Adukia, Central Council
Member and convenor of the Group ably assisted by other members of the
Group, viz., CA. Pankaj Adukia, CA. Abhay Arolkar and CA. Vijay Joshi for
v

squeezing out time out of their professional and personal commitments and
preparing the basic draft of this <strong>Technical</strong> <strong>Guide</strong>. I would also take the
opportunity of placing on record my gratitude to CA. Akeel Master for reviewing
the draft and giving his valuable comments and suggestions.
I also wish to thank CA. Uttam Prakash Agarwal, President and CA. Amarjit
Chopra, Vice President for their continuous support and encouragement to the
initiatives of the Board. I must also thank my colleagues from the Council at the
Internal Audit Standards Board, viz., CA. Ved Jain, CA. Abhijit Bandyopadhyay,
CA. Bhavna G. Doshi, CA. Pankaj I. Jain, CA. Sanjeev K. Maheshwari, CA.
Mahesh P. Sarda, CA. S. Santhanakrishnan, CA. Vijay K. Garg, Shri Krishna
Kant, Shri Manoj K. Sarkar and Shri K. P. Sasidharan for their vision and support.
I also wish to place on record my gratitude for the coopted members on the
Board, viz., CA. N. K. Aneja, CA. Verendra Kalra, CA. M. Guruprasad, CA. Dilip
Kumar Vadilal Shah and CA. K. S. Sundara Raman as also special invitees on
the Board, viz., CA. K. P. Khandelwal, CA. S. Sundarraman, CA. Ravi H. Iyer,
CA. Rajiv Dave, CA. Pawan Chagti, CA. Ram Mohan Johri and CA. Arindam
Guha for their devotion in terms of time as well as views and opinions to the
cause of the professional development. I also wish to place on record the efforts
put in by CA. Jyoti Singh, Secretary, Internal Audit Standards Board and CA. Arti
Aggarwal, Senior Executive Officer, for their inputs in giving final shape to the
publication.
I am sure that the members of the Institute would find the <strong>Technical</strong> <strong>Guide</strong>
immensely useful in understanding the intricacies of the subject matter and in
carrying out their professional duties diligently.
January 29, 2010
Hyderabad
CA. Shantilal Daga
Chairman
Internal Audit Standards Board
vi

CONTENTS
Foreword................................................................................................... iii
Preface.......................................................................................................v
Glossary.................................................................................................... ix
Introduction ............................................................................................ xvii
CHAPTER :
1. Treasury- An Introduction .............................................................. 1 - 4
2. Treasury Products and Services............................................. 1 - 7
3. The Treasury Dealing Room................................................... 1 - 3
4. Organisational Structure of A Bank’s Treasury........................ 1 - 6
5. Investment Portfolio..................................................................... 1 - 13
6. Asset Liability Management...........................................................1 – 6
7. Treasury Risks....................................................................... 1 - 6
8. Treasury Unit – Fundamental Controls........................................ 1 - 13
9. Internal Audit of Treasury Operations............................................ 1 - 6
ANNEXURES :
Annexure A- Specimen Checklist for Internal Audit of Treasury Operations......
Annexure B - Specimen Checklist for Internal Audit of Foreign
Exchange Operations of Treasury.........................................
Annexure C- Specimen Checklist for Internal Audit of Domestic
Operations of Treasury........................................................
Annexure D- Guidance Note on Market Risk Management ...................
Annexure E - Assets Liability Management (ALM) System....................
Annexure F- RBI Mc <strong>Guide</strong> primary dealers 2009.................................
Annexure G RBI Mc Capadeqrm 2009 .................................................
vii

Annexure H- RBI Mc Callmoney 2009..................................................
Annexure I - RBI Mc Cd 2009..............................................................
Annexure J - RBI Mc Comlpaper 2009.................................................
Annexure K- RBI Mc Prunormsinvestt 2009 ........................................
viii

GLOSSARY
Arbitrage
The purchase or sale of an instrument and
simultaneous taking of an equal and
opposite position in a related market, in
order to take advantage of small price
differentials between markets.
Asset Class Securities with identical risk/reward
composition, attributes and features.
At-the-money
Asset Allocation
Asset Liability Management
(ALM)
An option contract with identical risk/ reward
composition and features.
Investment practice that divides funds
among different markets to achieve
diversification for risk management
purposes and/or expected returns consistent
with an investor’s objectives.
A risk management technique designed to
earn an adequate return while maintaining a
comfortable surplus of assets beyond
liabilities.
Business Risk Risk associated with the unique
circumstances of a particular entity, as they
might affect the price of that entity’s
securities.
Back-office
Cash
The departments and processes related to
the settlement of financial transactions.
Money in the form of authorized currency
(including coins) and bank balances.
Cash Management: The strategy by which a company
administers and invests its cash.

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
Cash Flow at Risk
Cash Position
Centralised Funds
Management System (CFMS)
The Cash Flow at Risk approach answers
the question of how large the deviation
between actual cash flow and the planned
value (or that used in the budget) is due to
changes in the underlying risk factors.
Cash Position in foreign exchange deals
with all the transactions effecting Nostro
account, funding of Nostro (in case of
overdraft), utilization of surplus cash
balance in Nostro and deployment of funds
so as to ensure optimum utilization.
Examples are delivery under forward
contracts, inward /outward telex transfer,
etc. It is also called fund position.
The Centralised Funds Management
System (CFMS) provides for a centralised
viewing of balance positions of the account
holders across different accounts
maintained at various locations of the RBI.
Collar Option A protective options strategy that is
implemented after a long position in a stock
has experienced substantial gains. It is
created by purchasing a “put option” while
simultaneously writing a “call option.” (also
known as “hedge wrapper”)
Cost of Carry
Cross Hedge
Credit Information Bureau of
India Ltd. (CIBIL)
Expenses incurred while a position is being
held, for example, interest on securities
bought on margin, dividends paid on short
positions, and other expenses.
Hedging a cash market position in a futures
or option contract for a different but pricerelated
commodity.
India’s first credit information bureau- is a
repository of information, which contains the
credit history of commercial and consumer
x

Glossary
Currency Position
Currency Risk
Day Trading
Derivative
Duration
Earnings at Risk
Electronic Clearing Services
(ECS) ECS (Credit)
ECS (Debit)
borrowers. CIBIL provides this information to
its members in the form of credit information
reports.
It deals with daily sale/purchase of foreign
currency/transaction. It could be excess,
less or equal. In that case we call it
overbought (more purchase) oversold (more
sales) or square (purchase matches sales)
respectively.
The probability of an adverse change in
exchange rates.
Refers to positions which are opened and
closed on the same trading day.
A contract that changes in value in relation
to the price movements of a related or
underlying security, future or other physical
instrument. An option is the most common
derivative instrument.
The weighted average term to maturity of a
security's cash flows, where the weights are
the present value of each cash flow as a
percentage to the security's price.
Outcome of notional interest rate shock on
interest income.
Credit clearing ensures multiple repetitive
credits to the accounts of constituents of
banks situated at various branches of banks
on the basis of a single debit to the account
of a corporate customer called the “user”.
Debit clearing ensures multiple repetitive
debits to the accounts of constituents of banks
situated at various branches of banks and a
corresponding single debit to the account of a
corporate customer called the “user”.
xi

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
Expected Loss
Financial Risk
Forward
High frequency but low severity from any
activity or risk.
Uncertainty of results to the investor due to
financial modality.
The pre-specified exchange rate for a
foreign exchange contract settling at some
agreed future date, based upon the interest
rate differential between the two currencies
involved.
Fundamental Analysis Analysis of economic and political
information with the objective of determining
future movements in a financial market.
Futures Contract
Growth Stock
Herstatt Risk or Systemic Risk
Hedge
Indian Financial Network
(INFINET)
An obligation to exchange a good or
instrument at a set price on a future date.
(The primary difference between a future
and a forward is that futures are typically
traded over an exchange (Exchange Traded
Contracts – ETC), versus forwards, which
are considered Over the Counter (OTC)
contracts. An OTC is any contract not traded
on an exchange.)
Stock of a company which is growing
earnings and/or revenue faster than its
industry or the overall market, and as
compared to stock with similar risk features.
This risk was in focus in 1974 when Herstattt
Bank (a German bank) had to shutter down,
as settlement of second leg of currency
could not be completed due to time
zonefactors.
A position or combination of positions that
reduces the risk of your primary position.
The Indian Financial Network (INFINET) is
the communication backbone for the Indian
xii

Glossary
Inflation
Initial Margin
In the Money
Leading Indicators
Limit Order
Liquidity
Liquidity Risk
Banking and Financial Sector. All banks,
public sector undertakings, private sector
organisations, co-operative, etc., and the
premier financial institutions in the country
are eligible to become members of the
INFINET.
An economic condition whereby prices for
consumer goods rise, eroding purchasing
power.
The initial deposit of collateral required to
enter into a position as a guarantee on
future performance.
Situation in which an option's strike price is
below the current market price of the
underlier (for a call option) or above the
current market price of the underlier (for a
put option). Such an option has intrinsic
value.
Statistics that are considered to predict
future economic activity.
An order with restrictions on the maximum
price to be paid or the minimum price to be
received.
The ability of a market to accept large
transaction with minimal to no impact on
price stability.
The risk that arises from the difficulty of
selling an asset. An investment may
sometimes need to be sold quickly.
Unfortunately, an insufficient secondary
market may prevent the liquidation or limit
the funds that can be generated from the
asset.
xiii

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
Liquidation
Long Position
Market Risk
Mark-to-Market
Maturity
National Settlement System
(NSS)
Negotiated Dealing System
(NDS)
Offer
Open Position
Operational Risk
Over the Counter (OTC)
Overnight
Political Risk
The closing of an existing position through
the execution of an off-setting transaction.
A position that appreciates in value if market
prices increase.
Exposure to changes in market prices.
Process of re-evaluating all open positions
with the current market prices. These new
values then determine margin requirements.
The date for settlement or expiration of a
financial instrument.
All clearings conducted in all clearing
houses in all parts of the country will be
settled in a single centralized location in
central bank money.
Negotiated Dealing System (NDS) is an
electronic platform for facilitating dealing in
Government Securities and Money Market
Instruments.
The rate at which a dealer is willing to sell a
currency.
A deal not yet reversed or settled with a
physical payment.
The risk of loss resulting from inadequate or
failed internal processes, people and
systems, or from external events.
It is used to describe any transaction that is
not conducted over an exchange.
A trade that remains open until the next
business day.
Exposure to changes in governmental policy
which will have an adverse effect on an
investor’s position.
xiv

Glossary
Position
Premium
Primary Dealers
Quote
Rate
Risk
Risk Management
Roll Over
Settlement
Settlement Risk
The netted total holdings of a given
currency.
In the currency markets, it describes the
amount by which the forward or futures price
exceed the spot price.
Primary dealers can be referred to as
Merchant Bankers to the Government of
India, comprising the first tier of the
government securities market. Satellite
dealers work in tandem with the Primary
dealers forming the second tier of the
market to cater to the retail requirements of
the market.
An indicative market price, normally used for
information purposes only.
The price of one currency in terms of
another, typically used for dealing purposes.
Exposure to uncertain change, most often
used with a negative connotation of adverse
change.
The employment of financial analysis and
trading techniques to reduce and/or control
exposure to various types of risk.
Process whereby the settlement of a deal is
rolled forward to another value date. The
cost of this process is based on the interest
rate differential of the two currencies.
The process by which a trade is entered into
the books and records of the counterparts to
a transaction .The settlement of currency
trades may or may not involve the actual
physical exchange of one currency for
another.
The risk that one party will fail to deliver the
terms of a contract with another party at the
time of settlement.
xv

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
Short Position
Spot Price
Spread
Structured Financial
Messaging Solution (SFMS)
Swap
Tail Risk
<strong>Technical</strong> Analysis
Tick Size
Transaction Cost
Transaction Date
Turnover
Value at Risk (VAR)
Yield to Maturity (YTM)
Investments position that benefit from a
decline in market price.
The current market price. Settlement of spot
transactions usually occurs within two
business days.
The difference between the bid and offer
prices.
SFMS allows intra/inter bank message
transfer. This also provides for transfer of
file attached in a secured mode.
A currency swap is the simultaneous sale
and purchase of the same amount of a
given currency at a forward exchange rate.
Probability of loss due to most unsecured
market movements.
An effort to forecast prices by analyzing
market data, i.e., historical price trends and
averages, volumes, open interest, etc.
The smallest increment in which the price for
a futures contract can move.
The cost of buying or selling a financial
instrument.
The date on which a trade occurs.
The total money value of all executed
transactions in a given time period.
It is a measure of how the market value of
an asset or of a portfolio of assets is likely to
decrease over a certain time period under
usual conditions.
The percentage rate of return paid on a
bond, note, or other fixed income security if
the investor buys and holds it to its maturity
date.
xvi

INTRODUCTION
1. Preface to the Standards on Internal Audit issued by the Institute of
Chartered Accountants of India defines Internal Audit as follows:
“Internal audit is an independent management function, which involves a
continuous and critical appraisal of the functioning of an entity with a view to
suggest improvements thereto and add value to and strengthen the overall
governance mechanism of the entity, including the entity’s strategic risk
management and internal control system. Internal audit, therefore, provides
assurance that there is transparency in reporting, as a part of good governance.”
2. Internal audit objectives, with specific reference to treasury function in a
bank, includes following important aspects:
(a)
(b)
(c)
(d)
(e)
(f)
(g)
(h)
(i)
To ensure that policies and procedures relating to all treasury activities
have been framed and are periodically reviewed for adequacy and
coverage.
To determine whether management has planned for liquidity needs for
both normal operating conditions and emergency situations.
To ensure adequate physical and access control procedures are in
place in the department.
To verify existence of satisfactory controls in the processing of deals.
To ascertain that the bank receives favorable rates for all its deals.
To check authenticity and appropriateness of the sources of inputs
used for valuation of unquoted treasury instruments.
To check that there is accurate recording and accounting of positions.
To ensure that proper documentation procedures and filing systems are
in place.
To ensure that limits are set for different procedures and they are
adhered to in a consistent manner.

(j)
(k)
(l)
(m)
To verify that any violations are promptly reported and properly dealt
with.
To ensure that reconciliation is being made timely and accurately,
including daily reconciliation of the dealer’s profit and loss to the general
ledger.
To evaluate the adequacy and effectiveness of the internal control
system and to suggest measures for improvement, if any.
To indicate probable risk-prone areas within treasury, based on the
prevailing external economic environment, and to offer views for
safeguarding the interest of the bank.
(n) To aid and facilitate risk based supervision function of the RBI (Pillar 2
of the Basel Accord) in regard to a bank’s treasury/market risk business
areas.
(o)
(p)
(q)
To ensure compliance with the guidelines issued by the RBI, SEBI,
FEMA, FEDAI, etc., and other guidelines issued from time to time.
To verify that interest and dividend income is accounted for fully and
correctly.
To verify that all counterparty confirmations are received.
3. The precise scope of risk-based internal audit of treasury transactions
must be determined by each bank for low, medium, high, very high and
extremely high risk areas. This <strong>Technical</strong> <strong>Guide</strong> contains matter relevant for
domestic compliance only. In case of overseas treasury operations, the RBI
guidelines on the subject and the domicile country requirements will also be
required to be considered.
xviii

CHAPTER 1
TREASURY- AN INTRODUCTION
Meaning
1.1 A treasury is any place where currency or items of high monetary value
are kept. The term “treasury” was first used in classical times to describe the
votive buildings erected to house gifts to the gods, such as the Siphnian Treasury
in Delphi or other similar buildings erected in Olympia, Greece by competing citystates,
to impress others during the ancient Olympic Games.
1.2 A treasury can either be:
• The part of a government which manages all money and revenue;
• The funds of a government or institution or individual;
• The government department responsible for collecting, managing and
spending public revenues;
• A depository ( room or building) where wealth and precious objects can be
kept; or
• The center of financial operations within an organisation.
Treasury in Banks
1.3 Traditionally, the treasury function in banks was limited to Funds
management, i.e., maintaining adequate cash balances to meet day-to-day
requirements and deploying surplus funds from operations. The treasury in a
bank is also responsible for maintenance of reserve requirements (Cash Reserve
Ratio and Statutory Liquidity Ratio). Treasury was considered a service centre
and liquidity management was its main function.
The scope of treasury has now expanded beyond liquidity management and
treasury has now evolved as a profit centre with its own trading and investment
activity.
1.4 Presently, as per RBI circular on “<strong>Guide</strong>lines – Accounting Standard 17
(Segment Reporting) – Enhancement of Disclosures dated April 18, 2007, banks

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
are required to report under the following business segments as primary
reporting format and for the purpose of segment reporting under Accounting
Standard (AS) 17, “Segment Reporting”:
(a)
(b)
(c)
(d)
Treasury
Corporate / Wholesale banking
Retail banking and
Other banking operations
“Domestic” and “International” segments will be the geographic segments for
disclosure. Treasury activity in a bank depends on its size, complexity of
operations, area of operations and risk profile.
Integrated Treasury
1.5 Traditionally, the domestic treasury operations were independent of
forex dealings of a bank. The need for an integrated treasury rose in the
backdrop of interest rate deregulations, liberalization of exchange control,
development of forex market and advancement in the settlement systems and
dealing environment. The integrated treasury besides performing the functions of
the traditional roles also performs the following functions:
(a) Reserve management and Investment- This involves meeting Cash Reserve
Ratio (CRR)/Statutory Liquidity Ratio (SLR) obligations and having an
optimum mix of investment portfolio.
(b) Liquidity and Funds management- This involves analysis of major cash
flows; providing inputs to planning group on funding mix( currency, tenor and
cost) and yield expected in credit and investment.
(c) Asset liability management and term money- This involves determining the
optimum size and growth rate of the balance sheet; and also price the
assets and liabilities in accordance with the prescribed guidelines.
(d) Risk Management- This involves managing all market risks associated with
the bank’s assets and liabilities. Risk management also includes
management of credit risks on treasury products and operations risks on
payments and settlements.
(e) Transfer pricing- Ideally , the integrated unit should provide benchmark rates
after assuming market risks to various business groups and product
2

Treasury- An Introduction
categories about adopting the correct business strategy to ensure that the
funds are deployed optimally.
(f) Derivative products- Treasury can develop Interest rate swaps, and other
derivative products to hedge the bank’s exposure and also sell such
products to customers or other banks.
(g) Arbitrage- This involves simultaneous buying and selling of the same type of
assets in two different markets in order to make risk-less profits.
(h) Capital adequacy- This focuses on quality of assets and Return on
investments is key criteria for evaluating the efficiency of deployed funds.
(i) Canalizing and managing other asset instruments into investment
instruments e.g., instruments resulting out of Corporate Debt Restructuring,
Asset Reconstruction, Pass Thru certificates, Asset Backed Securitization
(ABS), Mortgage Backed Securitization(MBS), etc.
(j) To monitor the Rating Migrations on an on going basis and take timely
corrective action.
(k) To minimize the level of provisional requirements due to non-performing
investments.
1.6 Treasury operations play a pivotal role in not only improving the bottom
line of banks but also in Balance Sheet management by reducing risks by
hedging sensitive exposures. Treasury management would, normally, consist of
management of its cash flows, banking, money market and capital market
transactions; effective control of the risks associated with those activities; and the
pursuit of optimum performance consistent with those risks keeping in mind the
business objectives and in consonance with the regulatory framework.
Objectives of Treasury management
1.7 The objectives of treasury management can be stated as under:
(a) To plan, organize and manage funds profitably and to ensure compliance
with respect to regulatory requirements (SLR/CRR).
(b) Treasury services are also being utilized for Balance Sheet management
(CRAR-Capital Risk weighted Adequacy Ratio, Asset and Liability product
hedging, etc).
(c) To optimize return on surplus funds invested and to keep cost of funds to the
minimum.
3

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
(d) To keep investment portfolio healthy and liquid.
(e) To minimize non-performing investments.
(f) To take advantage of market volatility and trade/arbitrage in permitted
products (including overseas) and avail arbitrage opportunities between
rupee and forex treasury operations.
(g) To invest in tax free instruments as per the tax planning of the bank.
(h) To conduct derivative transactions to hedge bank’s own balance sheet gaps
and exposure of the clients.
(i) To optimize returns from forex operations.
Areas in treasury management
1.8 From the viewpoint of a bank or a financial institution, treasury management
covers the following major areas:
(a) Liquidity risk management
(b) Interest risk management
(c) Currency risk management
(d) Equity risk management
(e) Commodity risk management
(f) Investment management.
4

CHAPTER 2
TREASURY PRODUCTS AND SERVICES
Money Market
2.1 Money market desk is involved in management of assets and
liabilities of the bank. The main function involves the following:
(a)
(b)
(c)
(d)
Management of statutory reserves viz., Cash Reserve Ratio (CRR)
and Statutory Liquidity Ratio (SLR) of the bank.
Daily Funds Management for the bank.
Balance Sheet Management.
Debt Securities Trading.
Range of Products
2.2 The Money Market Desk trades in the following Instruments:
(i)
(ii)
Treasury-Bills
• Treasury Bills (T-bills) are short-term debt instruments issued by
the Central Government for maturities of 91, 182 and 364 days.
• Commercial banks, primary dealers, mutual funds, corporates,
institutions, provident or pension funds and insurance
companies can participate.
• RBI issues a calendar of T-bill auctions. Periodic auctions are
held for their issue and these are tradable in the secondary
market, which is quite active.
• T-bills are issued at a discount to face value and are
redeemable at par on maturity.
Commercial Paper (CP)
• A Commercial Paper (CP) is an unsecured money market
instrument through which corporate entities raise short-term
money.

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
(iii)
(iv)
(v)
• It is issued as per RBI guidelines. (Refer “Master Circular on
<strong>Guide</strong>lines for Issue of Commercial Paper” dated July 1, 2009.)
• It is issued at a discount to face value
• It can be issued either in the form of a promissory note or in a
dematerialised form.
• It attracts issuance stamp duty in primary issue.
• It has to be mandatorily rated for issuance by one of the four
credit rating agencies.
• It can be issued for maturities between a minimum of seven
days and a maximum upto one year from the date of issue.
Call Linked Products
• Corporates can participate both as lenders and borrowers.
• It can be issued for a maximum period of 89 days.
• Pricing is linked to a benchmark like, MIBOR.
• Flexible call or put option could be exercised.
Certificates of Deposit (CD)
• Certificate of Deposits (CDs) are unsecured, negotiable money
market instrument usually issued at a discount on face value.
(Refer to RBI Master Circular on <strong>Guide</strong>lines for Issue of
Certificates of Deposit dated July 1, 2009.)
• The maturity period is from 7 days to 12 months.
• It attracts issuance stamp duty and is issued in dematerialised
form or as a Usance Promissory note. .
• They are negotiable, and transferred by endorsement and
delivery, after 15 days of issue.
Collateralised Borrowing and Lending Obligations (CBLO)
• CBLO is a money market instrument designed to meet the
borrowing and lending needs of banks, financial institutions,
mutual funds, NBFCs and corporates.
6

(vi)
Treasury Products and Services
• Borrowing and lending is collateralised i.e., secured using G-
Sec or T-Bills.
• Trades are screen based and with Clearing Corporation of
India Limited (CCIL) being central counter party.
Repo/ Reverse Repo
The Reserve Bank of India (Amendment) Act, 2006 provides a legal
definition of “repo” and “reverse repo” as an instrument for borrowing
(lending) funds by selling (purchasing) securities with an agreement to
repurchase (resell) the securities on a mutually agreed future date at an
agreed price which includes interest for the funds borrowed (lent). Such a
transaction is called a Repo when viewed from the perspective of the seller
of the securities and Reverse Repo when viewed from the perspective of
the buyer of the securities. Thus, whether a given agreement is termed as a
Repo or Reverse Repo depends on which party initiated the transaction.
Market participants may undertake repos from any of the three categories
of investments, viz., Held for Trading, Available for Sale and Held to
Maturity.
(vii)
Liquidity Adjustment Facility (LAF) with RBI
Liquidity adjustment facilities are used to aid banks in resolving any shortterm
cash shortages during periods of economic instability or from any other
form of stress caused by forces beyond their control. All commercial banks
(except RRBs) and Primary Dealers having current account and SGL account
with RBI can use eligible securities as collateral through a repo agreement
and will use funds to alleviate their short-term requirements, thus remaining
stable.
RBI has issued Circular “Liquidity Adjustment Facility – Revised Scheme” on
March 25, 2004 which lays down the revised scheme effective from March
29, 2009.
Operation of LAF through repo by means of daily auctions has provided the
benchmark for collateralised lending and borrowing in the money market.
This mechanism has helped in providing liquidity to the government
securities market.
7

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
(viii) Inter-Bank Participation Certificate (IBPC)
The objective behind introduction of this instrument is to even out the short
term liquidity within the banking system. This instrument was introduced in
1988 and Scheduled commercial banks were permitted to share a portion of
their eligible loan assets with other banks through issue of IBPC. RBI has
vide Circular “Inter-Bank Participations – Scheduled Commercial Banks”
dated August 4, 2009 has allowed Regional Rural Banks (RRBs) to also
issue IBPCs. The bank sharing its loan portfolio is known as issuing bank,
and the bank which is buying the portion of loan portfolio through IBPC is
known as participating bank. Both issuing and participating bank will have to
execute participation contract. The loan asset which is to be shared with
participating bank must be a standard loan asset and it cannot be more than
40 per cent of the outstanding advance at the time of issue of IBPC. As per
the existing guidelines of the RBI, commercial banks have been permitted to
issue two types of IBPCs which are as under:
(a)
With Risk Sharing Basis
Under risk sharing participation certificate scheme, risk of default of the
borrower is shared by the issuing bank and the participating bank. The
participating bank has no recourse to the issuing bank if there is default by
the borrower for that loan amount which is shared. The IBPC can be issued
for a minimum period of 91 days and a maximum period of 180 days.
(b)
Without Risk Sharing Basis
Under without risk sharing participation certificate scheme, the participating
bank does not share any risk with the issuing bank and, therefore,
participating bank has a right to receive the payment from the issuing bank
even though the borrower has defaulted in its payment. Tenor of IBPC under
this scheme cannot be more than 90 days.
Forex Market
2.3 Customers (exporters and importers) buy and sell their foreign
exchange needs from the treasury in various currencies depending on their
business exposure. Rates are quoted by the dealers depending on the
amounts and delivery period. Dealers trade on these flows from the
customers and try to maximize profits. Besides, customer flows, dealers take
proprietary position in various currencies in Spot and Forward contracts for
trading.
8

Range of Products
Treasury Products and Services
2.4 The following are products traded in Foreign Exchange Market:
(i)
Spot Contract
It is the simplest and most common foreign exchange transaction widely used
by corporates to cover their receivables and payables. The commitment by
the client is to buy and sell one currency against another at a fixed rate for
delivery two business days after the transaction. This eliminates the possible
risk due to exchange rate fluctuation for the client. Corporate can buy or sell
foreign currency for genuine transactional purposes only.
(ii)
Forward Contract
It is a contract between the bank and its customers in which the
exchange/conversion of currencies would take place at future date at a rate
of exchange in advance under the contract. The essential idea of entering
into a forward contract is to peg the price and thereby avoid the price risk.
Forward Rates = spot rate +/- premium/discount
(iii)
Currency Swaps
It is an agreement between two parties to exchange obligations in different
currencies at the beginning, during the tenure and at the end of the
transaction. At the start, initial principal is exchanged, though it is not
obligatory. Periodic interest payments (either fixed or floating) are exchanged
throughout the life of the contract. The principal is exchanged invariably on
termination at the exchange rate decided at the start of the transaction. By
means of currency swap, the associated currency and interest rate risks on
the underlying asset can be hedged.
(iv)
Interest Rates Swaps(IRS)
It is a financial transaction in which two counterparties agree to exchange
streams of cash flows throughout the life of contract in which one party pays
a fixed interest rate on a notional principal and the other pays a floating rate
on the same sum. The basic purpose of IRS is to hedge the interest rate risk
of constituents and enable them to structure the asset/liability profile best
suited to their respective cash flows.
9

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
(v)
Options
It is a contract between the bank and its customers in which the customer has
the right to buy/sell a specified amount of underlying asset at fixed price within
a specific period of time, but has no obligation to do so. In this contract, the
customer has to pay specified amount upfront to the counterparty which is
known as premium. This is in contrast to the forward contract in which both
parties have a binding contract. This is a facility offered to customers to enable
them to book forward contracts in cross currencies at a target rate or price.
This facility helps the customers to encash the currency movements in late
European market, New York market and early Asian market
(vi)
Forward Rate Agreement (FRA)
A Forward Rate Agreement (FRA) is an agreement between the bank and a
customer to pay or receive the difference (called settlement money) between an
agreed fixed rate (FRA rate) and the interest rate prevailing on stipulated future
date (the fixing date) based on a notional amount for an agreed period (the
contract period). In short, this is a contract whereby interest rate is fixed now for
a future period. The basic purpose of the FRA is to hedge the interest rate risk.
For example, if a borrower is going to borrow FC loan for 6 months at LIBOR rate
after 3 months, he can buy an FRA whereby he can fix interest rate for the loan.
Capital Market
2.4 Funds are also invested through:
a) Investment in units of Mutual fund- Mutual Fund is a trust that
pools the savings of a number of investors who share a common
financial goal. Each scheme of a mutual fund can have different
character and objectives. Mutual funds issue units to the investors,
which represent an equitable right in the assets of the mutual fund.
b) Investment in Equity IPO – These are securities which were not
previously available and are offered to the investing public for the
first time.
Regulatory Framework for Capital Markets in India
2.5 In India, the capital market is regulated by the Capital Markets
Division of the Department of Economic Affairs, Ministry of Finance. The
division is responsible for formulating the policies related to the orderly
growth and development of the securities markets (i.e., share, debt and
10

Treasury Products and Services
derivatives) as well as for protecting the interest of the investors. In
particular, it is responsible for following:
(i)
(ii)
(iii)
(iv)
institutional reforms in the securities markets;
building regulatory and market institutions;
strengthening investor protection mechanism; and
providing efficient legislative framework for securities markets, such
as Securities and Exchange Board of India Act, 1992 (SEBI Act
1992), Securities Contracts (Regulation) Act, 1956, and the
Depositories Act, 1996.
The Division administers these legislations and the rules framed thereunder.
2.6 The Securities and Exchange Board of India (SEBI) is the regulatory
authority established under the SEBI Act 1992. The Preamble of the SEBI
describes the basic functions of the SEBI, as to protect the interests of the
investors in securities and to promote the development of, and to regulate the
securities market and for matters connected therewith or incidental thereto”. It
involves regulating the business in stock exchanges; supervising the working of
stock brokers, share transfer agents, merchant bankers, underwriters, etc; as
well as prohibiting unfair trade practices in the securities market. The following
departments of SEBI take care of the activities in the secondary market:-
• Market Intermediaries Registration and Supervision Department (MIRSD)
– It is concerned with the registration, supervision, compliance
monitoring and inspections of all market intermediaries in respect of all
segments of the markets, such as equity, equity derivatives, debt and
debt related derivatives.
• Market Regulation Department (MRD) – It is concerned with formulation
of new policies as well as supervising the functioning and operations
(except relating to derivatives) of securities exchanges, their
subsidiaries, and market institutions such as clearing and settlement
organizations and depositories.
• Derivatives and New Products Departments (DNPD) – It is concerned
with supervising trading at derivatives segments of stock exchanges,
introducing new products to be traded and consequent policy changes.
11

CHAPTER 3
THE TREASURY DEALING ROOM
3.1 The Treasury Dealing Room within a bank is, generally, the
clearinghouse for matching, managing and controlling market risks. It may
provide funding, liquidity and investment support for the assets and liabilities
generated by regular business of the bank. The Dealing Room is responsible
for the proper management and control of market risks in accordance with
the authorities granted to it by the bank's Risk Management Committee. The
Dealing Room is also responsible for meeting the needs of business units in
pricing market risks for application to its products and services. The Dealing
Room acts as the bank's interface to international and domestic financial
markets and, generally, bears responsibility for managing market risks in
accordance with the instructions received from the bank's Risk Management
Committee.
3.2 The Dealing Room may also have allocated to it by the Risk
Management Committee, a discretionary limit within which it may take market
risk on a proprietary basis. For these reasons, effective control and
supervision of bank's Dealing Room activities is critical to its effectiveness in
managing and controlling market risks.
3.3 It is critical to effective functioning of the Dealing Room that the
dealer has access to a comprehensive Dealing Room manual covering all
aspects of their day-to-day activities. All dealers active in day-to-day trading
activities must acknowledge familiarity with and provide an undertaking in
writing to adhere to the bank's dealing guidelines and procedures. The
Dealing Room procedures manual should be comprehensive in nature
covering operating procedures for all the bank’s trading activities in which the
Dealing Room is involved and, in particular, must cover the bank's
requirements in respect of:
a) Code of Conduct - All dealers active in day-to-day trading activities in
the lndian market must acknowledge familiarity with and provide an
undertaking to adhere to Foreign Exchange Dealers’ Association of India
(FEDAI) code of conduct (and Fixed Income Money Market and

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
Derivatives Association of India (FIMMDA) Code of Conduct where
applicable).
b) Adherence to Internal Limits - All dealers must be aware of,
acknowledge and provide an undertaking to adhere to the limits
governing their authority to commit the bank to risk exposures, as they
apply to their own particular risk responsibilities and level of seniority.
c) Adherence to RBI limits and guidelines - All dealers must
acknowledge and provide an undertaking to adhere to their responsibility
to remain within RBI limits and guidelines in their area of activity.
d) Dealing with Brokers - All dealers should be aware of, acknowledge
and provide an undertaking to remain within the guidelines governing the
bank's activities with brokers, including conducting business only with
brokers authorised by bank's Risk Management Committee on the bank's
Brokers Panel. The following are important aspects in this regard:
(i) Ensuring that their activities with brokers do not allow for the brokers
to act as principals in transactions but remain strictly in their
authorised role as market intermediaries.
(ii) Requiring brokers to provide all broker’s notes and confirmations of
transactions before close of business each day (or exceptionally by
the beginning of the next business day, in which case the note must
be prominently marked by the broker as having been transacted the
previous day, and the back office must recast the previous night's
position against limits reports) to the bank's back office for
reconciliation with transaction data.
(iii) Ensuring all brokerage payments and statements are received.
reconciled and paid by the bank's back office department and under
no circumstances authorised or any payment released by dealers.
(iv) Prohibiting acceptance by the dealers of gifts, gratifications or other
favours from brokers, instances of which should be reported in detail
to RBI’s Department of Banking Supervision indicating the nature of
the case.
(v) Prohibiting dealers from nominating a broker in transactions not
done through that broker.
14

The Treasury Dealing Room
(vi) Rules should be framed for prompt investigation of complaints
against dealers and malpractices by brokers and reporting to FEDAI
and RBI’s Department of Banking Supervision.
e) Dealing Hours - All dealers should be aware of the bank's normal trading
hours, cut-off time for overnight positions and rules governing after hours
and off-site trading (if allowed by the bank).
f) Security and Confidentiality - All dealers should be aware of the bank's
requirements in respect of maintaining confidentiality over its own and its
customers' trading activities as well as the responsibility for secure
maintenance of access media, keys, passwords and PINS.
g) Staff Rotation and leave requirements - All dealers should be aware of
the requirement to take at least one period of leave of not less than 14
days continuously per annum, and the bank's internal policy in regards to
staff rotation.
h) Customer/User Appropriateness and Suitability Policy - Banks usually
have a ‘Customer/User Appropriateness and Suitability Policy’ in place
for transacting in complex treasury instruments such as, derivatives. The
objective of such policy is to protect the bank against the credit,
reputation and litigation risks which may arise on account of ‘misselling’
products to users who may not understand the nature of the risks
inherent in these transactions or products. All front office sales team or
dealers, must be aware of and be educated about such policy. Sales
dealers should conduct proper due diligence regarding ‘user
appropriateness and suitability’ of products before offering derivative
products or other complex treasury instruments to users.
15

CHAPTER 4
ORGANISATIONAL STRUCTURE OF A
BANK’S TREASURY
4.1 The various functions handled by a bank treasury can be divided as
under:
(a) Front-office: Dealing – Risk taking
(b) Mid-office: Risk Management and Management Information
(c) Back-office: Confirmations, Settlements, Accounting and
Reconciliation.
1. Front-office
4.2 The scope of functions of front-office, as the name itself states, is to
buy, sell and trade in money market instruments, securities, forex, equity,
derivatives and precious metal. The decisions in regard to any restructuring,
reorganizing, pre payment, etc. are taken at front-office. The front-office dealers
keep track of and develop their views on different asset class, securities,
currencies, derivative products which are put up to Department Head/Investment
Committee for arriving at trading/strategic investment entry/exit decisions.
4.3 Front-office functions can be summarized as under:
• Significant interaction with various trading and delivery teams;
• Liquidity Management;
• ALM implementation;
• Striking of Deals (trading) and earning profits from trading;
• Maintenance of CRR and SLR;
• Follow ‘When Issued Securities’ place order and square up the order well in
time against future holding;
• Manage short selling and square off the securities well in advance; and
• Reporting to respective authorities.

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
Mid-office
4.4 The mid-office can be considered to be the conscience keeper of the
treasury. It is responsible for the critical functions of independent market risk
monitoring, measurement, analysis and reporting for the bank's Asset-
Liability Management Committee (ALCO). Ideally, this is a full time function of
reporting to, or encompassing the responsibility for, acting as Asset-Liability
Management Committee (ALCO)'s secretariat. An effective mid-office
provides independent risk assessment which is critical to Asset-Liability
Management Committee (ALCO)'s key function of controlling and managing
market risks in accordance with the mandate established by the Board/Risk
Management Committee. It is a highly specialised function and must include
trained and competent staff, and expert in market risk concepts.
4.5 The methodology of analysis and reporting will vary from bank to
bank depending on their degree of sophistication and exposure to market
risks. These same criteria will govern the reporting requirements demanded
of the mid-office, which may vary from simple gap analysis to computerized
VaR modeling. Mid-office staff may prepare forecasts (simulations) showing
the effects of various possible changes in market conditions related to risk
exposures. Banks using VaR or modeling methodologies should ensure that
its Asset-Liability Management Committee (ALCO) are aware of and
understand the nature of the output, how it is derived, assumptions and
variables used in generating the outcome and any shortcomings of the
methodology employed. Segregation of duties principles must be evident in
this function which must report to Asset-Liability Management Committee
(ALCO) independently of the treasury function.
4.6 The main functions of mid-office can be summarized as under:
(i)
Management of risks:
(a)
Market risk which arises on account of:
- Interest rate movement
- Foreign exchange rate movement
- Commodity prices
- Equity prices
18

(b)
(c)
Back-Office
Liquidity risk
Country risk
(i)
(ii)
(iii)
Organisational Structure of a Bank’s Treasury
Independent market risk monitoring, measurement,
analysis and reporting for bank’s ALCO (Asset
Liability Management Committee)
Formation of Investment policy for bank’s treasury
Formation of ALM policy for the bank.
4.7 The back-office is responsible for delivery and settlement of all
transactions concluded by the front-office officials. It is also responsible for
reconciliation of securities portfolio with respective holding entity. Payment of
brokerage to brokers, empanelment of brokers, reviewing performance of
brokers and monitoring the volume of business passed on to each broker is also
under the purview of back-office.
4.8 The main functions of back-office can be summed up as under:
• Co-ordination with front-office to ensure optimum usage of all treasury
dealing systems;
• Internal control and check over treasury dealings, confirmation and
settlement activities, and accounting thereof;
• Ensuring compliance with stated treasury procedures and stipulations;
• Monitoring of SLR/CRR maintenance and submission of compliances, MIS
to Board of Directors and RBI;
• Audit facilitation (concurrent, statutory and AFI / RBI).
4.9 The key controls over market risk activities, and particularly over
dealing room activities, exist in the back-office. It is critical that clear
segregation of duties and reporting lines is maintained between dealing room
staff and back-office staff, as well as clearly defined physical and systems
access is also maintained between the two areas. It is essential that critical
back-office controls are executed diligently and completely at all times
including:
a) The control over confirmations both inward and outward: All
confirmations for transactions concluded by the dealing room must be
19

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
issued and received by the back-office only. Discrepancies in transaction
details, non-receipts and receipts of confirmations without application
must be resolved promptly to avoid instances of unrecorded risk
exposure.
b) The control over dealing accounts (vostros and nostros) - Prompt
reconciliation of all dealing accounts is an essential control to ensure
accurate identification of risk exposures. Discrepancies, non-receipts and
receipts of funds without application must be resolved promptly to avoid
instances of unrecorded risk exposure. Unreconciled items and
discrepancies in these accounts must be kept under heightened
management supervision, and as such discrepancies may at times have
significant liquidity impacts, represent unrecognised risk exposures, or at
worst represent collusion or fraud.
c) Revaluations and marking-to-market of market risk exposures: All
market rates used by the bank for marking risk exposures to market or
used to revalue assets or for risk analysis models such as, Value at Risk
analysis must be sourced independently of the dealing room in order to
provide an independent risk and performance assessment.
One of the audit objectives with specific reference to treasury also includes
verifying the authenticity and appropriateness of the sources of inputs used
for valuation of unquoted treasury instruments and derivative products (such
as swaps, options) which the bank has entered into. When quotations or
rates are not directly available for treasury instruments, then usually such
instruments are valued as at any reporting date using appropriate valuation
techniques or models. Such valuation techniques involve an amount of
subjectivity and also certain objective parameters such as, reference to any
recent past market transaction in the underlying instrument or a like
instrument. Such model based valuations require data feed or inputs (such
as ‘volatility’ in case of valuing options using Black-Scholes Model).
The inherent risk here is the appropriateness of the input parameters fed into
the valuation model/technique, stale quotes. For example, where the bank
has positions in interest rate swaps then for the purpose of projecting the
future floating interest rates (for projecting future cashflows) the appropriate
interest rate curve should be used (this is usually the par curve). As per
extant RBI guidelines, investments in unquoted equity shares should be
valued at their break-up value, however, the latest financials of the respective
20

Organisational Structure of a Bank’s Treasury
companies may not be available to the banks for determining the break-up
value.
The risk of using inappropriate or stale quotes for valuation has a direct
bearing not only on financial reporting but also on computing exposure limits.
Thus, the scope of the auditor should include an evaluation of the control
environment surrounding the valuation and marking-to-market of treasury
instruments. If the bank has an established and independent mid-office
function, the responsibility or soliciting quotes, rates, curves resides with the
mid-office. Another related risk to valuation and marking-to-market of
treasury investments is the timely monitoring of non-performing investments
(‘NPIs’). RBI has defined NPIs as investments where the interest/return or
principal has been in arrears for a period exceeding 90 days. The important
consideration for NPIs is that, banks should not reckon income on such
investments and should provide for depreciation on them appropriately, such
depreciation is further not allowed to be set-off against appreciation on other
performing investments. The back-office of a bank should have appropriate
procedures/controls instated for timely capturing of NPIs.
d) Monitoring and reporting of risk limits and usage: Reporting of usage
of risk against limits established by the Risk Management Committee (as
well as Credit Department for Counterparty risk limits) should be
maintained by the back-office independently of the dealing room.
Maintenance of all limit systems must also be undertaken by the backoffice
and access to limit systems (such as counterparty limits, overnight
limits, etc.) must be secure from access and tampering by unauthorised
personnel. If the bank has an established and independent mid-office
function, this responsibility may properly pass on to the mid-office.
e) Control over payments systems: The procedures and systems for
making payments must be under, at least, dual control in the back-office
independent from the dealing function. Payment systems should be at all
times secure from access or tampering by unauthorised personnel.
f) Reconciliation of dealers profit or loss account: All dealers at the end
of day prepare their profit or loss account for the day and compute their
net open position. The back-office personnel who are independent of the
front-office dealer are responsible for recording and processing of the
deals/transactions into the general ledger system or the core banking
system. Banks should have in place a process of daily reconciliation of
21

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
the dealers profit or loss vis-à-vis the profit or loss as per the general
ledger system to avoid instances of unrecorded transactions.
g) Controls in respect of financial reporting and MIS: A bank’s financial
statements include many exhaustive disclosures with treasury related
disclosures forming a significant portion thereof (such as, concentration
risk for swaps, PV01 disclosures for derivatives, maturity pattern for
investments, forex). The collation of information to be presented in these
disclosures is tedious and requires liaisoning with several treasury subfunctions.
Further, banks also have an exhaustive base of MIS (such as
ALM, concentration exposures, VAR or other measures capturing market
risk, net open positions) presented at the various senior management
committees (such as ALCO, Risk, Board, Investment, Credit).
Contents of an MIS pack or in a bank’s financials have a direct bearing on
the management decision making and users of financial statements. The
internal auditor should include within his scope the controls around
information flow and data integrity for collation and preparation of the
disclosures and MIS reports.
22

CHAPTER 5
INVESTMENT PORTFOLIO
5.1 The primary function of banks is to accept deposits and to lend money.
Earlier, the investments were made only to meet out the SLR requirements. By
the span of time the face of banking has changed. Due to the recessionary
conditions in the economy the credit demand decreased substantially. It forced
the banks to invest the surplus medium to long term funds in SLR/NSLR
securities and debts. The investments portfolio of a bank may have a number of
varieties of instruments. Keeping in view the return from lending and surplus
investments, dynamic decision making is required whereby return on deployment
is optimized.
5.2 The banks investment book may comprise the following:
(a)
(b)
(c)
(d)
(e)
(f)
(g)
(h)
(i)
(j)
(k)
(l)
(m)
Central Government dated securities
State Government developmental loans
Treasury Bills
Trust Securities
Equity / Preference Shares
Units of Mutual Funds
Pass through Certificate/CDR/ARCIL
Commercial Papers
Corporate Bonds and Debentures
Bonds and debentures of PSUs, Government / Semi-Government
autonomous bodies, etc.
Venture capital investments
Investment in subsidiaries and joint ventures(Indian/overseas)
Other Asset backed/Mortgage backed securities.

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
Merchant and Trading in Precious Metal
5.3 The RBI launched the gold import scheme in September, 2000 and
subsequently, included import of silver business in the same. Precious metal
dealing desk functions is a part of inter-bank forex desk in the front office of the
treasury. Presently, banks only deal in gold and silver in terms of approval
obtained from the RBI. Gold and silver are imported on a consignment basis from
the designated supplier on the terms and conditions agreed to with them by the
bank. Precious metal consignment is kept in the vaults of designated branches or
security agencies. As and when the parts of consignment are sold to the
importers in India the remittances are being made to the suppliers for the gold
quantity on spot payment basis. Similarly, trading in gold and silver is done with
the agreement tied foreign banks.
Investment Policy
5.4 RBI has issued Master Circular on “Prudential Norms for
classification,valuation and operation of investment portfolio by banks” (DBOD
No. BP. BC.3 / 21.04.141 / 2009-10) on July 1, 2009.
The following is a gist of RBI guidelines issued to banks with respect to
investment policy.
(a) Banks should frame Internal Investment Policy <strong>Guide</strong>lines and obtain the
Board’s approval.
(b) The investment policy guidelines should be implemented to ensure that
operations in securities are conducted in accordance with sound and
acceptable business practices
(c) The size of the bank’s operations, composition of assets and liabilities, risk
policy and risk appetite are to be considered while framing the policy.
(d) The broad structure of the Investment policy should be based on:
(i) No sale transaction is to be completed without the bank actually holding
the relative security
(ii) Banks may sell a government security already contracted for purchase
subject to certain conditions.
(iii) Banks successful in the auction of primary issue of government
securities, may enter into contracts for sale of the allotted securities in
accordance with the terms and conditions given in the Master Circular.
24

Investment Portfolio
(iv) All the transactions put through by a bank, either on outright basis or
ready forward basis and whether through the mechanism of Subsidiary
General Ledger (SGL) Account or Bank Receipt (BR), should be
reflected on the same day in its investment account and, accordingly,
for SLR purpose wherever applicable.
(v) All brokerage deals have to be specifically approved by the delegated
authorities in the bank and a
(vi) separate account of brokerage paid, broker-wise, should be
maintained.For issue of Bank Receipts ( BRs), the banks should adopt
the format prescribed by the Indian Banks' Association (IBA) and strictly
follow the guidelines prescribed by them in this regard. The banks,
subject to the above, could issue BRs covering their own sale
transactions only and should not issue BRs on behalf of their
constituents, including brokers.
(vii) The banks should be circumspect while acting as agents of their broker
clients for carrying out transactions in securities on behalf of brokers.
(viii) Investment in equity shares and debentures must be undertaken after
considering the following:
• Build up adequate expertise in equity research by establishing a
dedicated equity research department, as warranted by their scale
of operations;
• Formulate a transparent policy and procedure for investment in
shares, etc., with the approval of the Board; and
• The decision in regard to direct investment in shares, convertible
bonds and debentures should be taken by the Investment
Committee set up by the bank's Board. The Investment Committee
should be held accountable for the investments made by the bank.
(ix) The bank’s Board of Directors should specify:
• the level of authority to put through deals,
• procedure to be followed for obtaining the sanction of the
appropriate authority,
• procedure to be followed while putting through deals,
• various prudential exposure limits, and
• the reporting system.
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
Internal control System
5.5 The abovementioned Master Circular issued by the RBI requires the
banks to adopt the following guidelines for internal control system while
undertaking investment transactions:
(a) There should be a clear functional separation of trading, settlement,
monitoring and control, and accounting.
(b) There should be a functional separation of trading and back office functions
relating to banks' own Investment Accounts, Portfolio Management Scheme
(PMS) Clients' Accounts and other Constituents (including brokers')
accounts.
(c) PMS Clients Accounts should be subjected to a separate audit by external
auditors.
(d) For every transaction entered into, the trading desk should prepare a deal
slip containing data relating to following:
‣ nature of the deal,
‣ name of the counter-party,
‣ whether it is a direct deal or through a broker, and if through a broker,
name of the broker,
‣ details of security,
‣ amount,
‣ price, and
‣ contract date and time.
The deal slips should be serially numbered and controlled separately to ensure
that each deal slip has been properly accounted for. Once the deal is concluded,
the dealer should immediately pass on the deal slip to the back office for
recording and processing. For each deal there must be a system of issue of
confirmation to the counterparty.
(e) Once a deal has been concluded, there should not be any substitution of the
counter party bank by another bank by the broker, through whom the deal
has been entered into; likewise, the security sold/purchased in the deal
should not be substituted by another security.
26

Investment Portfolio
(f) The Accounts Section should independently write the books of account on
the basis of vouchers passed by the back office.
(g) Records of SGL and BR transactions should be maintained.
(h) Balances as per bank's books should be reconciled at quarterly intervals
with the balances in the books of the Public Debt office (PDOs).
(i) The investment transactions should be reported to the top management, on
a weekly basis covering the following:
• details of transactions in securities,
• details of bouncing of SGL transfer forms issued by other banks,
• BRs outstanding for more than one month, and
• a review of investment transactions undertaken during the period.
(j) Bankers' cheques/ pay orders should be issued for third party transactions,
including inter-bank transactions.
(k) In case of investment in shares, the surveillance and monitoring of
investment should be done by the Audit Committee of the Board. In each of
its meetings it shall review:
• the total exposure of the bank to capital market both fund based and
non-fund based, in different forms,
• ensure that the guidelines issued by RBI are complied with, and
• adequate risk management and internal control systems are in place.
(l) In order to avoid any possible conflict of interest, it should be ensured that
the stockbrokers as directors on the Boards of banks or in any other
capacity, do not involve themselves in any manner with the Investment
Committee or in the decisions in regard to making investments in shares,
etc., or advances against shares.
(m) An on-going internal audit system should be in place to report the
deficiencies directly to the management of the bank.
(n) The banks should get compliance in key areas certified by their statutory
auditors and furnish such audit certificate to the Regional Office of
Department of Banking Supervision of RBI under whose jurisdiction the HO
of the bank falls.
27

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
Classification
5.6 The RBI’s Master Circular on “Prudential norms for clarification,
valuation and operation of investment portfolio by banks” lays down that the
entire investment portfolio of the banks (including SLR securities and non-SLR
securities) should be classified under three categories
(a) Held to Maturity
(b) Available for Sale and
(c) Held for Trading.
However, in the balance sheet, the investments will continue to be disclosed as
per the following existing six classifications:
(a) Government securities,
(b) Other approved securities,
(c) Shares,
(d) Debentures and Bonds,
(e) Subsidiaries/ joint ventures, and
(f) Others (CP, Mutual Fund Units, etc.).
Held to Maturity
5.7 The securities acquired by the banks with the intention to hold them up
to maturity will be classified under Held to Maturity (HTM).The investments
included under “Held to Maturity” should not exceed 25 per cent of the
bank’s total investments. The banks may include, at their discretion, under
Held to Maturity category securities less than 25 per cent of total
investment. The following investments will be classified under ‘Held to
Maturity’ but will not be accounted for the purpose of ceiling of 25%
specified for this category:
a) Re-capitalisation bonds received from the Government of India towards
their re-capitalisation requirement and held in their investment portfolio.
This will not include re-capitalisation bonds of other banks acquired for
investment purposes.
28

Investment Portfolio
b) Investment in subsidiaries and joint ventures. [A joint venture would be
one in which the bank, along with its subsidiaries, holds more than 25% of
the equity.]
c) The investments in debentures/ bonds, which are deemed to be in the
nature of an advance.
5.8 Banks are, however, allowed since September 2, 2004, to exceed the
limit of 25 per cent of total investment under HTM category provided the excess
comprises only of SLR securities; and the total SLR securities held in HTM is not
more than 25 per cent of their DTL as on last Friday of the second preceding
fortnight.
Profit on sale of investments in this category should be first taken to the Profit &
Loss Account and thereafter be appropriated to the ‘Capital Reserve Account’.
Loss on sale will be recognised in the Profit & Loss Account.
Available for Sale and Held for Trading
5.9 The securities acquired by the banks with the intention to trade by
taking advantage of the short-term price/interest rate movements will be
classified under Held for Trading (HFT). The securities which do not fall within
the above two categories will be classified under Available for Sale. The banks
will have the freedom to decide on the extent of holdings under Available for Sale
and Held for Trading categories taking into account various aspects such as
basis of intent, , trading strategies, risk management capabilities, tax planning,
manpower skills, capital position. HFT securities are to be sold within 90 days
from the date of acquisition. Profit or loss on sale of investments in both the
categories will be taken to the Profit & Loss Account.
Shifting among Categories
5.10 As per the RBI <strong>Guide</strong>lines, banks may shift investments to/from Held to
Maturity category with the approval of the Board of Directors once a year. Such
shifting will normally be allowed at the beginning of the accounting year. No
further shifting to/from this category will be allowed during the remaining part of
that accounting year. Banks may shift investments from Available for Sale
category to Held for Trading category with the approval of their Board of
Directors/ ALCO/ Investment Committee. In case of exigencies, such shifting
may be done with the approval of the Chief Executive of the bank/ Head of the
ALCO, but should be ratified by the Board of Directors/ ALCO.
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
5.11 Shifting of investments from Held for Trading category to Available for
Sale category is generally not allowed. However, it will be permitted only under
exceptional circumstances with the approval of the Board of Directors/ ALCO/
Investment Committee. Transfer of scrips from one category to another, under all
circumstances, should be done at the acquisition cost/ book value/ market value
on the date of transfer, whichever is the least, and the depreciation, if any, on
such transfer should be fully provided for.
Valuation
5.12 RBI <strong>Guide</strong>lines for valuation for the three categories is as follows:
(a)
(b)
Held to maturity
(i) Investments classified under Held to Maturity category need not be
marked to market and will be carried at acquisition cost, unless it is
more than the face value, in which case the premium should be
amortised over the period remaining to maturity.
(ii) Banks should recognise any diminution, other than temporary, in
the value of their investments in subsidiaries/ joint ventures which
are included under Held to Maturity category and provide therefore.
Such diminution should be determined and provided for each
investment individually.
Available for sale
(i) The individual scrips in the Available for Sale category will be
marked to market at quarterly or at more frequent intervals.
(ii) While the net depreciation under each classification should be
recognised and fully provided for, the net appreciation under each
classification should be ignored.
(iii) The book value of the individual securities would not undergo any
change after the marking of market.
(iv) The provisions required to be created on account of depreciation in
the Available for Sale category in any year should be debited to the
Profit & Loss Account and an equivalent amount (net of tax benefit,
if any, and net of consequent reduction in the transfer to Statutory
Reserve) or the balance available in the Investment Fluctuation
Reserve Account, whichever is less, shall be transferred from the
Investment Fluctuation Reserve Account to the Profit & Loss
30

(c)
Investment Portfolio
Account. In the event provisions created on account of depreciation
in the Available for Sale category are found to be in excess of the
required amount in any year, the excess should be credited to the
Profit & Loss Account and an equivalent amount (net of taxes, if
any, and net of transfer to Statutory Reserves as applicable to such
excess provision) should be appropriated to the Investment
Fluctuation Reserve Account to be utilised to meet future
depreciation requirement for investments in this category. The
amount debited to the Profit & Loss Account for provision and the
amount credited to the Profit & Loss Account for reversal of excess
provision should be debited and credited respectively under the
head “Expenditure – Provisions & Contingencies”. The amounts
appropriated from the Profit & Loss Account and the amount
transferred from the Investment Fluctuation Reserve to the Profit &
Loss Account should be shown as ‘below the line’ items after
determining the profit for the year.
Held for Trading category
The individual scrips in the Held for Trading category will be revalued at monthly
or at more frequent intervals and provided for as in the case of those in the
Available for Sale category. The book value of the individual scrip will change
with the revaluation.
General
5.13 In respect of securities included in any of the three categories where
interest/ principal is in arrears, the banks should not reckon income on the
securities and should also make appropriate provisions for the depreciation in the
value of the investment. The banks should not set-off the depreciation
requirement in respect of these non-performing securities against the
appreciation in respect of other performing securities.
Market value
5.14 The ‘market value’ for the purpose of periodical valuation of investments
included in the Available for Sale and the Held for Trading categories would be
the market price of the scrip as available from the trades/ quotes on the stock
exchanges, SGL account transactions, price list of RBI, prices declared by
Primary Dealers Association of India (PDAI) jointly with the Fixed Income Money
Market and Derivatives Association of India (FIMMDA) periodically.
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
In respect of unquoted securities, the procedure as detailed below should be
adopted.
Unquoted Non-SLR Securities-Debentures/ Bonds
5.15 All debentures/ bonds other than debentures/ bonds which are in the
nature of advance, should be valued on the YTM basis. Such debentures/ bonds
may be of different companies having different ratings. These will be valued with
appropriate mark-up over the YTM rates for Central Government securities as
put out by PDAI/ FIMMDA periodically. The mark-up will be graded according to
the ratings assigned to the debentures/ bonds by the rating agencies subject to
the following: -
(a)
(b)
(c)
The rate used for the YTM for rated debentures/ bonds should be at least
50 basis points above the rate applicable to a Government of India loan of
equivalent maturity. The special securities, which are directly issued by
Government of India to the beneficiary entities, which do not carry SLR
status, may be valued at a spread of 25 basis points above the
corresponding yield on Government of India securities, with effect from the
financial year 2008 - 09. At present, such special securities comprise: Oil
Bonds, Fertiliser Bonds, bonds issued to the State Bank of India (during
the recent rights issue), Unit Trust of India, Industrial Finance Corporation
of India Ltd., Food Corporation of India, Industrial Investment Bank of
India Ltd., the erstwhile Industrial Development Bank of India and the
erstwhile Shipping Development Finance Corporation.
The rate used for the YTM for unrated debentures/ bonds should not be
less than the rate applicable to rated debentures/ bonds of equivalent
maturity. The mark-up for the unrated debentures/ bonds should
appropriately reflect the credit risk borne by the bank.
Where the debenture/ bonds is quoted and there have been transactions
within 15 days prior to the valuation date, the value adopted should not be
higher than the rate at which the transaction is recorded on the stock
exchange.
Investment Fluctuation Reserve
5.16 A reserve is to be maintained to guard against any possible reversal of
interest rate environment on unexpected developments. It is prudent to transfer
maximum amount of gains realised on sale of securities to the Investment
Fluctuation Reserve (IFR). Banks are free to build IFR up to 10 per cent of the
32

Investment Portfolio
investment portfolio under HFT and AFS with the approval of the Board of
Directors. The amount held under IFR arising out of gains on sale of investments
will be reckoned for the purpose of TIER –II capital.
Transactions through SGL Account
5.17 SGL or CSGL are a demat form of holding government securities with
the RBI. SGL stands for 'Subsidiary General Ledger' account. It is a facility
provided by RBI to large banks and financial institutions to hold their investments
in Government securities and Treasury bills in the electronic book-entry form.
Such institutions can settle their trades for securities held in SGL through a
Delivery-versus-Payments (DVP) mechanism which ensures movement of funds
and securities simultaneously.
5.18 As all investors in Government securities do not have an access to the
SGL accounting system, the RBI has permitted such investors to hold their
securities in physical stock certificate form. The RBI, being the R&T agent of all
Government securities issued by Central and State Governments, keeps the
records of holding of various investors in the securities issued. The SGL, in short
keeps the names of all investor in a particular security at any point of time. The
securities are held in electronic form in SGL accounts. They may also open a
Constituent SGL account with any entity authorised by the RBI for this purpose
and thus avail of the DVP settlement. Such client accounts are referred to as
Constituent SGL accounts.
5.19 Securities kept on behalf of customers by banks or PDs in Constituent
SGL account are kept in a segregated CSGL A/c with the RBI. Thus, if the bank
or the PD buys security for his client, it gets credited to the CSGL account of
bank or PD with the RBI. Successful bidders are allotted securities bid by them.
The RBI can debit their current accounts for amount payable and credit their SGL
account with the securities allotted to them. The amount debited to the current
account is placed to the credit of Government Account. In the same manner
secondary market operations are also handled by the RBI.
5.20 The following are to be noted with regard to transactions through SGL
Account:
• It is necessary for both the selling bank and the buying bank to maintain
current account with the RBI.
• All transactions in Govt. securities for which SGL facility is available should
be put through SGL A/c only.
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
• A SGL transfer form issued by a bank in favour of another bank should not
bounce for want of sufficient balance of securities in the SGL A/c of seller or
for want of sufficient balance of funds in the current A/c of the buyer. If a
SGL transfer form bounces for want of sufficient balance in the SGL A/c, the
(selling) bank which has issued the form will be liable to the penal action
against it.
• If the bouncing of the SGL form occurs thrice, the bank will be debarred from
trading with the use of the SGL facility for a period of 6 months from the
occurrence of the third bouncing.
• The SGL transfer form received by purchasing banks should be deposited in
their SGL A/c Immediately, i.e., the date of lodgment of the SGL Form with
the RBI shall be within one working day after the date of signing of the
Transfer Form.
• No sale should be effected by way of return of SGL form held by the bank.
• Participants must indicate the deal/trade/contract date in Part C of the SGL
Form under Sale date. Where this is not completed the SGL Form will not be
accepted by the RBI.
• SGL transfer forms should be signed by two authorised officials of the bank
whose signatures should be recorded with the respective PDOs of the
Reserve Bank and other banks.
Non-performing Investments
5.21 In respect of securities included in any of the three categories where
interest/ principal is in arrears, the banks should not reckon income on the
securities and should also make appropriate provisions for the depreciation in the
value of the investment. The banks should not set-off the depreciation
requirement in respect of these non-performing securities against the
appreciation in respect of other performing securities.
5.22 A non performing investment (NPI), similar to a non performing advance
(NPA), is one where:
(a)
(b)
Interest/ instalment (including maturity proceeds) is due and remains
unpaid for more than 90 days.
The above would apply mutatis-mutandis to preference shares where the
fixed dividend is not paid.
34

(c)
(d)
(e)
(f)
Investment Portfolio
In the case of equity shares, in the event the investment in the shares of
any company is valued at Re.1 per company on account of the nonavailability
of the latest balance sheet, those equity shares would also be
reckoned as NPI.
If any credit facility availed by the issuer is NPA in the books of the bank,
investment in any of the securities issued by the same issuer would also
be treated as NPI and vice versa.
The investments in debentures / bonds, which are deemed to be in the
nature of advance would also be subjected to NPI norms as applicable to
investments.
In case of conversion of principal and / or interest into equity, debentures,
bonds, etc., such instruments should be treated as NPA abinitio in the
same asset classification category as the loan if the loan's classification is
substandard or doubtful on implementation of the restructuring package
and provision should be made as per the norms.
Income Recognition
5.23 Banks may book income on accrual basis on securities of corporate
bodies/ public sector undertakings in respect of which the payment of interest
and repayment of principal have been guaranteed by the Central Government or
a State Government, provided interest is serviced regularly and as such is not in
arrears. Banks may book income from dividend on shares of corporate bodies on
accrual basis provided dividend on the shares has been declared by the
corporate body in its Annual General Meeting and the owner's right to receive
payment is established. Banks may book income from Government securities
and bonds and debentures of corporate bodies on accrual basis, where interest
rates on these instruments are pre-determined and provided interest is serviced
regularly and is not in arrears. Banks should book income from units of mutual
funds on cash basis.
Broken Period Interest
5.24 Banks should not capitalise the Broken Period Interest paid to seller as
part of cost, but treat it as an item of expenditure under Profit and Loss
Account in respect of investments in Government and other approved
securities. However, the banks should comply with the requirements of
Income Tax Authorities in the manner prescribed by them.
35

CHAPTER 6
ASSET LIABILITY MANAGEMENT
6.1 Asset Liability Management (ALM) defines management of all assets
and liabilities (both off and on balance sheet items) of a bank. It requires
assessment of various types of risks and altering the asset liability portfolio to
manage risks. Asset Liability Management provides a comprehensive and
dynamic framework for measuring, monitoring and managing liquidity, interest
rate, foreign exchange, equity and commodity price risks of a bank that needs to
be closely integrated with the banks' business strategy. It involves assessment of
various types of risks and altering the asset-liability portfolio in a dynamic way in
order to manage risks.
6.2 As per the RBI <strong>Guide</strong>lines on Asset Liability Management (ALM)
System, the ALM process rests on following three pillars:
(i) ALM Information Systems
• Management Information Systems
• Information availability, accuracy, adequacy and expediency.
(ii) ALM Organisation
• Structure and responsibilities
• Level of top management involvement
(iii) ALM Process
• Risk parameters
• Risk identification
• Risk measurement
• Risk management
• Risk policies and tolerance levels.
6.3 ALM has to be supported by a management philosophy which clearly
specifies the risk policies and tolerance limits. This framework needs to be built

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
on sound methodology with necessary information system as back up. Thus,
information is the key to the ALM process. It is, however, recognised that varied
business profiles of banks in the public and private sector as well as those of
foreign banks do not make the adoption of a uniform ALM System for all banks
feasible. There are various methods prevalent world-wide for measuring risks.
These range from the simple Gap Statement to extremely sophisticated and data
intensive Risk Adjusted Profitability Measurement methods.
6.4 Successful implementation of the risk management process would
require strong commitment on the part of the senior management in the bank, to
integrate basic operations and strategic decision making with risk management.
The Board should have overall responsibility for management of risks and should
decide the risk management policy of the bank and set limits for liquidity, interest
rate, foreign exchange and equity price risks.
6.5 The Asset - Liability Committee (ALCO) consisting of the bank's senior
management including CEO should be responsible for ensuring adherence to the
limits set by the Board as well as for deciding the business strategy of the bank
(on the assets and liabilities sides) in line with the bank's budget and decided risk
management objectives. The ALM Support Groups consisting of operating staff
should be responsible for analysing, monitoring and reporting the risk profiles to
the ALCO. The staff should also prepare forecasts (simulations) showing the
effects of various possible changes in market conditions related to the balance
sheet and recommend the action needed to adhere to bank's internal limits.
6.6 The scope of ALM function can be described as follows:
(a)
(b)
(c)
(d)
(e)
Liquidity risk management
Management of market risks
Trading risk management
Funding and capital planning
Profit planning and growth projection
ALM Models
6.7 Analytical models are very important for ALM analysis and scientific
decision making. The basic models are as follows:
(a)
(b)
GAP Analysis Model
Duration GAP Analysis Model
38

(c)
(d)
Scenario Analysis Model
Value at Risk (VaR) model
Gap Analysis Model
Asset Liability Management
6.8 Gap analysis model measures the direction and extent of asset-liability
mismatch through either funding or maturity gap. It is computed for assets and
liabilities of differing maturities and is calculated for a set time horizon. This
model looks at the repricing gap that exists between the interest revenue earned
on the bank's assets and the interest paid on its liabilities over a particular period
of time * . It highlights the net interest income exposure of the bank to changes in
interest rates in different maturity buckets.
6.9 Repricing gaps are calculated for assets and liabilities of differing
maturities. A positive gap indicates that assets get repriced before liabilities,
whereas a negative gap indicates that liabilities get repriced before assets. The
bank looks at the rate sensitivity (the time the bank manager will have to wait in
order to change the posted rates on any asset or liability) of each asset and
liability on the balance sheet. The general formula that is used is as follows:
NIIi = R i (GAPi)
While NII is the net interest income, R refers to the interest rates impacting
assets and liabilities in the relevant maturity bucket and GAP refers to the
differences between the book value of the rate sensitive assets and the rate
sensitive liabilities. Thus, when there is a change in the interest rate, one can
easily identify the impact of the change on the net interest income of the bank.
Interest rate changes have a market value effect. The basic weakness with this
model is that this method takes into account only the book value of assets and
liabilities and hence ignores their market value. This method, therefore, is only a
partial measure of the true interest rate exposure of a bank.
Duration Model
6.10 Duration is an important measure of the interest rate sensitivity of
assets and liabilities as it takes into account the time of arrival of cash flows and
the maturity of assets and liabilities. It is the weighted average time to maturity of
all the preset values of cash flows. Duration basically refers to the average life of
the asset or the liability.
*
Saunders, 1997.
39

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
6.11 The following equation describes the percentage fall in price of the bond
for a given increase in the required interest rates or yields:-
DP p = D ( dR /1+R)
The larger the value of the duration, the more sensitive is the price of that asset
or liability to changes in interest rates. As per the above equation, the bank will
be immunized from interest rate risk if the duration gap between assets and the
liabilities is zero. The one important benefit of duration model is that it uses the
market value of assets and liabilities.
6.12 Under this technique assumptions were made on various conditions, for
example: -
• Several interest rate scenarios were specified for the next 5 or 10 years.
These specified conditions like declining rates, rising rates, a gradual
decrease in rates followed by a sudden rise, etc. Ten or twenty scenarios
could be specified in all.
• Assumptions were made about the performance of assets and liabilities
under each scenario. They included prepayment rates on mortgages or
surrender rates on insurance products.
• Assumptions were also made about the firm's performance like, the rates at
which new business would be acquired for various products, demand for the
product, etc.
• Market conditions and economic factors like, inflation rates and industrial
cycles were also included.
6.13 Based upon these assumptions, the performance of the firm's balance
sheet could be projected under each scenario. If projected performance was poor
under specific scenarios, the ALM committee would adjust assets or liabilities to
address the indicated exposure. Let us consider the procedure for sanctioning a
commercial loan. The borrower, who approaches the bank, has to appraise the
banks credit department on various parameters like, industry prospects,
operational efficiency, financial efficiency, management qualities and other
things, which would influence the working of the company. On the basis of this
appraisal, the banks would then prepare a credit grading sheet after covering all
the aspects of the company and the business in which the company is in. Then
the borrower would then be charged a certain rate of interest which would cover
the risk of lending. The main shortcoming of scenario analysis was that it was
highly dependent on the choice of scenarios. It also required that many
40

Asset Liability Management
assumptions were to be made about how specific assets or liabilities will perform
under specific scenarios. Gradually, the firms recognized a potential for different
type of risks which was overlooked in ALM analysis.
Relationship between Treasury and ALM
6.14 The banking operations are confined to lending, accepting deposits and
miscellaneous services. It is the treasury which operates in financial markets
directly, establishing a link between core banking functions and market
operations. Thus, the market risk is identified and monitored through treasury.
Treasury uses derivatives and other means to bridge the liquidity and rate
sensitivity gaps. Treasury products are marketable and liquidity can be infused at
any point of time. Treasury monitors exchange rate and interest rate movements.
Hence, risk management is an integral part of treasury. In many banks, either
ALM desk is part of the dealing room or Asset Liability Management Committee
(ALCO) support group is part of the treasury team. The head of the treasury is an
important member of ALCO, thereby contributing not only to risk management
but also to product pricing and other policy issues.
RBI <strong>Guide</strong>lines on Asset Liability Management
6.15 The RBI had issued guidelines on ALM system vide Circular No. DBOD.
BP. BC. 8 / 21.04.098/ 99 dated February 10, 1999, which covered, among
others, interest rate risk and liquidity risk measurement, reporting framework and
prudential limits. The abovementioned guidelines are given in Annexure VII of
the <strong>Guide</strong>.
6.16 RBI reviewed the above guideline and made the following changes vide
Circular “<strong>Guide</strong>lines on Asset Liability Management (ALM) System –
amendments” (DBOD. No. BP. BC. 38 / 21.04.098/ 2007-08) dated October 24,
2007:
• As per the revised guidelines, banks must adopt a more granular approach
to measurement of liquidity risk by splitting the first time bucket of 1-14 days
in the Statement of Structural Liquidity into three time buckets – next day, 2-
7 days and 8-14 days.
• The net cumulative negative mismatches during the next day, 2-7 days, 8-14
days and 15-28 days buckets should not exceed 5 per cent, 10 per cent, 15
per cent and 20 per cent of the cumulative cash outflows in the respective
buckets in order to recognise the cumulative impact on liquidity,
41

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
• Banks may undertake dynamic liquidity management and should prepare the
Statement of Structural Liquidity on daily basis. The Statement of Structural
Liquidity, may, however, be reported to RBI, once a month, as on the third
Wednesday of every month. However, the frequency of supervisory
reporting of the Structural Liquidity position shall be fortnightly, with effect
from the fortnight beginning April 1, 2008.
42

CHAPTER 7
TREASURY RISKS
7.1 Banks are highly sensitive to treasury risks, as the risks arrive out of
high leverage treasury business enjoys. The risks of losing capital are much
more than the credit business. Treasury faces broadly three types of risk, viz.,
market risk, credit risk, and operational risk.
Market Risk
7.2 Market risk may be defined as the possibility of loss to a bank caused
by changes in the market variables. The Bank for International Settlements (BIS)
defines market risk as “the risk that the value of on or off-balance sheet positions
will be adversely affected by movements in equity and interest rate markets,
currency exchange rates and commodity prices”. Thus, market risk is the risk to
the bank’s earnings and capital due to changes in the market level of interest
rates or prices of securities, foreign exchange and equities, as well as the
volatilities of those prices.
Market risk broadly covers liquidity risk, interest rate risk and foreign exchange
risk.
Liquidity Risk
7.3 Liquidity risk is the potential inability to meet the bank's liabilities as they
become due. It arises when the banks are unable to generate cash to cope with
a decline in deposits or increase in assets. It originates from the mismatches in
the maturity pattern of assets and liabilities. Measuring and managing liquidity
needs are vital for effective operation of commercial banks. By assuring a bank's
ability to meet its liabilities as they become due, liquidity management can
reduce the probability of an adverse situation developing.The liquidity risk in
banks manifest in different dimensions:
(a)
(b)
Funding Risk - need to replace net outflows due to unanticipated
withdrawal/non-renewal of deposits (wholesale and retail);
Time Risk - need to compensate for non-receipt of expected inflows of
funds, i.e., performing assets turning into non-performing assets; and

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
(c)
Call Risk - due to crystallisation of contingent liabilities and unable to
undertake profitable business opportunities when desirable.
Interest Rate Risk (IRR)
7.4 Interest rate risk is the risk where changes in market interest rates might
adversely affect a bank's financial condition. The immediate impact of changes in
interest rates is on the Net Interest Income (NII). A long term impact of changing
interest rates is on the bank's net worth since the economic value of a bank's
assets, liabilities and off-balance sheet positions get affected due to variation in
market interest rates. The interest rate risk when viewed from these two
perspectives is known as 'earnings perspective' and 'economic valueperspective’,
respectively.
7.5 Management of interest rate risk aims at capturing the risks arising from
the maturity and repricing mismatches and is measured both from the earnings
and economic value perspective.
(a)
(b)
Earnings perspective involves analysing the impact of changes in
interest rates on accrual or reported earnings in the near term. This is
measured by measuring the changes in the Net Interest Income (NII) or
Net Interest Margin (NIM), i.e., the difference between the total interest
income and the total interest expense.
Economic Value perspective involves analysing the changes of impact
of interest on the expected cash flows on assets minus the expected
cash flows on liabilities plus the net cash flows on off-balance sheet
items. It focuses on the risk to networth arising from all repricing
mismatches and other interest rate sensitive positions. The economic
value perspective identifies risk arising from long term interest rate
gaps.
Foreign Exchange Risk
7.6 Foreign exchange risk may be defined as the risk that a bank may suffer
losses as a result of adverse exchange rate movements during a period in which
it has an open position, either spot or forward, or a combination of the two, in an
individual foreign currency. The banks are also exposed to interest rate risk,
which arises from the maturity mismatching of foreign currency positions. Even in
cases where spot and forward positions in individual currencies are balanced, the
maturity pattern of forward transactions may produce mismatches. As a result,
44

Treasury Risks
banks may suffer losses due to changes in premium/discounts of the currencies
concerned.
7.7 In the forex business, banks also face the risk of default of the
counterparties or settlement risk. While such type of risk crystallisation does not
cause principal loss, banks may have to undertake fresh transactions in the
cash/spot market for replacing the failed transactions. Thus, banks may incur
replacement cost, which depends upon the currency rate movements. Banks
also face another risk called time-zone risk or “Herstatt risk” which arises out of
time lags in settlement of one currency in one centre and the settlement of
another currency in another time zone. The forex transactions with counterparties
from another country also trigger sovereign or country risk. The three important
issues that need to be addressed in this regard are:
(a)
(b)
(c)
Credit Risk
Nature and magnitude of exchange risk;
Strategy to be adopted for hedging or managing exchange risk; and
Tools of managing exchange risk;
7.8 Credit risk is defined as the possibility of losses associated with
diminution in the credit quality of borrowers or counterparties. In a bank's
portfolio, losses stem from outright default due to inability or unwillingness of a
customer or counterparty to meet commitments in relation to lending, trading,
settlement and other financial transactions. Alternatively, losses result from
reduction in portfolio value arising from actual or perceived deterioration in credit
quality. Credit risk emanates from a bank's dealings with an individual, corporate,
bank, financial institution or a sovereign.
7.9 Credit risk may take the following forms:
• in the case of direct lending - principal/and or interest amount may not
be repaid;
• in the case of guarantees or letters of credit - funds may not be
forthcoming from the constituents upon crystallization of the liability;
• in the case of treasury operations - the payment or series of payments
due from the counter parties under the respective contracts may not be
forthcoming or ceases;
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
• in the case of securities trading businesses - funds/ securities
settlement may not be effected;
• in the case of cross-border exposure - the availability and free transfer
of foreign currency funds may either cease or restrictions may be
imposed by the sovereign.
Operational Risk
7.10 Britain's oldest merchant bank, Barings Bank, collapsed in 1995 due to
unauthorised trading by a single trader, Nick Leeson, General Manager, Barings
Futures (Singapore). The collapse of the bank was mainly attributed to failure of
systems and procedures of control. The most serious failure was that Leeson
controlled both the front and back offices and there was no middle office. There
was no single person within Barings responsible for supervising Leeson.
7.11 Basel I defined operational risk as “the risk of direct or indirect loss
resulting from inadequate or failed internal processes, people and systems or
from external events”. Basel II, however, defined operational risk as, “the risk of
loss resulting from inadequate or failed internal processes, people and systems
or from external events”. For emergence of such a risk four causes have been
mentioned and they are people, process, systems and external factors.
(a) People risk - Lack of key personnel, lack of adequate
training/experience of dealer (measured in terms of opportunity
cost/employee turnover), unauthorised access to the dealing room,
tampering voice recorders, nexus between the front and back offices,
etc.
(b)
(c)
(d)
Process risk - Wrong reporting of important market developments to the
management resulting in faulty decision making, errors in entry of data
in deal slips, non-monitoring of exposure in positions, loss of interest
owing to the liquidity beyond prescribed limits, non-revision of card rates
in cases of volatility, non-monitoring of closing and opening positions,
wrong funding of accounts (wrong currency, wrong way swap), lack of
policies, particularly in respect of new products.
Systems: Losses due to systems failure such as NDS — not
maintaining secrecy of system passwords.
Legal and regulatory risk: Treasury activities should comply with the
regulatory and statutory obligation.
46

Treasury Risks
7.12 It is necessary that formal policies are in place with respect to trigger
limits; stop loss limits; prudential limits; well defined procedures and check lists;
effective internal controls and audit; insurance, wherever possible; business
process re-engineering to eliminate weak links in the process chain; prudential
limits on investments in banks; cap on unrated issues and private placements;
sub-limits for PSU bonds, corporate bonds and guaranteed bonds; same degree
of credit risk analysis in the case of any loan proposal; and more stringent
appraisal for non-borrower issuers.
Market Risk Limits
7.13 Market risk limits should be established at different levels of the entity,
i.e., the entity as a whole, various risk-taking units, trading desk heads and
individual traders. In determining how market risk limits are established and
allocated, management should take into account following factors:
(a)
(b)
(c)
(d)
(e)
Past performance of the trading unit;
Experience and expertise of the traders;
Level of sophistication of the pricing, valuation and measurement
systems; quality of internal controls;
Projected level of trading activity having regard to the liquidity of
particular products and markets; and
Ability of the operating systems to settle the resultant trades.
Commonly Used Market Risk Limits
7.14 The following are some of the commonly used market limits:
(a)
Notional or Volume Limits
Limits based on notional amount of derivatives contracts are the most basic and
simplest form of limits for controlling the risks of derivatives transactions. They
are useful in limiting transaction volume, liquidity and settlement risks. However,
these limits cannot take account of price sensitivity and volatility.
(b)
Stop Loss Limits
These limits are established to avoid unrealized loss in a position from exceeding
a specified level. When these limits are reached, the position will either be
liquidated or hedged. Typical stop loss limits include those relating to
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
accumulated unrealized losses for a day, a week or a month. Some institutions
also establish management action trigger (MAT) limits in addition to stop loss
limits. These are for early warning purposes. For example, management may
establish a MAT limit at 75 per cent of the stop loss limit. When the unrealized
loss reaches 75 per cent of the stop loss limit, management will be alerted of the
position and may trigger certain management actions, such as close monitoring
of the position, reducing or early closing out the position before it reaches the
stop loss limits. The above loss triggers complement other limits, but they are
generally not sufficient by themselves. They are not anticipatory; they are based
on unrealized losses to date and do not measure the potential earnings at risk
based on market characteristics. They will not prevent losses larger than the stop
loss limits if it becomes impossible to close out positions, e.g., because of market
illiquidity.
(c)
Gap or Maturity Band Limits
These limits are designed to control loss exposure by controlling the volume or
amount of the derivatives that mature or are repriced in a given time period.
For example, management can establish gap limits for each maturity band of 3
months, 6 months, 9 months, one year, etc. to avoid maturities concentrating in
certain maturity bands. Such limits can be used to reduce the volatility of
derivatives revenue by staggering the maturity and/or repricing and thereby
smoothening the effect of changes in market factors affecting price. Maturity
limits can also be useful for liquidity risk control and the repricing limits can be
used for interest rate management.Similar to notional and stop loss limits, gap
limits can be useful to supplement other limits, but are not sufficient to be used in
isolation as they do not provide a reasonable proxy for the market risk exposure
which a particular derivatives position may present to the institution.
(d)
Value-at-risk Limits
These limits are designed to restrict the amount of potential loss from certain
types of derivatives products or the whole trading book to levels (or percentages
of capital or earnings) approved by the board and senior management. To
monitor compliance with the limits, management calculates the current market
value of positions and then uses statistical modeling techniques to assess the
probable loss (within a certain level of confidence) given historical changes in
market factors.
There are three main approaches to calculating value-at-risk : the correlation
method, also known as the variance/ co-variance matrix method; historical
48

Treasury Risks
simulation and Monte Carlo simulation. The advantage of value-at-risk (VAR)
limits is that they are related directly to the amount of capital or earnings which
are at risk. The level of VAR limits should reflect the maximum exposures
authorized by the board and senior management, the quality and sophistication
of the risk measurement systems and the performance of the models used in
assessing potential loss by comparing projected and actual results. A drawback
in the use of such models is that they are only as good as the assumptions on
which they are based (and the quality of the data which has been used to
calculate the various volatilities, correlations and sensitivities).
(e)
Options Limits
These are specifically designed to control the risks of options. Options limits
should include Delta, Gamma, Vega, Theta and Rho limits.
• Delta is a measure of the amount an options price would be expected to
change for a unit change in the price of the underlying instrument.
• Gamma is a measure of the amount delta would be expected to change
in response to a unit change in the price of the underlying instrument.
• Vega is a measure of the amount an option's price would be expected to
change in response to a unit change in the price volatility of the
underlying instrument.
• Theta is a measure of the amount an option's price would be expected
to change in response to changes in the options time to expiration.
• Rho is a measure of the amount an option's price would be expected to
change in response to changes in interest rates.
49

CHAPTER 8
TREASURY UNIT – FUNDAMENTAL
CONTROLS
8.1 Every banking entity is different and the challenge lies in the integration
of effective controls into the correct area of risk, i.e., how well controls are
designed and executed. Thus, every entity has to identify its areas of risk and
decide how much control is required. Unfortunately, there is no standard
precedent for a treasury to simply follow. It is only with careful analysis and
understanding of the business and its risks that controls can be implemented in a
targeted and effective manner. In order to do this is real skill and expertise is
required. Proper controls not only save a bank from financial loss, but also assist
management in the running of the business more effectively.
Risk Appetite
8.2 It may be noted that before deciding on the control framework, it is
necessary to determine ‘risk appetite’. This depends on the type of business and
treasury operation. For instance, one would expect to see a tighter control
framework around a business that runs a profit centre treasury and trades to
make a return as opposed to a more simple transaction based (e.g., purely
hedging) treasury. Similarly, a different framework is also required for a treasury
that runs a more manual process as opposed to one that has a greater level of
straight through processing.
Governance
8.3 The bank’s board has the ultimate responsibility for ensuring that an
adequate system of internal controls is established and maintained. The
importance of the board and senior management understanding the risks the
business is facing, articulating its risk appetite and developing policies and
procedures that reflect that position hardly needs to be stressed. Every bank
should have a policy that covers the identification, measurement, management,
monitoring and control of financial risk. The policy should be approved by the
board. The board should also establish a Treasury Committee that meets every

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
month or so. Members of this committee normally consist of the treasurer, chief
financial officer (CFO), representatives from areas such as, tax or corporate
finance, and perhaps a person from the business operations side.
8.4 The Treasury Committee should receive a report, along with minutes of
the previous meeting. The report should include a review of the past month's
treasury performance and also look into the future, to see what actions treasury
will need to take (e.g., replacing funding facilities). However, treasury reports are
often not particularly clear or meaningful and procedures should be adopted to
developing a clear, concise, timely and relevant reporting process. Treasury
Committee should also carry out a half yearly review of investment portfolio of
treasury to vouch safe adherence of investment policy laid down by the bank as
well as the applicable RBI guidelines.
Operating Controls
8.5 The first 'line of defense' is a set of operating controls around the
processes undertaken in the treasury function. Some of the operating controls
crucial to the functioning of a treasury are discussed in the following paragraphs.
Segregation of Duties
8.6 No two treasuries are the same. However, one thing is for sure, it is vital
that different individuals within the front, middle (if there is one) and back offices
are responsible for the different activities during the deal life cycle (such as,
dealing, recording, confirmation, settlement, reporting and monitoring).The frontoffice
should be responsible for the operation of the strategy approved by the
board or treasury committee, and designing and executing transactions to
manage the financial risks of the business. The back-office provides the
necessary checks to prevent unauthorised trading and minimise the potential for
error or fraud. The role of the back-office is to check, confirm, settle and reconcile
trades conducted by the front-office and possibly provide management
information.
8.7 It is ideal that the people who perform the respective duties of frontoffice
and back-office have different reporting lines.
If it is impossible to have total separation (as in the case of small treasuries) then
at least the responsibilities should be segregated such that no two sequential
steps are undertaken by the same person. These responsibilities include:
• identification of positions and dealing;
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Treasury Unit – Fundamental Controls
• authorization of deals;
• confirmations;
• authorization of settlement;
• release of settlement; and
• accounting.
Dealing
8.8 It is market practice for dealers to select banks to be contacted on the
basis of known competitiveness in the relevant instrument, creditworthiness and
limit availability. Competitive quotes should always be sought, unless there is a
specific reason not to do so. Records should be maintained of banks contacted
and rates quoted, indicating those that have been accepted. This should ensure
that no one bank or broker is favoured over another and the best returns are
being achieved. Once the deal has been struck, the dealer should immediately
input the details into the deal recording system, either a specialist treasury
management system (TMS) or the bank's alternative to this. Normally, the
system will automatically number the trades using a sequence of numbers. The
TMS is the firm's official record of the trade, but the dealer may choose to have
either paper deal tickets or a 'blotter'. These can be useful when confirming that
all trades have been input into the system and that they are accurate. This would
typically be conducted by the back-office. The phones of dealers should be taped
to provide a record if there is a dispute with counterparty. These tapes should be
checked regularly to ensure that the tapes are working and there is room to
continue recording. Dealers should not have access to these tapes.
Access to the Front -office
8.9 There has been debate over the physical access to the dealing room
within a treasury environment. It is common within a banking environment to
have staff from the front and back offices physically separated. Otherwise, the
entity will need to rely more heavily on IT controls, e.g., computers locked with
password entry. House-keeping becomes extremely important with systems,
ensuring old users are deleted and current users have the correct access profile.
System Security
8.10 Irrespective of the physical set-up of the treasury, it is important that
systems have passwords that are regularly checked and that personal computers
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
are locked if unattended. Timeout locks should assist this if a machine is not
touched for a period of time. Control procedures within treasury usually depend
to a great extent upon the correct usage of computer software packages. All
authorized users should be assigned a unique user identification (ID) and
personal password. Users should log out of the system when it is not being used
and, particularly, when leaving their desks. All computers should have screen
saver passwords that prevent access, other than by password, if the computer is
left unattended.
8.11 The following are some of the important system controls implemented
by banks in the present day treasury environment:
(a)
(b)
(c)
(d)
In a treasury system with online deal entry (usually referred to as a
front-office dealing system), deals are entered directly in the system.
The back-office support function has only view rights to the deals
entered into such dealing system and every time they note a new deal
they confirm the particulars of the deal with the back-office of the
counterparty to the transaction. On confirmation, they approve the deal
through their security ID in the system and only then the deal finally gets
booked. In case of discrepancies, the back-office informs the front-office
dealer and then the deal is not booked in the system.
In case of foreign exchange transactions, the treasury system is
configured to compare the rates at which the transactions are done by
the bank with the market rate range and generate an exception report.
This report is useful to note significant variations in rates which the
dealers would have transacted at.
Front-office systems in banks may be configured to compute limits on a
real-time basis, such as, dealer limits, counterparty limits, broker limits,
currency limits, exposure limits, etc. When a transaction is entered into
the system these limits are automatically computed and flashed on the
screen to prompt the dealer of a potential limit breach if the deal is
executed.
Systems may also be configured to perform automated nostro
reconciliations whereby the system extracts the bank’s nostro account
data from the general ledger and account statements of the
counterparty bank and then matches the similar trades and generates
an exception report for trade mismatches (or reconciling items). A
designated back-office team tracks the ageing of such reconciling items
54

(e)
(f)
Treasury Unit – Fundamental Controls
and follows up with the respective functions within the bank for resolving
the same.
As noted above, all authorized users are assigned a unique user
identification (ID) and personal password. In any IT environment,
usually, the user rights and entitlements to the various IT systems is
clearly defined and documented and also subjected to a periodic review.
In an instance when a user ID that does not have access to a particular
set of information or command is trying to retrieve such information,
then a modification log automatically gets saved in the system which
gives details of the user ID trying to gain unauthorised access. Such
controls are referred to as ‘fraud risk controls’.
Some bank’s IT system are interfaced to the financial accounting or
general ledger system. At the end of the day, usually, the balances and
positions in all the systems is uploaded in the financial accounting
system. At the time of such upload an exception report/log is
automatically generated which gives the details of the balances which
could not be uploaded correctly or completely. Banks have a dedicated
team in their back-office who are only responsible for resolving the open
items in such exception report on a timely basis.
8.12 IT creates opportunities but also calls for a new genre of risks, such as:
♦
♦
♦
♦
Logical or processing errors caused by the underlying program code.
Systematic errors may be more difficult to detect.
Unauthorised access to systems due to compromised controls over
access IDs and passwords or non-discontinuance of system access for
exit/transfer cases of staff members.
Non-updation of master data fields leading to errors (such as, mailing
address, customer name, staff account status, dormant/unclaimed
account status).
Loss of laptops, remote access control devices, blackberry, palmtops or
personal digital assistants (‘PDAs’) which may get misused for
authorising certain transactions or initiating certain communication.
8.13 The banking industry is one of the most significant users of technology
as compared to other industries. The bank’s management also enforces controls
such as, periodic reviews of access to the financial system resources and other
confidential/critical data, to confirm the appropriateness of these access rights
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
(access control matrix). An internal auditor should, therefore, have as a part of
his scope the evaluation of the IT general control environment. IT general
controls offers the backdrop on which various specific system controls operate,
hence, the effectiveness of specific system controls depends on the
effectiveness of IT general controls.
Confirmations
8.14 It is usually the responsibility of the back-office to confirm the details of
all the treasury transactions before settlement is made so as to minimise the risk
of error or fraud.
Settlement
8.15 Once transactions have been confirmed, the back-office is responsible
for initiating any payment that may be required. Back-office will also usually be
responsible for questioning 'failed' trades, i.e., if a trade is not settled correctly,
the back office will try and resolve the query by contacting the counterparty or
broker.
Disaster Recovery
8.16 Treasury should maintain and update a disaster recovery plan (DRP)
operative in circumstances leading to partial breakdown of facilities or the
inability to access the building. The DRP is to assist the treasury department to
continue its daily responsibilities with immediate effect in such types of
unforeseen conditions.
Personnel
8.17 The recruitment process that is followed by an organisation is important
to ensure that people employed have the right skills and experience, as well as
the outlook to match the organisation. Once a decision of hiring has been made,
employees need ongoing training in accordance with their job requirements. This
should be provided internally and externally to ensure people are kept up-to-date
with market developments and leading practice.
In addition, a good way of making it easier for newcomers is to have an up-todate
and comprehensive procedures manual. By rotating the staff and forcing
them to have one holiday of at least two weeks each year, a different person is
allowed to carry out their duties on a day-to-day basis and this helps to prevent
and detect fraud.
56

Document Security
Treasury Unit – Fundamental Controls
8.18 All paper records should be filed in cabinets. Sensitive or valuable
documents should be kept in locked and preferably fire proof storage.
Oversight Controls
8.19 The treasurer should receive the following reports on a daily basis.
• breached credit limits;
• list of deals done for the day;
• off-market trades, with an explanation; and
• changes to standing data.
8.20 Back-office management should also ensure that their controls are
being conducted as they were designed. Some examples include a summary of
unreconciled items, suspense account items and outstanding confirmations that
have not been matched. It is very useful to see how numerous and large these
amounts are, and also how long they have been outstanding. Needless to say,
concurrent audit of treasury operations would ensure that these controls are in
operation.
Monitoring Controls and Treasury Reporting
8.21 Regular reporting to management is the most common form of
monitoring treasury activity. The purpose of treasury reporting is:
(a)
To inform senior management of financial exposure;
(b ) To demonstrate to senior management that treasury activity is
within parameters authorised by the board; and
(c)
To promote the analysis of activities and performance measurement
within treasury and so lead to improvements in efficiency and control.
8.22 The treasury report will include information on the major risks of the
business and the performance of the treasury function over the past month.
Examples of such information are:
• Economic update - based on market sources (e.g., relationship banks)
giving details on the current economic environment and likely future
scenarios and how these will impact the bank;
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
• Foreign exchange - open positions, average forex rates achieved as
compared to forecast, gains and losses on forex trading, translation
exposure and steps to control that exposure;
• Long term funding - graph of funding horizon and plans to implement
new funding to replace existing lines, headroom over existing facilities,
cost of funds, loan covenants and compliance;
• Interest rate exposure - sensitivity to interest rate movement, proportion
of fixed and floating debt;
• Cash management and investments - returns on funds over the month
as compared to a benchmark, cash forecasts over the short and long
term;
• Bank relationships and credit exposure - how bank relationships are
being managed, exposures as compared to limits, headroom; and
• A record of outstanding guarantees and the costs involved.
58

CHAPTER 9
INTERNAL AUDIT OF TREASURY
OPERATIONS
Scope of Internal Audit with Special Reference to
Treasury/Market Risk Segments
9.1 The precise scope of risk-based internal audit must be determined by
each bank for low, medium, high, very high and extremely high risk areas.
However, at the minimum, it must review/report on the following aspects:-
(a)
(b)
(c)
(d)
(e)
(f)
(g)
(h)
(i)
Process by which risks are identified and managed in various areas;
Control environment in various areas;
Gaps, if any, in control mechanism which might lead to frauds,
identification of fraud prone areas;
Data integrity, reliability and integrity of Management Information
system;
Internal, regulatory and statutory compliance;
Budgetary control and performance reviews;
Transaction testing/verification of assets to the extent considered
necessary;
Monitoring compliance with the internal audit report; and
Variation, if any, in the assessment of risks under the audit plan vis-àvis
the risk-based internal audit.
9.2 The scope of risk-based internal audit should also include review of the
systems in place for ensuring compliance with money laundering controls;
identifying potential inherent business risks and control risks, if any; suggesting
various corrective measures and undertaking follow up reviews to monitor the
action taken thereon.

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
Functional Independence
9.3 The internal auditor should be independent from the internal control
process in order to avoid any conflict of interest. He should be given an
appropriate standing within the bank to carry out the assignments. He should not
be assigned the responsibility of performing other accounting or operational
functions. The internal audit staff should perform their duties with objectivity and
impartiality. The internal audit head should not report to any authority below the
level of the Board of Directors/Audit Committee.
Code of Ethics and Internal Auditors
9.4 A code of ethics is necessary and appropriate for the profession of
internal auditing, as it is founded on the trust placed in its objective assurance
about risk management, control, and governance. A member of the Institute of
Chartered Accountants of India, carrying out an internal audit activity, would
apart from other requirements, additionally be governed by:-
(i) the requirements of the Chartered Accountants Act, 1949;
(ii)
(iii)
the Code of Ethics issued by the Institute of Chartered Accountants of
India; and
other relevant pronouncements of the Institute of Chartered
Accountants of India.
Internal auditor has to uphold the golden principles of integrity, objectivity,
confidentiality and competence.
Stages of Internal Audit
9.5 The internal audit of treasury operations can be broadly divided into
following five stages:
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Internal Audit of Treasury Operations
Pre-commencement Work
Knowledge of the entity and its environment
Overall audit plan – Audit Programme
Audit Documentation
Audit Procedures
Pre-commencement Work
Internal Audit Report
9.6 The following points have to be considered before commencing the
internal audit:
(a)
(b)
Decision on whether the engagement should be accepted. This will be
based on:
• Consider whether capability, time and resources are available;
and
• Consider whether it satisfies ethical requirements.
Internal auditor cannot be the statutory auditor for the same financial
year or the same bank.
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
(c)
(d)
(e)
The decision for acceptance or rejection of assignment has to be
communicated to the concerned authority.
The objective and scope of work has to be considered with specific
considerations to time available for conducting internal audit.
The internal auditor and the auditee should agree on the terms of the
engagement before commencement. The agreed terms should be
recorded in an engagement letter. Standard on Internal Audit (SIA) 8,
“Terms of Internal Audit Engagement” establishes standards and
provides guidance in respect of terms of engagement of the internal
audit activity whether carried out in house or by an external agency.
Knowledge of the Entity and its Environment
9.7 The next step is that the internal auditor should obtain knowledge of the
entity’s business and its operating environment, including its regulatory
environment and the industry in which it operates, sufficient to enable him to
review the key risks and entity-wide processes, systems, procedures and
controls. Standard on Internal Audit (SIA) 15, “Knowledge of the Entity and its
Environment” establishes standards and provides guidance on these aspects. It
also sets out the guidelines regarding the application, usage and documentation
of such knowledge by the internal auditor.
9.8 The internal auditor should specifically obtain knowledge on following
aspects:-
(a)
(b)
(c)
(d)
(e)
(f)
(g)
(h)
Relevant laws and regulations
Circulars/<strong>Guide</strong>lines issued by the RBI
Circulars/<strong>Guide</strong>lines issued by the head office of the bank
Organisational structure
Type/nature of transactions
Accounting system
Internal control framework
• Risk assessment
• Monitoring
Risk Management
62

(i)
• Risk tolerance
• Back-up system
Reporting requirements
Internal Audit of Treasury Operations
9.9 Knowledge of the entity’s business is a frame of reference within which
the internal auditor exercises professional judgment in reviewing the processes,
controls and risk management procedures of the entity. Understanding the
business and using this information appropriately assists the internal auditor in:
(a)
(b)
(c)
(d)
Assessing the risks and identifying key focus area.
Planning and performing the internal audit effectively and efficiently.
Evaluating audit evidence.
Providing better quality of services to the client.
Overall Internal Audit Plan
9.10 The success of any internal audit is dependent upon an appropriate
audit plan and its timely execution. The internal audit plan should be
comprehensive enough to ensure that it helps in achieving of the overall
objectives of an internal audit. The following are some of the important aspects in
this regard:
(a)
(b)
The annual audit plan, approved by the Board, should include the
schedule and the rationale for audit work planned.
The plan should include all risk areas and their prioritization based on
the level of risk.
9.11 Internal audit plan should cover areas such as:
• Obtaining the knowledge of the legal and regulatory framework within
which the entity operates.
• Obtaining the knowledge of the entity’s accounting and internal control
systems and policies.
• Determining the effectiveness of the internal control procedures adopted
by the entity.
• Determining the nature, timing and extent of procedures to be
performed.
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
• Identifying the activities warranting special focus based on the
materiality and criticality of such activities, and their overall effect on
operations of the entity.
• Identifying and allocating staff to the different activities to be
undertaken.
• Setting the time budget for each of the activities.
• Identifying the reporting responsibilities.
The internal audit plan should also identify the benchmarks against which the
actual results of the activities, the actual time spent, the cost incurred would be
measured.
9.12 Adequate planning ensures that appropriate attention is devoted to
significant areas of audit. Planning also ensures that the work is carried out in
accordance with the applicable pronouncements of the Institute of Chartered
Accountants of India. ICAI has till date issued 17 Standards on Internal Audit and
the same are as follows.
(a)
(b)
(c)
(d)
(e)
(f)
(g)
(h)
(i)
(j)
(k)
(l)
(m)
Standard on Internal Audit (SIA) 1, Planning an Internal Audit
Standard on Internal Audit (SIA) 2, Basic Principles Governing Internal
Audit
Standard on Internal Audit (SIA) 3, Documentation
Standard on Internal Audit (SIA) 4, Reporting
Standard on Internal Audit (SIA) 5, Sampling
Standard on Internal Audit (SIA) 6, Analytical Procedures
Standard on Internal Audit (SIA) 7, Quality Assurance in Internal Audit
Standard on Internal Audit (SIA) 8, Terms of Internal Audit Engagement
Standard on Internal Audit (SIA) 9, Communication with Management
Standard on Internal Audit (SIA) 10, Internal Audit Evidence
Standard on Internal Audit (SIA) 11, Consideration of Fraud in an
Internal Audit
Standard on Internal Audit (SIA) 12, Internal Control Evaluation
Standard on Internal Audit (SIA) 13, Enterprise Risk Management
64

(n)
(o)
(p)
(q)
Internal Audit of Treasury Operations
Standard on Internal Audit (SIA) 14, Internal Audit in an Information
Technology Environment
Standard on Internal Audit (SIA) 15, Knowledge of the Entity and its
Environment
Standard on Internal Audit (SIA) 16, Using the Work of an Expert
Standard on Internal Audit (SIA) 17, Consideration of Laws and
Regulations in an Internal Audit
Internal Audit Procedures
9.13 After completing the preliminary review, the internal auditor performs the
procedures outlined in the audit program. These procedures usually test the
internal controls and the accuracy and the propriety of the transactions. The audit
procedures would include:
(a)
(b)
(c)
(d)
(e)
Inspection
Observation
Inquiry and confirmation
Computation
Analytical Procedures
9.14 While selecting the internal audit tests and procedures that meet the
internal audit objectives with regard to internal control and risk assessment, the
internal auditor should consider the following items:
(a)
(b)
(c)
(d)
The requirements to meet internal audit objectives.
The relative materiality of matters to be investigated.
The effectiveness of system of accounting and internal control.
The estimates of costs of implementing internal audit test plans in
relation to likely benefits to be derived.
Risk Assessment Process and Methodology
9.15 The risk assessment process should, inter alia, include the following:-
(a)
Identification of inherent business risks in various activities undertaken
by the bank.
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
(b)
(c)
(d)
(e)
Evaluation of the effectiveness of the control systems for monitoring the
inherent risks of the business activities.
Drawing up a risk matrix for taking into account both the factors, viz.,
inherent business risks and control risks.
The basis for determination of the level (high, medium, low) and trend
(increasing, stable, decreasing) of inherent business risks and control
risks should be clearly spelt out. The risk assessment may make use of
both quantitative and qualitative approaches. While the quantum of
credit, market, and operational risks could largely be determined by
quantitative assessment, the qualitative approach may be adopted for
assessing the quality of controls in various business activities. In order
to focus attention on areas of greater risk to the bank, identification of
activity-wise and location-wise risks should be undertaken.
The risk assessment methodology should include, inter alia, the
following parameters:
• Previous internal audit reports and compliance;
• Proposed changes in business lines or change in focus;
• Significant change in management/key personnel;
• Results of latest regulatory examination report;
• Reports of external auditor;
• Industry trends and other environmental factors;
• Time lapsed since last audit;
• Volume of business and complexity of activities; and
• Substantial performance variations from the budget.
9.16 For the risk assessment to be accurate, it will be necessary to have in
place proper MIS and data integrity. The internal audit function should be kept
informed of all developments such as introduction of new products, changes in
reporting lines, changes in accounting practices/policies, etc. The risk
assessment should invariably be undertaken on a yearly basis. The assessment
should also be periodically updated to take into account changes in business
environment, activities and work processes, etc.
66

Risk Perspectives
Internal Audit of Treasury Operations
9.17 Inherent business risks indicate the intrinsic risk in a particular
area/activity of the bank and could be grouped into low, medium and high
categories depending on the severity of risk. Control risks arise out of inadequate
control systems, deficiencies, gaps and/or likely failures in the existing control
processes. The control risks could also be classified into low, medium and high
categories.
Risk and Audit Matrix
9.18 In the overall risk assessment both the inherent business risks and
control risks should be factored in. The overall risk assessment as reflected in
each cell of the risk matrix is explained below:
Inherent Business Risks
High
Medium
Low
RISK MATRIX
A
High Risk
D
Medium
Risk
G
Low Risk
B
Very High
Risk
E
High Risk
H
Medium
Risk
C
Extremely
High Risk
F
Very High
Risk
I
High Risk
Low Medium High
Control Risks
Risk Assessment
A. High Risk: Even though the control risk is low, this is a high risk area
due to high inherent business risks.
B. Very High Risk: The high inherent business risk coupled with medium
control risk makes this a Very High Risk area
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
C. Extremely High Risk: Both the inherent business risk and control risk
are high which makes this an Extremely High Risk area. This area
would require immediate audit attention, maximum allocation of audit
resources besides ongoing monitoring by the bank’s top management.
D. Medium Risk: Although the control risk is low this is a Medium Risk area
due to medium inherent business risks.
E. High Risk: Although the inherent business risk is medium this is a High
Risk area because of control risk also being medium.
F. Very High Risk: Although the inherent business risk is medium, this is a
Very High Risk area due to high control risk.
G. Low Risk: Both the inherent business risk and control risk are low.
H. Medium Risk: The inherent business risk is low and the control risk is
medium.
I. High Risk: Although the inherent business risk is low, due to high control
risk this becomes a High Risk area.
9.19 The banks should also analyse the inherent business risks and control
risks with a view to assess whether these are showing a stable, increasing or
decreasing trend. Illustratively, if an area falls within cell ‘B’ or ‘F’ of the Risk
Matrix and the risks are showing an increasing trend, these areas would also
require immediate audit attention, maximum allocation of audit resources besides
ongoing monitoring by the bank’s top management (as applicable for cell ‘C’).
The Risk Matrix should be prepared for each business activity/location.
Internal Audit Documentation
9.20 Internal auditor should have proper working papers that will enable him
to substantiate his results. The internal auditor’s work papers serve as the
connecting link between the audit assignment, the auditor's fieldwork, and the
final report. Work papers contain the records of planning and preliminary
surveys, audit procedures, fieldwork, and other documents relating to the internal
audit. Most importantly, the work papers document the internal auditor's
conclusions and the reasons those conclusions were reached. As each audit
step in the audit procedures is satisfied, the internal audit supervisor should
request review of the related work papers.
68

Internal Audit of Treasury Operations
9.21 Standard on Internal Audit (SIA) 3, “Documentation” establishes
standards and provides guidance on the documentation requirements in an
internal audit. Internal auditor’s working papers serve the following purposes:
• Aid in planning, performance, and review of internal audit.
• Document whether the internal audit objectives were achieved.
• A support for internal audit reports.
• Record information.
• Document internal audit findings and accumulate evidence
• Basis for supervisory review.
• Support and evidence for issues like fraud, lawsuits, etc.
• Basis /reference for subsequent internal audit.
• Document whether the internal audit objectives were achieved.
• Facilitate third party reviews.
• Aid to peer review.
• Provide a basis for evaluating the internal audit's quality assurance
programme.
9.22 The internal audit documentation should cover all the important aspects
of an engagement, viz., engagement acceptance, engagement planning, risk
assessment and assessment of internal controls, evidence obtained and
examination/evaluation carried out, review of the findings, communication and
reporting and follow-up. The internal audit documentation would, therefore,
generally, include:
• Planning documents and internal audit procedures.
• Controls questionnaires, flowcharts, checklists and narratives.
• Notes and minutes resulting from interviews.
• Organisational data such as charts and job descriptions.
• Copies of important documents.
• Information about operating and financial policies.
• Results of control evaluations.
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
• Letters of confirmation and representation.
• Analysis and test of transactions, processes, and account balances.
• Results of analytical review procedures.
• Audit reports and management responses.
• Audit correspondence that documents the audit conclusions reached.
9.23 Internal audit documentation should be sufficiently complete and
detailed for an internal auditor to obtain an overall understanding of the audit.
Reporting
9.24 The internal auditor’s report should contain a clear written
expression of significant observations, suggestions/recommendation
based on the policies, processes, risks, controls and transaction
processing taken as a whole and managements’ responses. Standard on
Internal Audit (SIA) 4, “Reporting” establishes standards on the form and
content of the internal auditor’s report.
9.25 The internal auditor’s report includes the following basic elements,
ordinarily, in the following layout:
(a) Title;
(b) Addressee;
(c) Report Distribution List;
(d) Period of coverage of the Report;
(e) Opening or introductory paragraph;
(i) identification of the processes/functions and items of
financial statements audited; and
(ii) a statement of the responsibility of the entity’s management
and the responsibility of the internal auditor;
(f) Objectives paragraph - statement of the objectives and
scope of the internal audit engagement;
(g) Scope paragraph (describing the nature of an internal
audit):
70

(i)
(ii)
(iii)
(h)
(i)
(j)
(k)
(l)
(m)
(n)
Internal Audit of Treasury Operations
a reference to the generally accepted audit procedures in
India, as applicable;
a description of the engagement background and the
methodology of the internal audit together with procedures
performed by the internal auditor; and
a description of the population and the sampling technique
used.
Executive Summary, highlighting the key material issues,
observations, control weaknesses and exceptions;
Observations, findings and recommendations made by the
internal auditor;
Comments from the local management;
Action Taken Report – Action taken/ not taken pursuant to
the observations made in the previous internal audit reports;
Date of the report;
Place of signature; and
Internal auditor’s signature with Membership Number.
A measure of uniformity in the form and content of the internal auditor’s
report is desirable because it helps to promote the reader’s understanding
of the internal auditor’s report and to identify unusual circumstances when
they occur.
71

Annexures

ANNEXURE – A
SPECIMEN CHECKLIST FOR INTERNAL
AUDIT OF TREASURY OPERATIONS
The internal auditor’s procedures with respect to the following specific areas of
treasury operations are as follows:
S. No. Description Remarks
I. General
a
b
c
d
e
f
II.
a
b
c
Whether the bank has policies for all treasury activities
Whether the policy commensurate with the nature of
operations and adequately covers all the activities.
Whether the policy include a list of responsible
persons.
Whether the policy specifies types and purposes of the
financial Instruments.
Whether the policy specifies frequency of reporting
and reporting authority.
Whether the Cash Reserve Ratio and Statutory
Liquidity Ratios has been maintained.
Organisation Structure
Whether treasury activities are over sighted by an
officer independent of day-to-day activities.
Whether there is an effective segregation of key duties
including dealing, settlement and
accounting/reconciliation.
Whether the policy and procedures are properly
documented and easily accessible to all staff.

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
d
e
f
Whether there is a job descriptions or delegations for
key treasury positions.
Whether sufficient resources are available to operate
the treasury effectively.
Whether there is segregation between functions of
authorization, execution and recording of transactions.
III. Personnel: Training, Compliance and
Performance
a
b
c
IV.
a
b
c
d
V. Limits
a
b
c
Whether all personnel are appropriately trained.
Whether all employees’ references are properly
checked.
Whether all the employees signs an ethics policy at
the time of joining.
Deal Execution Process
Whether transactions concluded by the dealing room
are confirmed by the back office manager.
Whether there is a systematic procedure of filing.
Examine third party payment and verify that a letter of
instruction to that effect is filed.
Whether outward confirmations are recorded in a
register.
Check counterparty exposure limit for all brokers,
lenders, etc.
Check deal limits i.e., maximum amount, a person can
transact without seeking higher level approval.
Check product limits i.e., maximum exposure, the
entity should have in a particular instrument or
product.
76

Annexure – A
d
VI.
a
b
Check sector limits i.e., maximum investment in a
particular sector.
Recording Control
i) Control over Documents
Whether all money market deals have been timely
carried out and accurately recorded.
Whether all the documents and statements have been
received from concerned parties (brokers, bankers and
lenders, etc.) and properly filed in a logical sequence.
c Whether filed copies are pre-numbered and
continuous for ease of reference and filing.
ii) Control over Accounting Procedures
a
b
c
d
e
f
VII.
a
b
Whether adequate systems are in place to track all
matured investments.
Whether there are accurate recording and accounting
of positions..
Whether an independent person checks the recording
of postings.
Whether all deals are recorded in the General Ledger.
Whether account reconciliation has been done and
time frame has been set for clearing all outstanding
items.
Inspect source documents and verify that they are
initialed by the checkers.
Reconciliation of Bank Accounts and Treasury
Records with the General Ledger
Verify the bank balance with bank statement.
Whether the treasury srecords is reconciled to the
general ledger.
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
VIII.
a
b
c
d
e
IX.
a
b
c
d
e
f
g
h
i
j
Cash Management
Whether there is an effective procedure for monitoring
the daily cash position.
Whether the management has planned the liquidity
needs for normal operating conditions and emergency
situations.
Whether cash forecasting has been done after trend
analysis.
Obtain Bank statements.
Review the liquidity position.
Investment
Review the investment strategy and verify whether the
investment strategy is followed in letter and spirit.
Whether authority level are set for investment in
different instrument monetary limits.
Obtain the list of investments.
Analyse the investment portfolio statements.
Whether all investments are in name of the bank.
Whether the bank has all the documents with regard to
ownership of investments.
Whether the bank utilises third party investment
managersand verify the reasons for such selection.
How does the entity control the investment managers’
activities.
Whether the investment managers are apprised of the
investment policies of the entity. How does the entity
ensure compliance with them.
How is the performance of internal / external
investment managers evaluated.
78

Annexure – A
X
a
XI
a
b
Documentation for Derivative transactions
Whether derivative contracts are properly
documented. Note:
The following instructions in this regard may, therefore,
be strictly adhered to:
(i) For the sake of uniformity and standardisation in
respect of all derivative products, participants may use
ISDA documentation, with suitable modifications.
Counterparties are free to modify the ISDA Master
Agreement by inserting suitable clauses in the
schedule to the ISDA Master to reflect the terms that
the counterparties may agree to, including the manner
of settlement of transactions and choice of governing
law of the Agreement.
(ii) besides the ISDA Master Agreement, participants
should obtain specific confirmation for each
transaction which should detail the terms of the
contract such as gross amount, rate, value date, etc.
duly signed by the authorised signatories.
(iii) It is also preferable to make a mention of the
Master Agreement in the individual transaction
confirmation.
(iv) Participants should further evaluate whether the
counterparty has the legal capacity, power and
authority to enter into derivative transactions.
(v) Participants must ensure that ISDA Master
Agreement is signed with the counterparty prior to
undertaking any derivatives business with them.
(vi) Participants shall obtain documentation regarding
customer suitability, appropriateness, etc. as specified.
Investment in Debt Securities
Verify the frequency of interest payments.
Whether the bank has obtained information about the
issuer and the credit rating.
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
c
d
Whether the bank has checked the terms of the issue
like the use of the issue proceeds, the monitoring
agency, the formation of trustees, the secured or
unsecured nature of the bonds, the assets underlying
the security and the credit-worthiness of the
organisation.
Check the Yield To Maturity (YTM) of the debt security
with the YTMs of other comparable debt securities of
the same class and features.
80

ANNEXURE – B
SPECIMEN CHECKLIST FOR INTERNAL
AUDIT OF FOREIGN EXCHANGE
OPERATIONS OF TREASURY
The internal auditor’s procedures with respect to the following specific areas of
foreign exchange operations are as follows:
Sr.
No.
I
Interbank Deal
Particulars
Remarks
a
b
Whether the bank has specified the dealing hours for the
dealers operating in foreign exchange market.
Whether adequate care is exercised in selecting and
grooming the dealers.
c1.3 Whether dealers operate in the interbank market
according to the guidelines lay down by the
management
d
Whether there is a system of rotation of duties of
dealers.
e1.5 Whether dealers have furnished an undertaking to
conform to the code of conduct prescribed by Foreign
Exchange Dealer’s Association of India (FEDAI).
f
Whether the trading date, time and the transaction serial
number are entered automatically in the system and the
same can not be altered by the dealer after a contract is
finalised.

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
g
h
i
k
l
m
n
o
p
q
r
s
t
In case of deviations in the transaction data, whether
approval of the competent official is taken.
Whether late deals are marked and included in day’s
position.
Whether the access to the equipment and tapes are
subject to strict control.
Whether a dealer’s pad is maintained by the front office
to record the inter bank and merchant deals.
Whether any delay of more than half an hour was
observed between striking the deal and entering the
same in K+.
Whether deal confirmations are stamped in case of
“phone” deals which do not have a REUTER’s screen.
Whether a default register as prescribed by RBI vide its
letter no. ECS: 95/86(SPL)-82/83 dated January 30,
1982 is maintained.
Whether deal slips are serially numbered.
Whether all required particulars are furnished therein
and slips are checked / signed / initialed by the dealer.
Whether the deal slips are immediately prepared and
passed on to back office immediate after conclusion of
the deals.
Whether accounting department keeps the receipt of
confirmations/Reuter’s screen/telex message of the
deals received from counterparty banks and checks the
correctness thereof.
Whether the deal slips, contract notes, etc. are
maintained in proper sets and in sequential order to
facilitate control and further reference.
Whether back office prepares monthly bank wise lists of
all, unconfirmed outstanding exchange contracts and the
outstanding are followed-up with the counterparty banks
expeditiously to finally settle the deals.
82

Annexure – B
u Whether any unusual features are noticed in inter bank /
inter-office dealings, e.g., transactions concluded for
window dressing in the books.
v
w
x
y
z
aa
ab
II
Whether any swap deal has been undertaken at level
rate and if so, the reasons thereof.
Whether the base rates at which the deals were
concluded and the swap differences were realistic and
reflect the prevailing conditions in the interbank market.
Whether there is any deal that not reflect in dealers pad
but found subsequently.
Whether specimen signature of counter party Banks is
kept for verification of deals.
Whether accounting entries are promptly booked, and
payments committed under the deals are promptly
advised and effected. Whether receipts are suitably
recorded in the Nostro Account.
Whether exchange confirmatory message over telex are
obtained where business with other authorised dealers
is done, directly over telephone.
Whether dealers nominate brokers after the deals of the
above nature have been struck.
Merchant
a
b
c
d
Whether the profit/ loss on cancellation of merchant
deals has been correctly calculated and accounted for.
Whether statement of overnight position including late
deals is submitted.
Whether reconciliation of the positions between the
dealers’ records and the accounting system is done.
Whether the osition and the Fund Registers are continuously
updated on the basis of deal slips and the reports of business
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
flowing in from the Branches (CPC & NRI).
e
f
g
h
III
a
b
c
d
e
f
g
Whether the rates for the foreign currencies are being
taken thrice a day (viz. at opening hours, afternoon and
closing hours).
Whether crystallization of export bills are promptly
resorted on respective due dates.
Whether there is any overdue merchant contract
outstanding without utilization / cancellation. (as per the
latest FEDAI guidelines, contracts will automatically
have to be cancelled, if not utilized by due date / within
delivery period.)
Whether forward purchase/sales (FP/FS) cancellation
charges are collected on due date.
Brokerage
Whether branch is maintaining panel of brokers
approved by the management .
Whether substitution of one bank by another in interbank
contract by brokers is noticed.
Whether provisions of Income Tax Act regarding the tax
deducted at source (TDS) on brokerage have been
complied with.
Whether all brokerage claims are being verified from the
above broker-wise register.
Whether the back office is preparing a monthly summary
of brokerage paid to each broker in the abovementioned
register and the contents thereof are being submitted to
head office.
Whether back office department ensures that all broker
notes have been received expeditiously and particulars
therein including the dates thereof agree with relative
deal slips.
In case of discrepancies in the brokers note, whether the
84

Annexure – B
same are brought to the dealer’s attention and
clarification / rectification obtained promptly from the
dealer and / or broker directly by the ccounting
Department.
h Whether brokers, with whom no hotlines are
established, are also encouraged over extra telephone
lines.
a
b
c
d
e
f
i
j
IV
Whether brokerage bills received by the backup
department from the brokers, are sent to the dealers for
certification.
Whether brokerage on outright and swap deals has
been paid as per revised rates prescribed in terms of
FEDAI Rules.
Limits
Whether limit is fixed for the exposure to other banks in
respect of interbank dealings. If so, whether the dealings
are within the limits. If not, verify the procedure followed
for regularisingit.
Whether day light limits have been exceeded and if so,
check the extent. Ascertain and indicate the reasons for
same and verify whether higher authorities ratified the
same.
Whether the overnight open position limits in various
currencies, as fixed by the management, have been
exceeded at any time and if so,verify the time and extent.
Indicate the action taken to regularize the position.
Whether the gap limits are adhered to. If not, indicate the
details and the steps taken to comply with the
requirements in this regard.
Whether statements of maturities are being submitted to
higher authorities / RBI by accounting department and
check the intervals of the submission also.
Whether particulars reported in Gap statements are
85

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
correct as per the office records.
g
h
i
V
a
b
c
d
e
f
g
h
Whether any dealing limits have been fixed for the
dealer. Checkthe date when these limits were fixed.
Whether they have been exceeded, and if so,chack the
time and extent. Also indicate action taken by the division
for obtaining ratification / confirmation.
Whether there is any exceeding in respect of single
country exposure.
Whether off credit countries exposure are monitored on
a daily basis.
POS Register
Whether daily currency position report (Form IC-5 of
guidelines) is being submitted to higher authorities.
Whether statement of currency positions in each
currency as on the last Friday of each month computed
after taking into account the effect of all pipeline
transactions, is submitted to the management indicating
the steps to be taken for reducing the distortions, if any.
Whether the particulars reported in the last statement of
true currency positions prepared and submitted to the
management are correct as per records maintained.
Whether there is any alteration / correction at the dates
of the contracts in order to manipulate currency position.
Whether dealers have maintained position pads, funds
chart and maturity pattern of the contracts.
Whether currency wise position and funds position is
communicated and / or updated in the system frequently
to enable the dealer to have updated position.
Whether positions are taken purely for covering
positions.
Whether positions are also taken in advance.
86

Annexure – B
VI
a
b
c
d
Nostro Reconciliation
Whether accounting entries are promptly booked and
payments committed under the deals are promptly
advised and effected. Whether receipts are suitably
recorded in the “Nostro” account.
Whether a separate department / section, under the
charge of a separate official, is there forreconciliation
work.
Whether the officials attached to the reconciliation
department have been entrusted with the operation of
Nostro Accounts or passing of entries in the Mirror
Account.
Whether statement of accounts are received at least
once in month by the reconciliation department and the
department is:
(a) Watching the receipt of statement
(b) Ensuring that there are no unauthenticated
alterations, erasures, etc.
e Whether the reconciliation work is undertaken
expeditiously and is upto date.
f
g
h
i
Whether the credits are advised to the concerned
branches immediately.
Whether the follow up action on the entries, especially
debit items appearing in the statements and/or mirror
account is promptly initiated / taken.
Whether the department is submitting a report once a
month to the higher authorities indicating the progress of
reconciliation work and the special features, such as
large non reconciled items etc., and if so, what action has
been taken on such reports by the branch?
Whether large balance has been held in an inoperative
account, for a long period and if so, the reasons thereof.
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
j
k
l
m
n
o
VII
Indicate the details of arrangement, if any made for
automatic transfer of funds to secure benefit of interest
for overnight idle funds.
Whether overdrawn balance of US $ 5 lacs and above for
continuous period of more than 5 days have been
observed and if so, give details, also indicate whether the
matter has been reported to RBI for post facto approval
as required under Exchange Control Manual (ECM).
Whether bank has been submitting the BAL Statements
promptly and regularly to RBI and the particulars reported
in the last BAL statements submitted to RBI are correct
as per bank's records.
Whether any new Nostro account opened during the
month is under review. If so, whether the same has been
reported to RBI?
Whether any large overdrafts observed in Nostro
accounts during the month and if so, whether conductive
/ monitoring method are initiated.
Whether proper registers are maintained regarding the
rupee postings in Nostro account.
R- Returns
a Whether timely, accurate and comprehensive
management information system is in place,
b
c
VIII
a
b
Whether monitoring and reporting is undertaken by
officials who are not directly concerned with trading
activities.
Whether R-Returns are submitted to RBI within the
stipulated due-date.
Forex Profits/ Losses
Whether dealer-wise profit targets are fixed.
Whether the bank is reckoning only the Nostro balances
for adjustment of the profits / losses revealed in the
88

Annexure – B
mirror accounts or whether it also consider the forward
transactions as at the date of evaluation.
c
IX
a
b
c
X
a
b
c
d
e
Check rates used to liquidate the month-wise positions.
Whether any departure is noticed in this regard. Whether
this work is entrusted to a department / person
independent of the dealing function.
Trading Operations Done by the Division
Whether the position taken by the dealer is in tune with
the prevailing rates in the market, the loss or profitability
of the trading transactions. Whether the dealer has
exceeded the cut-loss prescribed by the head office.
Whether the profit arrived by the division on trading
operations is correct.
Whether the trading operations does not exceed and are
within the IGL / AGL prescribed by the head office.
Dealing Room: System/Ethics/ Profit Evaluation
Check brief description of organizational set-up and
whether the dealing function is separated from the
accounting, funding and other back-up functions.
Whether, before the dealer starts the work for the days,
he confers on the trend in the overnight markets and
markets still operating in the same time zone and keep
the management informed of the conclusion.
Whether dealer is allowed to sign contract notes, passing
accounting entries and sending payment
instructions/receipt intimations to correspondents /
brokerage claims.
Whether the deals are done from outside the dealing
rooms / hours.
Whether a “Rate Scan report is:
- Prepared for each day showing the day’s market spread
for each currency dealt by it during the day both spot
and forward and submits it to an official independent of
the dealing department.
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
f
XI
a
b
c
d
e
f
g
XII
a
- On a test verification of such reports with relative deal
slips whether there was any aberration detected in the
rates and if so what is explanation given by the dealer
and where the aberrations few by exception or were they
quite frequent.
Check procedure / policy followed for posting / rotation of
staff. Whether consideration of knowledge and
experience of the foreign exchange department are taken
into account while posting the staff.
Internal Control
Whether data processing system is adequate to the
nature / volume of activities and is designed to functional
separation.
Whether back up facilities are available for deployment in
case of system failure and other emergencies.
Whether job rotation is provided to the dealers as well as
back office personnel.
Whether clear functional separation of dealing, back
office, settlement / accounting / reconciliation is being
observed.
Whether the bank has the system of internal audit of the
Forex Department.
Whether the bank has proper system of receiving,
distributing and filing all relevant RBI circulars.
Whether the bank has sufficient number of Exchange
Control Manuals with all the amendments.
Overnight Placement of Orders in Trading
Whether there are any instances that the bank has
invested funds in overseas markets above $10 million (or
25% of Unimpaired Tier 1 capital) or borrowed above $
10 million (or 25% of Unimpaired Tier 1 Capital)
whichever is higher, from the correspondents.
90

Annexure – B
b
c
d
e
f
g
h
Whether the limit for placement of overnight orders is
exceeded during the month.
Whether the dealers place overnight orders only with
correspondent banks with which they maintain Nostro
accounts and other approved counter party banks, for
which exposure limits are fixed by the competent
authority from time to time.
Whether exit points for the position, i.e., stop loss are
clearly mentioned.
Whether the division is submitting the details of overnight
orders placed to higher authorities in their daily report on
trading.
Whether the amount placed as overnight orders is within
the IGL / AGL limits fixed by the head office.
Whether the amount placed as overnight orders is shown
as VaR as VaR Trading position.
Whether the overall overnight position includes the
amount of overnight orders.
91

ANNEXURE – C
SPECIMEN CHECKLIST FOR INTERNAL
AUDIT OF DOMESTIC OPERATIONS OF
TREASURY
The internal auditor’s procedures with respect to the following specific
areas of domestic operations of treasury would include:
I
Sr.
No
a
b
c
d
II
Investment Policy
Particulars
Whether bank has framed an investment policy.
Whether the policy is revised periodically and is in
accordance with the RBI guidelines/
Whether the policy after approval by Board is sent to
RBI.
Whether the investment activity of the bank is in
consonance with the policy
Internal Control System
Remarks
a. Whether there is functional separation of trading,
settlement, monitoring, control and accounting.
b
Whether the deal slips contain the requisite particulars
such as nature of the deal, name of the counterparty,
category (HTM/AFS/HFT). Whether it is a direct deal or
through a broker, and if through a broker, name of the
broker, brokerage amount, details of security, amount,
price, yield, contract date and time has been recorded.

Annexure – C
c
d
e
f
g
h
Whether there is a functional separation of trading and
back office functions relating to banks' own Investment
Accounts, Portfolio Management Scheme (PMS),
Clients' Accounts and other constituents (including
brokers’) accounts.
Whether there is a system to ensure that no sale
transactions are put without actually holding the security
in its investment account by the bank.
Whether all the deals as per the Kondor (FO) tally with
the deal details as per ITMS.
Whether deal slips are serially numbered and controlled
separately to ensure that each deal slip has been
properly accounted for.
Whether there is a system of issue of confirmation to
counter party and whether timely receipt of requisite
written confirmation from counter party is monitored.
Whether any modifications were made in the deal
tickets.
i Whether there has been any change in the security /
counterparty after conclusion of the deal.
j
k
l
m
n
Whether the back office monitors the essential details on
the counterparty confirmation.
Whether a dealer’s pad/deal blotter is maintained in
respect of all transactions.
Whether any discrepancies were observed in the
dealer’s pad / deal blotter.
Whether there is proper system for signature verification
in respect of the confirmations received from the
counterparty.
Whether there was any instance of substitution of the
counterparty bank by another bank by the broker.
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
o Whether there was any instance of security
sold/purchased in the deal been substituted by another
security.
p
q
r
s
t
III
Whether the accounts section independently writes the
books of account on the basis of the vouchers received
from the back office.
Whether profit or loss on sale is arrived at by applying
weighted average cost as required by the investment
policy of the bank.
Whether a written contingency plan is in place to ensure
that in the event of a breakdown of the equipment, back
up facilities can be deployed at a short notice.
In case of a sale transactions entered into on basis of
the corresponding purchase contract, whether the
purchase contract is confirmed prior to the sale contract
and whether the same is guaranteed by CCIL or else the
security is contracted for purchase from the RBI. Also
whether the same transaction settles in the same
settlement cycle as per the preceding purchase contract
or in a subsequent settlement cycle.
In case of securities purchased from RBI through OMO,
whether the same transaction is entered into only on
receiving the confirmation of buy deal or the allotment
advises recieved from RBI.
SGL Forms
a. Whether there is a system of control, accounting and
verification of authenticity of SGL transfer forms issued /
received.
b
c
Whether SGL transfer forms are issued on semi/security
paper in the prescribed format.
Whether the same are serially numbered.
d
Whether SGL forms are signed by two authorised
signatories whose signatures are placed on record with
the PDO.
94

Annexure – C
e
f
g
h
i
j
k
m
n
o
p
q
Whether there is a system of verification of SGL forms
received from other banks and confirmation of the
authorised signatories.
Whether proper records of SGL forms issued are
maintained.
Whether there were any instances of bouncing of SGL
forms. If yes, whether these instances were reported to
RBI immediately.
Whether SGL forms received are deposited in the SGL
account immediately (within 24 hours).
Whether any sales are affected by return of SGL forms
held.
Whether it is ensured that there is sufficient balance in
the SGL account before issuing SGL forms.
Whether there were instances where Bank held an
oversold position, i.e., selling the security without the
adequate balance in investment account.
Whether the SGL balances are reconciled at monthly
intervals with balances in the books of PDO.
Whether the settlement of transactions as per bank’s
books is reflected correctly in the RBI statements.
Whether the bank has drawn cheques on their account
with the RBI for third party transactions, including interbank
transactions.
Whether any sale was made of security allotted to bank
in the auction for primary issues. If yes, whether the
contract of sale was entered once only and on the basis
of an authenticated allotment advice by RBI.
Whether there is a system of reporting exceptions in
securities transactions like bouncing of SGL transfer
forms to the top management.
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
a
b
c
d
r
s
IV
a
b
c
d
Whether the RBI guidelines on Delivery Versus Payment
(DVP) III system are adhered to.
Whether the RBI guidelines on Portfolio Management
Scheme (PMS) operations are adhered to.
Negotiated Dealing Systems (NDS)
Whether the deals are put through by the dealers and
settled by the back office.
Whether the settlement of transactions in Government
securities and Repo transactions are settled in electronic
form as per RBI guidelines.
On completion and approval of the deal by the buyer and
seller, whether the same is taken over by Clearing
Corporation of India Ltd. (CCIL) for settlement via
electronic mode.
Whether the report on settlements received from
Clearing Corporation of India Ltd. (CCIL) at the end of
the day is reconciled with the books.
e. Whether all the call deals are reported on Negotiated
Dealing Systems (NDS) as required.
V
Ready Forward Deals
Whether the bank has entered into any ready forward
deal other than in the permitted securities (i.e., Treasury
Bills and other approved securities).
Whether all the ready forward contracts are settled
through the SGL account maintained with RBI with CCIL
acting as a central counterparty for all such transactions.
Whether any ready forward deal was entered into
without actually holding the security in the portfolio of the
bank.
In case of sale, whether the corresponding amount is
deducted from the investment account of the bank and
its SLR assets for the entire period of holding by
purchasers/ counterparty.
96

Annexure – C
e
Whether any forward or double ready forward deals
were put through in any securities on behalf of PMS
Clients and other constituents including brokers.
f Whether any ready forward transactions were
undertaken by the bank with parties other than banks,
financial institutions and mutual funds notified by RBI
during the period under review.
g
h
i
j
k
b
c
d
e
f
VI
Whether the existing ready forward deals in dated
securities have been completed on due dates without
resorting to any roll over or extension.
Whether the ready forward deals are correctly accounted
for.
Whether the bank has followed the guidelines issued by
the RBI (RBI Master circular dated 2 nd July 2007) in
respect of ready forward transactions.
Whether the securities contracted for repurchase are
sold on the basis of the settlement cycle coinciding with
the second leg of ready forward deal or a subsequent
settlement cycle.
Whether any double ready forward transactions have
been put through.
Transactions with Constituents
Whether the bank is providing a facility to its customers
for opening of constituent account.
Whether the bank maintains the separate account in
respect of constituents.
Whether requisite instructions in respect of settlements
are received from the constituent account holders.
Whether the deal details are correctly recorded in the
ITMS system.
Whether the Constituent Subsidiary General Ledger
(CSGL) balances are reconciled at monthly intervals with
balances in the books of Public Debt Office (PDO).
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
g
h
VII
Whether the signature in the requisition letter received
from the constituent match with the list of authorised
signatories.
Whether the bank obtains independent confirmation from
the constituents of the holdings held by the bank on their
behalf.
Call Money Transactions
a Whether call borrowal/deposit receipts are
acknowledged by the counterparty.
b
c
d
e
f
Whether cheques received from counterparties were
deposited on the same day.
Whether cheques received from counter parties were
routed through clearing channels.
Whether there were any defaults on settlement.
Whether interest paid on call borrowings and interest
received on call lending were computed correctly.
Whether the transactions of borrowing by the bank
during the month are correctly accounted.
VIII Banker’s Reciepts
a
b
a
IX
b
c
Whether bank receipts have been issued or received.
Whether the bank has any outstanding banker’s
receipts.
Dealings Through Brokers
Whether criteria have been laid down for empanelment
and delisting of brokers andit is being reviewed annually.
Whether the brokers are the members of specified stock
exchanges.
Whether services of broker(s), who are not empanelled
with the bank, are taken.
98

Annexure – C
X
d
e
f
g
h
i
j
k
l
A
a
b
c
Whether broker note is received for each deal entered
through broker containing relevant details.
Whether the details given in the broker's note agree with
the details as per the deal ticket.
Whether the brokers contract note clearly indicates the
name of the counterparty.
Whether broker-wise record is being maintained of deals
put through brokers and brokerage is paid.
Whether the bills received from brokers are checked and
reviewed by the staff independent of trading prior to
payment.
Whether the broker’s role is restricted to bring the two
parties to deal together (i.e. broker is not involved in
funds settlement and delivery of securities).
Whether the transactions entered into through individual
brokers exceed 5% of the total transactions.
If yes, whether such excesses have been reported to the
Board through half yearly review.
Whether accounting for brokerage is correct.
Non-SLR Investments
General
Whether bank’s aggregate capital market exposure is
within the limit of 40 per cent of its net worth on a solo
and consolidated basis as per RBI circular ref no:
DBOD. No. Dir. BC. 47/13.07.05/2006-2007 dated 15 th
December 2006.
Whether the bank is monitoring the exposure limits in
respect of the investment transactions in Non-SLR
securities.
Whether the bank has framed an investment policy in
respect of investments in Non SLR investments
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
including prudential limits on investments in bonds and
debentures, caps on unrated issues, private placements,
sub-limits for PSU bonds, corporate bonds and
guaranteed bonds, etc.
d
e
f
g
h
Whether the bank has exceeded the limit of 25% of the
total Investment portfolio for investments under Held to
Maturity category.
Whether the credit exposure in respect of investments in
corporate is being monitored.
Whether the physical verification of investments was
conducted. In case where the stock is held in Demat
form, whether the same have been checked with the
holding statement received from the Depository
Participants (DP).
Whether the investment of the bank in unlisted securities
is in consonance with RBI circular no. DBOD.BP.BC.
44/21.04.141/ 2003-04 dated November 12, 2003 and
DBOD. NO. BP.BC. 53/ 21.04.141 /2003 dated
December 10, 2003.
• Whether original maturity period is not less than 1
year, except for those exempted category given in
RBI Circular dated December 10, 2003.
• Whether prudential limits were complied with as on
31 st March of previous year.
• Whether the security (except for those exempted
category) has been rated. Whether rating is as per
RBI guidelines prescribed vide circular dated
December 10, 2003.
• Whether the investments are made in listed debt
securities of companies, which have complied with
SEBI guidelines.
In case investment is in privately placed security,
whether copy of offer document has been filed with
Credit Information Bureau (India) Ltd. (CIBIL).
100

Annexure – C
i
j
k
l
m
n
o
p
q
r
Whether total investments in unlisted non-SLR securities
exceed 10% of total investment in non-SLR securities as
on March 31 of the Previous Year.
Whether excess over 10%, if any, is on account of
investment in securitization papers issued for
infrastructure projects, bonds/debentures/Pass through
certificates issued by Securitization Companies and
Reconstruction Companies.
Whether excess over 10% as mentioned above, if any, is
within 20% of total investment in non-SLR and is in
prescribed instruments.
Whether internal credit analysis and internal rating
system is referred to the Credit Committee/ Independent
authority for their assessment.
Whether quarterly review of investments in non-SLR has
been undertaken as per RBI guidelines and placed
before the Board.
Whether there is any default (of privately placed
security) with regard to interest/ installment. If yes,
whether matter reported to Credit Information Bureau
(India) Ltd. (CIBIL) along with a copy of the offer
document.
Whether any investment is non-performing investment
(NPI).
Whether extent of non-performing investment in non-
SLR category has been placed before Board for review
at least at quarterly intervals.
Whether all trades other than spot transactions in listed
security are executed through stock exchange.
Whether transition time frame, as detailed below, is
being adhered to:
• RBI guidelines with regard to investment in units of
mutual fund schemes where the entire corpus is
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
B
a
b
C
a
invested in debt securities will be applicable from
31-12-2004.
• With effect from January 1, 2005 only investment in
units of such mutual fund schemes which have an
exposure to unlisted securities of less than 10 per
cent of the corpus of the fund will be treated on par
with listed securities for the purpose of compliance
with the prudential limits prescribed in the above
guidelines.
A) Investments in the existing unlisted securities (those
issued on or before November 30, 2003).
B) With effect from April, 2004, investments in above
category of unlisted securities until 31-12-2004
provided the issuers have applied to the stock
exchange(s) for listing and the security is rated
minimum investment grade.
C) Investment in unlisted securities issued after
November 30, 2003 provided it is up to 10% of
incremental Non-SLR investments over the
outstanding Non-SLR investments as on November
30, 2003 up to December 31, 2004.
Bonds and Debentures
Whether the bank has invested in any securities, which
do not have the minimum rating as prescribed by the
investment policy of the bank. If so and where the
external rating is not available, Whether the bank has
obtained the waiver from the appropriate authority for the
same.
Whether any delay was observed in receipt of stock or
any instance of delivery of stock with late receipt of
funds.
Equity Shares
Whether there were any investments in equity shares
during the month under review.
102

Annexure – C
b
c
d
e
f
g
h
i
D
a
b
c
Whether separate broker notes are received for each
transaction.
Whether the investments and dis-investments are done
in respect of scripts approved by the Board.
Whether all the scripts are listed on the stock exchange.
Whether all purchases and sales result in actual receipt/
delivery and no arbitrage operation is undertaken.
Whether the Investment Committee reviews the
investments in equities.
Whether the investments in shares in a company exceed
30% of the paid up capital of that company or 30% of its
own share capital and reserves, whichever is less, as
required by Section 19(2) of the Banking Regulation Act.
Whether transaction in equities are reflected in the
DEMAT statement within reasonable period and there
are no instances of abnormal delays in the debit/credit of
the instrument to the Bank’s demat account.
Whether the Closing Stock Report tallies with the DP
Holding Statement.
Mutual Funds
Whether any transaction undertaken in mutual funds
during the month is under review. If yes, appropriate
documents were kept on record.
Whether there are any transaction put through by the
branches. If yes, whether required documents such as
the e-mail containing approval of the appropriate
authority and the transaction statement are attached with
the deal ticket.
Whether in case of sale, the Net Asset Value (NAV) at
which the sale is made matches with the statement of
account received from the mutual fund.
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
d
e
Whether accounting for purchases and sales including
profit or loss on sale is correctly done.
Whether dividend has been received on the mutual fund
units.
f
E
Whether any amount lying in the application money as
on month ending is outstanding for more than 30 days. If
yes, verify the details of the same.
Commercial Paper
a
b
c
d
e
f
Whether the tenors of the Commercial Papers are not
less than 7 days and not exceeding one year from the
date of issue?
Whether the denominations of Commercial Papers are in
multiples of Rs.5 lakhs.
Whether bank is holding letter from issuing and Paying
Agent (IPA) that they are holding in custody certified
copies of:
• Credit Rating Certificate
• Letter of offer of CP
• Board resolution authorising issue of the CP
• Declaration from the issuer that the amount
proposed to be raised is within the ceiling mentioned
by the credit rating agency or as approved by the
Board whichever is lower, and also state the amount
of CP issued and subscribed so far on the strength
of the credit rating under reference.
Whether maturity date of Commercial Paper is not
beyond the date upto which the credit rating of the issuer
is valid.
Whether the transactions have been accounted for
correctly.
Whether the interest on Commercial paper is accrued in
accordance with the RBI guidelines dated 13 July, 2006.
104

Annexure – C
a
F
Certificate of Deposit (CD)
Whether the maturity period of the CDs is in accordance
with the RBI Circuilar.
b Whether the denomination of CDs is in multiples of Rs. 1
lakh.
a
b
c
d
e
f
g
h
XI
A
Accounting and Valuation
Accounting
Whether the bank has classified its investments into
‘Held to Maturity (HTM), Available for Sale (AFS) and
Held for Trading (HFT)’ as per RBI guidelines.
Whether the category of the investment is decided at the
time of acquisition of the security and the same is
mentioned on the deal ticket.
Whether cost associated with acquisition of securities
such as brokerage, commission and stamp charges, etc.
are recognised as expenses and not as part of cost of
investment.
Whether the shifting of investment to/from Held to
Maturity is done by the bank at the beginning of the year
with the approval of the Board of Directors.
Whether there was an instance of an investment in the
Held for Trading category not sold off within the
stipulated period of 90 days.
Whether approval has been obtained from the
appropriate authority for transfer of security from
Available for Sale to Held for Trading or vice versa.
Whether the shifting between categories has been done
at the least of market value of security, acquisition cost
or book value as on the day of transfer.
Whether loss is recognised on transfer of security from
one category to another.
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
i
j
k
l
m
n
B
a
b
a
b
c
d
Whether all the transactions have been correctly
accounted.
Whether income on securities was accounted correctly.
Whether the investment in the nature of advanceare in
accordance with the guidelines issued by RBI.
Whether the broken period interest paid at the time of
acquisition of security is taken as part of cost of the
investment.
Whether broken period interest has been correctly
calculated.
Whether the bank has been accruing interest on
securities at monthly intervals Or at more frequent
intervals.
Valuation
i. Held to Maturity Category
Whether investments under the HTM category are
carried at their acquisition cost and are not marked to
market.
Whether any premium on the acquisition of a security is
amortised over the balance period.
ii. Available for Sale Category
Whether the valuation of investments has been done at
quarterly intervals or at more frequent intervals as
required by RBI guidelines.
Whether necessary accounting entries for valuation are
passed in accordance with the RBI guidelines.
Whether investments are revalued at cost or market
price which ever is lower.
Whether the net depreciation, if any, under each
classification has been provided for.
106

Annexure – C
a
b
c
d
a
b
c
XII
iii. Held for Trading Category
Whether investments are marked to market at monthly
intervals as required by RBI guidelines.
Whether the net depreciation, if any, under each
classification has been provided for.
Whether equity investments under each of the above
three categories are marked to market at monthly or
more frequent intervals as required by the RBI
<strong>Guide</strong>lines on.
Whether treasury bills are valued at carrying cost by the
bank.
Audit, Review and Reporting
Whether half-yearly review of investment portfolio
indicating and certifying an adherence to the laid down
investments policy and procedures and RBI guidelines is
undertaken and whether the same has been placed
before the Board within a month and a copy of the same
was forwarded to RBI.
Whether periodical returns are submitted to RBI on due
dates.
Whether the returns submitted to RBI are accurate.
XIII Income
a
b
c
d
Whether due date diary for interest and redemption is
maintained by the back office.
Whether redemption money due is received during the
monthon due dates
Whether there are cases of overdue redemptions in
investments. If yes, verify the details.
Whether interest due is received during the month for all
investments as per coupon dates falling within that
month.
107

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
e
f
g
h
i
Whether there are any cases of overdue interest on
investments. If yes, verify the details.
Whether the interest on delayed payment is received.
Whether interest accrued on investments is correctly
computed.
Whether TDS on interest is accounted for properly.
In case the interest/principal on the debentures/ bonds is
in arrears, whether the provisions for the same are
made.
108

ANNEXURE – D
GUIDANCE NOTE ON MARKET RISK
MANAGEMENT
INDEX
Chapter
No.
1. Policy Framework
2. Organizational set up
Subject
Page No.
3. Liquidity Risk Management
4. Interest Rate Risk Management
5. Foreign Exchange Risk Management
6. The Treatment of Market Risk in the
Proposed Basel Capital Accord:
Annexures
Annexure I BCBS Principles for the Assessment of
Liquidity Management in Banks
Annexure II BCBS Principles for Interest Rate Risk
Management
Annexure III Sources, effects and measurement of
interest rate risk
Annexure IV Value at Risk
Annexure V Stress Testing

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
Chapter 1- Policy Framework
1.1 Market Risk may be defined as the possibility of loss to a bank
caused by changes in the market variables. The Bank for International
Settlements (BIS) defines market risk as “the risk that the value of ‘on’ or
‘off’ balance sheet positions will be adversely affected by movements in
equity and interest rate markets, currency exchange rates and commodity
prices”. Thus, Market Risk is the risk to the bank’s earnings and capital
due to changes in the market level of interest rates or prices of securities,
foreign exchange and equities, as well as the volatilities of those changes.
Besides, it is equally concerned about the bank’s ability to meet its
obligations as and when they fall due. In other words, it should be ensured
that the bank is not exposed to Liquidity Risk. This Guidance Note would,
thus, focus on the management of Liquidity Risk and Market Risk, further
categorized into interest rate risk, foreign exchange risk, commodity price
risk and equity price risk.
1.2 An effective market risk management framework in a bank
comprises risk identification, setting up of limits and triggers, risk
monitoring, models of analysis that value positions or measure market
risk, risk reporting, etc. These aspects are elaborately discussed in the
ensuing paragraphs.
1.2.1 Risk Identification
• All Risk Taking Units must operate within an approved Market Risk
Product Programme; this should define procedures, limits and
controls for all aspects of the product.
• New products may operate under a Product Transaction
Memorandum on a temporary basis while a full Market Risk Product
Programme is being prepared. At the minimum this should include
procedures, limits and controls. The final product transaction program
should include market risk measurement at an individual product and
aggregate portfolio level.
1.2.2 Limits and Triggers
• All trading transactions will be booked on systems capable of
accurately calculating relevant sensitivities on a daily basis; usage of
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Sensitivity and Value at Risk limits for trading portfolios and limits for
accrual portfolios (as prescribed for ALM) must be measured daily.
Where market risk is not measured daily, Risk Taking Units must
have procedures that monitor activity to ensure that they remain
within approved limits at all times.
• Mandatory market risk limits are required for Factor Sensitivities and
Value at Risk for mark to market trading and appropriate limits for
accrual positions including Available-for-Sale portfolios. Requests for
limits should be submitted annually for approval by the Risk Policy
Committee. The approval will take into consideration the Risk Taking
Unit's capacity and capability to perform within those limits evidenced
by the experience of the Traders, controls and risk management,
audit ratings and trading revenues.
• Approved Management Action Triggers or Stop-loss are required for
all mark to market risk taking activities.
• Risk Taking Units are expected to apply additional, appropriate
market risk limits, including limits for basis risk, to the products
involved; these should be detailed in the Market Risk Product
Programme.
1.2.3 Risk Monitoring
• A rate reasonability process is required to ensure that all transactions
are executed and revalued at prevailing market rates; rates used at
inception or for periodic marking to market for risk management or
accounting purposes must be independently verified.
• Financial Models used for revaluations for income recognition
purposes or to measure or monitor Price Risk must be independently
tested and certified.
• Stress tests must be performed preferably quarterly for both trading
and accrual portfolios. This may be done when the underlying
assumptions of the model/ market conditions significantly change as
decided by the Asset Liability Committee.
1.2.4 Models of analysis
• Line Management must ensure that the software used in Financial
Models that value positions or measure market risk is performing
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appropriate calculations accurately.
• The Risk Policy Committee is responsible for administering the model
control and certification policy, providing technical advice through
qualified and competent personnel. It is left to the bank to seek any
independent certification.
• Financial Models must be fully documented and minimum standards
of documentation must be established.
• Someone other than the person who wrote the software code must
perform certification of models; testers must be competent in
designing and conducting tests; records of testing must be kept,
including details of the type of tests and their results. Assumptions
contained in the Financial Models must be documented as part of he
initial certification and reviewed annually. Unusual parameter
sourcing conventions require annual approval by the Risk Policy
Committee.
• Any mathematical model that uses theory, formulae or numerical
techniques involving more than simple arithmetic operations must be
validated to ensure that the algorithm employed is appropriate and
accurate.
• Persons who are acceptable to the Risk Policy Committee and
independent of the area creating the model must validate models in
writing. It is left to the bank to decide on who should validate, whether
internal or external, at the discretion of the Risk Policy Committee.
• Models to calculate risk measures like Sensitivities to market factors
either at transaction or portfolio level and Value-at-Risk should be
validated independently.
• Unauthorised or unintended changes should not be made to the
models. These standards should also apply to models that are run on
spreadsheets until development of fully automated processors for
generating valuations and risk measurements.
• The models should also be subject to model assumption review on a
periodic basis. The purpose of this review is to ensure applicability of
the model over time and that the model is valid for its original
intended use. The review consists of evaluating the components of
the financial model and the underlying assumptions, if any.
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1.2.5 Risk Reporting: Risk report should enhance risk communication
across different levels of the bank, from the trading desk to the CEO. In
order of importance, senior management reports should:
• be timely
• be reasonably accurate
• highlight portfolio risk concentrations
• include written commentary, and
• be concise.
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Chapter 2- Organisational Set Up
2.1 Management of market risk should be the major concern of top
management of banks. The Boards should clearly articulate market risk
management policies, procedures, prudential risk limits, review mechanisms and
reporting and auditing systems. The policies should address the bank’s
exposure on a consolidated basis and clearly articulate the risk measurement
systems that capture all material sources of market risk and assess the effects
on the bank. The operating prudential limits and the accountability of the line
management should also be clearly defined. The Asset-Liability Management
Committee (ALCO) should function as the top operational unit for managing the
balance sheet within the performance/ risk parameters laid down by the Board.
2.2 Successful implementation of any risk management process has to
emanate from the top management in the bank with the demonstration of its
strong commitment to integrate basic operations and strategic decision making
with risk management. Ideally, the organization set up for Market Risk
Management should be as under :-
• The Board of Directors
• The Risk Management Committee
• The Asset-Liability Management Committee (ALCO)
• The ALM support group/ Market Risk Group
i) The Board of Directors should have the overall responsibility for
management of risks. The Board should decide the risk
management policy of the bank and set limits for liquidity, interest
rate, foreign exchange and equity price risks.
ii)
The Risk Management Committee will be a Board level Sub
committee including CEO and heads of Credit, Market and
Operational Risk Management Committees. It will decide the policy and
strategy for integrated risk management containing various risk
exposures of the bank including the market risk. The
responsibilities of Risk Management Committee with regard to
market risk management aspects include:
• Setting policies and guidelines for market risk measurement,
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iii)
management and reporting
• Ensuring that market risk management processes (including
people, systems, operations, limits and controls) satisfy bank’s
policy
• Reviewing and approving market risk limits, including triggers
or stop-losses for traded and accrual portfolios
• Ensuring robustness of financial models, and the effectiveness
of all systems used to calculate market risk
• Appointment of qualified and competent staff; Ensuring posting
of qualified and competent staff and of independent market risk
manager/s, etc.
The Asset-Liability Management Committee, popularly known as
ALCO should be responsible for ensuring adherence to the limits
set by the Board as well as for deciding the business strategy of
the bank in line with bank’s budget and decided risk management
objectives. The role of the ALCO should include, inter alia, the
following:-
• Product pricing for deposits and advances
• Deciding on desired maturity profile and mix of incremental
assets and liabilities
• Articulating interest rate view of the bank and deciding on the
future business strategy
• Reviewing and articulating funding policy
• Decide the transfer pricing policy of the bank
• Reviewing economic and political impact on the balance sheet
The size (number of members) of ALCO would depend on
the size of each institution, business mix and organisational
complexity. To ensure commitment of the Top Management
and timely response to market dynamics, the CEO/CMD or the
ED should head the Committee. The Chiefs of Investment,
Credit, Resources Management or Planning, Funds
Management / Treasury (forex and domestic), International
Banking and Economic Research can be members of the
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iv)
Committee. In addition, the Head of the Technology Division
should also be an invitee for building up of MIS and related
computerisation. Some banks may even have Sub-committees
and Support Groups.
The ALM Support Groups consisting of operating staff should be
responsible for analysing, monitoring and reporting the risk profiles to
the ALCO. The Risk management group should prepare forecasts
(simulations) showing the effects of various possible changes in market
conditions related to the balance sheet and recommend the action
needed to adhere to bank’s internal limits, etc.
v) The Middle Office is responsible for the critical functions of independent
market risk monitoring, measurement, analysis and reporting for the
bank’s ALCO. Ideally this is a full time function reporting to, or
encompassing the responsibility for, acting as ALCO's secretariat. An
effective Middle Office provides the independent risk assessment which
is critical to ALCO's key-function of controlling and managing market
risks in accordance with the mandate established by the Board/Risk
Management Committee. It is a highly specialised function and must
include trained and competent staff, expert in market risk concepts. The
methodology of analysis and reporting will vary from bank to bank
depending on their degree of sophistication and exposure to market risks.
These same criteria will govern the reporting requirements demanded of
the Middle Office, which may vary from simple gap analysis to
computerised VaR modelling. Middle Office staff may prepare forecasts
(simulations) showing the effects of various possible changes in market
conditions related to risk exposures. Banks using VaR or modelling
methodologies should ensure that its ALCO are aware of and
understand the nature of the output, how it is derived, assumptions
and variables used in generating the outcome and any shortcomings of
the methodology employed. Segregation of duties should be evident in
the middle office which must report to ALCO independently of the
treasury function. In respect of banks without a formal Middle Office, it
should be ensured that risk control and analysis should rest with a
department with clear reporting independence from Treasury or risk
taking units, until formal Middle Office frameworks are established.
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TYPICAL ORGANISATIONAL STRUCTURE FOR RISK MANAGEMENT
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2.3 The Dealing Room
The Treasury Dealing Room within a bank is generally the clearing house for
matching, managing and controlling market risks. It may provide funding,
liquidity and investment support for the assets and liabilities generated by
regular business of the bank. The Dealing Room is responsible for the proper
management and control of market risks in accordance with the authorities
granted to it by the bank's Risk Management Committee. The Dealing Room
also is responsible for meeting the needs of business units in pricing market
risks for application to its products and services. The Dealing Room acts as
the bank's interface to international and domestic financial markets and
generally bears responsibility for managing market risks in accordance with
instructions received from the bank's Risk Management Committee.
The Dealing Room may also have allocated to it by Risk Management
Committee, a discretionary limit within which it may take market risk on a
proprietary basis. For these reasons effective control and supervision of
bank's Dealing Room activities is critical to its effectiveness in managing and
controlling market risks.
Critical to a Dealing Room's effective functioning is dealers’ access to a
comprehensive Dealing Room manual covering all aspects of their day-today
activities. All dealers active in day-to-day trading activities must
acknowledge familiarity with and provide an undertaking in writing to adhere
to the bank's dealing guidelines and procedures. A Dealing Room procedures
manual should be comprehensive in nature covering operating procedures
for all the bank’s trading activities in which the Dealing Room is involved and
in particular must cover the bank's requirements in respect of:
• Code of Conduct - all dealers active in day-to-day trading activities in
the lndian market must acknowledge familiarity with and provide an
undertaking to adhere to FEDAI code of conduct (and FIMMDA when
available).
• Adherence to Internal Limits - All dealers must be aware of,
acknowledge and provide an undertaking to adhere to the limits
governing their authority to commit the bank to risk exposures as they
apply to their own particular risk responsibilities and level of seniority.
• Adherence to RBI limits and guidelines - All dealers must
acknowledge and provide an undertaking to adhere to their
responsibility to remain within RBI limits and guidelines in their area of
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• Dealing with Brokers - All dealers should be aware of, acknowledge
and provide an undertaking to remain within the guidelines governing
the bank's activities with brokers including conducting business only
with brokers authorised by bank's Risk Management Committee on the
bank's Brokers Panel.
• Ensuring their activities with brokers do not allow for the brokers to act
as principals in transactions, but remain strictly in their authorised role
as market intermediaries.
• Requiring brokers to provide all broker notes and confirmations of
transactions before close of business each day (or exceptionally by the
beginning of the next business day, in which case the note must be
prominently marked by the broker as having been transacted the
previous day, and the Back Office must recast the previous night's
position against limits reports) to the bank's Back Office for
reconciliation with transaction data.
• Ensuring all brokerage payments and statements are received,
reconciled and paid by the bank's Back Office department and under no
circumstances authorised or any payment released by dealers.
• Prohibiting the acceptance by dealers of gifts, gratifications or other
favours from brokers, instances of which should be reported in detail to
RBI’s Department of Banking Supervision indicating the nature of the
case
• Prohibiting dealers from nominating a broker in transactions not done
through that broker.
• Rules for the prompt investigation of complaints against dealers and
malpractices by brokers and reporting to FEDAI and RBI’s Department
of Banking Supervision.
• Dealing Hours - All Dealers should be aware of the bank's normal
trading hours, cut off time for overnight positions and rules governing
after hours and off-site trading (if allowed by the bank)
• Security and Confidentiality - All dealers should be aware of the
bank's requirements in respect of maintaining confidentiality over its
own and its customers' trading activities as well as the responsibility for
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secure maintenance of access media, keys, passwords and PINS.
• Staff Rotation and leave requirements - All dealers should be aware
of the requirement to take at least one period of leave of not less than
14 days continuously per annum, and the bank's internal policy in
regards to staff rotation.
2.4 The Back Office
The key controls over market risk activities, and particularly over Dealing
Room activities, exist in the Back Office. It is critical that both a clear
segregation of duties and reporting lines is maintained between Dealing
Room staff and Back Office staff, as well as clearly defined physical and
systems access between the two areas. It is essential that critical Back Office
controls are executed diligently and completely at all times including:
• The control over confirmations both inward and outward: All
confirmations for transactions concluded by the Dealing Room must be
issued and received by the Back Office only. Discrepancies in
transaction details, non-receipts and receipts of confirmations without
application must be resolved promptly to avoid instances of unrecorded
risk exposure.
• The control over dealing accounts (vostros and nostros)- Prompt
reconciliation of all dealing accounts is an essential control to ensure
accurate identification of risk exposures. Discrepancies, non-receipts
and receipts of funds without application must be resolved promptly to
avoid instances of unrecorded risk exposure. Unreconciled items and
discrepancies in these accounts must be kept under heightened
management supervision as such discrepancies may at times have
significant liquidity impacts, represent unrecognised risk exposures, or
at worst represent collusion or fraud.
• Revaluations and marking-to-market of market risk exposures: All
market rates used by the bank for marking risk exposures to market,
used to revalue assets or for risk analysis models such as Value at Risk
analysis, must be sourced independently of the Dealing Room to
provide an independent risk and performance assessment. If the bank
has an established and independent Middle Office function, this
responsibility may properly pass to the Middle Office.
• Monitoring and reporting of risk limits and usage: Reporting of
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usage of risk against limits established by the Risk Management
Committee (as well as Credit Department for Counterparty risk limits)
should be maintained by the Back Office independently of the Dealing
Room. The Back Office must also undertake maintenance of all limit
systems and access to limit systems (such as counterparty limits,
overnight limits etc.) must be secure to avoid unauthorised access and
tampering. If the bank has an established and independent Middle
Office function, this responsibility may properly pass to the Middle
Office.
• Control over payments systems: The procedures and systems for
making payments must be under at least dual control in the Back Office
independent from the dealing function. Payments systems should be at
all times secure from access or tampering by unauthorised personnel.
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Chapter 3- Liquidity Risk Management
3.1 Liquidity risk is the potential inability to meet the bank’s liabilities
as they become due. It arises when the banks are unable to generate
cash to cope with a decline in deposits or increase in assets. It
originates from the mismatches in the maturity pattern of assets and
liabilities. Measuring and managing liquidity needs are vital for effective
operation of commercial banks. By assuring a bank’s ability to meet its
liabilities as they become due, liquidity management can reduce the
probability of an adverse situation developing.
3.2 Analysis of liquidity risk involves the measurement of not only
the liquidity position of the bank on an ongoing basis but also
examining how funding requirements are likely to be affected under
crisis scenarios. Net funding requirements are determined by analysing
the bank’s future cash flows based on assumptions of the future
behaviour of assets and liabilities that are classified into specified time
buckets and then calculating the cumulative net flows over the time
frame for liquidity assessment.
3.3 Future cash flows are to be analysed under “what if” scenarios
so as to assess any significant positive / negative liquidity swings that
could occur on a day-to-day basis and under bank specific and general
market crisis scenarios. Factors to be taken into consideration while
determining liquidity of the bank’s future stock of assets and liabilities
include their potential marketability, the extent to which maturing
assets /liability will be renewed, the acquisition of new assets / liability
and the normal growth in asset / liability accounts.
3.4 Factors affecting the liquidity of assets and liabilities of the bank
cannot always be forecast with precision. Hence they need to be
reviewed frequently to determine their continuing validity, especially
given the rapidity of change in financial markets.
3.5 The liquidity risk in banks manifest in different dimensions:
i) Funding Risk – need to replace net outflows due to
unanticipated withdrawal/non-renewal of deposits (wholesale
and retail);
ii) Time Risk – need to compensate for non-receipt of expected
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inflows of funds, i.e. performing assets turning into nonperforming
assets; and
iii) Call Risk – due to crystallisation of contingent liabilities and
unable to undertake profitable business opportunities when
desirable.
3.6 The first step towards liquidity management is to put in place an
effective liquidity management policy, which, inter alia , should spell
out the funding strategies, liquidity planning under alternative
scenarios, prudential limits, liquidity reporting / reviewing, etc. Liquidity
measurement is quite a difficult task and can be measured through
stock or cash flow approaches. The key ratios, adopted across the
banking system are Loans to Total Assets, Loans to Core Deposits,
Large Liabilities (minus) Temporary Investments to Earning Assets
(minus) Temporary Investments, Purchased Funds to Total Assets,
Loan Losses/Net Loans, etc.
3.7 While the liquidity ratios are the ideal indicator of liquidity of
banks operating in developed financial markets, the ratios do not
reveal the intrinsic liquidity profile of Indian banks which are operating
generally in an illiquid market. Experiences show that assets commonly
considered as liquid like Government securities, other money market
instruments, etc. have limited liquidity as the market and players are
unidirectional. Thus, analysis of liquidity involves tracking of cash flow
mismatches. For measuring and managing net funding requirements,
the use of maturity ladder and calculation of cumulative surplus or
deficit of funds at selected maturity dates is recommended as a
standard tool. The format prescribed by RBI in this regard under ALM
System should be adopted for measuring cash flow mismatches at
different time bands. The cash flows should be placed in different time
bands based on projected future behaviour of assets, liabilities and offbalance
sheet items. In other words, banks should have to analyse the
behavioural maturity profile of various components of on / off-balance
sheet items on the basis of assumptions and trend analysis supported
by time series analysis. Banks should also undertake variance
analysis, at least, once in six months to validate the assumptions. The
assumptions should be fine-tuned over a period which facilitate near
reality predictions about future behaviour of on / off- balance sheet
items. Apart from the above cash flows, banks should also track the
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impact of prepayments of loans, premature closure of deposits and
exercise of options built in certain instruments which offer put/call
options after specified times. Thus, cash outflows can be ranked by the
date on which liabilities fall due, the earliest date a liability holder could
exercise an early repayment option or the earliest date contingencies
could be crystallised.
3.8 The difference between cash inflows and outflows in each time
period, the excess or deficit of funds, becomes a starting point for a
measure of a bank’s future liquidity surplus or deficit, at a series of
points of time. The banks should also consider putting in place certain
prudential limits as detailed below to avoid liquidity crisis:
i) Cap on inter-bank borrowings, especially call borrowings;
ii) Purchased funds vis-à-vis liquid assets;
iii) Core deposits vis-à-vis Core Assets i.e. Cash Reserve Ratio,
Statutory Liquidity Ratio and Loans;
iv) Duration of liabilities and investment portfolio;
v) Maximum Cumulative Outflows across all time bands;
vi) Commitment Ratio – track the total commitments given to
corporates/banks and other financial institutions to limit the offbalance
sheet exposure;
vii) Swapped Funds Ratio, i.e. extent of Indian Rupees raised out of
foreign currency sources.
3.9 Banks should also evolve a system for monitoring high value
deposits (other than inter-bank deposits) say Rs.1 crore or more to
track the volatile liabilities. Further, the cash flows arising out of
contingent liabilities in normal situation and the scope for an increase
in cash flows during periods of stress should also be estimated. It is
quite possible that market crisis can trigger substantial increase in the
amount of draw downs from cash credit/overdraft accounts, contingent
liabilities like letters of credit, etc.
3.10 The liquidity profile of the banks could be analysed on a static
basis, wherein the assets and liabilities and off-balance sheet items
are pegged on a particular day and the behavioural pattern and the
sensitivity of these items to changes in market interest rates and
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environment are duly accounted for. The banks can also estimate the
liquidity profile on a dynamic way by giving due importance to:
1) Seasonal pattern of deposits/loans;
2) Potential liquidity needs for meeting new loan demands,
unavailed credit limits, potential deposit losses, investment
obligations, statutory obligations, etc.
3.11 Contingency Funding Plan
• All banks are required to produce a Contingency Funding Plan.
These plans are to be approved by ALCO, submitted annually as
part of the Liquidity and Capital Plan, and reviewed quarterly. The
preparation and the implementation of the plan may be entrusted
to the treasury.
• Contingency Funding Plans are liquidity stress tests designed to
quantify the likely impact of an event on the balance sheet and the
net potential cumulative gap over a 3-month period. The plan also
evaluates the ability of the bank to withstand a prolonged adverse
liquidity environment. At least two scenarios require testing:
Scenario A, a local liquidity crisis, and Scenario B, where there is
a nationwide name problem or a downgrade in the credit rating if
the bank is publicly rated.
• The bank’s contingency funding plans should reflect the funding
needs of any bank managed mutual fund whose own Contingency
Funding Plan indicates a need for funding from the bank.
• Reports of Contingency Funding plans should be performed at
least quarterly and reported to ALCO.
• If a Contingency Funding plan results in a funding gap within a 3-
month time frame, the ALCO must establish an action plan to
address this situation. The Risk Management Committee should
approve the action plan.
• At a minimum, Contingency Funding plans under each scenario
must consider the impact of accelerated runoff of Large Funds
Providers.
• The plans must consider the impact of a progressive, tiered
deterioration, as well as sudden, drastic events.
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• Balance sheet actions and incremental sources of funding should
be dimensioned with sources, time frame and incremental
marginal cost and included in the Contingency Funding plans for
each scenario.
• Assumptions underlying the Contingency Funding plans,
consistent with each scenario, must be reviewed and approved by
ALCO.
• The Chief Executive / Chairman must be advised as soon as a
decision has been made to activate or implement a Contingency
Funding Plan. Either the Chief Executive or the Risk Management
Committee may call for implementation of a Contingency Funding
Plan.
• The ALCO will implement the Contingency Funding Plan,
amending it with the approval of the Risk Management Committee,
where necessary, to meet changing conditions; daily reports are to
be submitted to the Treasury Head, comparing actual cashflows
with the assumptions of the Contingency Funding Plan.
3.12 Foreign Currency Liquidity Management
3.12.1 For banks with an international presence, the treatment of assets
and liabilities in multiple currencies adds a layer of complexity to
liquidity management for two reasons. First, banks are often less well
known to liability holders in foreign currency markets. Therefore, in the
event of market concerns, especially if they relate to a bank’s domestic
operating environment, these liability holders may not be able to
distinguish rumour from fact as well or as quickly as domestic currency
customers. Second, in the event of a disturbance, a bank may not
always be able to mobilise domestic liquidity and the necessary foreign
exchange transactions in sufficient time to meet foreign currency
funding requirements. These issues are particularly important for banks
with positions in currencies for which the foreign exchange market is
not highly liquid in all conditions.
3.12.2 Banks should, therefore, have a measurement, monitoring and
control system for liquidity positions in the major currencies in which it
is active. In addition to assessing its aggregate foreign currency
liquidity needs and the acceptable mismatch in combination with its
domestic currency commitments, a bank should also undertake
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separate analysis of its strategy for each currency individually.
3.12.3 When dealing in foreign currencies, a bank is exposed to the
risk that a sudden change in foreign exchange rates or market liquidity,
or both, could sharply widen the liquidity mismatches being run. These
shifts in market sentiment might result either from domestically
generated factors or from contagion effects of developments in other
countries. In either event, a bank may find that the size of its foreign
currency funding gap has increased. Moreover, foreign currency assets
may be impaired, especially where borrowers have not hedged foreign
currency risk adequately. The Asian crisis of the late 1990s
demonstrated the importance of banks closely managing their foreign
currency liquidity on a day-to-day basis.
3.12.4 The particular issues to be addressed in managing foreign
currency liquidity will depend on the nature of the bank’s business. For
some banks, the use of foreign currency deposits and short-term credit
lines to fund domestic currency assets will be the main area of
vulnerability, while for others it may be the funding of foreign currency
assets with domestic currency. As with overall liquidity risk
management, foreign currency liquidity should be analysed under
various scenarios, including stressful conditions.
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Chapter 4- Interest Rate Risk (IRR) Management
4.1 Interest rate risk is the risk where changes in market interest rates
might adversely affect a bank’s financial condition. The immediate impact of
changes in interest rates is on the Net Interest Income (NII). A long term
impact of changing interest rates is on the bank’s networth since the
economic value of a bank’s assets, liabilities and off-balance sheet positions
get affected due to variation in market interest rates. The interest rate risk
when viewed from these two perspectives is known as ‘earnings perspective’
and ‘economic value’ perspective, respectively.
4.2 Management of interest rate risk aims at capturing the risks arising
from the maturity and repricing mismatches and is measured both from the
earnings and economic value perspective.
Earnings perspective involves analysing the impact of changes in
interest rates on accrual or reported earnings in the near term. This is
measured by measuring the changes in the Net Interest Income (NII)
or Net Interest Margin (NIM) i.e. the difference between the total
interest income and the total interest expense.
Economic Value perspective involves analysing the changes of
impact og interest on the expected cash flows on assets minus the
expected cash flows on liabilities plus the net cash flows on offbalance
sheet items. It focuses on the risk to networth arising from all
repricing mismatches and other interest rate sensitive positions. The
economic value perspective identifies risk arising from long- term
interest rate gaps.
4.3 The management of Interest Rate Risk should be one of the critical
components of market risk management in banks. The regulatory restrictions
in the past had greatly reduced many of the risks in the banking system.
Deregulation of interest rates has, however, exposed them to the adverse
impacts of interest rate risk. The Net Interest Income (NII) or Net Interest
Margin (NIM) of banks is dependent on the movements of interest rates. Any
mismatches in the cash flows (fixed assets or liabilities) or repricing dates
(floating assets or liabilities), expose bank’s NII or NIM to variations. The
earning of assets and the cost of liabilities are now closely related to market
interest rate volatility.
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4.4 Generally, the approach towards measurement and hedging of IRR
varies with the segmentation of the balance sheet. In a well functioning risk
management system, banks broadly position their balance sheet into Trading
and Banking Books. While the assets in the trading book are held primarily
for generating profit on short-term differences in prices/yields, the banking
book comprises assets and liabilities, which are contracted basically on
account of relationship or for steady income and statutory obligations and are
generally held till maturity. Thus, while the price risk is the prime concern of
banks in trading book, the earnings or economic value changes are the main
focus of banking book.
4.5 Trading Book
The top management of banks should lay down policies with regard to
volume, maximum maturity, holding period, duration, stop loss, defeasance
period, rating standards, etc. for classifying securities in the trading book.
While the securities held in the trading book should ideally be marked to
market on a daily basis, the potential price risk to changes in market risk
factors should be estimated through internally developed Value at Risk (VaR)
models. The VaR method is employed to assess potential loss that could
crystallise on trading position or portfolio due to variations in market interest
rates and prices, using a given confidence level, usually 95% to 99%, within
a defined period of time. The VaR method should incorporate the market
factors against which the market value of the trading position is exposed. The
top management should put in place bank-wide VaR exposure limits to the
trading portfolio (including forex and gold positions, derivative products, etc.)
which is then disaggregated across different desks and departments. The
loss making tolerance level should also be stipulated to ensure that potential
impact on earnings is managed within acceptable limits. The potential loss in
Present Value Basis Points should be matched by the Middle Office on a
daily basis vis-à-vis the prudential limits stipulated (see section 2.5 for
mandatory risk limits). The advantage of using VaR is that it is comparable
across products, desks and Departments and it can be validated through
‘back testing’. However, VaR models require the use of extensive historical
data to estimate future volatility. VaR model also may not give good results in
extreme volatile conditions or outlier events and stress test has to be
employed to complement VaR. The stress tests provide management a view
on the potential impact of large size market movements and also attempt to
estimate the size of potential losses due to stress events, which occur in the
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‘tails’ of the loss distribution. Banks may also undertake scenario analysis
with specific possible stress situations (recently experienced in some
countries) by linking hypothetical, simultaneous and related changes in
multiple risk factors present in the trading portfolio to determine the impact of
moves on the rest of the portfolio. VaR models could also be modified to
reflect liquidity risk differences observed across assets over time.
International banks are now estimating Liquidity adjusted Value at Risk
(LaVaR) by assuming variable time horizons based on position size and
relative turnover. In an environment where VaR is difficult to estimate for lack
of data, non- statistical concepts such as stop loss and gross/net positions
can be used.
4.6 Banking Book
The changes in market interest rates have earnings and economic value
impacts on the bank’s banking book. Thus, given the complexity and range of
balance sheet products, banks should have IRR measurement systems that
assess the effects of the rate changes on both earnings and economic value.
The variety of techniques ranges from simple maturity (fixed rate) and
repricing (floating rate) gaps and duration gaps to static simulation, based on
current on-and-off-balance sheet positions, to highly sophisticated dynamic
modelling techniques that incorporate assumptions on behavioural pattern of
assets, liabilities and off-balance sheet items and can easily capture the full
range of exposures against basis risk, embedded option risk, yield curve risk,
etc.
4.7 Rigidities and the remedial measures:
4.7.1 However, there are certain rigidities at micro level of banks and also at
the systemic level, which the banks have to address. At the micro level, the
banks have to strengthen their Management Information System (MIS) and
computer processing capabilities for accurate measurement of interest rate
risk in their banking books, which impact, in the short-term, their net interest
income (NII) or net interest margin (NIM) or “spread” and in the long-term, the
economic value of the bank.
4.7.2 At the systemic level, the rigidities are the following:
• Most of the liabilities of banks, like deposits and borrowings are on fixed
interest rate basis while their assets like loans and advances are on
floating rate basis.
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• There is still some regulation in place on interest rates in the system,
such as savings bank deposit, export credit, refinances, etc.
• There is no definite interest rate repricing dates for floating Prime
Lending Rate (PLR) based products like loans and advances, thereby
placing them in accurate time buckets for measurement of interest rate
risk difficult.
he RBI has taken a number of measures to correct the systemic rigidities, like
introduction of:
• Floating rate deposits,
• Fixed rate lending,
• Tenor-linked PLR,
• Interest rate derivative products like Interest Rate Swaps (IRSs) and
Forward Rate Agreements (FRAs), and
• For pricing of rupee interest rate derivatives, banks have been allowed
to use interest rate implied in foreign exchange forward market, etc.
4.7.3 In order to align the Indian accounting standards with the international
best practices and taking into consideration the evolving international
developments, the norms for classification and valuation of investments have
been modified with effect from September 30, 2000. Now, the entire
investment portfolio is required to be classified under three categories, viz.,
Held to Maturity, Available for Sale and Held for Trading. While the
securities ‘Held for Trading’ and ‘Available for Sale’ should be marked to
market periodically, the securities ‘Held to Maturity’, which should not exceed
25% of the total investments need not be marked to market.
4.8 The Narasimham Committee II on Banking Sector Reforms had
recommended that in order to capture market risk in the investment portfolio,
a risk-weight of 5% should be applied for Government and other approved
securities for the purpose of capital adequacy. The Reserve Bank of India
has prescribed 2.5% risk-weight for capital adequacy for market risk on SLR
and non-SLR securities, with effect from 31 March 2000 and 2001
respectively, in addition to appropriate risk-weights for credit risk. It may be
mentioned here that the Basle Committee on Banking Supervision (BCBS) of
the Bank for International Settlements (BIS) has introduced capital charge for
market risk, inter alia, for the interest rate related instruments and equity
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positions in the trading book and gold and forex position in both trading and
banking books. The banks in India are required to apply the 2.5% risk-weight
for capital charge for market risk for the whole investment portfolio and 100%
risk- weight on open gold and forex position limits. In the “New Capital
Adequacy Framework” consultative paper, the BCBS recognises the
significance of interest rate risk in some banking books and proposes to
develop a capital charge for interest rate risk in the banking book for banks
where interest rate risks are significantly above average (“outliers”). (The
proposed Basel Capital Accord is separately covered in Chapter 7 and
annexure)
4.9 Equity Position Risk Management
Internationally banks use VAR models for management of equity position
risk. The banks should devise specific price risk structure (like sensitivity
limits, VAR, stop-loss limits) and the methods to measure liquidity of shares
to mitigate equity position risk.
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Chapter 5- Foreign Exchange Risk Management
5.1 The risk inherent in running open foreign exchange positions have
been heightened in recent years by the pronounced volatility in forex rates,
thereby adding a new dimension to the risk profile of banks’ balance sheets.
Foreign Exchange Risk maybe defined as the risk that a bank may
suffer losses as a result of adverse exchange rate movements during a
period in which it has an open position, either spot or forward, or a
combination of the two, in an individual foreign currency. The banks are
also exposed to interest rate risk, which arises from the maturity mismatching
of foreign currency positions. Even in cases where spot and forward positions
in individual currencies are balanced, the maturity pattern of forward
transactions may produce mismatches. As a result, banks may suffer losses
as a result of changes in premia/discounts of the currencies concerned.
5.2 In the forex business, banks also face the risk of default of the
counterparties or settlement risk. While such type of risk crystallisation does
not cause principal loss, banks may have to undertake fresh transactions in
the cash/spot market for replacing the failed transactions. Thus, banks may
incur replacement cost, which depends upon the currency rate movements.
Banks also face another risk called time-zone risk or Herstatt risk which
arises out of time-lags in settlement of one currency in one centre and the
settlement of another currency in another time-zone. The forex transactions
with counterparties from another country also trigger sovereign or country
risk (dealt with in details in the guidance note on credit risk).
5.3 The three important issues that need to be addressed in this regard
are:
• Nature and magnitude of exchange risk
• The strategy to be adopted for hedging or managing exchange risk.
• The tools of managing exchange risk.
5.4 Nature and Magnitude of Risk
5.4.1 The first aspect of management of foreign exchange risk is to
acknowledge that such risk does exist and that it must be managed to avoid
adverse financial consequences. Many banks refrain from active
management of their foreign exchange exposure because they feel that
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financial forecasting is outside their field of expertise or because they find
it difficult to measure currency exposure precisely. However not recognising
a risk would not make it go away. Nor is the inability to measure risk any
excuse for not managing it. Having recognized this fact the nature and
magnitude of such risk must now be identified.
5.4.2 The basic difficulty in measuring exposure comes from the fact that
available accounting information which provides the most reliable base to
calculate exposure (accounting or translation exposure) does not capture the
actual risk a bank faces, which depends on its future cash flows and their
associated risk profiles (economic exposure). Also there is the distinction
between the currency in which cash flows are denominated and the currency
that determines the size of the cash flows. For instance a borrower selling
jewellery in Europe may keep its records in Rupees, invoice in Euros, and
collect Euro cash flow, only to find that its revenue stream behaves as if it
were in U.S. dollars! This occurs because Euro- prices for the exports might
adjust to reflect world market prices which could be determined in U.S.
dollars.
5.4.3 Another dimension of exchange risk involves the element of time. In
the very short run, virtually all local currency prices for goods and services
(although not necessarily for financial assets) remain unchanged after an
unexpected exchange rate change. However, over a longer period of time,
prices and costs respond to price changes. It is therefore necessary to
determine the time frame within which the bank can react to (unexpected)
rate changes.
5.4.4 For a bank, being a financial entity, it is relatively easier to gauge the
nature as well as the measure of forex risk simply because all financial
assets/liabilities are denominated in a currency. A bank’s future cash streams
are more predictable than those of a non-financial firm. Its net exposure, or
position, completely encapsulates the measure of its exposure to forex risk.
5.4.5 In order to manage forex risk some forex market relationships need to
be understood well. The first and most important of these is the covered
interest parity relationship. If there is free and unrestricted mobility of capital,
the interest differential between two currencies will equal the forward
premium/discount for either of the currency. This relationship must hold
under the assumptions; otherwise arbitrage opportunities will arise to restore
the relationship. However, in the case of Rupee, since it is not totally
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convertible, this relationship does not hold exactly. Although interest rate
differentials are the driving factor for the Dollar premium against the Rupee, it
also is a factor of forward demand / supply factors. This brings in typical
complications to forward hedging which must be taken into account.
5.4.6 From the above it can easily be determined that a currency with a
lower interest rate will be at a premium to a currency with a higher interest
rate. The other relationships in the forex market are not as deterministic as
the covered interest parity, but needs to be recognised to manage forex
exposure because they are the theoretical tools used for predicting exchange
rate movements, essential to any hedging strategy particularly to economic
risk as opposed to accounting risk. The most important of these is the
Purchasing Power Parity relationship which says exchange rate changes are
determined by inflation differentials. The Uncovered Interest Parity theory
says that the forward exchange rate is the best and unbiased predictor of
future spot rates under risk neutrality. These relationships have to be clearly
understood for any meaningful forex risk management process.
5.5 Managing Foreign Exchange Risk
5.5.1 For a bank therefore the first major decision on forex risk management
is for the management to fix its open foreign exchange position limits.
Although typically this is a management decision, it could also be subject to
regulatory capital and could also be required to be in tune with the regulatory
environment that prevails. These open position limits have two aspects, the
Daylight limit and the Overnight limit. The daylight limit could typically be
substantially higher for two reasons, (a) It is easier to manage exchange risk
when the market is open and the bank is actively present in the market and
(b) the bank needs a higher limit to accommodate client flows during
business hours. Overnight position, being subject to more uncertainty and
therefore being more risky should be much lower.
5.5.2 Having decided on the overall open position limits, the next step is to
allocate these limits among different operating centres of the bank (in the
case of banks which hold positions at multiple centres). Within a centre there
could be a further allocation among different dealers. It must however be
ensured that the bank has a system to monitor the overall open position limit
for the bank on a real time basis.
5.6 Tools and Techniques for managing forex risk
5.6.1 There are various tools, often substitutes, available for hedging of

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
foreign exchange risk like over the counter forwards, futures, money market
instruments, options and the like. Most currency management instruments
enable the bank to take a long or a short position to hedge an opposite short
or long position. In equilibrium and in an efficient market the cost of all will be
the same, according to the fundamental relationships. The tools differ to the
extent that they hedge different risks. In particular, symmetric hedging tools
like futures cannot easily hedge contingent cash flows where risk is nonlinear:
options may be better suited to the latter.
5.6.2 Foreign exchange forward contracts are the most common means
of hedging transactions in foreign currencies. However since they require
future performance, and if one party is unable to perform on the contract, the
hedge disappears, bringing in replacement risk which could be high. This
default risk also means that many banks may not have access to the forward
market to adequately hedge their exchange exposure. For such situations,
futures may be more suitable, where available, since they are exchange
traded and effectively minimise default risk. However, futures are
standardised and therefore may not be as versatile in terms of quantity and
tenor as over the counter forward contracts. This in turn gives rise to
assumption of basis risk.
5.6.3 Money market borrowing to invest in interest-bearing assets to offset a
foreign currency payment – also serves the same purpose as forward
contracts. This follows from the covered interest parity principle. Since the
carrying cost of a position is the same in both, the forex or the money market
hedging can also be done in either market. For instance, let us say a bank
has a short forward Dollar position. It can of course hedge the position by
buying forward Dollars. Alternatively it can borrow Rupees now, buy Dollar
with the proceeds, and place the Dollars in a forward deposit to meet the
short Dollar position on maturity. The Rupees received on the sale on
maturity are used to pay off the Rupee borrowing. The cost of this money
market hedge is the difference between the Rupee interest rate paid and the
US dollar interest rate earned. According to the interest rate parity theorem,
the interest differential equals the forward exchange premium, the
percentage by which the forward rate differs from the spot exchange rate. So
the cost of the money market hedge should be the same as the forward or
futures market hedge.
5.6.4 Currency options are another tool for managing forex risk. A foreign
exchange option is a contract for future delivery of a currency in exchange for
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another, where the holder of the option has the right to buy (or sell) the
currency at an agreed price, the strike or exercise price, but is not required to
do so. The right to buy is a call; the right to sell, a put. For such a right he
pays a price called the option premium. The option seller receives the
premium and is obliged to make (or take) delivery at the agreed-upon price if
the buyer exercises his option. In some options, the instrument being
delivered is the currency itself; in others, a futures contract on the currency.
American options permit the holder to exercise at any time before the
expiration date; European options, only on the expiration date.
5.6.5 Futures and forwards are contracts in which two parties oblige
themselves to exchange something in the future. They are thus useful to
hedge or convert known currency or interest rate exposures. An option, in
contrast, gives one party the right but not the obligation to buy or sell an
asset under specified conditions while the other party assumes an obligation
to sell or buy that asset if that option is exercised. Options being non-linear
instruments are more difficult to price and therefore their risk profiles need to
be well understood before they can be used. For example it needs to be
understood that the value of a currency changes not just when exchange rate
changes (the event for which the bank usually hedges using forwards/futures)
but also if the underlying volatility of the currency pair changes, a risk which
banks are not directly concerned with while hedging.
5.7 Treasury operations.
5.7.1 The primary treasury operation of a bank is that of catering to
customer needs, both in the spot as well as forward market. This lands the
bank with net foreign exchange positions which it needs to manage on a real
time basis. If the bank needs to sell Dollars forward to an importer, the bank
has a short Dollar position. It can offset the position by buying matching
forward Dollars in the market in which case all risks apart from the profit
element are covered for the bank. However, it may be easier for the bank to
immediately cover the forex risk with a purchase of Dollars in the spot
market. Here again the exchange risk is fully covered except for the profit
element. However the bank now has a swap position. This is called a gap.
The bank has a gap risk which affects it if interest rates change affecting the
forward premia for Dollar. In the case of our domestic markets, in addition,
premia could also change due to forward demand/supply factors. However,
gap risks are easier to manage than exchange risks. So the bank can build
up gaps, subject to the management mandated gap limits, and do offsetting
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swaps to reduce gap risks if it so desires periodically.
5.7.2 The bank’s treasury might also do transactions to take advantage of
disequilibrium situations, subject to such transactions being permissible. For
instance if the forward premium for 6 months is say 5% while the 6- month
interest differential between Rupee and Dollar is say 4%, the bank can
receive in the forex market (buy spot, sell 6-month swap to earn 5%
annualised for 6 months) and finance the transaction by borrowing in the
money market (money market cost being 4% annualised for 6 months).
5.7.3 The bank can also do transactions to take advantage of expected
interest rate changes. It can then use either the money market route
(mismatched cash-flow maturities) or the forex market route (by running a
gap risk).
5.7.4 The bank of course also trades on currency movements with a view to
make profits. Here the management must keep in place systems of stop loss
discipline, proper monitoring and evaluation of open positions, etc.
5.8 Risk Control Systems:
The management of the bank need to lay out clear and unambiguous
performance measurement criteria, accountability norms and financial limits
in its treasury operations. Management must specify in operational terms the
goals of exchange risk management. It must also clearly recognise the risks
of trading arising from open positions, credit risks, and operations risks. The
bank must also keep in place a system to independently evaluate through
marking to market the net positions taken. Marking to market should ideally
be based on objective market prices provided by an external agency. All
position limits should be made explicit and expressed in simple terms for
easy control.
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Chapter 6- Treatment of Market Risk in the Proposed
Basel Capital Accord
6.1 The Basle Committee on Banking Supervision (BCBS) had
issued comprehensive guidelines to provide an explicit capital cushion
for the price risks to which banks are exposed, particularly those
arising from their trading activities. The banks have been given
flexibility to use in- house models based on VaR for measuring market
risk as an alternative to a standardised measurement framework
suggested by Basle Committee. The internal models should, however,
comply with quantitative and qualitative criteria prescribed by Basle
Committee.
6.2 Reserve Bank of India has accepted the general framework
suggested by the Basle Committee. RBI has also initiated various
steps in moving towards prescribing capital for market risk. As an initial
step, a risk weight of 2.5% has been prescribed for investments in
Government and other approved securities, besides a risk weight each
of 100% on the open position limits in forex and gold. RBI has also
prescribed detailed operating guidelines for Asset-Liability
Management System in banks. As the ability of banks to identify and
measure market risk improves, it would be necessary to assign explicit
capital charge for market risk. While the small banks operating
predominantly in India could adopt the standardised methodology,
large banks and those banks operating in international markets should
develop expertise in evolving internal models for measurement of
market risk.
6.3 The Basle Committee on Banking Supervision proposes to
develop capital charge for interest rate risk in the banking book as well
for banks where the interest rate risks are significantly above average
(‘outliers’). The Committee is now exploring various methodologies for
identifying ‘outliers’ and how best to apply and calibrate a capital
charge for interest rate risk for banks. Once the Committee finalises
the modalities, it may be necessary, at least for banks operating in the
international markets to comply with the explicit capital charge
requirements for interest rate risk in the banking book. As the valuation
norms on banks’ investment portfolio have already been put in place
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
and aligned with the international best practices, it is appropriate to
adopt the Basel norms on capital for market risk. In view of this, banks
should study the Basel framework on capital for market risk as
envisaged in Amendment to the Capital Accord to incorporate market
risks published in January 1996 by BCBS and prepare themselves to
follow the international practices in this regard at a suitable date to be
announced by RBI.
6.4 The Proposed New Capital Adequacy Framework
The Basel Committee on Banking Supervision has released a Second
Consultative Document, which contains refined proposals for the three
pillars of the New Accord – Minimum Capital Requirements,
Supervisory Review and Market Discipline. It may be recalled that the
Basel Committee had released in June 1999 the first Consultative
Paper on a New Capital Adequacy Framework for comments.
However, the proposal to provide explicit capital charge for market risk
in the banking book which was included in the Pillar I of the June 1999
Document has been shifted to Pillar II in the second Consultative
Paper issued in January 2001. The Committee has also provided a
technical paper on evaluation of interest rate risk management
techniques. The Document has defined the criteria for identifying
outlier banks. According to the proposal, a bank may be defined as an
outlier whose economic value declined by more than 20% of the sum of
Tier 1 and Tier 2 capital as a result of a standardised interest rate
shock (200 bps.)
6.5 The second Consultative Paper on the New Capital Adequacy
framework issued in January, 2001 has laid down 13 principles
intended to be of general application for the management of interest
rate risk, independent of whether the positions are part of the trading
book or reflect banks' non-trading activities. They refer to an interest
rate risk management process, which includes the development of a
business strategy, the assumption of assets and liabilities in banking
and trading activities, as well as a system of internal controls. In
particular, they address the need for effective interest rate risk
measurement, monitoring and control functions within the interest rate
risk management process. The principles are intended to be of general
application, based as they are on practices currently used by many
international banks, even though their specific application will depend
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Annexure – D
to some extent on the complexity and range of activities undertaken by
individual banks. Under the New Basel Capital Accord, they form
minimum standards expected of internationally active banks. The
principles are given in Annexure II.
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Annexure-I
BCBS Principles for the Assessment of Liquidity
Management in Banks *
Developing a Structure for Managing Liquidity
Principle 1: Each bank should have an agreed strategy for the day-to-day
management of liquidity. This strategy should be communicated
throughout the organisation.
Principle 2: A bank’s board of directors should approve the strategy and
significant policies related to the management of liquidity. The board
should also ensure that senior management takes the steps necessary to
monitor and control liquidity risk. The board should be informed regularly
of the liquidity situation of the bank and immediately if there are any
material changes in the bank’s current or prospective liquidity position.
Principle 3: Each bank should have a management structure in place to
execute effectively the liquidity strategy. This structure should include the
ongoing involvement of members of senior management. Senior
management must ensure that liquidity is effectively managed, and that
appropriate policies and procedures are established to control and limit
liquidity risk. Banks should set and regularly review limits on the size of
their liquidity positions over particular time horizons.
Principle 4: A bank must have adequate information systems for
measuring, monitoring, controlling and reporting liquidity risk. Reports
should be provided on a timely basis to the bank’s board of directors,
senior management and other appropriate personnel.
Measuring and Monitoring Net Funding Requirements
Principle 5: Each bank should establish a process for the ongoing
measurement and monitoring of net funding requirements.
Principle 6: A bank should analyse liquidity utilising a variety of “what if”
scenarios.
Principle 7: A bank should review frequently the assumptions utilised in
managing liquidity to determine that they continue to be valid.
*
Sound Practices for managing liquidity in banking organizations, Basel Committee on
Banking Supervision, February, 2000
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Annexure – D
Managing Market Access
Principle 8: Each bank should periodically review its efforts to establish
and maintain relationships with liability holders, to maintain the
diversification of liabilities, and aim to ensure its capacity to sell assets.
Contingency Planning
Principle 9: A bank should have contingency plans in place that address
the strategy for handling liquidity crises and include procedures for making
up cash flow shortfalls in emergency situations.
Foreign Currency Liquidity Management
Principle 10: Each bank should have a measurement, monitoring and
control system for its liquidity positions in the major currencies in which it
is active. In addition to assessing its aggregate foreign currency liquidity
needs and the acceptable mismatch in combination with its domestic
currency commitments, a bank should also undertake separate analysis of
its strategy for each currency individually.
Principle 11: Subject to the analysis undertaken according to Principle
10, a bank should, where appropriate, set and regularly review limits on
the size of its cash flow mismatches over particular time horizons for
foreign currencies in aggregate and for each significant individual currency
in which the bank operates.
Internal Controls for Liquidity Risk Management
Principle 12: Each bank must have an adequate system of internal
controls over its liquidity risk management process. A fundamental
component of the internal control system involves regular independent
reviews and evaluations of the effectiveness of the system and, where
necessary, ensuring that appropriate revisions or enhancements to
internal controls are made. The results of such reviews should be
available to supervisory authorities.
Role of Public Disclosure in Improving Liquidity
Principle 13: Each bank should have in place a mechanism for ensuring
that there is an adequate level of disclosure of information about the bank
in order to manage public perception of the organisation and its
soundness.
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
BCBS Principles for Interest Rate Risk Management *
Annexure II
Board and senior management oversight of interest rate risk
Principle 1: In order to carry out its responsibilities, the board of directors
in a bank should approve strategies and policies with respect to interest
rate risk management and ensure that senior management takes the
steps necessary to monitor and control these risks. The board of directors
should be informed regularly of the interest rate risk exposure of the bank
in order to assess the monitoring and controlling of such risk.
Principle 2: Senior management must ensure that the structure of the
bank's business and the level of interest rate risk it assumes are
effectively managed, that appropriate policies and procedures are
established to control and limit these risks, and that resources are
available for evaluating and controlling interest rate risk.
Principle 3: Banks should clearly define the individuals and/or committees
responsible for managing interest rate risk and should ensure that there is
adequate separation of duties in key elements of the risk management
process to avoid potential conflicts of interest. Banks should have risk
measurement, monitoring and control functions with clearly defined duties
that are sufficiently independent from position-taking functions of the bank
and which report risk exposures directly to senior management and the
board of directors. Larger or more complex banks should have a
designated independent unit responsible for the design and administration
of the bank's interest rate risk measurement, monitoring and control
functions.
Adequate risk management policies and procedures
Principle 4: It is essential that banks' interest rate risk policies and
procedures are clearly defined and consistent with the nature and
complexity of their activities. These policies should be applied on a
consolidated basis and, as appropriate, at the level of individual affiliates,
especially when recognising legal distinctions and possible obstacles to
cash movements among affiliates.
*
Principles for the Management and Supervision of Interest Rate Risk, Supporting Document to the
New Basel Capital Accord, BCBS, January, 2001
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Annexure – D
Principle 5: It is important that banks identify the risks inherent in new
products and activities and ensure these are subject to adequate
procedures and controls before being introduced or undertaken. Major
hedging or risk management initiatives should be approved in advance by
the board or its appropriate delegated committee.
Risk measurement, monitoring and control functions
Principle 6: It is essential that banks have interest rate risk measurement
systems that capture all material sources of interest rate risk and that
assess the effect of interest rate changes in ways that are consistent with
the scope of their activities. The assumptions underlying the system
should be clearly understood by risk managers and bank management.
Principle 7: Banks must establish and enforce operating limits and other
practices that maintain exposures within levels consistent with their
internal policies.
Principle 8: Banks should measure their vulnerability to loss under
stressful market conditions - including the breakdown of key assumptionsand
consider those results when establishing and reviewing their policies
and limits for interest rate risk.
Principle 9: Banks must have adequate information systems for
measuring, monitoring, controlling and reporting interest rate exposures.
Reports must be provided on a timely basis to the bank's board of
directors, senior management and, where appropriate, individual business
line managers.
Internal controls
Principle 10: Banks must have an adequate system of internal controls
over their interest rate risk management process. A fundamental
component of the internal control system involves regular independent
reviews and evaluations of the effectiveness of the system and, where
necessary, ensuring that appropriate revisions or enhancements to
internal controls are made. The results of such reviews should be
available to the relevant supervisory authorities.
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Information for supervisory authorities
Principle 11: Supervisory authorities should obtain from banks sufficient
and timely information with which to evaluate their level of interest rate
risk. This information should take appropriate account of the range of
maturities and currencies in each bank's portfolio, including off-balance
sheet items, as well as other relevant factors, such as the distinction
between trading and non-trading activities.
Capital adequacy
Principle 12: Banks must hold capital commensurate with the level of
interest rate risk they undertake.
Disclosure of interest rate risk
Principle 13: Banks should release to the public information on the level
of interest rate risk and their policies for its management.
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Annexure – D
Sources, effects and measurement of interest rate risk *
Annexure-III
Interest rate risk is the exposure of a bank's financial condition to adverse
movements in interest rates. Accepting this risk is a normal part of banking
and can be an important source of profitability and shareholder value.
However, excessive interest rate risk can pose a significant threat to a
bank's earnings and capital base. Changes in interest rates affect a bank's
earnings by changing its net interest income and the level of other
interest-sensitive income and operating expenses. Changes in interest
rates also affect the underlying value of the bank's assets, liabilities and
off-balance sheet instruments because the present value of future cash
flows (and in some cases, the cash flows themselves) change when
interest rates change.
A. Sources of Interest Rate Risk
Repricing risk: As financial intermediaries, banks encounter interest rate
risk in several ways. The primary and most often discussed form of
interest rate risk arises from timing differences in the maturity (for fixed
rate) and repricing (for floating rate) of bank assets, liabilities and offbalance-sheet
(OBS) positions. While such repricing mismatches are
fundamental to the business of banking, they can expose a bank's income
and underlying economic value to unanticipated fluctuations as interest
rates vary. For instance, a bank that funded a long-term fixed rate loan
with a short-term deposit could face a decline in both the future income
arising from the position and its underlying value if interest rates increase.
These declines arise because the cash flows on the loan are fixed over its
lifetime, while the interest paid on the funding is variable, and increases
after the short-term deposit matures.
Yield curve risk: Repricing mismatches can also expose a bank to
changes in the slope and shape of the yield curve. Yield curve risk arises
when unanticipated shifts of the yield curve have adverse effects on a
bank's income or underlying economic value. For instance, the underlying
economic value of a long position in 10-year government bonds hedged
by a short position in 5-year government notes could decline sharply if the
*
Principles for the Management and Supervision of Interest Rate Risk, Supporting Document to the
New Basel Capital Accord, BCBS, January, 2001
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
yield curve steepens, even if the position is hedged against parallel
movements in the yield curve.
Basis risk: Another important source of interest rate risk (commonly
referred to as basis risk) arises from imperfect correlation in the
adjustment of the rates earned and paid on different instruments with
otherwise similar repricing characteristics. When interest rates change,
these differences can give rise to unexpected changes in the cash flows
and earnings spread between assets, liabilities and OBS instruments of
similar maturities or repricing frequencies.
Optionality: An additional and increasingly important source of interest
rate risk arises from the options embedded in many bank assets, liabilities
and OBS portfolios. Formally, an option provides the holder the right, but
not the obligation, to buy, sell, or in some manner alter the cash flow of an
instrument or financial contract. Options may be stand alone instruments
such as exchange-traded options and over-the-counter (OTC) contracts,
or they may be embedded within otherwise standard instruments. While
banks use exchange-traded and OTC-options in both trading and nontrading
accounts, instruments with embedded options are generally most
important in non-trading activities. They include various types of bonds
and notes with call or put provisions, loans which give borrowers the right
to prepay balances, and various types of non- maturity deposit
instruments which give depositors the right to withdraw funds at any time,
often without any penalties. If not adequately managed, the asymmetrical
payoff characteristics of instruments with optionality features can pose
significant risk particularly to those who sell them, since the options held,
both explicit and embedded, are generally exercised to the advantage of
the holder and the disadvantage of the seller. Moreover, an increasing
array of options can involve significant leverage which can magnify the
influences (both negative and positive) of option positions on the financial
condition of the firm.
B. Effects of Interest Rate Risk
As the discussion above suggests, changes in interest rates can have
adverse effects both on a bank's earnings and its economic value. This
has given rise to two separate, but complementary, perspectives for
assessing a bank's interest rate risk exposure.
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Annexure – D
Earnings perspective: In the earnings perspective, the focus of analysis
is the impact of changes in interest rates on accrual or reported earnings.
This is the traditional approach to interest rate risk assessment taken by
many banks. Variation in earnings is an important focal point for interest
rate risk analysis because reduced earnings or outright losses can
threaten the financial stability of an institution by undermining its capital
adequacy and by reducing market confidence. In this regard, the
component of earnings that has traditionally received the most attention is
net interest income (i.e. the difference between total interest income and
total interest expense). This focus reflects both the importance of net
interest income in banks' overall earnings and its direct and easily
understood link to changes in interest rates. However, as banks have
expanded increasingly into activities that generate fee-based and other
non-interest income, a broader focus on overall net income - incorporating
both interest and non-interest income and expenses - has become more
common. The non-interest income arising from many activities, such as
loan servicing and various asset securitisation programs, can be highly
sensitive to market interest rates. For example, some banks provide the
servicing and loan administration function for mortgage loan pools in
return for a fee based on the volume of assets it administers. When
interest rates fall, the servicing bank may experience a decline in its fee
income as the underlying mortgages prepay. In addition, even traditional
sources of non-interest income such as transaction processing fees are
becoming more interest rate sensitive. This increased sensitivity has led
both bank management and supervisors to take a broader view of the
potential effects of changes in market interest rates on bank earnings and
to factor these broader effects into their estimated earnings under different
interest rate environments.
Economic value perspective: Variation in market interest rates can also
affect the economic value of a bank's assets, liabilities and OBS positions.
Thus, the sensitivity of a bank's economic value to fluctuations in interest
rates is a particularly important consideration of shareholders,
management and supervisors alike. The economic value of an instrument
represents an assessment of the present value of its expected net cash
flows, discounted to reflect market rates. By extension, the economic
value of a bank can be viewed as the present value of bank's expected
net cash flows, defined as the expected cash flows on assets minus the
expected cash flows on liabilities plus the expected net cash flows on OBS

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
positions. In this sense, the economic value perspective reflects one view
of the sensitivity of the net worth of the bank to fluctuations in interest
rates. Since the economic value perspective considers the potential
impact of interest rate changes on the present value of all future cash
flows, it provides a more comprehensive view of the potential long-term
effects of changes in interest rates than is offered by the earnings
perspective. This comprehensive view is important since changes in nearterm
earnings – the typical focus of the earnings perspective - may not
provide an accurate indication of the impact of interest rate movements on
the bank's overall positions.
Embedded losses: The earnings and economic value perspectives
discussed thus far focus on how future changes in interest rates may
affect a bank's financial performance. When evaluating the level of interest
rate risk it is willing and able to assume, a bank should also consider the
impact that past interest rates may have on future performance. In
particular, instruments that are not marked to market may already contain
embedded gains or losses due to past rate movements. These gains or
losses may be reflected over time in the bank's earnings. For example, a
long term fixed rate loan entered into when interest rates were low and
refunded more recently with liabilities bearing a higher rate of interest will,
over its remaining life, represent a drain on the bank's resources.
C. Measuring Interest Rate Risk
The techniques available for measuring interest rate risk range from
calculations that rely on simple maturity and repricing tables, to static
simulations based on current on- and off-balance sheet positions, to highly
sophisticated dynamic modelling techniques that incorporate assumptions
about the behaviour of the bank and its customers in response to changes
in the interest rate environment. Some of these general approaches can
be used to measure interest rate risk exposure from both an earnings and
an economic value perspective, while others are more typically associated
with only one of these two perspectives. In addition, the methods vary in
their ability to capture the different forms of interest rate exposure: the
simplest methods are intended primarily to capture the risks arising from
maturity and repricing mismatches, while the more sophisticated methods
can more easily capture the full range of risk exposures.
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Annexure – D
Gap analysis: Simple maturity/repricing schedules can be used to
generate simple indicators of the interest rate risk sensitivity of both
earnings and economic value to changing interest rates. When this
approach is used to assess the interest rate risk of current earnings, it is
typically referred to as gap analysis. Gap analysis was one of the first
methods developed to measure a bank's interest rate risk exposure, and
continues to be widely used by banks. To evaluate earnings exposure,
interest rate sensitive liabilities in each time band are subtracted from the
corresponding interest rate sensitive assets to produce a repricing "gap"
for that time band. This gap can be multiplied by an assumed change in
interest rates to yield an approximation of the change in net interest
income that would result from such an interest rate movement. The size of
the interest rate movement used in the analysis can be based on a variety
of factors, including historical experience, simulation of potential future
interest rate movements, and the judgement of bank management. A
negative, or liability-sensitive, gap occurs when liabilities exceed assets
(including off-balance sheet positions) in a given time band. This means
that an increase in market interest rates could cause a decline in net
interest income. Conversely, a positive, or asset-sensitive, gap implies
that the bank's net interest income could decline as a result of a decrease
in the level of interest rates.
Limitations of Gap Analysis: Although gap analysis is a very commonly
used approach to assessing interest rate risk exposure, it has a number of
shortcomings. First, gap analysis does not take account of variation in the
characteristics of different positions within a time band. In particular, all
positions within a given time band are assumed to mature or reprice
simultaneously, a simplification that is likely to have greater impact on the
precision of the estimates as the degree of aggregation within a time band
increases. Moreover, gap analysis ignores differences in spreads between
interest rates that could arise as the level of market interest rates changes
(basis risk). In addition, it does not take into account any changes in the
timing of payments that might occur as a result of changes in the interest
rate environment. Thus, it fails to account for differences in the sensitivity
of income that may arise from option-related positions. For these reasons,
gap analysis provides only a rough approximation to the actual change in
net interest income which would result from the chosen change in the
pattern of interest rates. Finally, most gap analyses fail to capture
variability in non-interest revenue and expenses, a potentially important

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
source of risk to current income.
Duration
A maturity/repricing schedule can also be used to evaluate the effects of
changing interest rates on a bank's economic value by applying sensitivity
weights to each time band. Typically, such weights are based on
estimates of the duration of the assets and liabilities that fall into each time
band.
Duration is a measure of the percent change in the economic value
of a position that will occur given a small change in the level of
interest rates. Duration may also be defined as the weighted average of
the time until expected cash flows from a security will be received, relative
to the current price of the security. The weights are the present values of
each cash flow divided by the current price. In its simplest form, duration
measures changes in economic value resulting from a percentage change
of interest rates under the simplifying assumptions that changes in value
are proportional to changes in the level of interest rates and that the timing
of payments is fixed.
Modified duration ∗ is standard duration divided by 1 + r, where r is
the level of market interest rates - is an elasticity. As such, it reflects the
percentage change in the economic value of the instrument for a given
percentage change in 1 + r. As with simple duration, it assumes a linear
relationship between percentage changes in value and percentage
changes in interest rates.
In other words, Modified Duration = Macaulay’s Duration/(I+r), where
Macaulay’s Duration= CFt(t)/(I+r) / CFt/(1+r) to the power t CFt=Rupee
value of cash flow at time t
T= Number of periods of time until the cash flow payment
r=Periodic yield to maturity of the security generating cash flow and k=the
number of cash flows
Duration reflects the timing and size of cash flows that occur before the
instrument's contractual maturity. Generally, the longer the maturity or
next repricing date of the instrument and the smaller the payments that
occur before maturity (e.g. coupon payments), the higher the duration (in
∗ Timothy Koch (1995): Bank Management (Dryden, New York)
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Annexure – D
absolute value). Higher duration implies that a given change in the level of
interest rates will have a larger impact on economic value.
Duration-based weights can be used in combination with a maturity/
repricing schedule to provide a rough approximation of the change in a
bank's economic value that would occur given a particular change in the
level of market interest rates. Specifically, an "average" duration is
assumed for the positions that fall into each time band. The average
durations are then multiplied by an assumed change in interest rates to
construct a weight for each time band. In some cases, different weights
are used for different positions that fall within a time band, reflecting broad
differences in the coupon rates and maturities (for instance, one weight for
assets, and another for liabilities). In addition, different interest rate
changes are sometimes used for different time bands, generally to reflect
differences in the volatility of interest rates along the yield curve. The
weighted gaps are aggregated across time bands to produce an estimate
of the change in economic value of the bank that would result from the
assumed changes in interest rates.
Alternatively, a bank could estimate the effect of changing market rates by
calculating the precise duration of each asset, liability and off-balance
sheet position and then deriving the net position for the bank based on
these more accurate measures, rather than by applying an estimated
average duration weight to all positions in a given time band. This would
eliminate potential errors occurring when aggregating positions/cash
flows. As another variation, risk weights could also be designed for each
time band on the basis of actual percent changes in market values of
hypothetical instruments that would result from a specific scenario of
changing market rates. That approach - which is sometimes referred to as
effective duration - would better capture the non-linearity of price
movements arising from significant changes in market interest rates and,
thereby, would avoid an important limitation of duration.
Estimates derived from a standard duration approach may provide an
acceptable approximation of a bank's exposure to changes in economic
value for relatively non-complex banks. Such estimates, however,
generally focus on just one form of interest rate risk exposure - repricing
risk. As a result, they may not reflect interest rate risk arising – for
instance - from changes in the relationship among interest rates within a
time band (basis risk). In addition, because such approaches typically use
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
an average duration for each time band, the estimates will not reflect
differences in the actual sensitivity of positions that can arise from
differences in coupon rates and the timing of payments. Finally, the
simplifying assumptions that underlie the calculation of standard duration
means that the risk of options may not be well-captured.
The other methods of measurement of market risk, viz., Value at Risk
(VaR) and Stress Testing Techniques are elaborately discussed in the
subsequent chapters.
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Annexure – D
Value at Risk (VaR)
Annexure-IV
Definition: VaR is defined as an estimate of potential loss in a position or
asset/liability or portfolio of assets/liabilities over a given holding period
at a given level of certainty.
VaR measures risk. Risk is defined as the probability of the unexpected
happening - the probability of suffering a loss. VaR is an estimate of the
loss likely to suffer, not the actual loss. The actual loss may be different
from the estimate. It measures potential loss, not potential gain. Risk
management tools measure potential loss as risk has been defined as the
probability of suffering a loss. VaR measures the probability of loss for a
given time period over which the position is held. The given time period
could be one day or a few days or a few weeks or a year. VaR will change
if the holding period of the position changes. The holding period for an
instrument/position will depend on liquidity of the instrument/ market. With
the help of VaR, we can say with varying degrees of certainty that the
potential loss will not exceed a certain amount. This means that VaR will
change with different levels of certainty.
The Bank for International Settlements (BIS) has accepted VaR as a
measurement of market risks and provision of capital adequacy for
market risks, subject to approval by banks' supervisory authorities.
VaR Methodologies
VAR can be arrived as the expected loss on a position from an
adverse movement in identified market risk parameter(s) with a
specified probability over a nominated period of time.
Volatility in financial markets is usually calculated as the standard
deviation of the percentage changes in the relevant asset price over
a specified asset period. The volatility for calculation of VaR is usually
specified as the standard deviation of the percentage change in the risk
factor over the relevant risk horizon.
The following table describes the three main methodologies to calculate
VaR ∗
∗ Risk Management: A Practical <strong>Guide</strong>, RiskMetrics Group, J.P. Morgan, August, 1999
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
There are three main approaches to calculating value-at-risk: the correlation
method, also known as the variance/covariance matrix method; historical
simulation and Monte Carlo simulation. All three methods require a
statement of three basic parameters: holding period, confidence interval and
the historical time horizon over which the asset prices are observed.
Under the correlation method, the change in the value of the position is
calculated by combining the sensitivity of each component to price changes
in the underlying asset(s), with a variance/covariance matrix of the various
components' volatilities and correlation. It is a deterministic approach.
The historical simulation approach calculates the change in the value of a
position using the actual historical movements of the underlying asset(s), but
starting from the current value of the asset. It does not need a
variance/covariance matrix. The length of the historical period chosen does
impact the results because if the period is too short, it may not capture the
full variety of events and relationships between the various assets and within
each asset class, and if it is too long, may be too stale to predict the future.
The advantage of this method is that it does not require the user to make any
explicit assumptions about correlations and the dynamics of the risk factors
because the simulation follows every historical move.
The Monte Carlo simulation method calculates the change in the value of a
portfolio using a sample of randomly generated price scenarios. Here the
user has to make certain assumptions about market structures, correlations
between risk factors and the volatility of these factors. He is essentially
imposing his views and experience as opposed to the naive approach of the
historical simulation method. At the heart of all three methods is the model.
The closer the models fit economic reality, the more accurate the estimated
VAR numbers and therefore the better they will be at predicting the true VAR
of the firm. There is no guarantee that the numbers returned by each VAR
method will be anywhere near each other.
Other uses of VaR
VaR is used as a MIS tool in the trading portfolio in the trading portfolio to
“slice and dice” risk by levels/ products/geographic/level of organisation etc.
It is also used to set risk limits. In its strategic perspective, VaR is used to
decisions as to what business to do and what not to do. However VaR as a
useful MIS tool has to be “back tested” by comparing each day’s VaR with
actuals and necessary reexamination of assumptions needs to be made so
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Annexure – D
as to be close to reality. VaR, therefore, cannot substitute sound
management judgement, internal control and other complementary methods.
It is used to measure and manage market risks in trading portfolio and
investment portfolio.
Estimating Volatility
VaR uses past data to compute volatility. Different methods are employed to
estimate volatility. One is arithmetic moving average from historical time
series data. The other is the exponential moving average method. In the
exponential moving average method, the volatility estimates rises faster to
shocks and declines gradually. Further, different banks take different number
of days of past data to estimate volatility. Volatility also does not capture
unexpected events like EMU crisis of September 1992 (called “event risk”).
All these complicate the estimation of volatility. VaR should be used in
combination with "stress testing" to take care of event risks. Stress test takes
into account the worst case scenario.
Why Backtest
Backtests compare realized trading results with model generated risk
measures, both to evaluate a new model and to reassess the
accuracy of existing models. Although no single methodology for
backtesting has been established, banks using internal VaR models for
market risk capital requirements must backtest their models on a
regular basis. Banks should generally backtest risk models on a
monthly or quarterly basis to verify accuracy. In these tests, they
should observe whether trading results fall within pre-specified
confidence bands as predicted by the VaR models. If the models
perform poorly, they should probe further to find the cause (e.g., check
integrity of position and market data, model parameters, methodology).
The BIS outlines backtesting best practices in its January 1996
publication “Supervisory framework for the use of ‘backtestin’ in
conjunction with the internal models approach to market risk capital
requirements
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
Stress Testing
Annexure-V
“Stress testing” has been adopted as a generic term describing various
techniques used by banks to gauge their potential vulnerability to
exceptional, but plausible, events. Stress testing addresses the large
moves in key market variables of that kind that lie beyond day to day risk
monitoring but that could potentially occur. The process of stress testing,
therefore, involves first identifying these potential movements,
including which market variables to stress, how much to stress them by,
and what time frame to run the stress analysis over. Once these market
movements and underlying assumptions are decided upon, shocks are
applied to the portfolio. Revaluing the portfolios allows one to see what
the effect of a particular market movement has on the value of the
portfolio and the overall Profit and Loss.
Stress test reports can be constructed that summarise the effects of
different shocks of different magnitudes. Normally, then there is some kind
of reporting procedure and follow up with traders and management to
determine whether any action need to be taken in response.
Stress testing and value-at-risk ∗
Stress tests supplement value-at-risk VaR). VaR is thought to be a critical
tool for tracking the riskiness of a firm’s portfolio on a day-to-day level, and
for assessing the risk-adjusted performance of individual business units.
However, VaR has been found to be of limited use in measuring firms’
exposures to extreme market events. This is because, by definition, such
events occur too rarely to be captured by empirically driven statistical
models. Furthermore, observed correlation patterns between various
financial prices (and thus the correlations that would be estimated using
data from ordinary times) tend to change when the price movements
themselves are large. Stress tests offer a way of measuring and monitoring
the portfolio consequences of extreme price movements of this type.
∗ Philip Best: “Stress Testing”, Marc Lore & Lev Borodovsky (ed)-The Professional’s Handbook
of Financial Risk Management, Global Association of Risk Professionals (GARP), 2001
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Annexure – D
Stress Testing Techniques: Stress testing covers many different
techniques. The four discussed here are listed in the Table below along with
the information typically referred to as the “result” of that type of a stress test.
A simple sensitivity test isolates the short-term impact on a portfolio’s value
of a series of predefined moves in a particular market risk factor. For
example, if the risk factor were an exchange rate, the shocks might be
exchange rate changes of +/- 2 percent, 4 percent, 6 percent and 10 percent.
A scenario analysis specifies the shocks that might plausibly affect a
number of market risk factors simultaneously if an extreme, but possible,
event occurs. It seeks to assess the potential consequences for a firm of an
extreme, but possible, state of the world. A scenario analysis can be based
on an historical event or a hypothetical event. Historical scenarios employ
shocks that occurred in specific historical episodes. Hypothetical scenarios
use a structure of shocks thought to be plausible in some foreseeable, but
unlikely circumstances for which there is no exact parallel in recent history.
Scenario analysis is currently the leading stress testing technique.
A maximum loss approach assesses the riskiness of a business unit’s
portfolio by identifying the most potentially damaging combination of moves
of market risk factors. Interviewed risk managers who use such “maximum
loss” approaches find the output of such exercises to be instructive but they
tend not to rely on the results of such exercises in the setting of exposure
limits in any systematic manner, an implicit recognition of the arbitrary
character of the combination of shocks captured by such a measure.
Extreme value theory (EVT) is a means to better capture the risk of loss in
extreme, but possible, circumstances. EVT is the statistical theory on the
behaviour of the “tails” (i.e., the very high and low potential values) of
probability distributions. Because it focuses only on the tail of a probability
distribution, the method can be more flexible. For example, it can
accommodate skewed and fat-tailed distributions. A problem with the
extreme value approach is adapting it to a situation where many risk factors
drive the underlying return distribution. Moreover, the usually unstated
assumption that extreme events are not correlated through time is
questionable. Despite these drawbacks, EVT is notable for being the only
stress test technique that attempts to attach a probability to stress test
results.
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What Makes a good Stress Test
A good stress test should
• be relevant to the current position
• consider changes in all relevant market rates
• examine potential regime shifts (whether the current risk parameters will
hold or break down)
• spur discussion
• consider market illiquidity, and
• consider the interplay of market and credit risk
How should risk managers use stress tests:
Stress tests produce information summarising the bank’s exposure
to extreme, but possible, circumstances. The role of risk managers in the
bank should be assembling and summarising information to enable senior
management to understand the strategic relationship between the firm’s risktaking
(such as the extent and character of financial leverage employed) and
risk appetite. Typically, the results of a small number of stress scenarios
should be computed on a regular basis and monitored over time. Some of the
specific ways stress tests are used to influence decision-making are to:
‣ manage funding risk
‣ provide a check on modelling assumptions
‣ set limits for traders
‣ determine capital charges on trading desks’ positions
Limitations of Stress Tests
Stress testing can appear to be a straightforward technique. In practice,
however, stress tests are often neither transparent nor straightforward. They
are based on a large number of practitioner choices as to what risk factors to
stress, how to combine factors stressed, what range of values to consider,
and what time frame to analyse. Even after such choices are made, a risk
manager is faced with the considerable tasks of sifting through results and
identifying what implications, if any, the stress test results might have for how
the bank should manage its risk-taking activities.
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A well-understood limitation of stress testing is that there are no probabilities
attached to the outcomes. Stress tests help answer the question “How much
could be lost?” The lack of probability measures exacerbates the issue of
transparency and the seeming arbitrariness of stress test design. Systems
incompatibilities across business units make frequent stress testing costly for
some banks, reflecting the limited role that stress testing had played in
influencing the bank’s prior investments in information technology.
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ANNEXURE – E
ASSET - LIABILITY MANAGEMENT
(ALM) SYSTEM
BP.BC. 8/21.04.098/99 February 10, 1999
To
All Scheduled Commercial Banks
(excluding RRBs)
Dear Sir,
Asset - Liability Management ( ALM ) System
Please refer to our circular DBOD No. BP. BC. 94/21. 04. 098/ 98 dated
September 10, 1998 forwarding therewith draft <strong>Guide</strong>lines for putting in place
Asset-Liability Management (ALM) System in banks. The draft <strong>Guide</strong>lines
have been reviewed by us in the light of the issues raised/suggestions made
by banks in the seminars held at Bankers Training College and also at the
Review Meeting of the Chairmen/Chief Executive Officers of banks. The final
<strong>Guide</strong>lines revised on the basis of the feedback received from banks are
enclosed, for implementation by banks, effective April 1, 1999. In this
connection, we have to advise as under:
2. Banks should give adequate attention to putting in place an effective ALM
System. Banks should set up an internal Asset-Liability Committee (ALCO),
headed by the CEO/CMD or the ED. The Management Committee or any
specific Committee of the Board should oversee the implementation of the
system and review its functioning periodically.
3. Keeping in view the level of computerisation and the current MIS in banks,
adoption of a uniform ALM System for all banks may not be feasible. The
final guidelines have been formulated to serve as a benchmark for those
banks which lack a formal ALM System. Banks which have already adopted

Annexure – E
more sophisticated systems may continue their existing systems but they
should ensure to fine-tune their current information and reporting system so
as to be in line with the ALM System suggested in the <strong>Guide</strong>lines. Other
banks should examine their existing MIS and arrange to have an information
system to meet the prescriptions of the new ALM System. To begin with,
banks should ensure coverage of at least 60% of their liabilities and assets.
As for the remaining 40% of their assets and liabilities, banks may include the
position based on their estimates. It is necessary that banks set targets in the
interim, for covering 100 per cent of their business by April 1, 2000. The MIS
would need to ensure that such minimum information/data consistent in
quality and coverage is captured and once the ALM System stabilises and
banks gain experience, they must be in a position to switch over to more
sophisticated techniques like Duration Gap Analysis, Simulation and Value at
Risk for interest rate risk management.
4. In order to capture the maturity structure of the cash inflows and outflows,
the Statement of Structural Liquidity (Annexure-I) should be prepared, to start
with, as on the last reporting Friday of March/June/ September/December
and put up to ALCO/Top Management within a month from the close of the
last reporting Friday. It is the intention to make the reporting system on a
fortnightly basis by April 1, 2000. The Statement of Structural Liquidity should
be placed before the bank s Board in the next meeting. It would also be
necessary to take into account the rupee inflows and outflows on account of
previously contracted forex transactions (swaps, forwards, etc). Tolerance
levels for various maturities may be fixed by the bank s Top Management
depending on the bank s asset - liability profile, extent of stable deposit base,
the nature of cash flows, etc. In respect of mismatches in cash flows for the
1-14 days bucket and 15-28 days bucket, it should be the endeavour of the
bank s management to keep the cash flow mismatches at the minimum
levels. To start with, the mismatches (negative gap) during 1-14 days and 15-
28 days in normal course may not exceed 20% each of the cash outflows
during these time buckets. If a bank in view of its structural mismatches
needs higher limit, it could operate with higher limit with the approval of its
Board/Management Committee, giving specific reasons on the need for such
higher limit. The objective of RBI is to enforce the tolerance levels strictly
by April 1, 2000.
5. In order to enable the banks to monitor their liquidity on a dynamic basis
over a time horizon spanning from 1-90 days, an indicative format (Annexure
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
III) is enclosed. The statement of Short-term Dynamic Liquidity should be
prepared as on each reporting Friday and put up to the ALCO/Top
Management within 2/3 days from the close of the reporting Friday.
6. We advise that in the Statement of Interest Rate Sensitivity (Annexure - II)
only rupee assets, liabilities and off-balance sheet positions should be
reported. The statement should be prepared as on the last reporting Friday of
March/June/September/December and submitted to the ALCO / Top
Management within a month from the last reporting Friday. It should also be
placed before the bank s Board in the next meeting. The banks are expected
to move over to monthly reporting system by April 1, 2000. The information
collected in the statement would provide useful feedback on the interest rate
risk faced by the bank and the Top Management/Board would have to
formulate corrective measures and devise suitable strategies wherever
needed.
7. The guidelines for ALM cover the banks operations in domestic currency.
In regard to foreign currency risk, banks should follow the instructions
contained in Circular AD (MA Series) No.52 dated December 27, 1997 issued
by the Exchange Control Department.
8. As regards furnishing of data to RBI, a separate communication will follow
from the Department of Banking Supervision.
9. This circular may please be placed before the Board of Directors at its next
meeting
10. Please acknowledge receipt.
Yours faithfully,
(A . Ghosh)
Chief General Manager
Encl: As above
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Annexure – E
Asset - Liability Management (ALM) System in banks - <strong>Guide</strong>lines
In the normal course, banks are exposed to credit and market risks in view of
the asset-liability transformation. With liberalisation in Indian financial
markets over the last few years and growing integration of domestic markets
and with external markets, the risks associated with banks operations have
become complex and large, requiring strategic management. Banks are now
operating in a fairly deregulated environment and are required to determine
on their own, interest rates on deposits and advance in both domestic and
foreign currencies on a dynamic basis. The interest rates on banks
investments in government and other securities are also now market related.
Intense competition for business involving both the assets and liabilities,
together with increasing volatility in the domestic interest rates as well as
foreign exchange rates, has brought pressure on the management of banks
to maintain a good balance among spreads, profitability and long-term
viability. Imprudent liquidity management can put banks earnings and
reputation at great risk. These pressures call for structured and
comprehensive measures and not just ad hoc action. The Management of
banks has to base their business decisions on a dynamic and integrated risk
management system and process, driven by corporate strategy. Banks are
exposed to several major risks in the course of their business - credit risk,
interest rate risk, foreign exchange risk, equity / commodity price risk ,
liquidity risk and operational risk. It is, therefore, important that banks
introduce effective risk management systems that address the issues related
to interest rate, currency and liquidity risks.
Banks need to address these risks in a structured manner by upgrading their
risk management and adopting more comprehensive Asset-Liability
Management (ALM) practices than has been done hitherto. ALM, among
other functions, is also concerned with risk management and provides a
comprehensive and dynamic framework for measuring, monitoring and
managing liquidity, interest rate, foreign exchange and equity and commodity
price risks of a bank that needs to be closely integrated with the banks
business strategy. It involves assessment of various types of risks and
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
altering the asset-liability portfolio in a dynamic way in order to manage risks.
2. This note lays down broad guidelines in respect of interest rate and
liquidity risks management systems in banks which form part of the Asset-
Liability Management (ALM) function. The initial focus of the ALM function
would be to enforce the risk management discipline viz. managing business
after assessing the risks involved. The objective of good risk management
systems should be that these systems will evolve into a strategic tool for
bank management.
3. The ALM process rests on three pillars:
• ALM Information Systems
‣ Management Information Systems
‣ Information availability, accuracy, adequacy and expediency
• ALM Organisation
‣ Structure and responsibilities
‣ Level of top management involvement
• ALM Process
‣ Risk parameters
‣ Risk identification
‣ Risk measurement
‣ Risk management
‣ Risk policies and tolerance levels.
4. ALM Information Systems
ALM has to be supported by a management philosophy which clearly
specifies the risk policies and tolerance limits. This framework needs to be
built on sound methodology with necessary information system as back up.
Thus, information is the key to the ALM process. It is, however, recognised
that varied business profiles of banks in the public and private sector as well
as those of foreign banks do not make the adoption of a uniform ALM System
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Annexure – E
for all banks feasible. There are various methods prevalent world-wide for
measuring risks. These range from the simple Gap Statement to extremely
sophisticated and data intensive Risk Adjusted Profitability Measurement
methods. However, the central element for the entire ALM exercise is the
availability of adequate and accurate information with expedience and the
existing systems in many Indian banks do not generate information in the
manner required for ALM. Collecting accurate data in a timely manner will be
the biggest challenge before the banks, particularly those having wide
network of branches but lacking full scale computerisation. However, the
introduction of base information system for risk measurement and monitoring
has to be addressed urgently. As banks are aware, internationally, regulators
have prescribed or are in the process of prescribing capital adequacy for
market risks. A pre-requisite for this is that banks must have in place an
efficient information system.
Considering the large network of branches and the lack of (an adequate)
support system to collect information required for ALM which analyses
information on the basis of residual maturity and behavioural pattern, it will
take time for banks in the present state to get the requisite information. The
problem of ALM needs to be addressed by following an ABC approach i.e.
analysing the behaviour of asset and liability products in the sample
branches accounting for significant business and then making rational
assumptions about the way in which assets and liabilities would behave in
other branches. In respect of foreign exchange, investment portfolio and
money market operations, in view of the centralised nature of the functions, it
would be much easier to collect reliable information. The data and
assumptions can then be refined over time as the bank management gain
experience of conducting business within an ALM framework. The spread of
computerisation will also help banks in accessing data.
5. ALM Organisation
5.1 a) Successful implementation of the risk management process would
require strong commitment on the part of the senior management in
the bank, to integrate basic operations and strategic decision making
with risk management. The Board should have overall responsibility
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
for management of risks and should decide the risk management
policy of the bank and set limits for liquidity, interest rate, foreign
exchange and equity price risks.
b) The Asset - Liability Committee (ALCO) consisting of the bank's
senior management including CEO should be responsible for ensuring
adherence to the limits set by the Board as well as for deciding the
business strategy of the bank (on the assets and liabilities sides) in
line with the bank s budget and decided risk management objectives.
c) The ALM Support Groups consisting of operating staff should be
responsible for analysing, monitoring and reporting the risk profiles to
the ALCO. The staff should also prepare forecasts (simulations)
showing the effects of various possible changes in market conditions
related to the balance sheet and recommend the action needed to
adhere to bank s internal limits.
5.2 The ALCO is a decision making unit responsible for balance sheet
planning from risk - return perspective including the strategic management of
interest rate and liquidity risks. Each bank will have to decide on the role of
its ALCO, its responsibility as also the decisions to be taken by it. The
business and risk management strategy of the bank should ensure that the
bank operates within the limits / parameters set by the Board. The business
issues that an ALCO would consider, inter alia, will include product pricing for
both deposits and advances, desired maturity profile and mix of the
incremental assets and liabilities, etc. In addition to monitoring the risk levels
of the bank, the ALCO should review the results of and progress in
implementation of the decisions made in the previous meetings. The ALCO
would also articulate the current interest rate view of the bank and base its
decisions for future business strategy on this view. In respect of the funding
policy, for instance, its responsibility would be to decide on source and mix of
liabilities or sale of assets. Towards this end, it will have to develop a view on
future direction of interest rate movements and decide on funding mixes
between fixed vs floating rate funds, wholesale vs retail deposits, money
market vs capital market funding , domestic vs foreign currency funding, etc.
Individual banks will have to decide the frequency for holding their ALCO
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Annexure – E
meetings.
5.3 Composition of ALCO
The size (number of members) of ALCO would depend on the size of each
institution, business mix and organisational complexity. To ensure
commitment of the Top Management and timely response to market
dynamics, the CEO/CMD or the ED should head the Committee. The Chiefs
of Investment, Credit, Resources Management or Planning, Funds
Management / Treasury (forex and domestic), International Banking and
Economic Research can be members of the Committee. In addition, the Head
of the Technology Division should also be an invitee for building up of MIS
and related computerisation. Some banks may even have Sub-committees
and Support Groups.
5.4 Committee of Directors
The Management Committee of the Board or any other Specific Committee
constituted by the Board should oversee the implementation of the system
and review its functioning periodically.
5.5 ALM Process:
The scope of ALM function can be described as follows:
• Liquidity risk management
• Management of market risks
• Trading risk management
• Funding and capital planning
• Profit planning and growth projection
The guidelines given in this note mainly address Liquidity and Interest Rate
risks.
6. Liquidity Risk Management
6.1 Measuring and managing liquidity needs are vital for effective operation
of commercial banks. By assuring a bank s ability to meet its liabilities as
they become due, liquidity management can reduce the probability of an
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
adverse situation developing. The importance of liquidity transcends
individual institutions, as liquidity shortfall in one institution can have
repercussions on the entire system. Banks management should measure not
only the liquidity positions of banks on an ongoing basis but also examine
how liquidity requirements are likely to evolve under different assumptions.
Experience shows that assets commonly considered as liquid like
Government securities and other money market instruments could also
become illiquid when the market and players are unidirectional. Therefore
liquidity has to be tracked through maturity or cash flow mismatches. For
measuring and managing net funding requirements, the use of a maturity
ladder and calculation of cumulative surplus or deficit of funds at selected
maturity dates is adopted as a standard tool. The format of the Statement of
Structural Liquidity is given in Annexure I.
6.2 The Maturity Profile as given in Appendix I could be used for measuring
the future cash flows of banks in different time buckets. The time buckets,
given the Statutory Reserve cycle of 14 days may be distributed as under:
i) 1 to 14 days
ii) 15 to 28 days
iii) 29 days and upto 3 months
iv) Over 3 months and upto 6 months
v) Over 6 months and upto 1 year
vi) Over 1 year and upto 3 years
vii) Over 3 years and upto 5 years
viii) Over 5 years
6.3 The investments in SLR securities and other investments are assumed as
illiquid due to lack of depth in the secondary market and are therefore
required to be shown under respective maturity buckets, corresponding to the
residual maturity. However, some of the banks may be maintaining securities
in the Trading Book , which are kept distinct from other investments made for
complying with the Statutory Reserve requirements and for retaining
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relationship with customers. Securities held in the Trading Book are subject
to certain preconditions like :
i) The composition and volume are clearly defined;
ii) Maximum maturity/duration of the portfolio is restricted;
iii) The holding period not to exceed 90 days;
iv) Cut-loss limit prescribed;
v) Defeasance periods (product-wise) i.e. times taken to liquidate the position
on the basis of liquidity in the secondary market are prescribed;
vi) Marking to market on a daily/weekly basis and the revaluation gain/loss
charged to the profit and loss account; etc.
Banks which maintain such Trading Books and complying with the above
standards are permitted to show the trading securities under 1-14 days, 15-
28 days and 29-90 days buckets on the basis of the defeasance periods. The
Board/ALCO of the banks should approve the volume, composition,
holding/defeasance period, cut loss, etc. of the Trading Book and copy of the
policy note thereon should be forwarded to the Department of Banking
Supervision, RBI.
6.4 Within each time bucket there could be mismatches depending on cash
inflows and outflows. While the mismatches upto one year would be relevant
since these provide early warning signals of impending liquidity problems, the
main focus should be on the short-term mismatches viz., 1- 14 days and 15-
28 days. Banks, however, are expected to monitor their cumulative
mismatches (running total) across all time buckets by establishing internal
prudential limits with the approval of the Board / Management Committee.
The mismatches (negative gap) during 1-14 days and 15-28 days in normal
course may not exceed 20% of the cash outflows in each time bucket. If a
bank in view of its current asset -liability profile and the consequential
structural mismatches needs higher tolerance level, it could operate with
higher limit sanctioned by its Board / Management Committee giving specific
reasons on the need for such higher limit. The discretion to allow a higher
tolerance level is intended for a temporary period, i.e. till March 31, 2000.
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
6.5 The Statement of Structural Liquidity ( Annexure I ) may be prepared by
placing all cash inflows and outflows in the maturity ladder according to the
expected timing of cash flows. A maturing liability will be a cash outflow while
a maturing asset will be a cash inflow. It would also be necessary to take into
account the rupee inflows and outflows on account of forex operations. While
determining the likely cash inflows / outflows, banks have to make a number
of assumptions according to their asset - liability profiles. For instance, Indian
banks with large branch network can (on the stability of their deposit base as
most deposits are rolled-over) afford to have larger tolerance levels in
mismatches in the long-term if their term deposit base is quite high. While
determining the tolerance levels the banks may take into account all relevant
factors based on their asset-liability base, nature of business, future strategy,
etc. The RBI is interested in ensuring that the tolerance levels are determined
keeping all necessary factors in view and further refined with experience
gained in Liquidity Management.
6.6 In order to enable the banks to monitor their short-term liquidity on a
dynamic basis over a time horizon spanning from 1-90 days, banks may
estimate their short-term liquidity profiles on the basis of business projections
and other commitments for planning purposes. An indicative format
(Annexure III) for estimating Short-term Dynamic Liquidity is enclosed.
7. Currency Risk
7.1 Floating exchange rate arrangement has brought in its wake pronounced
volatility adding a new dimension to the risk profile of banks balance sheets.
The increased capital flows across free economies following deregulation
have contributed to increase in the volume of transactions. Large cross
border flows together with the volatility has rendered the banks balance
sheets vulnerable to exchange rate movements.
7.2 Dealing in different currencies brings opportunities as also risks. If the
liabilities in one currency exceed the level of assets in the same currency,
then the currency mismatch can add value or erode value depending upon
the currency movements. The simplest way to avoid currency risk is to
ensure that mismatches, if any, are reduced to zero or near zero. Banks
undertake operations in foreign exchange like accepting deposits, making
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Annexure – E
loans and advances and quoting prices for foreign exchange transactions.
Irrespective of the strategies adopted, it may not be possible to eliminate
currency mismatches altogether. Besides, some of the institutions may take
proprietary trading positions as a conscious business strategy.
7.3 Managing Currency Risk is one more dimension of Asset- Liability
Management. Mismatched currency position besides exposing the balance
sheet to movements in exchange rate also exposes it to country risk and
settlement risk. Ever since the RBI (Exchange Control Department)
introduced the concept of end of the day near square position in 1978, banks
have been setting up overnight limits and selectively undertaking active day
time trading. Following the introduction of <strong>Guide</strong>lines for Internal Control over
Foreign Exchange Business in 1981, maturity mismatches (gaps) are also
subject to control. Following the recommendations of Expert Group on
Foreign Exchange Markets in India (Sodhani Committee) the calculation of
exchange position has been redefined and banks have been given the
discretion to set up overnight limits linked to maintenance of capital to Risk-
Weighted Assets Ratio of 8% of open position limit.
7.4 Presently, the banks are also free to set gap limits with RBI s approval
but are required to adopt Value at Risk (VaR) approach to measure the risk
associated with forward exposures. Thus the open position limits together
with the gap limits form the risk management approach to forex operations.
For monitoring such risks banks should follow the instructions contained in
Circular A.D (M. A. Series) No.52 dated December 27, 1997 issued by the
Exchange Control Department.
8. Interest Rate Risk (IRR)
8.1 The phased deregulation of interest rates and the operational flexibility
given to banks in pricing most of the assets and liabilities imply the need for
the banking system to hedge the Interest Rate Risk. Interest rate risk is the
risk where changes in market interest rates might adversely affect a bank s
financial condition. The changes in interest rates affect banks in a larger way.
The immediate impact of changes in interest rates is on bank s earnings (i.e.
reported profits) by changing its Net Interest Income (NII). A long-term impact
of changing interest rates is on bank s Market Value of Equity (MVE) or Net
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
Worth as the economic value of bank s assets, liabilities and off-balance
sheet positions get affected due to variation in market interest rates. The
interest rate risk when viewed from these two perspectives is known as
earnings perspective and economic value perspective, respectively. The risk
from the earnings perspective can be measured as changes in the Net
Interest Income (NII) or Net Interest Margin (NIM). There are many analytical
techniques for measurement and management of Interest Rate Risk. In the
context of poor MIS, slow pace of computerisation in banks and the absence
of total deregulation, the traditional Gap analysis is considered as a suitable
method to measure the Interest Rate Risk in the first place. It is the intention
of RBI to move over to the modern techniques of Interest Rate Risk
measurement like Duration Gap Analysis, Simulation and Value at Risk over
time when banks acquire sufficient expertise and sophistication in acquiring
and handling MIS.
The Gap or Mismatch risk can be measured by calculating Gaps over
different time intervals as at a given date. Gap analysis measures
mismatches between rate sensitive liabilities and rate sensitive assets
(including off-balance sheet positions). An asset or liability is normally
classified as rate sensitive if:
i) within the time interval under consideration, there is a cash flow;
ii) the interest rate resets/reprices contractually during the interval;
iii) RBI changes the interest rates (i.e. interest rates on Savings Bank
Deposits, DRI advances, Export credit, Refinance, CRR balance, etc.)
in cases where interest rates are administered ; and
iv) it is contractually pre-payable or withdrawal before the stated maturities.
8.2 The Gap Report should be generated by grouping rate sensitive liabilities,
assets and off-balance sheet positions into time buckets according to
residual maturity or next repricing period, whichever is earlier. The difficult
task in Gap analysis is determining rate sensitivity. All investments,
advances, deposits, borrowings, purchased funds, etc. that mature/reprice
within a specified timeframe are interest rate sensitive. Similarly, any
principal repayment of loan is also rate sensitive if the bank expects to
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Annexure – E
receive it within the time horizon. This includes final principal payment and
interim instalments. Certain assets and liabilities receive/pay rates that vary
with a reference rate. These assets and liabilities are repriced at predetermined
intervals and are rate sensitive at the time of repricing. While the
interest rates on term deposits are fixed during their currency, the advances
portfolio of the banking system is basically floating. The interest rates on
advances could be repriced any number of occasions, corresponding to the
changes in PLR.
The Gaps may be identified in the following time buckets:
i) 1-28 days
ii 29 days and upto 3 months
iii) Over 3 months and upto 6 months
iv) Over 6 months and upto 1 year
v) Over 1 year and upto 3 years
vi) Over 3 years and upto 5 years
vii) Over 5 years
viii) Non-sensitive
The various items of rate sensitive assets and liabilities and off-balance
sheet items may be classified as explained in Appendix - II and the Reporting
Format for interest rate sensitive assets and liabilities is given in Annexure II.
8.3 The Gap is the difference between Rate Sensitive Assets (RSA) and Rate
Sensitive Liabilities (RSL) for each time bucket. The positive Gap indicates
that it has more RSAs than RSLs whereas the negative Gap indicates that it
has more RSLs. The Gap reports indicate whether the institution is in a
position to benefit from rising interest rates by having a positive Gap (RSA >
RSL) or whether it is in a position to benefit from declining interest rates by a
negative Gap (RSL > RSA). The Gap can, therefore, be used as a measure
of interest rate sensitivity.
8.4 Each bank should set prudential limits on individual Gaps with the
approval of the Board/Management Committee. The prudential limits should
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
have a bearing on the Total Assets, Earning Assets or Equity. The banks
may work out Earnings at Risk (EaR) or Net Interest Margin (NIM) based
on their views on interest rate movements and fix a prudent level with the
approval of the Board/Management Committee.
8.5 RBI will also introduce capital adequacy for market risks in due course.
9. General
9.1 The classification of various components of assets and liabilities into
different time buckets for preparation of Gap reports (Liquidity and Interest
Rate Sensitivity) as indicated in Appendices I & II is the benchmark. Banks
which are better equipped to reasonably estimate the behavioural pattern,
embedded options, rolls-in and rolls-out, etc of various components of assets
and liabilities on the basis of past data / empirical studies could classify them
in the appropriate time buckets, subject to approval from the ALCO / Board.
A copy of the note approved by the ALCO / Board may be sent to the
Department of Banking Supervision.
9.2 The present framework does not capture the impact of embedded
options, i.e. the customers exercising their options (premature closure of
deposits and prepayment of loans and advances) on the liquidity and interest
rate risks profile of banks. The magnitude of embedded option risk at times of
volatility in market interest rates is quite substantial. Banks should therefore
evolve suitable mechanism, supported by empirical studies and behavioural
analysis to estimate the future behaviour of assets, liabilities and off-balance
sheet items to changes in market variables and estimate the embedded
options.
9.3 A scientifically evolved internal transfer pricing model by assigning values
on the basis of current market rates to funds provided and funds used is an
important component for effective implementation of ALM System. The transfer
price mechanism can enhance the management of margin i.e. lending or credit
spread, the funding or liability spread and mismatch spread. It also helps
centralising interest rate risk at one place which facilitates effective control and
management of interest rate risk. A well defined transfer pricing system also
provides a rational framework for pricing of assets and liabilities.
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Maturity Profile Liquidity
Heads of Accounts
A. Outflows
1. Capital, Reserves and
Surplus
2. Demand Deposits
(Current and Savings Bank
and Current Deposits
APPENDIX I
Classification into time buckets
Over 5 years bucket.
Savings may be Bank Deposits)
classified into volatile and core
portions. Savings Bank (10%) and
Current (15%) Deposits are generally
withdrawable on demand. This portion
may be treated as volatile. While
volatile portion can be placed in the first
time bucket i.e., 1-14 days, the core
portion may be placed in over 1- 3
years bucket.
The above classification of Savings
Bank and Current Deposits is only a
benchmark. Banks which are better
equipped to estimate the behavioural
pattern, roll-in and roll-out, embedded
options, etc. on the basis of past
data/empirical studies could classify
them in the appropriate buckets, i.e.
behavioural maturity instead of
contractual maturity, subject to the
approval of the Board/ALCO.
3. Term Deposits Respective maturity buckets. Banks
which are better equipped to estimate
the behavioural pattern, roll-in and rollout,
embedded options, etc. on the
basis of past data/empirical studies
could classify the retail deposits in the
appropriate buckets on the basis of
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
4. Certificates of Deposit,
Borrowings and Bonds
(including Sub-ordinated
Debt)
5. Other Liabilities and Provisions
behavioural maturity rather than
residual maturity. However, the
wholesale deposits should be shown
under respective maturity buckets.
Respective maturity buckets. Where
call/put options are built into the issue
structure of any instrument/s, the
call/put date/s should be reckoned as
the maturity date/s and the amount
should be shown in the respective time
buckets.
i) Bills Payable The core component which could
reasonably be estimated on the basis of
past data and behavioural pattern may
be shown under over 1-3 years time
bucket. The balance amount may be
placed in 1-14 days bucket.
ii) Inter-office Adjustment
iii) Provisions other than for
loan loss and depreciation in
investments
iv) Other Liabilities
6. Export Refinance –
Availed
B. Inflows
1. Cash 1-14 days bucket.
The net credit balance may be shown in
1-14 days bucket.
Respective buckets depending on the
purpose.
Respective maturity buckets. Items not
representing cash payables (i.e. income
received in advance, etc.) may be
placed in over 5 years bucket.
Respective maturity buckets of
underlying assets.
2. Balances with RBI While the excess balance over the
required CRR/SLR may be shown
under 1-14 days bucket, the Statutory
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Annexure – E
3. Balances with other Banks
(i) Current Account
(ii) Money at Call and Short
Notice, Term Deposits and
other placements
Balances may be distributed amongst
various time buckets corresponding to
the maturity profile of DTL with a timelag
of 14 days.
(i) Non-withdrawable portion on account
of stipulations of minimum balances
may be shown under over 1-3 years
bucket and the remaining balances may
be shown under 1-14 days bucket..
(ii) Respective maturity buckets
4. Investments (Net of provisions) #
(i) Approved securities i) Respective maturity buckets
excluding the amount required to be
reinvested to maintain SLR
corresponding to the DTL profile in
various time buckets.
(ii) Corporate debentures
and bonds, PSU bonds, CDs
and CPs, Redeemable
preference shares, Units of
Mutual Fund (close ended),
etc.
(iii) Shares/Units of Mutual
Funds (open ended)
(iv) Investments in
Subsidiaries/ Joint Ventures
ii) Respective maturity buckets.
Investments classified as NPAs should
be shown under over 3-5 years bucket
(sub-standard) or over 5 years bucket
(doubtful).
(iii) Over 5 years bucket.
(iv) Over 5 years bucket.
# Provisions may be netted from the gross investments provided provisions
are held security-wise. Otherwise provisions should be shown in over 5
years bucket.
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
(v) Securities in the Trading
Book
5. Advances (Performing)
(i) Bills Purchased and
Discounted (including bills
under DUPN)
(ii) Cash Credit / Overdraft
(including TOD) and
Demand Loan component of
Working Capital.
(iii) Term Loans
(v) 1-14 days, 15-28 days and 29-90
days according to defeasance periods.
(i) Respective maturity buckets.
(ii) Banks should undertake a study
behavioural and seasonal pattern of
availments based on outstandings and
the core and volatile portion should be
identified. While the volatile portion
could be shown in the near-term
maturity buckets, the core portion may
be shown under over 1-3 years bucket.
(iii) Interim cash flows may be shown
under respective maturity buckets.
6. NPAs (Net of provisions, interest suspense and claims received from
ECGC/DICGC )
(i) Sub-standard
(i) Over 3-5 years bucket.
(ii) Doubtful and Loss
(ii) Over 5 years bucket.
7. Fixed Assets Over 5 years bucket
8. Other Assets
(i) Inter-office Adjustment The net debit balance may be shown in
1-14 days bucket. Intangible assets and
assets not representing cash
receivables may be shown in over 5
years bucket.
(ii) Leased Assets
Interim cash flows may be shown under
respective maturity buckets.
C. Contingent Liabilities / Lines of Credit committed / available and
other Inflows / Outflows
1. (i) Lines of Credit
committed to/ from
Institutions
(i) 1-14 days bucket.
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Annexure – E
(ii) Unavailed portion of
Cash Credit/Overdraft/
Demand loan component of
Working Capital limits
(outflow)
(iii) Export Refinance –
Unavailed (inflows)
2. Letters of Credit /
Guarantees (outflow)
3. Repos / Bills
Rediscounted (DUPN) /
Swaps INR / USD, maturing
forex forward contracts etc.
(outflow / inflow)
4. Interest payable /
receivable (outflow/inflow)
Accrued interest which are
appearing in the books on
the reporting day
(ii) Banks should undertake a study of
the behavioural and seasonal pattern of
potential availments in the accounts
and the amounts so arrived at may be
shown under relevant maturity buckets
upto 12 months.
(iii) 1-14 days bucket.
Devolvement of Letters of Credit/
Guarantees, initially entails cash
outflows. Thus, historical trend analysis
ought to be conducted on the
devolvements and the amounts so
arrived at in respect of outstanding
Letters of Credit / Guarantees (net of
margins) should be distributed amongst
various time buckets. The assets
created out of devolvements may be
shown under respective maturity
buckets on the basis of probable
recovery dates.
Respective maturity buckets.
Respective maturity buckets.
Note :
i. Liability on account of event cash flows i.e. short fall in CRR balance on
reporting Fridays, wage settlement, capital expenditure, etc. which are
known to the banks and any other contingency may be shown under
respective maturity buckets.
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
ii.
All overdue liabilities may be placed in the 1-14 days bucket.
iii. Interest and instalments from advances and investments, which are
overdue for less than one month may be placed in over 3-6 months,
bucket. Further, interest and instalments due (before classification as
NPAs) may be placed in over 6-12 months bucket without the grace
period of one month if the earlier receivables remain uncollected.
D. Financing of Gap :
In case the negative gap exceeds the prudential limit of 20% of outflows, (1-
14 days and 15-28 days) the bank may show by way of a foot note as to how
it proposes to finance the gap to bring the mismatch within the prescribed
limits. The gap can be financed from market borrowings (call / term), Bills
Rediscounting, Repos and deployment of foreign currency resources after
conversion into rupees ( unswapped foreign currency funds ), etc.
# Provisions may be netted from the gross investments provided provisions
are held security-wise. Otherwise provisions should be shown in over 5
years bucket.
Interest Rate Sensitivity
Heads of Accounts
Liabilities
1. Capital, Reserves and
Surplus
APPENDIX - II
Rate sensitivity and time bucket
Non-sensitive.
2. Current Deposits Non-sensitive.
3. Savings Bank Deposits Sensitive to the extent of interest
paying (core) portion. This may be
included in over 3-6 months bucket.
The non-interest paying portion may
be shown in non-sensitive bucket.
Where banks can estimate the future
behaviour/sensitivity of current/savings
bank deposits to changes in market
182

4. Term Deposits and
Certificates of Deposit
Annexure – E
variables, the sensitivity so estimated
could be shown under appropriate time
buckets.
Sensitive and reprices on maturity.
The amounts should be distributed to
different buckets on the basis of
remaining term to maturity. However,
in case of floating rate term deposits,
the amounts may be shown under the
time bucket when deposits
contractually become due for repricing.
5. Borrowings – Fixed Sensitive and reprices on maturity.
The amounts should be distributed to
different buckets on the basis of
remaining maturity.
6. Borrowings – Floating Sensitive and reprices when interest
rate is reset. The amounts should be
distributed to the appropriate bucket
which refers to the repricing date.
7. Borrowings – Zero Coupon Sensitive and reprices on maturity.
The amounts should be distributed to
the respective maturity buckets.
8. Borrowings from RBI Upto 1 month bucket.
9. Refinances from other
agencies.
10. Other Liabilities and Provisions
i) Bills Payable i) Non-sensitive.
ii) Inter-office Adjustment
iii) Provisions
iv) Others
(a) Fixed rate : As per respective
maturity.
(b) Floating rate : Reprices when
interest rate is reset.
ii) Non-sensitive.
iii) Non-sensitive.
iv) Non-sensitive.
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
11. Repos / Bills Rediscounted
(DUPN), Swaps
(Buy / Sell) etc.
Assets
Reprices only on maturity and should
be distributed to the respective
maturity buckets.
1. Cash Non - sensitive.
2. Balances with RBI Interest earning portion may be shown
in over 3 – 6 months bucket. The
balance amount is non-sensitive.
3. Balances with other Banks
i) Current Account i) Non-sensitive.
ii) Money at Call and Short
Notice, Term Deposits and
Notice, Term Deposits and
4. Investments (Performing).
ii) Sensitive on maturity. The amounts
should be distributed other placements
to the respective maturity buckets.
i) Fixed Rate / Zero Coupon i) Sensitive on maturity.
ii) Floating Rate
ii) Sensitive at the next repricing date
5. Shares/Units of Mutual Non-sensitive.
Funds
6. Advances (Performing)
(i) Bills Purchased and (i) Sensitive on maturity.
Discounted (including bills
under DUPN)
(ii) Cash Credits / Overdrafts
(including TODs) / Loans
repayable on demand and
Term Loans
(ii) Sensitive only when PLR/risk
premium is changed. Of late, frequent
changes in PLR have been noticed.
Thus, each bank should foresee the
direction of interest rate movements of
funding options and capture the
amounts in the respective maturity
buckets which coincides with the time
taken by banks to effect changes in
PLR in response to changes in market
interest rates.
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Annexure – E
7. NPAs (Advances and Investments) *
(i) Sub-Standard
(ii) Doubtful and Loss
(i) Over 3-5 years bucket.
(ii) Over 5 years bucket.
8. Fixed Assets Non-sensitive.
9. Other Assets.
(i) Inter-office Adjustment
(ii) Leased Assets
(iii) Others
10. Reverse Repos, Swaps
(Sell/Buy) and Bills
Rediscounted (DUPN)
11. Other products (Interest Rate)
(i) Swaps
(ii) Other Derivatives
(i) Non-sensitive.
(ii) Sensitive on cash flows. The
amounts should be distributed to the
respective maturity buckets
corresponding to the cash flow dates.
(iii) Non-sensitive.
Sensitive on maturity.
(i) Sensitive and should be distributed
under different buckets with reference
to maturity.
(ii) Should be suitably classified as and
when introduced.
• Amounts to be shown net of provisions, interest suspense and claims
received from ECGC / DICGC.
185

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
ANNEXURE - I
Name of the bank :
Statement of Structural Liquidity as on :
(Amounts in Crores of Rupees)
OUTFLOWS
1 to
14
days
15 to
28
days
1.Capital
2.Reserves & Surplus
29
days
and
upto 3
months
RESIDUAL MATURITY
Over 3
months
and
upto 6
onths
Over 6 Over 1
Months year
and and
upto 1 upto 3
year years
Over 3
years
and
upto 5
years
Over
5
years
Total
3.Deposits XXX XXX XXX XXX XXX XXX XXX XXX XXX
(i) Current Deposits
(ii) Savings Bank
Deposits
(iii) Term Deposits
(iv) Certificates of
Deposit
4.Borrowings XXX XXX XXX XXX XXX XXX XXX XXX XXX
(i) Call and Short
Notice
(ii) Inter-Bank (Term)
(iii) Refinances
(iv) Others (specify)
5.Other Liabilities & XXX XXX XXX XXX XXX XXX XXX XXX XXX
Provisions
(i) Bills Payable
(ii) Inter-office
Adjustment
(iii) Provisions
186

Annexure – E
(iv) Others
6.Lines of Credit
committed to
XXX XXX XXX XXX XXX XXX XXX XXX XXX
(i) Institutions
(ii) Customers
7. Unavailed portion
of Cash Credit /
Overdraft / Demand
Loan component of
Working Capital
8. Letters of Credit /
Guarantees
9.Repos
10. Bills Rediscounted
(DUPN)
11.Swaps (Buy/Sell) /
maturing forwards
12. Interest payable
13.Others (specify)
A. TOTAL
OUTFLOWS
INFLOWS
1.Cash
2.Balances with RBI
3.Balances with other
Banks
XXX XXX XXX XXX XXX XXX XXX XXX XXX
(i) Current Account
(ii) Money at Call and
Short Notice, Term
Deposits and other
placements
187

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
4.Investments
(including those under
Repos but excluding
Reverse Repos)
5.Advances
(Performing)
XXX XXX XXX XXX XXX XXX XXX XXX XXX
(i) Bills Purchased
and Discounted
(including bills
under DUPN)
(ii) Cash Credits,
Overdrafts and
Loans repayable
on demand
(iii) Term Loans
6. NPAs (Advances
and Investments)*
7. Fixed Assets
8. Other Assets XXX XXX XXX XXX XXX XXX XXX XXX XXX
(i) Inter-office
Adjustment
ii) Leased Assets
(iii) Others
9. Reverse Repos
10. Swaps (Sell /
Buy)/ maturing
forwards
11. Bills discounted
(DUPN)
12. Interest receivable
13. Committed Lines
of Credit
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Annexure – E
14. Export Refinance
from RBI.
15. Others (specify)
B. TOTAL INFLOWS
C. MISMATCH (B-A)
D. CUMULATIVE
MISMATCH
E. C as % To A
* Net of provisions, interest suspense and claims received from
ECGC/DICGC.
189

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
ANNEXURE - II
Name of the bank:
Statement of Interest Rate Sensitivity as on:
(Amounts in Crores of Rupees)
LIABILITIES
1-28
days
29 days
and
upto 3
months
Over 3
months
and
upto 6
months
Over 6
months
and
upto 1
year
Over 1
year
and
upto 3
years
Over 3
Years
And
Upto 5
Years
Over
5
years
Nonsensitive
Total
1. Capital
2. Reserves &
Surplus
3. Deposits XXX XXX XXX XXX XXX XXX XXX XXX XXX
(i) Current Deposits
(ii) Savings Bank
Deposits
(iii) Term Deposits
(iv) Certificates of
Deposit
4. Borrowings XXX XXX XXX XXX XXX XXX XXX XXX XXX
(i) Call and Short
Notice
(ii) Inter-Bank(Term)
(iii) Refinances
(iv) Others (specify)
5. Other Liabilities &
Provisions
XXX XXX XXX XXX XXX XXX XXX XXX XXX
(i) Bills Payable
(ii) Inter-office
190

Annexure – E
Adjustment
(iii) Provisions *
(iv) Others
6. Repos
7. Bills Re
discounted (DUPN)
8. Swaps (Buy/Sell)
9. Others (specify)
A. TOTAL
LIABILITIES
* Excluding provisions for NPAs and investments.
ASSETS
1.Cash
2.Balances with RBI
3.Balances with other
Banks
(i) Current Account
(ii) Money at Call and
Short Notice, Term
Deposits and other
placements.
4.Investments
(including those under
Repos but excluding
Reverse Repos)
5.Advances
(Performing)
(i) Bills Purchased
and Discounted
(including bills under
DUPN)
(ii) Cash Credits,
Overdrafts and Loans
XXX XXX XXX XXX XXX XXX XXX XXX XXX
XXX XXX XXX XXX XXX XXX XXX XXX XXX
191

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
repayable on demand
(iii) Term Loans
6. NPAs (Advances
and Investments) *
7. Fixed Assets
8. Other Assets XXX XXX XXX XXX XXX XXX XXX XXX XXX
(i)Inter-office
Adjustment
(ii) Leased Assets
(iii) Others
9. Reverse Repos
10. Swaps (Sell/ Buy)
11.Bills Rediscounted
(DUPN)
12. Others (specify)
B. TOTAL ASSETS
C. GAP ( B-A )
OTHER PRODUCTS
(INTEREST RATE)
(i) FRAs
(ii) Swaps
(iii) Futures
(iv) Options
(v) Others
D. TOTAL OTHER
PRODUCTS
E.NET GAP (C-D)
F.CUMULATIVE GAP
G. E AS % TO B
XXX XXX XXX XXX XXX XXX XXX XXX XXX
* Amounts to be shown net of provisions, interest suspense and claims
received from ECGC/DICGC.
192

Annexure – E
ANNEXURE - III
Name of the Bank :
Statement of Short-term Dynamic Liquidity as on ..
A. Outflows
1 Net increase in loans and advances
2 Net increase in investments:
i) Approved securities
ii) Money market instruments (other than
Treasury bills)
iii) Bonds/Debentures /shares
iv) Others
3 Inter-bank obligations
4 Off-balance sheet items (Repos, swaps, bills
discounted, etc.)
5 Others
TOTAL OUTFLOWS
B. Inflows
1 Net cash position
2 Net increase in deposits (less CRR obligations)
3 Interest on investments
4 Inter-bank claims
5 Refinance eligibility (Export credit)
6 Off-balance sheet items (Reverse repos, swaps,
bills discounted, etc.)
7 Others
TOTAL INFLOWS
C. Mismatch (B - A)
D. Cumulative mismatch
E. C as a % to total outflows
(Amounts in Crores of Rupees)
1- 14 days 15-28 days 29-90 days
193

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
RBI/2007-2008/165
DBOD. No. BP. BC. 38 / 21.04.098/ 2007-08 October 24, 2007
Chairmen / Chief Executive Officers
All Commercial Banks
(excluding RRBs)
<strong>Guide</strong>lines on Asset-Liability Management (ALM) System –amendments
Reserve Bank had issued guidelines on ALM system vide Circular No. DBOD.
BP. BC. 8 / 21.04.098/ 99 dated February 10, 1999, which covered, among
others, interest rate risk and liquidity risk measurement / reporting framework and
prudential limits. As a measure of liquidity management, banks are required to
monitor their cumulative mismatches across all time buckets in their Statement of
Structural Liquidity by establishing internal prudential limits with the approval of
the Board / Management Committee. As per the guidelines, the mismatches
(negative gap) during the time buckets of 1-14 days and 15-28 days in the
normal course, are not to exceed 20 per cent of the cash outflows in the
respective time buckets.
2. Having regard to the international practices, the level of sophistication of banks
in India and the need for a sharper assessment of the efficacy of liquidity
management, these guidelines have been reviewed and it has been decided that:
(a) the banks may adopt a more granular approach to measurement of liquidity
risk by splitting the first time bucket (1-14 days at present) in the
Statement of Structural Liquidity into three time buckets viz. Next day , 2-7
days and 8-14 days.
(b) the Statement of Structural Liquidity may be compiled on best available data
coverage, in due consideration of non-availability of a fully networked
environment. Banks may, however, make concerted and requisite efforts
to ensure coverage of 100 per cent data in a timely manner.
(c) the net cumulative negative mismatches during the Next day, 2-7 days, 8-14
days and 15-28 days buckets should not exceed 5 % ,10%, 15 % and 20
194

Annexure – E
% of the cumulative cash outflows in the respective time buckets in order
to recognise the cumulative impact on liquidity.
(d) banks may undertake dynamic liquidity management and should prepare the
Statement of Structural Liquidity on daily basis. The Statement of
Structural Liquidity, may, however, be reported to RBI, once a month, as
on the third Wednesday of every month.
3. The format of Statement of Structural Liquidity has been revised suitably and
is furnished at Annex I. The guidance for slotting the future cash flows of banks in
the revised time buckets has also been suitably modified and is furnished at
Annex II. The format of the Statement of Short-term Dynamic Liquidity may also
be amended on the above lines.
4. To enable the banks to fine tune their existing MIS as per the modified
guidelines, the revised norms as well as the supervisory reporting as per the
revised format would commence with effect from the period beginning January 1,
2008 and the reporting frequency would continue to be monthly for the present.
However, the frequency of supervisory reporting of the Structural Liquidity
position shall be fortnightly, with effect from the fortnight beginning April 1, 2008.
Yours faithfully,
(Prashant Saran)
Chief General Manager-in-Charge
195

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
Annex - I
Name of the bank :
Statement of Structural Liquidity as on :
(Amounts in Crores of Rupees)
Residual maturity
OUTFLOWS
Day
2-7
8-14
15 -28
29
Over 3
Over 6
Over 1
Over 3
Over
Total
1
day s
day s
days
days
months
Month
year
years
5
and
and
and
and
and
years
upto 3
upto 6
upto 1
upto 3
upto 5
months
months
year
years
years
1. Capital
2. Reserves &
Surplus
3. Deposits XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX
(i) Current Deposits
(ii) Savings Bank
Deposits
(iii) Term Deposits
(iv) Certificates of
Deposit
4. Borrowings XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX
(i) Call and Short
Notice
(ii) Inter-Bank (Term)
(iii) Refinances
(iv) Others (specify)
5.Other Liabilities &
Provisions
XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX
(i) Bills Payable
196

Annexure – E
(ii) Provisions
(iii) Others
6. Lines of Credit
committed to
XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX
(i) Institutions
(ii) Customers
7. Unavailed portion
of Cash Credit /
Overdraft / Demand
Loan component of
Working Capital
8. Letters of Credit /
Guarantees
9. Repos
10. Bills Rediscounted
(DUPN)
11.Swaps (Buy/Sell) /
maturing forwards
12. Interest payable
13. Others (specify)
A. TOTAL
OUTFLOWS
B. CUMULATIVE
OUTFLOWS
197

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
Residual Maturity
INFLOWS Day 1
2-7
days
8-14
days
15 -28
days
Over 3 Over 6
29 days
months months
and
and and
upto 3
upto 6 upto
months
months 1year
Over 1
year
and
upto
3years
Over 3
years
and
upto 5
years
Over
5
years
Total
1. Cash
2. Balances with RBI
3.Balances with other
Banks
XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX
(i) Current Account
(ii) Money at Call and
Short Notice, Term
Deposits and other
placements
4.Investments
(including those
under Repos but
excluding Reverse
Repos)
5. Advances
(Performing)
XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX
(i) Bills Purchased
and Discounted
(including bills under
DUPN)
(ii) Cash Credits,
Overdrafts and Loans
repayable on
demand
(iii) Term Loans
6. NPAs (Advances
198

Annexure – E
and Investments) *
7. Fixed Assets
8. Other Assets XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX
(i) Leased Assets
(ii) Others
9. Reverse Repos
10. Swaps (Sell /
Buy)/ maturing
forwards
11.Bills Rediscounted
(DUPN)
12. Interest
receivable
13. Committed Lines
of Credit
14. Export Refinance
from RBI.
15. Others (specify)
C. TOTAL INFLOWS
D. MISMATCH( C-A )
E. MISMATCH as %
to OUTFLOWS
(D as % to A)
F. CUMULATIVE
MISMATCH
G. CUMULATIVE
MISMATCH as a %
to CUMULATIVE
OUTFLOWS ( F as a
% to B)
199

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
Annex - II
Guidance for slotting the future cash flows of banks in the revised
time buckets
Heads of Accounts
Classification into time buckets
A. Outflows
1. Capital, Reserves and
Surplus
Over 5 years bucket.
2. Demand Deposits
(Current and Savings Bank
Deposits)
Savings Bank and Current Deposits may be classified into volatile
and core portions. Savings Bank (10%) and Current (15%) Deposits
are generally withdrawable on demand. This portion may be treated
as volatile. While volatile portion can be placed in the Day 1, 2-7
days and 8-14 days time buckets, depending upon the experience
and estimates of banks and the core portion may be placed in over
1- 3 years bucket.
The above classification of Savings Bank and Current Deposits is
only a benchmark. Banks which are better equipped to estimate the
behavioural pattern, roll-in and roll-out, embedded options, etc. on
the basis of past data/empirical studies could classify them in the
appropriate buckets, i.e. behavioural maturity instead of
contractual maturity, subject to the approval of the Board/ALCO.
3. Term Deposits Respective maturity buckets. Banks which are better equipped to
estimate the behavioural pattern, roll-in and roll-out, embedded
options, etc. on the basis of past data/empirical studies could
classify the retail deposits in the appropriate buckets on the basis
of behavioural maturity rather than residual maturity. However, the
wholesale deposits should be shown under respective maturity
buckets.
(wholesale deposits for the purpose of this statement may be Rs 15
lakhs or any such higher threshold approved by the bank’s Board).
4. Certificates of Deposit,
Borrowings and Bonds
(including Sub-ordinated
Debt)
Respective maturity buckets. Where call/put options are built into the
issue structure of any instrument/s, the call/put date/s should be
reckoned as the maturity date/s and the amount should be shown in
the respective time buckets.
200

Annexure – E
Heads of Accounts
Classification into time buckets
5. Other Liabilities and
Provisions
(i) Bills Payable
(i) The core component which could reasonably be estimated on the
basis of past data and behavioural pattern may be shown under
‘Over 1-3 years’ time bucket. The balance amount may be placed in
Day 1, 2-7 days and 8-14 days buckets, as per behavioural pattern.
(ii) Respective buckets depending on the purpose.
(ii) Provisions other than for
loan loss and depreciation in
investments
(iii) Other Liabilities
(iii) Respective maturity buckets. Items not representing cash
payables (i.e. income received in advance, etc.) may be placed in
over 5 years bucket.
6. Export Refinance –
Availed
Respective maturity buckets of underlying assets.
B. Inflows
Heads of Accounts
Classification into time buckets
1. Cash Day 1 bucket.
2. Balances with RBI While the excess balance over the required CRR/SLR may be
shown under Day 1 bucket, the Statutory Balances may be
distributed amongst various time buckets corresponding to the
maturity profile of DTL with a time-lag of 14 days.
3. Balances with other
banks
(i) Current Account
(ii) Money at Call and Short
Notice, Term Deposits and
other placements
(i) Non-withdrawable portion on account of stipulations of minimum
balances may be shown under ‘Over 1-3 years’ bucket and the
remaining balances may be shown under Day 1 bucket.
(ii) Respective maturity buckets.
4. Investments (Net of
provisions) #
(i) Approved securities
(ii) Corporate debentures
(i) Respective maturity buckets, excluding the amount required to be
reinvested to maintain SLR corresponding to the DTL profile in
various time buckets.
(ii) Respective maturity buckets. Investments classified as NPIs
201

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
Heads of Accounts
and bonds, PSU bonds,
CDs and CPs, Redeemable
preference shares, Units of
Mutual Funds (close
ended), etc.
(iii) Shares
(iv) Units of Mutual Funds
(open ended)
(v) Investments in
Subsidiaries/ Joint Ventures
(vi) Securities in the Trading
Book
5. Advances (Performing)
Classification into time buckets
should be shown under over 3-5 years bucket (sub-standard) or over
5 years bucket (doubtful).
(iii) Listed shares (except strategic investments ) in 2-7days bucket,
with a haircut of 50%. Other shares in ‘Over 5 years’ bucket.
(iv) Day 1 bucket
(v) ‘Over 5 years’ bucket.
(vi) Day 1, 2-7 days, 8-14 days, 15-28 days and 29-90 days
according to defeasance periods.
# Provisions may be netted from the gross investments provided provisions
are held security-wise. Otherwise provisions should be shown in over 5 years
bucket.
202

Annexure – E
Heads of Accounts
(i) Bills Purchased and
Discounted (including bills
under DUPN)
(ii) Cash Credit / Overdraft
(including TOD) and
Demand Loan component
of Working Capital.
(iii) Term Loans
6. NPAs (Net of
provisions, interest
suspense and claims
received from
ECGC/DICGC )
(i) Sub-standard
(ii) Doubtful and Loss
7. Fixed Assets/ Assets
on lease
8. Other Assets
Intangible assets
C. Off balance sheet
items
1. Lines of Credit
committed / available
(i) Lines of Credit
committed to/ from
Institutions
(ii) Unavailed portion of
Cash Credit/ Overdraft /
Demand loan component of
Working Capital limits
(outflow)
(iii) Export Refinance –
Unavailed (inflow)
(i) Respective maturity buckets.
Classification into time buckets
(ii) Banks should undertake a study of behavioural and seasonal
pattern of availments based on outstandings and the core and
volatile portion should be identified. While the volatile portion could
be shown in the near-term maturity buckets, the core portion may be
shown under ‘Over 1-3 years’ bucket.
(iii) Interim cash flows may be shown under respective maturity
buckets.
(i) ‘Over 3-5 years’ bucket.
(ii) ‘Over 5 years’ bucket.
‘Over 5 years’ bucket / Interim cash flows may be shown under
respective maturity buckets.
Intangible assets and assets not representing cash receivables may
be shown in ‘Over 5 years’ bucket.
(i) Day 1 bucket.
(ii) Banks should undertake a study of the behavioural and seasonal
pattern of potential availments in the accounts and the amounts so
arrived at may be shown under relevant maturity buckets upto 12
months.
(iii) Day 1 bucket.
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
2. Contingent Liabilities
Letters of Credit /
Guarantees (outflow)
Devolvement of Letters of Credit/ Guarantees, initially entails cash
outflows. Thus, historical trend analysis ought to be conducted on
the devolvements and the amounts so arrived at in respect of
outstanding Letters of Credit / Guarantees (net of margins) should
be distributed amongst various time buckets. The assets created out
of devolvements may be shown under respective maturity buckets
on the basis of probable recovery dates.
3. Other Inflows / outflows
(i) Repos / Bills
(i) Respective maturity buckets.
Rediscounted (DUPN)/
CBLO/ Swaps INR / USD,
maturing forex forward
contracts etc. (outflow /
inflow)
(ii) Interest payable / (ii) Respective maturity buckets.
receivable (outflow / inflow)
Note:
(i)
(ii)
(iii)
Liability on account of event cash flows i.e. short fall in CRR balance on
reporting Fridays, wage settlement, capital expenditure, etc. which are
known to the banks and any other contingency may be shown under
respective maturity buckets. The event cash outflows, including
incremental SLR requirement should be reported against “Outflows –
Others”.
All overdue liabilities may be placed in the Day 1, 2-7 days and 8-14 days
buckets, based on behavioural estimates.
Interest and instalments from advances and investments, which are
overdue for less than one month may be placed in Day 1, 2-7 days and 8-
14 days buckets, based on behavioural estimates. Further, interest and
instalments due (before classification as NPAs) may be placed in ‘29 days
to 3 months bucket’ if the earlier receivables remain uncollected.
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Annexure – E
D. Financing of Gap:
In case the net cumulative negative mismatches during the Day 1, 2-7 days, 8-14
days and 15-28 days buckets exceed the prudential limit of 5 % ,10%, 15 % and
20% of the cumulative cash outflows in the respective time buckets, the bank
may show by way of a foot note as to how it proposes to finance the gap to bring
the mismatch within the prescribed limits. The gap can be financed from market
borrowings (call / term), Bills Rediscounting, Repos, LAF and deployment of
foreign currency resources after conversion into rupees (unswapped foreign
currency funds ), etc.
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
RBI/2007-08/278
DBOD. No. BP. BC. 68 / 21.04.098/ 2007-08 April 9, 2008
Chairmen / Chief Executive Officers
All Commercial Banks
(excluding RRBs)
<strong>Guide</strong>lines on Asset-Liability Management (ALM) System
Please refer to DBOD Circular No.DBOD. BP. BC. 38 / 21.04.098/ 2007-08
dated October 24, 2007 advising banks to adopt a more granular approach to
measurement of liquidity risk. Banks were also advised to undertake dynamic
liquidity management and prepare the Statement of Structural Liquidity on daily
basis. The Statement of Structural Liquidity was, however, to be reported to
RBI, once a month, as on the third Wednesday of every month.
2. It was also indicated that to enable the banks to fine tune their existing
MIS as per the modified guidelines, the revised norms as well as the
supervisory reporting as per the revised format would commence with
effect from the period beginning January 1, 2008 and the reporting
frequency would continue to be monthly for the present. However, the
frequency of supervisory reporting of the Structural Liquidity position shall be
fortnightly, with effect from April 1, 2008.
3. Accordingly, banks are advised to submit the Statement of Structural
Liquidity as on the first and third Wednesday of every month to Reserve
Bank of India, Department of Banking Supervision, OSMOS Division. The
due-date of the submission of the Statement would be the seventh day from the
reporting date.
Yours faithfully,
206
(P. Vijaya Bhaskar)
Chief General Manager

ANNEXURE – F
RBI MC GUIDE PRIMARY DEALERS
2009
TELEGRAMS: "RESERVBANK" POST BOX 10007
TELEPHONE 22661602/04 FAX NO. 022-22644158
RESERVE BANK OF INDIA
CENTRAL OFFICE
INTERNAL DEBT MANAGEMENT DEPARTMENT
RBI/2009-10/56 July 1, 2009
IDMD.PDRS. 01/03.64.00/2009-10
CENTRAL OFFICE BUILDING
MUMBAI 400 001
All Primary Dealers in the Government Securities Market
Dear Sir
Master Circular – Operational <strong>Guide</strong>lines to Primary Dealers
The Reserve Bank of India has, from time to time, issued a number of
guidelines/instructions/circulars to the Primary Dealers (PDs) in regard to their
operations in the Government Securities Market. To enable the PDs to have all
the current instructions at one place, this Master Circular is being issued,
incorporating the guidelines/instructions/directives on the subject issued upto
June 30, 2009. The additional guidelines applicable to banks undertaking PD
business departmentally are incorporated under Section II of this Master Circular.
The list of circulars consolidated is given in Annex. The guidelines on Risk
Management and Capital Adequacy for the stand alone PDs are being issued
vide our Master Circular IDMD.PDRD.02/03.64.00/2009-10 dated July 1, 2009.
The banks undertaking PD activities departmentally shall follow the extant

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
guidelines applicable to the banks regarding their capital adequacy requirement
and risk management.
Yours faithfully
(K.V.Rajan)
Chief General Manager
Encl: As above
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Annexure – F
Table of Contents
Section I: Regulations governing Primary Dealers
1. Primary Dealership System 2
2. Role of Primary Dealers in Primary Market 7
3. Primary Dealers operations - Sources and application of funds 10
4. Diversification of activities by stand-alone Primary Dealers 12
5. Investment <strong>Guide</strong>lines 15
6. Prudential systems/controls 18
7. Trading of Government Securities on Stock Exchanges 23
8. Business through brokers 25
9. Norms for Ready Forward transactions 26
10. Portfolio Management Services by PDs 27
11. <strong>Guide</strong>lines on interest rate derivatives 28
12. <strong>Guide</strong>lines on declaration of dividends 28
13. <strong>Guide</strong>lines on Corporate Governance 29
14. Prevention of Money Laundering Act, 2002 29
15. Violation/Circumvention of Instructions 29
Section II: Additional <strong>Guide</strong>lines applicable to banks undertaking PD
business departmentally
1. Introduction 30
2. Procedure for Authorisation of Primary Dealers 30
3. Applicabilty of <strong>Guide</strong>lines issued for PDs 30
4. Maintenance of books and accounts 32
5. Capital Adequacy and Risk Management 32
6. Supervision by RBI 33
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
Annexes:
I. Form of Undertaking 34
II. Statements/Returns required to be submitted by PDs 37
II A. Statements/Returns required to be submitted by banks on their PD
business 39
III. Illustration showing the underwriting scheme 40
IV. Illustration showing PDs commitment to T-Bill auctions 43
V. Format PDR–I 44
VI. Format PDR-II 46
VII. Format PDR-IV 48
VIII. Publication of Financial Results 52
IX. Interest Rate Risk of Rupee Derivatives 53
X. List of circulars consolidated 54
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Annexure – F
Section I: Regulations governing Primary Dealers
1. Primary Dealership System
1.1 Introduction
In 1995, the Reserve Bank of India (RBI) introduced the system of Primary
Dealers (PDs) in the Government Securities Market, which comprised
independent entities undertaking Primary Dealer activity. In order to broad base
the Primary Dealership system, banks were permitted to undertake Primary
Dealership business departmentally in 2006-07. Further, the standalone PDs
were permitted to diversify into business activities, other than the core PD
business, in 2006-07, subject to certain conditions. As on June 30, 2009, there
are six standalone PDs and eleven banks authorized to undertake PD business
departmentally.
1.2 The objectives of Primary Dealer System
The objectives of the PD system are:
i. To strengthen the infrastructure in the government securities market in
order to make it vibrant, liquid and broad based.
ii.
iii.
iv.
To ensure development of underwriting and market making capabilities for
government securities outside the RBI so that the latter will gradually shed
these functions.
To improve secondary market trading system, which would contribute to
price discovery, enhance liquidity and turnover and encourage voluntary
holding of government securities amongst a wider investor base.
To make PDs an effective conduit for conducting open market operations
(OMO).
1.3 Eligibility conditions
1.3.1 The following institutions are eligible to apply for Primary Dealership:
i. Subsidiary of scheduled commercial bank/s and all India financial
institution/s dedicated predominantly to the securities business and in
particular to the government securities market.
ii.
Company incorporated under the Companies Act, 1956 and engaged
predominantly in the securities business and in particular the government
securities market.
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
iii.
iv.
Subsidiaries/ joint ventures set up by entities incorporated abroad under
the approval of Foreign Investment Promotion Board (FIPB).
Banks which do not have a partly or wholly owned subsidiary undertaking
PD business and fulfill the following criteria :
a. Minimum net owned funds (NOF) of Rs.1,000 crore
b. Minimum CRAR of 9 per cent
c. Net NPAs of less than 3 per cent and a profit making record for the
last three years.
1.3.2 Indian banks which are undertaking PD business through a partly or
wholly owned subsidiary and wish to undertake PD business departmentally by
merging / taking over PD business from their partly / wholly owned subsidiary
may do so subject to fulfilling the criteria stipulated above.
1.3.3 Foreign banks operating in India who wish to undertake PD business
departmentally by merging the PD business being undertaken by a group entity
may do so subject to fulfillment of the criteria stipulated above.
1.3.4 A non-bank entity applying for permission to undertake PD business shall
obtain Certificate of Registration as an NBFC under Section 45-IA of the RBI Act,
1934 from the Department of Non-Banking Supervision, Reserve Bank of India.
1.3.5 A non-bank applicant shall have net owned funds (NOF) of a minimum of
Rs. 50 crore. In the case of a PD intending to diversify into permissible activities,
the minimum NOF shall be Rs.100 crore. NOF will be computed in terms of the
explanatory note to Section 45-IA of Chapter III-B of the Reserve Bank of India
Act, 1934.
1.3.6 PDs are not permitted to set up step-down subsidiaries.
1.4 Procedure for Authorisation of Primary Dealers
1.4.1 For enlistment as a Primary Dealer, an eligible institution should submit its
application to the Chief General Manager, Internal Debt Management
Department (IDMD), Reserve Bank of India. The Reserve Bank will consider the
application and, if satisfied, would grant approval `in principle’. The applicant will
thereafter submit an undertaking in respect of the terms and conditions agreed
to. Based on the application and undertaking, an authorization letter will be
issued by RBI. Continuation as a Primary Dealer would depend on its compliance
with the terms and conditions of authorisation.
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Annexure – F
Note: The decision to enlist Primary Dealers will be taken by Reserve Bank of
India based on its perception of market needs, suitability of the applicant and the
likely value addition to the system.
1.5 PDs’ role and obligations
PDs are expected to play an active role in the government securities market,
both in its primary and secondary market segments. A Primary Dealer will be
required to have a standing arrangement with RBI based on the execution of an
undertaking (Annex I) and the authorisation letter issued by RBI each year. The
major roles and obligations of PDs are as below:
i. Support to Primary Market: PDs are required to support auctions for
issue of Government dated securities and Treasury Bills as per the
minimum norms for underwriting commitment, bidding commitment and
success ratio as prescribed by RBI from time to time.
ii.
iii.
iv.
Market making in Government securities: PDs should offer two-way
prices in Government securities, through the Negotiated Dealing System-
Order Matching (NDSOM), over-the-counter market and recognised Stock
Exchanges in India and take principal positions in the secondary market
for Government securities.
PDs should maintain adequate physical infrastructure and skilled
manpower for efficient participation in primary issues, trading in the
secondary market, and to advise and educate investors.
A Primary Dealer shall have an efficient internal control system for fair
conduct of business, settlement of trades and maintenance of accounts.
v. A Primary Dealer will provide access to RBI to all records, books,
information and documents as and when required.
vi.
vii.
PDs’ investment in Government Securities and Treasury Bills on a daily
basis should be at least equal to its net call/notice/repo (including CBLO)
borrowing plus net RBI borrowing (through LAF/ Intra-Day Liquidity/
Liquidity Support) plus the minimum prescribed NOF.
PDs should annually achieve a minimum turnover ratio of 5 times for
Government dated securities and 10 times for Treasury Bills of the
average month-end stocks. The turnover ratio in respect of outright
transactions should not be less than 3 times in government dated
securities and 6 times in Treasury Bills (Turnover ratio is computed as the
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
viii.
ix.
ratio of total purchase and sales during the year in the secondary market
to average month-end stocks).
A PD should submit periodic returns as prescribed by RBI from time to
time.
PDs’ operations are subject to prudential and regulatory guidelines issued
by RBI from time to time.
1.6 Facilities from RBI to PDs
The Reserve Bank currently extends the following facilities to PDs to enable
them to effectively fulfill their obligations:
i. Access to Current Account facility with RBI.
ii.
iii.
iv.
Access to Subsidiary General Ledger (SGL) Account facility (for
Government securities) with RBI.
Permission to borrow and lend in the money market including call money
market and to trade in all money market instruments.
Memberships of electronic dealing, trading and settlement systems (NDS
platforms/INFINET/RTGS/CCIL).
v. Access to the Liquidity Adjustment Facility (LAF) of RBI.
vi.
vii.
Access to liquidity support from RBI under a scheme separately notified
for standalone PDs.
Favoured access to open market operations by Reserve Bank of India.
The facilities are, however, subject to review, depending upon the market
conditions and requirement.
1.7 Regulation
i. PDs are required to meet registration and such other requirements as
stipulated by the Securities and Exchange Board of India (SEBI) including
operations on the Stock Exchanges, if they undertake any activity
regulated by SEBI.
ii.
PDs are expected to join Primary Dealers Association of India (PDAI) and
Fixed Income Money Market and Derivatives Association (FIMMDA) and
abide by the code of conduct framed by them and such other actions as
initiated by them in the interest of the securities markets.
214

iii.
iv.
Annexure – F
In respect of transactions in Government securities, a Primary Dealer
should have a separate desk and maintain separate accounts in respect
of its own position and customer transactions and subject them to external
audit also.
Any change in the shareholding pattern / capital structure of a PD needs
prior approval of RBI. PDs should report any other material changes such
as business profile, organization, etc. affecting the conditions of licensing
as PD to RBI immediately.
v. Reserve Bank of India reserves the right to cancel the Primary Dealership
if, in its view, the concerned institution has failed to adhere to the terms of
authorisation or any other RBI guideline as applicable.
vi.
A Primary Dealer should bring to the RBI’s attention any major complaint
against it or action initiated/taken against it by authorities such as the
Stock Exchanges, SEBI, CBI, Enforcement Directorate, Income Tax, etc.
1.8 Supervision by RBI
1.8.1 Off-site supervision: PDs are required to submit prescribed periodic
returns to RBI promptly. The current list of such returns, their periodicity, etc. is
furnished in Annex II.
1.8.2 On-site inspection: RBI will have the right to inspect the books, records,
documents and accounts of the PD. PDs are required to make available all such
documents, records, etc. to the RBI officers and render all necessary assistance
as and when required.
2. Role of Primary Dealers in the Primary Market
Concomitant with the objectives of PD system, the PDs are expected to support
the primary issues of dated securities of Central Government and State
Government and Treasury Bills of Central Government, through
underwriting/bidding commitments and success ratios. The related guidelines are
as under:
2.1 Underwriting of Dated Government Securities
2.1.1 Dated securities of Central Government:
i. The underwriting commitment on dated securities of Central Government
will be divided into two parts - i) Minimum Underwriting Commitment
(MUC) and ii) Additional Competitive Underwriting (ACU).
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
ii.
iii.
iv.
The MUC of each PD will be computed to ensure that at least 50 percent
of the notified amount of each issue is mandatorily underwritten equally by
all PDs. The share under MUC will be uniform for all PDs, irrespective of
their capital or balance sheet size. The remaining portion of the notified
amount will be underwritten through an Additional Competitive
Underwriting (ACU) auction.
RBI will announce the MUC of each PD and the balance amount which
will be underwritten under the ACU auction. In the ACU auction, each PD
would be required to bid for an amount at least equal to its share of MUC.
A PD cannot bid for more than 30 per cent of the notified amount in the
ACU auction.
The auction could be either uniform price-based or multiple price-based
depending upon the market conditions and other relevant factors, which
will be announced before the underwriting auction for each issue.
v. Bids will be tendered by PDs within the stipulated time, indicating both the
amount of the underwriting commitment and underwriting commission
rates. A PD can submit multiple bids for underwriting. Depending upon the
bids submitted for underwriting, RBI will decide the cut-off rate of
commission and inform the PDs.
vi.
vii.
viii.
ix.
Underwriting commission: All successful bidders in the ACU auction will
be paid underwriting commission on the ACU segment as per the auction
rules. Those PDs who succeed in the ACU for 4 per cent and above of the
notified amount of the issue, will be paid commission on the MUC at the
weighted average of all the accepted bids in the ACU. Others will get
commission on the MUC at the weighted average rate of the three lowest
bids in the ACU.
In the GOI securities auction, a PD should bid for an amount not less than
their total underwriting obligation. If two or more issues are floated on the
same day, the minimum bid amount will be applied to each issue
separately.
Underwriting commission will be paid on the amount accepted for
underwriting by the RBI, irrespective of the actual amount of devolvement,
by credit to the current account of the respective PDs at the RBI, Fort,
Mumbai, on the date of issue of security.
In case of devolvement, PDs would be allowed to set-off the accepted
216

Annexure – F
bids in the auction against their underwriting commitment accepted by the
Reserve Bank. Devolvement of securities, if any, on PDs will take place
on pro-rata basis, depending upon the amount of underwriting obligation
of each PD after setting off the successful bids in the auction.
x. RBI reserves the right to accept any amount of underwriting up to 100 per
cent of the notified amount or even reject all the bids tendered by PDs for
underwriting, without assigning any reason.
xi.
An illustration pertaining to the underwriting procedure is given in Annex
III.
2.1.2 Dated securities of State Governments
i. On announcement of an auction of dated securities of the State
Governments for which auction is held, RBI may invite PDs to collectively
bid to underwrite up to 100 per cent of the notified amount of State
Development Loans (SDL).
ii.
iii.
iv.
A PD can bid to underwrite up to 30 per cent of the notified amount of the
issue. If two or more issues are floated on the same day, the limit of 30%
is applied by taking the notified amounts separately.
Bids will be tendered by PDs within the stipulated time, indicating both the
amount of the underwriting commitments and underwriting commission
rates. A PD can submit multiple bids for underwriting.
Depending upon the bids submitted for underwriting, the RBI will decide
the cut-off rate of commission and the underwriting amount up to which
bids would be accepted and inform the PDs.
v. RBI reserves the right to accept any amount of underwriting up to 100 per
cent of the notified amount or even reject all the bids tendered by PDs for
underwriting, without assigning any reason.
vi.
vii.
In case of devolvement, PDs would be allowed to set-off the accepted
bids in the auction against their underwriting commitment accepted by the
Reserve Bank. Devolvement of securities, if any, on PDs will take place
on pro-rata basis, depending upon the amount of underwriting obligation
of each PD after setting off the successful bids in the auction.
Underwriting commission will be paid on the amount accepted for
underwriting by the RBI, irrespective of the actual amount of devolvement,
by credit to the current account of the respective PDs at the RBI, Fort,
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
Mumbai, on the date of issue of security.
2.2 Bidding in Primary auctions of Treasury Bills
i. Each PD will individually commit, at the beginning of the year, to submit
bids for a fixed percentage of the notified amount of Treasury Bills in each
auction.
ii.
iii.
iv.
The minimum bidding commitment amount / percentage for each PD will
be determined by the Reserve Bank, in consultation with the PD. While
finalizing the bidding commitments, the RBI will take into account the net
owned funds (NOF), the offer made by the PD, its track record and its
past adherence to the prescribed success ratio. The amount/percentage
of minimum bidding commitment so determined by the Reserve Bank will
remain unchanged for the entire financial year or till the conclusion of
agreement on bidding commitments for the next financial year, whichever
is later.
In any auction of Treasury Bills, if a PD fails to submit the required
minimum bid or submits a bid lower than its commitment, the Reserve
Bank may take appropriate action against the PD.
A PD would be required to achieve a minimum success ratio of 40 percent
of bidding commitment for Treasury Bills auctions which will be monitored
on a half yearly basis. A PD is required to achieve the minimum level of
success ratio in each half year (April to September and October to March)
separately. (For illustrations please refer to Annex IV).
2.3 ‘When-Issued’ transactions in Central Government Securities
PDs shall adhere to the guidelines issued by the RBI vide circular IDMD.No.
2130 /11.01.01 (D) /2006-07 dated November 16, 2006, as amended from time
to time, for undertaking “When Issued” transactions.
2.4 Submission of non-competitive bids
PDs shall adhere to the guidelines issued vide circular RBI / 2008-09 / 479 -
IDMD.No.5877 / 08.02.33 / 2008-09 dated May 22, 2009, as amended from time
to time, in respect of submission of non-competitive bids in the auctions of the
Government of India securities.
2.5 Sale of securities allotted in primary issues on the same day
PDs shall adhere to the guidelines issued vide circulars IDMC.PDRS.No. PDS.1 /
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Annexure – F
03.64.00 / 2000-01 dated October 6, 2000 and RBI / 2005 / 461 –
IDMD.PDRS.4777 / 10.02.01 / 2004-05 dated May 11, 2005, for undertaking sale
of securities allotted in primary issues on the same day.
2.6 Settlement of primary auctions
PDs shall adhere to the guidelines issued vide circular IDMD.PDRD.No. 1393 /
03.64.00 / 2008-09 dated September 19, 2008. The primary auction settlement is
independent from the secondary market settlements and therefore has to be
funded separately. Successful PDs shall provide sufficient funds in their current
account with the RBI on the auction settlement days before 3:00 pm to meet their
obligations against the subscriptions in the primary auctions failing which the
shortage will be treated as an instance of ‘SGL bouncing’ and will be subjected to
the applicable penal provisions.
2.7 Secondary Market Transactions - Short-selling
PDs shall adhere to the guidelines issued by the RBI vide circular RBI / 2006-07 /
243 IDMD.No./11.01.01 (B)/2006-07 dated January 31, 2007, on short sale in
Central Government dated securities, as amended from time to time.
3. Primary Dealers operations - Sources and application of funds
3.1 PDs are permitted to borrow funds from call/notice/term money market
and repo (including CBLO) market. They are also eligible for liquidity support
from RBI.
3.2 PDs are allowed to borrow from call/notice market, on an average in a
reporting fortnight, up to 200 percent of their net owned funds (NOF) as at the
end March of the preceding financial year.
3.3 PDs may lend up to 25 percent of their NOF in call/notice market. The
limit will be determined by PDs on an average basis during a ‘reporting fortnight’.
3.4 These limits on borrowing and lending are subject to periodic review by
Reserve Bank of India.
3.5 Liquidity Support from RBI
In addition to access to the RBI's Liquidity Adjustment Facility, stand-alone PDs
are also provided with liquidity support by the Reserve Bank of India against
eligible Government securities including State Development Loans (SDLs). The
parameters based on which liquidity support will be allocated are given below:
i. Of the total liquidity support, half of the amount will be divided equally
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
ii.
iii.
iv.
among all the stand-alone PDs. The remaining half (i.e. 50%) will be
divided in the ratio of 1:1 based on market performance in primary market
and secondary market. Performance in primary market will be computed
on the basis of bids accepted in the T-Bill auction and G-sec auction in
the proportionate weights of 1 and 3. Similarly, the secondary market
performance will be judged on the basis of outright turnover in T-Bills and
dated Government securities in the proportionate weights of 1 and 3.
The PD-wise limit of liquidity support will be revised every half-year (April-
September and October-March) based on the market performance of the
PDs in the preceding six months.
The liquidity support to PDs will be made available at the ‘Repo rate’
announced by the Reserve Bank.
The liquidity support availed by a PD will be repayable within a period of
90 days. The penal rate of interest payable by PDs if liquidity support is
repaid after 90 days is Bank rate plus 5 percentage points for the period
beyond 90 days.
3.6 Inter-Corporate Deposits
3.6.1 Inter-Corporate Deposits (ICD) may be raised by Primary Dealers
sparingly and should not be used as a continuous source of funds. After proper
and due consideration of the risks involved, the Board of Directors of the PD
should lay down the policy in this regard, which among others, should include the
following general principles:
i. While the ceiling fixed on ICD borrowings should in no case exceed 50%
of the NOF as at the end of March of the preceding financial year, it is
expected that actual dependence on ICDs would be much below this
ceiling.
ii.
iii.
iv.
ICDs accepted by PDs should be for a minimum period of one week.
ICDs accepted from parent/promoter/group companies or any other
related party should be on "arms length basis" and disclosed in financial
statements as "related party transactions".
Funds raised through ICDs are subject to ALM discipline.
3.6.2 PDs are prohibited from placing funds in ICD market.
3.7 FCNR (B) loans / External Commercial Borrowings
220

Annexure – F
3.7.1 PDs may avail of FCNR(B) loans up to a maximum of 25% of the NOF as
at the end of March of the preceding financial year and subject to the foreign
exchange risk of such loans being hedged at all times at least to the extent of 50
per cent of the exposure.
3.7.2 PDs are not permitted to raise funds through External Commercial
Borrowings.
3.8 Reporting Requirements
3.8.1 PDs are required to report the sources and application of funds
maintained on daily basis and reported to RBI on fortnightly basis. The format of
return (PDR-I) is enclosed in Annex V.
3.8.2 PDs are required to report the securities market turnover on monthly
basis. The format of return (PDR-II) is enclosed in Annex VI.
3.8.3 PDs are required to submit a quarterly statement on capital adequacy in
the prescribed format (PDR-III).
3.8.4 PDs are required to report select financial and Balance Sheet indicators
on quarterly basis. The format of return (PDR-IV) is enclosed in Annex VII.
4. Diversification of activities by stand-alone Primary Dealers
4.1 Stand-alone Primary Dealers (PDs) are permitted to diversify their
activities, as considered appropriate, in addition to their existing business of
Government securities, subject to limits.
4.2 PDs may bifurcate their operations into core and non-core activities.
4.2.1 The following activities are permitted under core activities:
i. Dealing and underwriting in Government securities
ii.
iii.
iv.
Dealing in Interest Rate Derivatives
Providing broking services in Government securities
Dealing and underwriting in Corporate / PSU / FI bonds/ debentures
v. Lending in Call/ Notice/ Term/ Repo/ CBLO market
vi.
vii.
viii.
Investment in Commercial Papers
Investment in Certificates of Deposit
Investment in Security Receipts issued by Securitization Companies/
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
ix.
Reconstruction Companies, Asset Backed Securities (ABS), Mortgage
Backed Securities (MBS)
Investment in debt mutual funds where entire corpus is invested in debt
securities
4.2.2 PDs are permitted to undertake the following activities under non-core
activities:
4.2.2.1 Activities which are expected to consume capital such as:
i. Investment / trading in equity and equity derivatives market
ii.
iii.
Investment in units of equity oriented mutual funds
Underwriting public issues of equity
4.2.2.2 Services, which do not consume capital or require insignificant capital
outlay such as:
i. Professional Clearing Services
ii.
iii.
iv.
Portfolio Management Services
Issue Management Services
Merger & Acquisition Advisory Services
v. Private Equity Management Services
vi.
vii.
viii.
ix.
Project Appraisal Services
Loan Syndication Services
Debt restructuring services
Consultancy Services
x. Distribution of mutual fund units
xi.
Distribution of insurance products
4.2.3 For distribution of insurance products, the PDs may comply with the
guidelines contained in the circular DNBS(PD)CC.No.35/10.24/2003-04 dated
February 10, 2004 issued by the Department of Non-Banking Supervision.
4.2.4 Specific approvals of other regulators, if needed, should be obtained for
undertaking the activities detailed above.
4.2.5 PDs are not allowed to undertake broking in equity, trading / broking in
222

commodities, gold and foreign exchange.
223
Annexure – F
4.3 The investment in Government Securities should have predominance
over the non-core activities in terms of investment pattern. Stand-alone PDs are
required to ensure predominance by maintaining at least 50 per cent of their total
financial investments (both long term and short term) in Government Securities at
any point of time. Investment in Government securities will include the PD’s Own
Stock, Stock with RBI under Liquidity Support / Intra-day Liquidity (IDL)/ Liquidity
Adjustment Facility (LAF), Stock with market for repo borrowings and
Government Securities pledged with the Clearing Corporation of India Ltd (CCIL).
4.4 The exposure to non-core activities shall be subject to the guidelines on
regulatory and prudential norms for diversification of activities by stand-alone
PDs, which are as under:
4.4.1 The minimum NOF requirement for a PD, proposing to undertake noncore
activities, as detailed in para 4.2.2, should be Rs.100 crore as against Rs.50
crore for a PD, which does not diversify into these activities.
4.4.2 The exposure to non-core activities, as defined in paragraph 4.2.2 above ,
shall be subject to risk capital allocation as prescribed below.
4.4.2.1. PDs may calculate the capital charge for market risk on the stock
positions / underlying stock positions/ units of equity oriented mutual funds using
Internal Models (VaR based) based on the guidelines prescribed vide RBI Master
circular No. IDMD.PDRD. 2/03.64.00/2009-10 dated July 1, 2009 on Capital
Adequacy and Risk Management, as updated from time to time. PDs may
continue to provide for credit risk arising out of equity, equity derivatives and
equity oriented mutual funds as prescribed in the circular mentioned above.
4.4.2.2 The guidelines for both credit risk and market risk in respect of
Commercial Paper, Corporate / PSU / FI bonds / Underwriting are contained in
the RBI Master circular IDMD.PDRD./03.64.00/2009-10 dated July 1, 2009, as
updated from time to time.
4.4.2.3 The capital charge for market risk (VaR calculated at 99 per cent
confidence interval, 15-day holding period, with multiplier of 3.3) for the activities
defined in para 4.2.2.1 above should not be more than 20 per cent of the NOF as
per the last audited balance sheet.
4.4.2.4 PDs choosing to diversify into non-core business segments should define
internally the scope of diversification, organization structure and reporting levels
for those segments. PDs should clearly lay down exposure and risk limits for

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
those segments in the investment policy with the approval of their Board.
5. Investment <strong>Guide</strong>lines
5.1 Investment policy – PDs should frame and implement investment and
operational policy guidelines on securities transactions which should be
approved by their Boards. The guidelines should contain the broad objectives to
be followed while undertaking transactions in securities on their own account and
on behalf of clients, clearly define the authority to put through deals, and lay
down procedure to be followed while putting through deals, various prudential
exposure limits, policy regarding dealings through brokers, systems for
management of various risks, guidelines for valuation of the portfolio and the
reporting systems etc. Operational procedures and controls in relation to the dayto-day
business operations should also be worked out and put in place to ensure
that operations in securities are conducted in accordance with sound and
acceptable business practices. While laying down these guidelines, the PDs
should strictly adhere to Reserve Bank’s instructions, issued from time to time.
The effectiveness of the policy and operational guidelines should be periodically
evaluated.
5.2 PDs should necessarily hold their investments in Government securities
portfolio in SGL with RBI. They may also have a dematerialised account with
depositories (NSDL/CDSL). All purchase/sale transactions in Government
securities by PDs should be compulsorily through SGL/CSGL/Demat accounts.
5.3 PDs should hold all other investments such as commercial papers, bonds
and debentures, privately placed or otherwise, and equity instruments, only in
dematerialized form.
5.4 All problem exposures, which are not backed by any security or backed
by security of doubtful value, should be fully provided for. Where a PD has filed
suit against another party for recovery, such exposures should be evaluated and
provisions made to the satisfaction of auditors. Any claim against the PD should
also be taken note of and provisions made to the satisfaction of auditors.
5.5 The profit and loss account should reflect the problem exposures if any,
and also the effect of valuation of portfolio, as per the instructions issued by the
Reserve Bank, from time to time. The report of the statutory auditors should
contain a certification to this effect.
5.6 PDs should formulate, within the above parameters, their own internal
guidelines on securities transactions in both primary and secondary markets, with
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the approval of their Board of Directors.
5.7 <strong>Guide</strong>lines on investments in non-Government securities
Annexure – F
5.7.1 These guidelines cover PDs’ investments in non-Government securities
(including capital gains bonds, bonds eligible for priority sector status, bonds
issued by Central or State public sector undertakings with or without Government
guarantees and bonds issued by banks and financial companies) generally
issued by corporates, banks, FIs and State and Central Government sponsored
institutions, SPVs etc. These guidelines will, however, not be applicable to (i)
units of equity oriented mutual fund schemes where any part of the corpus can
be invested in equity, (ii) venture capital funds, (iii) commercial paper, (iv)
certificate of deposit, and (v) investments in equity shares. The guidelines will
apply to investments both in the primary market and the secondary market.
5.7.2 PDs should not invest in non-Government securities of original maturity of
less than one year, other than Commercial Paper and Certificates of Deposits,
which are covered under RBI guidelines.
5.7.3 PDs should undertake usual due diligence in respect of investments in
non-Government securities.
5.7.4 PDs must not invest in unrated non-Government securities.
5.7.5 PDs will abide by the requirements stipulated by the SEBI in respect of
corporate debt securities. Accordingly, while making fresh investments in non-
Government debt securities, PDs should ensure that such investments are made
only in listed debt securities, except to the extent indicated in paragraph 5.7.6
below.
5.7.6 PDs' investment in unlisted non-Government securities should not exceed
10% of the size of their non-Government securities portfolio on an on-going
basis. The ceiling of 10% will be inclusive of investment in Security Receipts
issued by Securitization Companies/Reconstruction Companies and also the
investment in Asset Backed Securities (ABS) and Mortgage Backed Securities
(MBS). The unlisted non-Government debt securities in which PDs may invest up
to the limits specified above, should comply with the disclosure requirements as
prescribed by the SEBI for listed companies.
5.7.7 PDs are required to report their secondary market transactions in
corporate bonds done in the OTC market on FIMMDA's reporting platform as
indicated vide circular IDMD.530/03.64.00/2007-08 dated July 31, 2007.
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
5.7.8 PDs should ensure that their investment policies duly approved by the
Board of Directors are formulated after taking into account all the relevant issues
specified in these guidelines on investment in non-Government securities. PDs
should put in place proper risk management systems for capturing and analysing
the risk in respect of non-Government securities before making investments and
taking remedial measures in time. PDs should also put in place appropriate
systems to ensure that investment in privately placed instruments is made in
accordance with the systems and procedures prescribed under respective PDs’
investment policy.
5.7.9 Boards of PDs should review the following aspects of investment in non-
Government Securities at least at quarterly intervals:
i. Total business (investment and divestment) during the reporting period.
ii.
iii.
iv.
Compliance with the prudential limits prescribed by the Board for
investment in non-Government securities.
Compliance with the prudential guidelines on non-Government securities
prescribed above.
Rating migration of the issuers/ issues held in the PDs’ books.
5.7.10 In order to help the creation of a central database on private placement of
debt, a copy of all offer documents should be filed with the Credit Information
Bureau (India) Ltd. (CIBIL) by the PDs. Further, any default relating to interest/
installment in respect of any privately placed debt should also be reported to
CIBIL by the investing PDs along with a copy of the offer document.
5.7.11 As per the SEBI guidelines, all trades with the exception of the spot
transactions, in a listed debt security, shall be executed only on the trading
platform of a stock exchange. In addition to complying with these SEBI
guidelines, (as and when applicable) PDs should ensure that all spot transactions
in listed and unlisted debt securities are reported on the NDS and settled through
the CCIL.
6. Prudential systems/controls
6.1 Internal Control System in respect of securities transactions
i. PDs should have an Audit Committee of the Board (ACB) which should
meet at least at quarterly intervals. The ACB should peruse the findings of
the various audits. ACB should ensure efficacy and adequacy of the audit
function.
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ii.
iii.
iv.
227
Annexure – F
All security transactions (including transactions on account of clients)
should be subjected to concurrent audit by internal/external auditors to the
extent of 100% and the results of the audit should be placed before the
CEO/CMD of the PD once every month. The compliance should be
monitored on ongoing basis and reported directly to the top management.
The concurrent audit should also cover the business done through
brokers and include the findings in their report.
The scope of concurrent audit should include monitoring of broker wise
limits, prudential limits laid down by RBI, accuracy and timely submission
of all regulatory returns, reconciliation of SGL/ CSGL balances with PDO
statements, reconciliation of current account balance with DAD
statements, settlements through CCIL, stipulations with respect to short
sale deals, when-issued transactions, constituent deals, money market
deals, adherence to accounting standards, verification of deal slips,
reasons for cancellation of deals, if any, transactions with related parties
on "arms length basis" etc.
PDs should have a system of internal audit focused on monitoring the
efficacy and adequacy of internal control systems.
v. All the transactions put through by the PD either on outright basis or ready
forward basis should be reflected on the same day in its books and
records i.e. preparation of deal slip, contract note, confirmation of the
counter party, recording of the transaction in the purchase/sale registers,
etc.
vi.
vii.
viii.
With the approval of their Board of Directors, PDs should place
appropriate exposure limits / dealing limits, for each of their counterparties
which cover all dealings with such counter parties including money
market, repos and outright securities transactions. These limits should be
reviewed periodically on the basis of financial statements, market reports,
ratings, etc. and exposures taken only on a fully collateralized basis
where there is slippage in the rating/assessment of any counterparty.
With the approval of their Boards, PDs should put in place reasonable
leverage ratio for their operations, which should take into account all
outside borrowings as a multiplier of their net owned funds.
There should be a clear functional separation of (i) trading (front office) (ii)
risk management (mid office), and (iii) settlement, accounting and
reconciliation (back office). Similarly, there should be a separation of

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
ix.
transactions relating to own account and constituents’ accounts.
For every transaction entered into, the trading desk should generate a
deal slip which should contain data relating to nature of the deal, name of
the counter-party, whether it is a direct deal or through a broker, and if
through a broker, name of the broker, details of security, amount, price,
contract date and time and settlement date. The deal slips should be
serially numbered and controlled separately to ensure that each deal slip
has been properly accounted for. Once the deal is concluded, the deal
slip should be immediately passed on to the back office for recording and
processing. For each deal, there must be a system of issue of
confirmation to the counter-party. The timely receipt of requisite written
confirmation from the counter-party, which must include all essential
details of the contract, should be monitored by the back office. With
respect to transactions matched on the NDS-OM module, the need for
counterparty confirmation of deals matched on NDS-OM does not arise.
x. Once a deal has been concluded, there should not be any substitution of
the counterparty by the broker. Similarly, the security sold/purchased in a
deal should not be substituted by another security under any
circumstances.
xi.
xii.
On the basis of vouchers passed by the back office (which should be
done after verification of actual contract notes received from the
broker/counter-party and confirmation of the deal by the counter party),
the books of account should be independently prepared.
PDs should periodically review securities transactions and report to the
top management, the details of transactions in securities, details of
funds/securities delivery failures, even in cases where shortages have
been met by CCIL.
6.2 Purchase/Sale of securities through SGL transfer forms
All PDs should report / conclude their transactions on NDS / NDS(OM) and
clear/settle them through CCIL as central counter-party. In such cases where
exceptions have been permitted to tender physical SGL transfer forms, the
following guidelines should be followed:
i. Records of all SGL transfer forms issued/received should be maintained
and a system for verification of the authenticity of the SGL transfer forms
received from the counter-party and confirmation of authorised signatories
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ii.
iii.
iv.
should be put in place.
Annexure – F
Under no circumstances, a SGL transfer form issued by a PD in favour of
a counterparty should bounce for want of sufficient balance in the
SGL/Current Account. Any instance of return of SGL form from the Public
Debt Office of the Reserve Bank for want of sufficient balance in the
account should be immediately brought to the notice of the PD’s top
management and reported to RBI with the details of transactions.
SGL Transfer forms received by purchasing PDs should be deposited in
their SGL Accounts immediately. No sale should be effected by way of
return of SGL form held by the PD.
SGL transfer form should be in a standard format prescribed by the
Reserve Bank and printed on semi-security paper of uniform size. They
should be serially numbered and there should be a control system in
place to account for each SGL form.
6.3 Bank Receipt or similar receipt should not be issued or accepted by the
PDs under any circumstances in respect of transactions in Government
securities.
6.4 Accounting Standards for securities transactions
i. PDs should adopt the practice of valuing all securities in their trading
portfolio on mark to market basis, at appropriate intervals.
ii.
iii.
iv.
Costs such as brokerage fees, commission or taxes incurred at the time
of acquisition of securities, are of revenue/deferred nature. The broken
period interest received/paid also get adjusted at the time of coupon
payment. PDs can adopt either the IAS or GAAP accounting standards,
but has to ensure that the method should be true and fair and should not
result in overstating the profits or assets value and should be followed
consistently and be generally acceptable especially to the tax authorities.
Broken period interest paid to seller as part of cost on acquisition of
Government and other securities should not be capitalised but treated as
an item of expenditure under Profit and Loss Account. The PDs may
maintain separate adjustment accounts for the broken period interest.
The valuation of the securities portfolio should be independent of the
dealing and operations functions and should be done by obtaining the
prices declared by Fixed Income Money Market and Derivatives
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
Association of India (FIMMDA) periodically.
v. PDs should publish their audited annual results in leading financial dailies
and on their website in the format prescribed (Annex VIII). The following
minimum information should also be included by way of notes to the
Balance Sheet: -
a. Net borrowings in call (average and peak during the period),
b. Basis of valuation,
c. Leverage Ratio (average and peak),
d. CRAR (quarterly figures), and
e. Details of the issuer composition of non-Government securities
investments.
PDs may also furnish more information by way of additional disclosures.
6.5 Reconciliation of holdings of Government securities
Balances as per PDs books should be reconciled at least at monthly intervals
with the balances in the books of PDOs. If the number of transactions so warrant,
the reconciliation should be undertaken at more frequent intervals. This
reconciliation should be periodically checked during audit.
6.6. Transactions on behalf of Constituents:
i. The PDs should be circumspect while acting as agent of their clients for
carrying out transactions in securities.
ii.
iii.
iv.
PDs should not use the constituents’ funds or assets for proprietary
trading or for financing of another intermediary’s operations.
All transaction records should give a clear indication that the transaction
belongs to constituents and does not belong to PDs’ own account.
The transactions on behalf of constituents and the operations in the
Constituent SGL accounts should be conducted in accordance with the
guidelines issued by RBI on the Constituent SGL accounts.
v. PDs who act as custodians (i.e. CSGL account holders) and offer the
facility of maintaining gilt accounts to their constituents, should not permit
settlement of any sale transaction by their constituents unless the security
sold is actually held in the gilt account of the constituent.
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vi.
Annexure – F
Indirect access to NDS-OM has been permitted to certain segments of
investors through banks and PDs vide circular IDMD.DOD.No.5893/
10.25.66/2007-08 dated May 27, 2008. PDs should adhere to the
guidelines on maintenance of gilt accounts and investments on behalf of
gilt account holders while undertaking 'constituent deals' on NDS-OM.
6.7 Failure to complete delivery of security/funds in an SGL transaction
Any default in delivery of security/funds in an SGL sale /purchase transaction
undertaken by a PD will be viewed seriously. A report on such transaction, even
if completed through the securities/funds shortage handling procedure of CCIL,
must be submitted to the Internal Debt Management Department, Reserve Bank
of India immediately. The occurrence of third default in a period of 6 months
(April -September and October-March) in funds and/or securities delivery will
result in debarment of the PD from the use of SGL facility for a period of 6
months from the date of the third occurrence. If, after restoration of the facility,
any default occurs again, the PD will be debarred permanently from the use of
SGL facility.
7. Trading of Government Securities on Stock Exchanges
7.1 With a view to encouraging wider participation of all classes of investors,
including retail, in Government securities, trading in Government securities
through a nationwide, anonymous, order driven screen based trading system on
stock exchanges, in the same manner in which trading takes place in equities,
has been permitted. Accordingly, trading of dated Government of India securities
in dematerialized form is allowed on automated order driven system of the
National Stock Exchange (NSE) of India, the Stock Exchange Mumbai (BSE) and
the Over the Counter Exchange of India (OTCEI). This trading facility is in
addition to the reporting/trading facility in the Negotiated Dealing System. Being a
parallel system, the trades concluded on the exchanges will be cleared by their
respective clearing corporations/clearing houses.
7.2 PDs are expected to play an active role in providing liquidity to the
Government securities market and promote retailing. They may, therefore, make
full use of the facility to distribute Government securities to all categories of
investors through the process of placing and picking-up orders on the
exchanges. PDs may open demat accounts with a Depository Participant (DP) of
NSDL/CDSL in addition to their accounts with RBI. Value free transfer of
securities between SGL/CSGL and demat accounts is enabled by PDO-Mumbai
subject to guidelines issued by RBI’s Department of Government and Bank
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
Accounts (DGBA).
7.3 Operational <strong>Guide</strong>lines
i. PDs should take specific approval from their Board to enable them to
trade in the Stock Exchanges.
ii.
iii.
iv.
PDs may undertake transactions only on the basis of giving and taking
delivery of securities.
Brokers/trading members shall not be involved in the settlement process;
all trades have to be settled either directly with clearing
corporation/clearing house (in case they are clearing members) or else
through clearing member custodians.
The trades done through any single broker will also be subject to the
current regulations on transactions done through brokers.
v. A standardized settlement on T+1 basis of all outright secondary market
transactions in Government Securities has been adopted to provide the
participants more processing time for transactions and to help in better
funds as well as risk management.
vi.
vii.
viii.
ix.
In the case of repo transactions in Government Securities, however,
market participants will have the choice of settling the first leg on either
T+0 basis or T+1 basis, as per their requirements.
Any settlement failure on account of non-delivery of securities/ nonavailability
of clear funds will be treated as SGL bouncing and the current
penalties in respect of SGL transactions will be applicable. Stock
Exchanges will report such failures to the respective Public Debt Offices.
PDs who are trading members of the Stock Exchanges may have to put
up margins on behalf of their non-institutional client trades. Such margins
are required to be collected from the respective clients. PDs are not
permitted to pay up margins on behalf of their client trades and incur
overnight credit exposure to their clients. In so far as the intra day
exposures on clients for margins are concerned, the PDs should be
conscious of the underlying risks in such exposures.
PDs who intend to offer clearing /custodial services should take specific
approval from SEBI in this regard. Similarly, PDs who intend to take
trading membership of the Stock Exchanges should satisfy the criteria laid
down by SEBI and the Stock Exchanges.
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8. Business through brokers
Annexure – F
8.1 Business through brokers and contract limits for approved brokers -
PDs may undertake securities or derivative transactions among themselves or
with clients through the members of the BSE, NSE and OTCEI. A
disproportionate part of the business should not be transacted through only one
or a few brokers. PDs should fix aggregate contract limits for each of the
approved brokers. A limit of 5%, of total transactions (both purchase and sales)
entered into by a PD during a year should be treated as the aggregate upper
contract limit for each of the approved brokers. However, if for any reason it
becomes necessary to exceed the aggregate limit for any broker, the specific
reasons there for should be recorded and the Board should be informed of this,
post facto.
8.2 With the approval of their top management, PDs should prepare a panel of
approved brokers, which should be reviewed annually or more often if so
warranted. Clear-cut criteria should be laid down for empanelment of brokers,
including verification of their creditworthiness, market reputation, etc. A record of
broker-wise details of deals put through and brokerage paid, should be maintained.
8.3 The brokerage on the deal payable to the broker, if any (if the deal was
put through with the help of a broker), should be clearly indicated on the
notes/memorandum put up seeking approval for putting through the transaction,
and a separate account of brokerage paid, broker-wise, should be maintained.
8.4 The role of the broker should be restricted to that of bringing the two
parties to the deal together. Settlement of deals between PDs and counterparties
should be directly between the counter-parties and the broker will have no
role in the settlement process.
8.5 While negotiating the deal, the broker is not obliged to disclose the
identity of the counter-party to the deal. On conclusion of the deal, he should
disclose the counter-party and his contract note should clearly indicate the name
of the counter-party.
9. Norms for Ready Forward transactions
Primary Dealers are permitted to participate in Ready Forward (Repo) market
both as lenders and borrowers. The terms and conditions subject to which ready
forward contracts (including reverse ready forward contracts) may be entered
into by PDs will be as under:
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
i. Repos may be undertaken only in a) dated securities and Treasury Bills
issued by the Government of India and b) dated securities issued by the
State Governments.
ii.
iii.
iv.
Repos may be entered into only with scheduled commercial banks, Urban
Cooperative banks, other PDs, NBFCs, mutual funds, housing finance
companies, insurance companies and any listed company, provided they
hold either an SGL account with RBI or a Gilt account with a custodian.
Listed companies can enter into repo transactions subject to the following
conditions:
(a)
(b)
(c)
The minimum period for Reverse Repo (lending of funds) by listed
companies is seven days. However, listed companies can borrow
funds through repo for shorter periods including overnight;
Where the listed company is a ‘buyer’ of securities in the first leg of
the repo contract (i.e. lender of funds), the custodian through
which the repo transaction is settled should block these securities
in the gilt account and ensure that these securities are not further
sold or re-repoed during the repo period but are held for delivery
under the second leg; and
The counterparty to the listed companies for repo/reverse repo
transactions should be either a bank or a Primary Dealer
maintaining SGL Account with the Reserve Bank.
A PD may not enter into a repo with its own constituent or facilitate a repo
between two of its constituents.
v. PDs should report all repos transacted by them (both on own account and
on the constituent's account) on the Negotiated Dealing System (NDS).
All repos shall be settled through the SGL Account/CSGL Account
maintained with the RBI, Mumbai, with the Clearing Corporation of India
Ltd (CCIL) acting as the central counter party.
vi.
vii.
viii.
The purchase/sale price of the securities in the first leg of a repo should
be in alignment with the market rates prevalent on the date of transaction.
Repo transactions, which are settled under the guaranteed settlement
mechanism of CCIL, may be rolled over, provided the security prices and
repo interest rate are renegotiated on roll over.
The Global Master Repos Agreement’ on repos, with suitable schedules,
234

Annexure – F
as proposed by FIMMDA may be entered into by PDs with their counter
parties to repos transactions.
10. Portfolio Management Services by PDs
10.1 PDs may offer Portfolio Management Services (PMS) to their clients
under the SEBI scheme of PMS, subject to the following conditions. Before
undertaking PMS, the PD must have obtained the Certificate of Registration as
Portfolio Manager from the SEBI and also a specific approval from the RBI.
i. PMS cannot be offered to any RBI regulated entity. However, advisory
services can be provided to them with suitable disclaimers.
ii.
iii.
Where applicable, the clients regulated by any other authority should
obtain clearance from the regulatory or any other authority before entering
into any PMS arrangement with the PD.
PDs are required to comply with the SEBI (Portfolio Managers)
Regulations, 1993 and any amendments issued thereto or instructions
issued there under.
10.2 In addition, PDs should adhere to the under noted conditions:
i. A clear mandate from the PMS clients should be obtained and the same
strictly followed. In particular, there should be full understanding on risk
disclosures, loss potential and the costs (fees and commissions) involved.
ii.
iii.
iv.
PMS should be entirely at the customer's risk without guaranteeing, either
directly or indirectly, any return.
Funds/securities, each time they are placed with the PD for portfolio
management, should not be accepted for a period less than one year.
Portfolio funds should not be deployed for lending in call/ notice/term
money/Bills rediscounting markets, badla financing or lending to/
placement with corporate/noncorporate bodies.
v. Client-wise accounts/records of funds accepted for management and
investments made there against should be maintained and the clients
should be entitled to get statements of account at frequent intervals.
vi.
Investments and funds belonging to PMS clients should be kept
segregated and distinct from each other and from those of the PD. As far
as possible, all client transactions should be executed in the market and
not off-set internally, either with the PD or any other client. All transactions
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
between the PD and any PMS client or between two PMS clients should
be strictly at market rates.
11. <strong>Guide</strong>lines on interest rate derivatives
11.1 PDs shall adhere to the guidelines laid down in circular
DBOD.No.BP.BC.86 /21.04.157 /2006-07 dated April 20, 2007 as applicable to
interest rate derivatives.
11.2 PDs are required to report all their IRS/FRA trades on the CCIL reporting
platform within 30 minutes from the deal time in terms of circular
IDMD/11.08.15/809/2007-08 dated August 23, 2007.
11.3 PDs are required to report to IDMD, as per the pro forma indicated in
Annex IX, their FRAs/ IRS operations on a monthly basis.
12. <strong>Guide</strong>lines on declaration of dividends
PDs should follow the following guidelines while declaring dividend distribution:
i. The PD should have complied with the regulations on transfer of profits to
statutory reserves and the regulatory guidelines relating to provisioning
and valuation of securities, etc.
ii.
iii.
iv.
PDs having Capital to Risk Weighted Assets Ratio (CRAR) below the
regulatory minimum of 15 per cent in any of the previous four quarters
cannot declare any dividend. For PDs having CRAR between the
regulatory minimum of 15 per cent during all the four quarters of the
previous year, but lower than 20 per cent in any of the four quarters, the
dividend payout ratio should not exceed 33.3 per cent. For PDs having
CRAR above 20 per cent during all the four quarters of the previous year,
the dividend payout ratio should not exceed 50 per cent. Dividend payout
ratio should be calculated as a percentage of dividend payable in a year
(excluding dividend tax) to net profit during the year.
The proposed dividend should be payable out of the current year’s profits.
In case the profit for the relevant period includes any extraordinary profit
income, the payout ratio should be computed after excluding such
extraordinary items for reckoning compliance with the prudential payout
ratio ceiling of 33.3 per cent or 50 per cent, as the case may be.
The financial statements pertaining to the financial year for which the PD
is declaring dividend should be free of any qualifications by the statutory
auditors, which have an adverse bearing on the profit during that year. In
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237
Annexure – F
case of any qualification to that effect, the net profit should be suitably
adjusted downward while computing the dividend payout ratio.
v. In case there are special reasons or difficulties for any PD in strictly
adhering to the guidelines, it may approach Reserve Bank in advance for
an appropriate ad hoc dispensation in this regard.
vi.
All the PDs declaring dividend should report details of dividend declared
during the accounting year as per the prescribed pro forma. The report
should be furnished within a fortnight of payment of dividend.
13. <strong>Guide</strong>lines on Corporate Governance
PDs may adhere to circular DNBS.PD/CC 94/03.10.042/2006-07 dated May 8,
2007 on guidelines on corporate governance.
14. Prevention of Money Laundering Act, 2002 - Obligations of NBFCs
PDs shall adhere to the guidelines contained in circular DNBS(PD).CC.68
/03.10.042/2005-06 dated April 5, 2006.
15. Violation/Circumvention of Instructions
Any violation/circumvention of the above guidelines or the terms and conditions
of the undertaking executed by a Primary Dealer with the Reserve Bank of India
(Annex I) would be viewed seriously and such violation would attract penal
action including the withdrawal of liquidity support, denial of access to the money
market, withdrawal of authorisation for carrying on the business as a Primary
Dealer, and/or imposition of monetary penalty or liquidated damages, as the
Reserve Bank may deem fit.
Section II: Additional <strong>Guide</strong>lines applicable to banks undertaking PD
business departmentally
1. Introduction
Scheduled commercial banks (except Regional Rural Banks) have been
permitted to undertake Primary Dealership business departmentally from 2006-
07.
2. Procedure for Authorisation of bank-PDs
2.1 Banks eligible to apply for Primary Dealership, for undertaking PD
business, (please see eligibility conditions at (iv) of paragraph 1.3.1 above) may
approach the Chief General Manager, Department of Banking Operations &
Development (DBOD), Reserve Bank of India, Central Office, Centre I, World

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
Trade Centre, Cuffe Parade, Mumbai-400 005. On obtaining an in-principle
approval from DBOD, banks may then apply to the Chief General Manager,
Internal Debt Management Department, Reserve Bank of India, 23rd Floor,
Central Office Building, Fort, Mumbai- 400 001 for an authorization for
undertaking PD business departmentally.
2.2 The banks, proposing to undertake the PD business by merging / taking
over PD business from their partly / wholly owned subsidiary, or foreign banks,
operating in India, proposing to undertake PD business departmentally by
merging the PD business being undertaken by a group company, will be subject
to the terms and conditions, as applicable, of the undertaking given by such
subsidiary/ group company till such time a fresh undertaking is executed by the
bank.
2.3 The banks authorized to undertake PD business will be required to have a
standing arrangement with RBI based on the execution of an undertaking
(Annex I) and the authorization letter issued by RBI each year (July-June).
3. Applicability of the guidelines issued for Primary Dealers
3.1 The bank-PDs would be governed by the operational guidelines as given
in Section – I above, to the extent applicable, unless otherwise stated.
Furthermore, the bank-PDs' role and obligations in terms of supporting the
primary market auctions for issue of Government dated securities and Treasury
Bills, underwriting of dated Government securities, market-making in
Government securities and secondary market turnover of Government securities
will also be on par with those applicable to stand-alone PDs as enumerated in
Section - I of this Master Circular.
3.2 Bank-PDs are expected to join Primary Dealers Association of India
(PDAI) and Fixed Income Money Market and Derivatives Association (FIMMDA)
and abide by the code of conduct framed by them and such other actions
initiated by them in the interests of the securities markets.
3.3 The requirement of ensuring minimum investment in Government
Securities and Treasury Bills on a daily basis based on net call/ RBI borrowing
and Net Owned Funds will not be applicable to bank-PDs who shall be guided by
the extant guidelines applicable to banks.
3.4 As banks have access to the call money market, refinance facility and the
Liquidity Adjustment Facility (LAF) of RBI, bank-PDs will not have separate
access to these facilities and liquidity support as applicable to the standalone
238

PDs.
Annexure – F
3.5 It is clarified that for the purpose of "when-issued trades" issued vide
circular IDMD.No/2130/11.01.01 (D)/2006-07 dated November 16, 2006, bank-
PDs will be treated as Primary Dealers.
3.6 Bank-PDs shall be guided by the extant guidelines applicable to banks as
regards borrowing in call/notice/term money market, Inter-Corporate Deposits,
FCNR (B) loans /External Commercial Borrowings and other sources of funds.
3.7 The investment policy of the bank may be suitably amended to include PD
activities also. Within the overall framework of the investment policy, the PD
business undertaken by the bank will be limited to dealing, underwriting
and market-making in Government Securities. Investments in Corporate/
PSU/ FIs bonds, Commercial Papers, Certificate of
deposits, debt mutual funds and other fixed income securities will not be deemed
to be a part of PD business.
3.8 The classification, valuation and operation of investment portfolio
guidelines as applicable to banks in regard to "Held for Trading" portfolio will also
apply to the portfolio of Government Dated Securities and Treasury Bills
earmarked for PD business.
3.9 The Government Dated Securities and Treasury Bills under PD business
will count for SLR.
3.10 Bank-PDs shall be guided by the extant guidelines applicable to banks as
regards business through brokers, ready forward transactions, interest rate
derivatives (OTC & exchange traded derivatives), investment in non-Government
Securities, Issue of Subordinated Debt Instruments and declaration of dividends.
4. Maintenance of books and accounts
4.1 The transactions related to Primary Dealership business, undertaken by a
bank departmentally, should be executed through the existing Subsidiary
General Ledger (SGL) account of the bank. However, such banks will have to
maintain separate books of accounts for transactions relating to PD business (as
distinct from normal banking business) with necessary audit trails. It should be
ensured that, at any point of time, there is a minimum balance of Rs. 100 crore of
Government Securities earmarked for PD business.
4.2 Bank-PDs should subject 100 per cent of the transactions and regulatory
returns submitted by PD department to concurrent audit. An auditors' certificate
239

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
for having maintained the minimum stipulated balance of Rs. 100 crore of
Government Securities in the PD-book on an ongoing basis and having adhered
to the guidelines/ instructions issued by RBI, should be forwarded to IDMD, RBI
on a quarterly basis.
5. Capital Adequacy and Risk Management
5.1 The capital adequacy and risk management guidelines applicable to a
bank undertaking PD activity departmentally, will be as per the extant guidelines
applicable to banks. In other words, for the purpose of assessing the bank's
capital adequacy requirement and coverage under risk management framework,
the PD activity should also be taken into account.
5.2 The bank undertaking PD activity may put in place adequate risk
management systems to measure and provide for the risks emanating from the
PD activity.
6. Supervision by RBI
6.1 The banks authorized to undertake PD business departmentally are
required to submit prescribed periodic returns to RBI promptly. The current list of
such returns and their periodicity, etc. is furnished in Annex II A.
6.2 Reserve Bank of India reserves its right to amend or modify the above
guidelines from time to time, as may be considered necessary.
240

Annexure – F
To
By
UNDERTAKING
The Chief General Manager,
Internal Debt Management Department,
Reserve Bank of India,
Central Office Building,
Mumbai-400 001.
……………………………………………………………….
Registered Office …………………………………………
………………………………………………………………
……………………………………………………………….
Annex I
WHEREAS the Reserve Bank of India (RBI) has offered in principle to permit us
to undertake Primary Dealer activity in Government securities in accordance with
the <strong>Guide</strong>lines issued thereon from time to time.
AND WHEREAS as a precondition to our being authorised to undertake Primary
Dealership activity we are required to furnish an undertaking covering the relative
terms and conditions.
AND WHEREAS at the duly convened Board of Directors meeting of
________________ on __________, the Board has authorised Shri/Smt./Kum.
_________________ and Shri/Smt./Kum. __________________ to execute and
furnish an UNDERTAKING to the Reserve Bank of India jointly and severally as
set out below:
NOW, THEREFORE, in consideration of the RBI agreeing to permit us to
undertake Primary Dealer activity, we hereby undertake and agree:
1. To commit to aggregatively bid in the auction of Treasury Bills and
Government of India Dated Securities, to the extent of …….per cent of
each issue of auction Treasury Bills and for a minimum amount equal to
the underwriting commitment (allotted under Minimum Underwriting
Commitment and Additional Competitive Underwriting) for Government of
India Dated Securities and to maintain the success ratio in aggregate
winning bids at not less than 40 per cent for Treasury Bills.
241

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
2. To offer to underwrite primary issues of Government of India dated
securities, Treasury Bills and State Government securities, for which
auction is held, and accept devolvement, if any, of any amount as may be
determined by RBI in terms of prevalent scheme for Bidding/Underwriting.
3. a) To determine prudential ceilings, with the prior approval of the
Board of Directors of the company, for reliance on borrowings from
the money market including repos, as a multiple of net owned
funds, subject to the guidelines, if any, issued by the Reserve Bank
in this regard. (applicable to standalone PDs only)
b) To adhere to prudential ceilings, with the prior approval of the
Board of Directors of the bank, subject to the guidelines, if any,
issued by the Reserve Bank in this regard. (applicable to bank-PDs
only)
4. To offer firm two-way quotes through the Negotiated Dealing System
(NDS) / NDS-OM, over the counter telephone market / recognised Stock
Exchanges in India and deal in the secondary market in Government
dated securities and Treasury Bills of varying maturity from time to time
and take principal positions.
5. To achieve a sizeable portfolio in Government securities and to actively
trade in the Government securities market.
6. To achieve an annual turnover of not less than 5 times in Government
dated securities and not less than 10 times in Treasury Bills of the
average of month-end stocks (in the book separately maintained for the
Primary Dealership business) subject to the turnover in respect of outright
transactions being not less than 3 times in government dated securities
and 6 times in Treasury Bills.
7. To maintain the capital adequacy standards prescribed by the Reserve Bank
of India, and to subject ourselves to all prudential and regulatory guidelines as
may be issued by the Reserve Bank of India from time to time.
8. To maintain adequate infrastructure in terms of both physical apparatus
and skilled manpower for efficient participation in primary issues, trading
in the secondary market, and for providing advice and education to
investors.
9. To adhere to “<strong>Guide</strong>lines on Securities Transaction to be followed by
Primary Dealers” issued vide circular IDMC.No.PDRS/2049-A/03.64.00
242

Annexure – F
/99-2000 dated December 31, 1999 and Master Circulars issued from
time to time and put in place necessary internal control systems for fair
conduct of business and settlement of trades and maintenance of
accounts.
10. To comply with all applicable Reserve Bank of India/Securities and
Exchange Board of India (SEBI) requirements under the existing
guidelines and which may be laid down from time to time in this behalf,
failing which RBI would be at liberty to cancel the authorisation as a
Primary Dealer.
11. To abide by the code of conduct as laid down by RBI/SEBI, the Primary
Dealers’ Association of India (PDAI) and the Fixed Income, Money
Markets and Derivatives Association of India (FIMMDA).
12. To maintain separate books of account for transactions relating to PD
business (distinct from the normal banking business) with necessary audit
trails and to ensure that, at any point of time, there is a minimum balance
of Rs. 100 crore of Government securities earmarked for PD business.
(applicable to bank-PDs only)
13. To maintain and preserve such information, records, books and
documents pertaining to our working as a Primary Dealer as may be
specified by the RBI from time to time.
14. To permit the RBI to inspect all records, books, information, documents
and make available the records to the officers deputed by the RBI for
inspection/scrutiny and render all necessary assistance.
15. To maintain at all times a minimum net owned funds of Rs. 50 crore /
Rs.100 crore in Government securities and to deploy the liquidity support
from the RBI, net borrowings from call money market and net repo
borrowings exclusively in Government securities. (applicable to
standalone PDs only)
16. To maintain an arms length relationship in transactions with group and
related entities.
17. To obtain prior approval of Reserve Bank of India for any change in the
shareholding pattern of the company. (applicable to standalone PDs only)
18. To submit in prescribed formats periodic reports including daily
transactions and market information, monthly report of details of
243

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
transactions in securities and risk position and performance with regard to
participation in auctions, annual audited accounts and an annual
performance review and such statements, certificates and other
documents and information as may be specified by RBI from time to time.
19. To report the matter immediately to Internal Debt Management
Department of the RBI and abide by such orders, instructions, decisions
or rulings given by the RBI if and when any kind of investigation/inquiry/
inspection is initiated against us by statutory/regulatory authorities, e.g.
SEBI/RBI, Stock Exchanges, Enforcement Directorate, Income-tax
authorities etc.
20. To pay an amount of Rupees Five Lakh, or as applicable, to the Reserve
Bank, for violation of any of the instructions issued by the Reserve Bank
in the matter or for non-compliance with any of the undertakings given
hereinabove.
We do hereby confirm that the above undertakings will be binding on our
successors and assigns.
Dated this day of Two Thousand …………..
Signed, sealed and delivered by the within named, )
being the authorized persons, in terms of the )
Resolution No._______ of the Board of Directors )
at the duly convened Meeting held on___________ )
in the in the presence of _______________ )
Signatory
Witness
Notes :
(i)
(ii)
(i)
(ii)
1. Para 3.a, 15 and 17 are applicable to standalone PDs only.
2. Paras 3.b, words in italics in para 6 and para 12 are applicable to bank-
PDs only.
244

Annexure – F
Annex II
A. Statements / Returns required to be submitted by Primary Dealers to
IDMD
Sr.
No.
Return/Report
Periodicity
Last date for
submission
1. PDR-I* Fortnightly Next working day of
the reporting fortnight
2. PDR-II* Monthly 10th of the following
month
3. PDR-III* Quarterly 15 of the month
following the reporting
quarter
4. PDR IV* Quarterly
15 th of the month of
the month following
the reporting quarter
5. Return on FRAs / IRS Monthly 10th of the following
month
6. Annual Report & Annual
Audited A/cs
7. Auditor's Certificate on Net
Owned Funds
8. Reconciliation of holdings
of Govt. Securities in own
A/c and constituent A/c
9. Investments in non-
Government securities
10 Details of dividend
declared during the
accounting year
Annual
Yearly
Yearly
Yearly
Yearly
As soon as annual
accounts audited and
finalised
30th June
One month from the
close of accounting
year
Disclosures in the
‘Notes on Accounts’
of the balance sheet,
with effect from the
financial year ending
31 March 2004.
Within a fortnight from
the payment of
dividend
Reference under
which required
PD <strong>Guide</strong>lines
IDMC.No.PDRS/2049A
/03.64.00/99-2000
dated December 31,
1999
IDMD.PDRS.No.3/03.6
4.00/2003-04 March
08, 2004
IDMD.PDRS.No
6/03.64.00/2003-04
June 03, 2004
245

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
* = Indicates that these returns should be submitted in electronic form as
an excel file attachment through e-mail.
B. Statements / Returns required to be submitted by Primary Dealers to
departments other than IDMD of Reserve Bank of India
Sr.
No.
Return/Report
Periodicity
To be filed
with Deptt.
Reference under which
required
1. Return on FRAs/IRS Fortnightly MPD MPD.BC.187/07.01.2
79/1999-2000 dated July 7,
1999.
2. Statement showing
balances of Govt.
Securities held on behalf
of each Gilt A/c holder
3. Return on Call Money
transactions with
Commercial Banks
Half-Yearly
Fortnightly
PDO
DEAP, DMB
4. Information for Issue of
Commercial Paper
On each issue of
CP
MPD IECD.2/08.15.01/200 1-02
dated July 23, 2001
Note: The last date prescribed for submission of these statements by the
departments concerned and/or IDMD should be adhered to.
246

Annexure – F
Annex II A
Statements / Returns required to be submitted by banks on their Primary
Dealership business to IDMD*:
Sr.
No.
Return/Report Periodicity Last date for submission
11. PDR-II** (format enclosed as Appendix
III)
12. Concurrent auditor certificate for having
maintained the minimum stipulated
balance of Rs. 100crore of Government
Securities in the PD book on an
ongoing basis.
13. Annual Report on PD activity of the
bank.
Monthly
Quarterly
Annual
10 th of the following month
15 th of the month following the
reporting month
Within 30 days of the finalization of
audited accounts.
* In addition to reports on "when issued" transactions and short-sales.
**Return should be submitted in electronic form as an excel file attachment
through email at pdrsidmc@rbi.org.in
247

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
Annex III
Illustration showing the underwriting amount, cut off rate of underwriting
fee accepted by Reserve Bank of India
Illustration showing the underwriting amount, cut-off of fee quoted,
commission payable to PDs
Instrument Name
Auction Type
XXXXXXXX
Multiple
Notified amount (NA) 4000
Total No. of PDs (n) 19
Minimum Underwriting Commitment (MUC ) 2000
(amount in crore)
Per PD MUC (MUC/ n) 105.263 Rounded
off to
Total PD commitment under MUC collectively (Adjusted
MUC)
Additional competitive underwriting ACU = (NA –
Adjusted MUC)
Minimum bidding by each PD in ACU (equal to per PD
MUC)
Total underwriting commitment for each PD under MUC
and ACU
2014
1986
106
212
Total Underwriting ( 212 *19) 4028
Minimum allotment to a PD to be eligible for higher
commission on MUC i.e. min 4% of Notified Amount
160
106
248

Annexure – F
Bids submitted under Additional Competitive Underwriting Auction
S.
No
PDs
participated
in U/W
auction
Amount
of bid in
ACU
(Rs.
Crore)
Cumulative
Amount
(Rs. Cr)
Underwriting
fee (in paise /
Rs.100)
Amount
of bid *
U/w fee
Remarks
Weighted
Average
underwriting
fee (paise /
Rs.100)
1 A 150 150 1.52 228.00 1.52
2 B 155 305 2.56 396.80 2.05
3 A 60 365 3.50 210.00
Three
lowest
bids
2.29
4 C 95 460 3.70 351.50 2.58
5 B 200 660 3.94 788.00 2.99
6 B 25 685 4.00 100.00 3.03
7 D 120 805 4.00 480.00 3.17
8 E 95 900 4.49 426.55 3.31
9 F 70 970 4.50 315.00 3.40
10 G 50 1020 4.75 237.50 3.46
11 E 115 1135 4.90 563.50 3.61
12 C 90 1225 4.94 444.60 3.71
13 F 220 1445 4.95 1089.00 3.90
14 G 200 1645 5.00 1000.00 4.03
15 H 120 1765 5.00 600.00 4.10
16 I 120 1885 5.00 600.00 4.15
17 I 109 1994 5.00 545.00 CUT-
OFF
4.20
18 I 25 2019 5.50 137.50 4.22
19 J 120 2139 5.94 712.80 4.31
20 K 120 2259 6.00 720.00 4.40
21 L 120 2379 6.00 720.00 4.48
249

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
22 M 55 2434 6.50 357.50 4.53
23 N 120 2554 6.94 832.80 4.64
24 O 120 2674 7.00 840.00 4.75
25 P 120 2794 7.00 840.00 4.84
26 Q 120 2914 7.00 840.00 4.93
27 R 106 3020 8.00 848.00 5.04
28 S 106 3126 8.50 901.00 5.16
29 M 80 3206 9.00 720.00 5.25
30 K 100 3306 9.25 925.00 5.38
Rate of commission payable to PDs on MUC for those
who have been allotted an amount >= 4% of ACU amount
4.20
(weighted average of all allotted
bids)
Rate of commission payable to other PDs on MUC 2.29
(weighted average of the three
lowest bids)
250

Annexure – F
PD Wise eligible commission on ACU and ACU Allotment
[a] [b] [c] [d]={[b]*10000000*[c]/100}/100
Successful PDs Successful bids in
ACU (Rs. Cr)
Underwriting fee bid
(in paise / Rs.100)
Bid wise commission payable on
ACU (In Rs.)
A 150 1.52 228,000.00
A 60 3.50 210,000.00
A Total 210 438,000.00
B 155 2.56 396,800.00
B 200 3.94 788,000.00
B 25 4.00 100,000.00
B Total 380 1,284,800.00
C 95 3.70 351,500.00
C 90 4.94 444,600.00
C Total 185 796,100.00
D 120 4.00 480,000.00
D Total 120 480,000.00
E 95 4.49 426,550.00
E 115 4.90 563,500.00
E Total 210 990,050.00
F 70 4.50 315,000.00
F 220 4.95 1,089,000.00
F Total 290 1,404,000.00
G 50 4.75 237,500.00
G 200 5.00 1,000,000.00
G Total 250 1,237,500.00
H 120 5.00 600,000.00
H Total 120 600,000.00
I 120 5.00 600,000.00
I 101 5.00 505,000.00
I Total 221 1,105,000.00
251

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
PD
MUC amount accepted
ACU amount accepted
Total amount accepted
(in (in (in
crore) crore) crore)
Underwriting Commission Details
Whether
ACU
accepted
is >= 4%
NA
Wighted
average fee
taken for
MUC
commission
calculation
(paise per
Rs.100)
Commn on MUC
Commission on ACU
Total Commission
A 106 210 316 YES 4.20 445,200 438,000 883,200
B 106 380 486 YES 4.20 445,200 1,284,800 1,730,000
C 106 185 291 YES 4.20 445,200 796,100 1,241,300
D 106 120 226 NO 2.29 242,740 480,000 722,740
E 106 210 316 YES 4.20 445,200 990,050 1,435,250
F 106 290 396 YES 4.20 445,200 1,404,000 1,849,200
G 106 250 356 YES 4.20 445,200 1,237,500 1,682,700
H 106 120 226 NO 2.29 242,740 600,000 842,740
I 106 221 327 YES 4.20 445,200 1,105,000 1,550,200
J 106 0 106 NO 2.29 242,740 0 242,740
K 106 0 106 NO 2.29 242,740 0 242,740
L 106 0 106 NO 2.29 242,740 0 242,740
M 106 0 106 NO 2.29 242,740 0 242,740
N 106 0 106 NO 2.29 242,740 0 242,740
O 106 0 106 NO 2.29 242,740 0 242,740
P 106 0 106 NO 2.29 242,740 0 242,740
Q 106 0 106 NO 2.29 242,740 0 242,740
R 106 0 106 NO 2.29 242,740 0 242,740
S 106 0 106 NO 2.29 242,740 0 242,740
TOTAL 2014 1986 4000 6,029,280 8,335,450 14,364,730
(Rs.)
252

Annexure – F
Annex IV
Illustrations showing adherence by PDs to Commitments on aggregative
bidding in auction of Treasury Bills and success ratio
1. A PD has committed to bid aggregatively Rs. 500 crore GOI Treasury Bills
as shown below. The success ratio to be maintained by the PD is 40 per
cent in respect of Treasury Bills. Various scenarios in respect of fulfillment
of the bidding commitment and the success ratio assuming that the bids
tendered and the bids accepted will be as under:
(1) Treasury Bills: (Rs. crore)
SCENARIOS (I) (II) (III)
Bidding Commitment (a) 500 500 500
Bids Tendered (b) 600 500 400
Bids Accepted (c) 300 200 100
Success Ratio Achieved (c)/(a) 60% 40% 20%
Fulfilment of Bidding Commitment Yes Yes No
Fulfilment of Success Ratio Yes Yes No
Success ratio in Treasury Bills is the ratio of bids accepted and bidding commitment.
253

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
PDR I Return
Name of PD:
Net Owned Funds(as per last b/s):
Return for fortnight ending:
date wise fortnightly statement
Annex V
1
A Outright purchases (Face Value)
(i) Government Securities and Treasury bills
(ii) Other securities
B Outright sales (Face Value)
(i) Government Securities and Treasury bills
(ii) Other securities
C Repo transactions
(i)
(ii)
Borrowing (amount)
- from Reserve Bank of India
- from the market
Lending (amount)
- to Reserve Bank of India
- to the market
D Call Money transactions
- Borrowing
- Lending
2 Outstanding balances (Settled position
figures)
A Sources of Funds
a) Net Owned funds (as per last audited
balance sheet)
b) Current years accruals under profit /loss
account
254

Annexure – F
c) Call Money Borrowings
d) Notice/Term Money borrowings
e) Borrowing from RBI under Assured
Support/LAF
f) Repo borrowing from market
g) Borrowing under CBLO
h) Borrowing under credit lines of banks/FIs
i) Borrowings through Inter-Corporate
Deposits
- maturing up to 14 days
- maturing beyond 14 days
j) FCNR(B) Loans
k) Commercial Paper/ Bond issuances
k) Others (Give details for items in excess of
Rs 10 crore)
Total
B
Application of Funds
a) Government Securities & Treasury bills
(Book value) @
i) Own Stock
ii) Stock with RBI under Assured
Support/LAF
iii) Stock with market for repo borrowing
b) Lending in Call money Market
c) Lending in Call/Notice/ Term money market
d) Repo Lending to market
e) Lending under CBLO
f) Repo lending to RBI
g) Corporate /PSU/FI Bonds
h) Investment in shares
255

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
i) Investment in Mutual funds schemes
- debt oriented
- equity oriented
j) Investment in Subsidiaries.
k) Other finacial assets if any
l) Fixed Assets
m) Others (Give details for items in excess of Rs
10 crore)
Total
Own Stock position (SGL Balance) (Face
value)
i) Treasury bills
ii)
Dated Government Securities
3 Portfolio duration for Government Securities
VaR for the day (with prescribed holding
period) as % of portfolio
@ Exclude stock received as pledge for repo lending to RBI/market participants
and also the stock reported under a (ii) and a (iii).
256

Annexure – F
PDR – II Format
Annex VI
257

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
PRIMARY DEALER'S MONTHLY REPORT Form PDR 2
Name of the Primary Dealer
Statement as at the end of:
(Rs. in crores) Cumulative figures
SECTION A - SECURITES MARKETS TURNOVER
Dated GOI State Govt. T-bills Total
Securities Securities
I. PRIMARY MARKET
NEW SUBSCRIPTIONS
i) Bidding commitment* N.A.
ii) Bids Tendered**
iii) Non-competive bids
iv) Bids Accepted ( A )
v) Success Ratio N.A N.A
REDEMPTIONS (B)
II. TOTAL = I(A)+I(B)
III. UNDERWRITING
i) Amount offered for
underwriting
N.A.
ii) Amount of underwriting
accepted by RBI
N.A.
iii) Amount of devolvement N.A.
iv) Underwriting fee received N.A.
IV. SECONDARY MARKET
TURNOVER – OTC OUTRIGHT
(including OMO)
i) Purchases
ii) Sales
TOTAL OUTRIGHT TURNOVER (A)
i) Purchases
ii) Sales
258

Annexure – F
REPURCHASE AGREEMENTS
i) Repo (both legs)
ii) Reverse Repo (both legs)
TOTAL REPOS TURNOVER (B)
V. Total Turnover - OTC (IV(A)+IV(B))
VI. SECONDARY MARKET TURNOVER –
STOCK EXCHANGES
i) Purchases N.A. N.A.
ii) Sales N.A. N.A.
SECTION - B: EXCHANGE TRADED INTEREST RATE DERIVATIVES
I. Activity during the month
91-Day T-bill
month 1
month2
month3
10 year zero coupon bond
month 1
month2
month3
10 year notional bond
month 1
month2
month3
NPA** of the NPA of the NPA of the NPA of the
futures contract futures contract futures contract futures contract
outstanding at the entered into reversed outstanding at
beginning of the during the during the the end of the
month month month month
(NPA is to be furnished according to the underlying interest exposure wise break up)
II.
Analysis of "highly effective" hedges
A certificate from Concurrent Auditors stating that the size of the hedge portfolio and that the
hedge is highly effective as per the definition of RBI circular dated June 3, 2003
259

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
III. Analysis of trading positions
NPA of the Trading
Futures Position
91-Day T-bill
month2
month3
10 year zero coupon bond
month2
month3
10 year notional bond
month2
month3
** NPA = Notional Principal Amount
MTM value of the trading
futures position
Signature
260

Annexure – F
Name of the Primary Dealer :
Annex VII
PDR – IV
Quarterly return on select Financial & Balance Sheet indicators for quarter
ended
I. BALANCE SHEET INDICATORS
SOURCES OF FUNDS
Share Capital
Reserves & Surplus
Deposits, if any
Secured loans
Unsecured loans
TOTAL
APPLICATION OF FUNDS
Fixed Assets
Gross Block
less Depreciation
Net block
Add Capital work in progress
Investments
a. Govt. Securities
1. Dated GOI securities
2. State Govt. Securities
3. T-bills
b. Others (Specify)
Current Assets, Loans and Advances
(A) Current Assets Accrued Interest
Stock – in – Trade Cash & Bank
balance
Quarter ended
(cumulative)
(Rs. in crore)
Previous
Quarter
261

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
(B) Loans & Advances
Less:
Current Liabilities and provisions
Liabilities
Provisions
Net Current Assets
Deferred Tax
Miscellaneous Expenses not written off
Others (specify)
TOTAL
II. P& L INDICATORS
INCOME
Discount Income
1. G-secs
2. Others
Interest Income
1. G-secs
2. Call/Term
3. Repo
4. Others
Trading Profits
1. G-secs
2. Others
Other Income
1. G-secs
2. Others (specify)
TOTAL INCOME
Quarter ended
(cumulative)
Previous
Quarter
EXPENDITURE
262

Annexure – F
Interest Expenses
1. Call/Term
2. Repo
3. Borrowing from RBI
4. Others
Operating Expenses
Establishment & Administrative Expenses
Provisions against doubtful assets
Depreciation on Fixed Assets
Other expenses (specify)
TOTAL EXPENDITURE
PROFIT BEFORE TAX
Less provision for taxation and deferred tax
PROFIT AFTER TAX
III. FINANCIAL INDICATORS
Certain Key Figures
Dividend paid/proposed
Retained earnings
Average Earning assets
Average Non-earning assets
*** Average total assets
1. Average dated G-secs (Central and
State)
2. Average T-Bills
3. Other average assets
**** Average Interest bearing liabilities
1. Call borrowing
2. Repo
3. Borrowing from RBI
4. Others
263

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
Average yield on assets
(Total interest income/Average Earning
Assets)
Average cost of funds
(Total interest expended/Average
interest bearing liabilities)
Net interest income
Non-interest income
Non-interest expenditure
Net total income
Measures of Return
Return on Assets
Before
tax (PBT/Ave.Total Assets)
After
tax (PAT/Ave.Total Assets)
Return on average Equity
Before tax (PBT/Ave.Equity) After
tax (PAT/Ave.Equity)
Return on Capital Employed
Before tax (PBT/(Owners' Equity+Total
Debt))
After Tax (PAT/(Owners' Equity+Total Debt))
Net Margin Analysis
Net Margin (PAT/Total Income)
Interest expenses/Total income
IV. PERFORMANCE INDICATORS
NOF (Rs. In crore)
CRAR (as %)
Quarter ended
(cumulative)
Previous
Quarter
264

Annexure – F
Average duration of the Portfolio (in years)
Average leverage (as ratio)
Effect of 1% shock in yields on portfolio
value
(Rs. in crore)
***** MTM value of all securities (Rs. In
crore)
Notes:
1. The details of share capital, reserves,etc. may be enclosed as Annexes.
2. Where average figures are involved, it may be taken to mean as average
of month end balances.
*** Average assets refers to the simple average of month end book balance.
**** Average liabilities refers to the simple average of month end book
balance.
***** Before adjusting Repo transactions and MTM depreciation on IRS
transactions.
Signature
265

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
Publication of Financial Results
Name of Primary Dealer
Audited Financial Results for the year ended 31st March ………
Sources of Funds
Capital
Reserves and Surplus
Loans
Secured
Unsecured
(of which call money borrowings)
Application of Funds
Fixed Assets
Investments
Government Securities (inclusive of T. Bills)
Commercial Papers
Corporate Bonds
Loans and Advances
(of which call money lendings)
Non Current Assets
Others
Profits and Loss account
Income (business segment wise)
Interest
Discount
Trading Profit
Annex VIII
266

Annexure – F
Expenses
Interest
Administrative Costs
Profit before tax
Net Profit
Regulatory Capital required (as per Capital Adequacy <strong>Guide</strong>lines)
Actual Capital
Return on Net Worth
267

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
Monthly Return on Interest Rate Risk of Rupee Derivatives
Name of the Bank/Institution:
As at end-month
1. Cash Bonds Market Value (Rs.
in Crore)
Annex IX
PV01(Rs. In
Crore)
(a) (b) (c)
(a) HFT (See Note 1)
(b) AFS (See Note 1)
(c) HTM (See Note 1)
Total [(a) to (c) above]
2. Rupee Interest Rate Derivatives Notional Amount
(Rs. In Crore)
PV01(Rs. In
Crore)
(a) Bond Futures (See Note 1)
(b) MIBOR (OIS) (See Note 2)
(c) MIFOR (See Note 2)
(d) G-Sec benchmarks
(e) Other benchmarks (Please report
separately)
(See Note2)
(See Note
2&4)
(f) Forward Rate Agreements (See Note 3)
Total [(a) to (f) above]
3. Grand Total of (1) & (2)
4. Tier I Capital
Note 1. PV01 may be taken as POSITIVE for long positions and NEGATIVE for
short positions. Note 2. PV01 may be taken as POSITIVE if receiving a swap and
NEGATIVE if paying a swap. Note 3. For FRAs, use the PVO1 of the underlying
deposit/instrument.
Note 4. In 2 (e) above, swaps on other benchmarks such as LIBOR may be
reported separately for each benchmark
268

Annexure – F
List of circulars consolidated
Annex X
No Circular no Date Subject
1 IDMC.PDRS.1532./03.
64.00/1999-00
November 2, 1999 Primary Dealers – Leverage
2 IDMC.PDRS.2049A/03
.64.00/1999-2000
December 31,
1999
<strong>Guide</strong>lines on Securities transactions
to be followed by Primary Dealers
3 IDMC.PDRS.5122./03.
64.00/1999-00
June 14,2000 <strong>Guide</strong>lines on Securities
Transactions by Primary dealers
4 IDMC.PDRS.4135/03.
64.00/2000-01
5 IDMC.PDRS.87/03.64.
00/2001-02
April 19,2001
July 5, 2001
Scheme for Bidding, Underwriting
and Liquidity support to Primary
Dealers
Liquidity support to Primary Dealers
6 IDMC.PDRS.1382./03.
64.00/2000-01
September 18,
2001
Dematerialised holding of bonds and
debentures
7 IDMC.PDRS.3369./03.
64.00/2001-02
January 17, 2002 <strong>Guide</strong>lines on Counter party limits
and Inter-corporate deposits
8 IDMC.PDRS.4881/03.
64.00/2001-02
9 IDMC.PDRS.5018./03.
64.00/2001-02
May 8,2002
May 17, 2002
<strong>Guide</strong>lines to Primary Dealers
Scheme for Bidding, Underwriting
and liquidity support to Primary
dealers 2001-02
10 IDMC.PDRS.5039./03.
64.00/2001-02
11 IDMC.PDRS.5323./03.
64.00/2001-02
May 20,2002 Transactions in Government
securities
June 10,2002 Transactions in Government
securities
12 IDMC.PDRS.418./03.6
4.00/2002-03
July 26,2002
Publication of Financial results
13 IDMC.PDRS.1724./03.
64.00/2002-03
October 23, 2002 Underwriting of Government dated
securities by Primary Dealers
269

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
No Circular no Date Subject
14 IDMC.PDRS.2269./03.
64.00/2002-03
15 IDMC.PDRS.2896./03.
64.00/2002-03
November
28,2002
January 14, 2003
Publication of Financial results
Trading in Government securities on
Stock Exchanges
16 IDMC.PDRS.3432./03.
64.00/2002-03
February 21, 2003 Ready Forward Contracts
17 IDMC.PDRS.3820./03.
64.00/2002-03
18 IDMC.PDRS.1./03.64.
00/2002-03
19 IDMC.PDRS.4802./03.
64.00/2002-03
March 24, 2003
April 10, 2003
June 3, 2003
Availment of FCNR(B) loans by
Primary Dealers
Portfolio Management Services by
Primary Dealers – <strong>Guide</strong>lines
<strong>Guide</strong>lines on Exchange Traded
Interest Rate Derivatives
20 IDMC.PDRS.122./03.6
4.00/2002-03
September 22,
2003
Rationalisation of returns submitted
by Primary Dealers
21 IDMD. PDRS.No.3/
03.64.00/2003-04
March 08, 2004
Prudential guidelines on investment
in non-Government securities
22 IDMD.PDRS.05/10.02.
01/2003-04
March 29, 2004 Transactions in Government
Securities
23 IDMD.PDRS. No06/
03.64.00/2003-04
June 03, 2004
Declaration of dividend by Primary
Dealers
24 IDMD.PDRS. 01
10.02.01/2004-05
25 IDMD.PDRS. 02
/03.64.00/2004-05
July 23, 2004 Transactions in Government
securities
July 23, 2004 Success Ratio in Treasury Bill
auctions for Primary Dealers
26 RBI/2004-05/ 136 – August 24, 2004
IDMD.PDRS.No/ 03
/10.02.16/2004-05
Dematerialization of Primary Dealer’s
investment in equity
27 RBI/2005/459/IDM
D.PDRS/4783/10.02
.01/2004-05
May 11, 2005
Government Securities Transactions
– T+1 settlement
270

Annexure – F
No Circular no Date Subject
28 RBI/2005/460/IDM
D.PDRS/4779/10.02
.01/2004-05
May 11, 2005
Ready Forward Contracts
29 RBI/ 2005 / 461 May 11, 2005
IDMD.PDRS.4777 /
10.02.01 / 2004-05
Sale of securities allotted in primary
issues
30 RBI/2005/474/IDM
D.PDRS/4907/03.64
.00/2004-05
May 19, 2005 Conduct of Dated Government
Securities Auction under Primary
Market Operations (PMO) module
of PDO-NDS – Payment of
Underwriting Commission
31 RBI/2005-06/ 73 July 20, 2005 Transactions in Government
IDMD.PDRS. 337
Securities
/10.02.01/2005-06
32 RBI/2005-06/132
IDMD.No.766/10.26
.65A/2005-06
33 RBI/2005-06/308
DBOD.FSD.BC.No.6
4/24.92.01/2005-06
34 RBI/2006-07/49
IDMD.PDRS/26/03.
64.00/2006-07
35 RBI/2006-2007/298
FMD.MOAG No.13
/01.01.01/2006-07
36 IDMD.530/03.64.00
/2007-08
37 DBOD.FSD.BC.No.2
5/24.92.001/2006-07
38 IDMD.PDRS.1431/03.
64.00/2006-07
August 22, 2005 NDS-OM – Counterparty
Confirmation
February 27, 2006 <strong>Guide</strong>lines for banks’ undertaking PD
business
July 4, 2006
Diversification of activities by standalone
Primary Dealers- Operational
<strong>Guide</strong>lines
March 30, 2007 Liquidity Adjustment Facility-
Acceptance of State Development
Loans under Repos
July 31, 2007 FIMMDA Reporting Platform for
Corporate Bond Transactions
August 9, 2006
October 5, 2006
<strong>Guide</strong>lines for banks undertaking
PD business
Operational guidelines for banks
undertaking/proposing to undertake
PD business
271

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
No Circular no Date Subject
39 IDMD/11.08.15/809/20
07-08
40 RBI/2007-2008/186
IDMD.PDRS.No.2382
/03.64.00/2007-08
41 IDMD.DOD.No.5893/
10.25.66/2007-08
42 RBI/2008-09/187
IDMD.PDRD.No.1393
/ 03.64.00 / 2008-09
43 RBI/2008-09/479
IDMD.No.5877/08.02.
33 / 2008-09
August 23, 2007
November 14,
2007
May 27, 2008
September 19,
2008
May 22, 2009
Reporting platform for OTC Interest
Rate Derivatives
Revised Scheme of Underwriting
Commitment and Liquidity Support
NDS-Order Matching (OM) Sytem
– Access through the CSGL route
Settlement of Primary Auctions
– Shortage of Funds
Auction process of Government of
India Securities
272

ANNEXURE – G
RBI MC CAPADEQRM 2009
TELEGRAMS: "RESERVBANK" POST BOX 10007
TELEPHONE 22661602/04 FAX NO. 022-22644158
RESERVE BANK OF INDIA CENTRAL OFFICE
INTERNAL DEBT MANAGEMENT DEPARTMENT
CENTRAL OFFICE BUILDING
MUMBAI 400 001
RBI/2009-10/55 July 1, 2009
IDMD.PDRD.02/03.64.00/2009-10
Dear Sir
All Primary Dealers in the Government Securities Market
Master Circular on Capital Adequacy Standards and Risk Management
<strong>Guide</strong>lines for standalone Primary Dealers
The Reserve Bank of India has, from time to time, issued a number of guidelines
on Capital Adequacy Standards and Risk Management for standalone Primary
Dealers (PDs). To enable the PDs to have all the current instructions at one
place, a Master Circular incorporating the guidelines on the subject is enclosed
as an Appendix.
2. Banks undertaking PD activities departmentally may follow the extant
guidelines applicable to banks in regards to their capital adequacy requirement
and risk management.
Yours faithfully
(K.V.Rajan)
Chief General Manager
Encl : As above

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
RESERVE BANK OF INDIA
INTERNAL DEBT MANAGEMENT DEPARTMENT
CENTRAL OFFICE BUILDING
MUMBAI 400 001
(Ref: RBI/2009-10/ IDMD.PDRD.02 /03.64.00/2009-10 dated July 1, 2009)
CAPITAL FUNDS & CAPITAL REQUIREMENTS
General <strong>Guide</strong>lines
1 General
APPENDIX
1.1 Capital adequacy standards for Primary Dealers in Government Securities
market have been in vogue since December 2000. The guidelines were revised
keeping in view the developments in the market, experience gained over time
and introduction of new products like exchange traded derivatives. The revised
guidelines were issued vide circular IDMD.1/(PDRS)03.64.00/2003-04 dated
January 07, 2004. The present circular has been updated with the guidelines on
capital requirements issued subsequent to the aforesaid circular.
2 Capital Funds
Capital Funds would include the following elements:
2.1 Tier-I Capital
Tier-I Capital would mean paid-up capital, statutory reserves and other disclosed
free reserves. Investment in subsidiaries where applicable, intangible assets,
losses in current accounting period, deferred tax asset (DTA) and losses brought
forward from previous accounting periods will be deducted from the Tier I capital.
In case any PD is having substantial interest/ (as defined for NBFCs) exposure
by way of loans and advances not related to business relationship in other Group
companies, such amounts will be deducted from its Tier I capital.
2.2 Tier-II capital
Tier II capital includes the following:-
(i)
Undisclosed reserves and cumulative preference shares other than those
which are compulsorily convertible into equity. Cumulative Preferential
shares should be fully paid-up and should not contain clauses which
274

Annexure – G
(ii)
(iii)
(iv)
(v)
permit redemption by the holder.
Revaluation reserves discounted at a rate of fifty five percent;
General provisions and loss reserves to the extent these are not
attributable to actual diminution in value or identifiable potential loss in
any specific asset and are available to meet unexpected losses, up to the
maximum of 1.25 percent of total risk weighted assets;
Hybrid debt capital instruments, which combine certain characteristics of
equity and certain characteristics of debt.
Subordinated debt:
a) To be eligible for inclusion in Tier II capital, the instrument should
be fully paid-up, unsecured, subordinated to the claims of other creditors,
free of restrictive clauses, and should not be redeemable at the initiative
of the holder or without the consent of the Reserve Bank of India. It often
carries a fixed maturity, and as it approaches maturity, it should be
subjected to progressive discount, for inclusion in Tier II capital.
Instruments with an initial maturity of less than 5 years or with a remaining
maturity of one year should not be included as part of Tier II capital.
Subordinated debt instruments eligible to be reckoned as Tier II capital
will be limited to 50 percent of Tier I capital.
b) The subordinated debt instruments included in Tier II capital may
be subjected to discount at the rates shown below:
Remaining Maturity of
Instruments
Rate of Discount (%)
Less than one year 100
One year and more but less than
two years
Two years and more but less than
three years
Three years and more but less than
four years
Four years and more but less than
five years
80
60
40
20
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
2.3 Tier – III Capital
Tier III capital is the capital issued to meet solely the market risk capital charge in
accordance with the criteria as laid down below.
The principal form of eligible capital to cover market risk consists of shareholders'
and retained earnings (Tier I Capital) and supplementary capital (Tier II Capital).
But PDs may also employ a third tier of capital ("Tier III"), consisting of short-term
subordinated debt, as defined below, for the sole purpose of meeting a portion of
the capital requirements for market risks.
For short-term subordinated debt to be eligible as Tier III Capital, it needs, if
circumstances demand, to be capable of becoming part of PD's permanent
capital and available to absorb losses in the event of insolvency. It must,
therefore, at a minimum;
(i)
(ii)
(iii)
(iv)
be unsecured, subordinated and fully paid up;
have an original maturity of at least two years;
not be repayable before the agreed repayment date unless the RBI
agrees;
be subject to a lock-in clause that neither interest nor principal may be
paid (even at maturity) if such payment means that the PD falls below or
remains below its minimum capital requirement.
2.4 <strong>Guide</strong>lines on Subordinated Debt Instruments
<strong>Guide</strong>lines relating to the issue of Subordinated Debt Instruments under Tier II
and Tier III Capital are furnished below:
i. The amount of Subordinated Debt to be raised may be decided by the
Board of Directors of the PD.
ii.
iii.
iv.
The primary dealers may issue subordinated Tier II and Tier III bonds at
coupon rates as decided by their Boards of Directors.
The instruments should be 'plain vanilla' with no special features like
options, etc.
The debt securities shall carry a credit rating from a Credit Rating Agency
registered with the Securities and Exchange Board of India.
v. The issue of Subordinated Debt instruments should comply with the
guidelines issued by SEBI vide their circular SEBI/MRD/SE/AT/36/2003/
276

vi.
vii.
viii.
ix.
Annexure – G
30/09 dated September 30, 2003 as amended from time to time, wherever
applicable.
In case of unlisted issues of Subordinated Debt, the disclosure
requirements as prescribed by the SEBI for listed companies in terms of
the above guidelines should be complied with.
Necessary permission from the Foreign Exchange Department of the
Reserve Bank of India should be obtained for issuing the instruments to
NRIs/FIIs. PDs should comply with the terms and conditions, if any,
prescribed by SEBI/other regulatory authorities in regard to issue of the
instruments.
Investments by PDs in Subordinated Debt of other PDs/banks will be
assigned 100% risk weight for capital adequacy purpose. Further, the
PD’s aggregate investments in Tiers II and III bonds issued by other PDs,
banks and financial institutions shall be restricted up to 5 percent of the
investing PD's total capital. The capital for this purpose will be the same
as that reckoned for the purpose of capital adequacy.
The PDs should submit a report to the Internal Debt Management
Department, Reserve Bank of India giving details of the capital raised,
such as, amount raised, maturity of the instrument, rate of interest
together with a copy of the offer document, soon after the issue is
completed.
2.5 Minimum Requirement of Capital Funds
PDs are required to maintain a minimum Capital to Risk-weighted Assets Ratio
(CRAR) norm of 15 percent on an ongoing basis.
In calculating eligible capital, it will be necessary first to calculate the PDs’
minimum capital requirement for credit risk, and thereafter its market risk
requirement, to establish how much Tier I and Tier II capital is available to
support market risk. Eligible capital will be the sum of the whole of the PDs’ Tier I
capital, plus all of its Tier II capital under the limits imposed as summarized in
Annex C. Tier III capital will be regarded as eligible only if it meets the criteria set
out in para 2.3 above.
3 Measurement of Risk Weighted Assets:
The details of credit risk weights for the various on-balance sheet items and
offbalance sheet items based on the degree of credit risk and methodology of
277

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
computing the risk weighted assets for the credit risk are listed in Annex A. The
procedure for calculating capital charge for market risk is detailed in Annex B. In
order to ensure consistency in the calculation of the capital requirements for
credit and market risks, an explicit numerical link will be created by multiplying
the measure of market risk by 6.67 (i.e., the reciprocal of the credit risk ratio of
15%) and adding the resulting figure to the sum of risk-weighted assets compiled
for credit risk purposes. The ratio will then be calculated in relation to the sum of
the two, using as the numerator only eligible capital as given in Annex C.
4 Regulatory reporting of Capital adequacy:
All PDs should report the position of their capital adequacy in PDR III return on a
quarterly basis. The PDR III statement is given in Annex D. Apart from the
Appendices I to V which are to be submitted alongwith PDR III, PDs should also
take into consideration the criteria for use of internal model to measure market
risk capital charge (as given in Annex E) alongwith the "Back Testing"
mechanism (detailed in Annex F)
5 Diversification of PD Activities
5.1 The guidelines on diversification of activities by stand-alone Primary
Dealers have been issued vide circular IDMD. PDRS.26/03.64.00/2006-07 dated
July 4, 2006.
5.2 The capital charge for market risk (Value-at-Risk calculated at 99 per cent
confidence interval, 15-day holding period, with multiplier of 3.3) for the activities
defined below should not be more than 20 per cent of the NOF as per the last
audited balance sheet:
1. Investment / trading in equity and equity derivatives
2. Investment in units of equity oriented mutual funds
3. Underwriting public issues of equity
5.3 PDs may calculate the capital charge for market risk on the stock
positions / underlying stock positions/ units of equity oriented mutual funds using
Internal Models (Value-at-Risk based) based on the guidelines prescribed in
Appendix III of Annex D. PDs may continue to provide for credit risk arising out
of equity, equity derivatives and equity oriented mutual funds as prescribed
Annex A.
278

Annexure – G
6 Risk reporting of derivatives business
In order to capture interest rate risk arising out of interest rate derivative
business, all PDs are advised to report the interest rate derivative transactions,
as per the format enclosed in Annex G, to the Chief General Manager, Internal
Debt Management Department, RBI, Central Office, Mumbai, as on last Friday of
every month.
279

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
CAPITAL ADEQUACY FOR CREDIT RISK
Risk weights for calculation of CRAR
(a)
On-Balance Sheet assets
Annex A
All the on-balance sheet items are assigned percentage weights as per degree of
credit risk. The value of each asset/item is to be multiplied by the relevant risk
weight to arrive at risk adjusted value of the asset, as detailed below. The
aggregate of the Risk Weighted Assets will be taken into account for reckoning
the minimum capital ratio.
Nature of asset/item Percentage weight
(i) Cash balances and balances in Current 0
Account with RBI
(ii) Amounts lent in call/notice money market/ 20
Other money market instruments of banks/
FIs including CDs and balances in Current
account with banks
(iii)
Investments
(a) `Government’securities/‘Approved’securities 0
guaranteed by Central/State Governments
[other than at (e) below]
(b) Fixed Deposits, Bonds of banks and FIs 20
(as specified by DBOD)
(c) Bonds issued by banks/Financial Institutions 100
as Tier II capital
(d) Shares of all Companies and 100
debentures/bonds/Commercial
Paper of Companies other than in (b)
above/units of mutual funds
(e) Securities of Public Sector Undertakings 20
guaranteed by Government but issued
outside the market borrowing programme
(f) Securities of and other claims on 100
280

(iv)
(v)
(vi)
Primary Dealers including rediscounting of
bills discounted by other PDs
(g) Bills discounted by banks/FIs that are 20
Rediscounted
Current assets
(a) Inter-corporate deposits 100
(b) Loans to staff 100
(c)
Other secured loans and advances
considered good 100
(d) Bills purchased/discounted 100
(e) Others (to be specified) 100
Fixed Assets (net of depreciation)
(a) Assets leased out (net book value) 100
(b) Fixed Assets 100
Other assets
(a)
Notes: (1)
Income tax deducted at
source (net of provision) 0
(b) Advance tax paid (net of provision) 0
(c) Interest accrued on Government securities 0
(d) Others (to be specified and risk weight x
indicated as per counter party)
Annexure – G
Netting may be done only in respect of assets where provisions for
depreciation or for bad and doubtful debts have been made.
(2) Assets which have been deducted from capital fund as at `Capital
Funds’ above, shall have a risk weight of `zero’.
(3) The PDs net off the Current Liabilities and Provisions from the
Current Assets, Loans and Advances in their Balance Sheet, as
the Balance Sheet is drawn up as per the format prescribed under
the Companies Act. For capital adequacy purposes, no such
netting off should be done except to the extent indicated above.
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
(b)
Off-Balance Sheet items
The credit risk exposure attached to off-Balance Sheet items has to be first
calculated by multiplying the face value of each of the off-Balance Sheet items by
‘credit conversion factor’ as indicated in the table below. This will then have to be
again multiplied by the weights attributable to the relevant counter-party as
specified above under balance sheet items.
Nature of item
Credit
Conversion
Factor
percentage
i) Financial guarantees considered 100
as credit substitutes
ii) Other guarantees 50
iii) Share/debenture/stock 50
underwritten
iv) Partly-paid shares/debentures/other
securities 100
and actual devolvement
v) Notional Equity /Index position underlying the
equity Derivatives * 100
vi) Bills discounted/rediscounted 100
vii) Repurchase agreements (e.g. buy/sell) 100
where the credit risk remains with the PD
viii) Other contingent liabilities/ 50
commitments like standby facility with
original maturity of over one year
ix) Similar contingent liabilities/ 0
commitments with original maturity of
upto one year or which can be unconditionally
cancelled at any time
*For guidelines on calculation of notional positions underlying the equity
derivatives, please refer to section A.2, Annex B (Measurement of Market Risk)
Note: Cash margins/deposits shall be deducted before applying the Conversion
Factor.
282

(c)
Interest Rate Contracts
Annexure – G
For the trading/hedging positions in Interest Rate related contracts, such as,
interest rate swaps, forward rate agreements, basis swaps, interest rate futures,
interest rate options, exchange traded interest rate derivatives and other
contracts of similar nature, risk weighted asset and the minimum capital ratio will
be calculated as per the two steps given below.
Step 1
The notional principal amount of each instrument is to be multiplied by the
conversion factor given below:
Original Maturity
Less than one year
One year and less than two years
For each additional year
Step 2:
Conversion Factor
0.5 per cent
1.0 per cent
1.0 per cent
The adjusted value thus obtained shall be multiplied by the risk weightage
allotted to the relevant counter-party as specified below:
Government/any exposure guaranteed by Government 0%
Banks/Financial Institutions (as specified by DBOD) 20%
Primary Dealers in the Government Securities market 100%
All others 100%
(d)
Foreign Exchange Contracts (if permitted):
Like the interest rate contracts, the outstanding contracts should be first
multiplied by a conversion factor as shown below:
Aggregate outstanding foreign exchange contracts of
original maturity
• less than one year 2%
• for each additional year or part thereof 3%
This will then have to be again multiplied by the weights attributable to the
relevant counter-party as specified above.
Foreign exchange contracts with an original maturity of 14 calendar days or less,
irrespective of the counterparty, may be assigned "zero" risk weight as per
international practice.
283

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
MEASUREMENT OF MARKET RISK
Annex B
Market risk may be defined as the possibility of loss caused by change in
market variables. The objective in introducing the capital adequacy for
market risk is to provide an explicit capital cushion for the price risk to which
the PDs are especially exposed in their portfolio.
The methods for working out the capital charge for market risks are the
standardised model and the internal risk management framework based
model. PDs would continue to calculate capital charges based on the
standardised method as also under the internal risk management framework
based (VaR) model and maintain the higher of the two requirements.
However, where price data is not available for specific category of assets,
then PDs may follow the standardized method for computation of market risk.
In such a situation, PDs shall disclose to Reserve Bank of India, details of
such assets and ensure that consistency of approach is followed. PDs should
obtain Reserve Bank of India’s permission before excluding any category of
asset for calculations of market risk. The Bank would normally consider the
instruments of the nature of fixed deposits, commercial bills etc., for this
purpose. Such items will be held in the books till maturity and any diminution
in the value will have to be provided for in the books.
Note: In case of underwriting commitments, following points should be
adhered to:
a) In case of devolvement of underwriting commitment for government
securities, 100% of the devolved amount would qualify for the
measurement of market risk.
b) In case of underwriting under merchant banking issues (other than
Gsecs), where price has been committed/frozen at the time of
underwriting, the commitment is to be treated as a contingent liability
and 50% of the commitment should be included in the position for
market risk. However, 100% of devolved position should be subjected
to market risk measurement. The methodology for working out the
capital charges for market risk on the portfolio is explained below:
A: Standardised Method: Capital charge under standardized method
will be the measures of risk arrived at in terms of paragraphs A.1-3 below
summed arithmetically.
284

A1. For fixed income instruments
Annexure – G
Under standardized method, duration method would continue to apply as
hitherto. Under this, the price sensitivity of all interest rate positions viz.,
Dated securities, Treasury bills, Bills purchased/Discounted, Commercial
papers, PSU/FI/Corporate Bonds, Special Bonds, Mutual fund units and
derivative instruments like IRS, FRAs, Interest Rate Futures etc., including
underwriting commitments/devolvement and other contingent liabilities having
interest rate/equity risk will be captured.
In duration method, the capital charge is the sum of four components given
below:
a) the net short or long position in the whole trading book;
b) a small proportion of the matched positions in each time-band (the
“vertical disallowance’’);
c) a larger proportion of the matched positions across different timebands
(the “horizontal disallowance’’) ;
d) a net charge for positions in options, where appropriate
Note : Since blank short selling in the cash position is not allowed, netting as
indicated at (a) and the system of `disallowances’ as at (b) and (c) above are
applicable currently only to the PDs entering into FRAs/ IRSs/ exchange
traded derivatives.
However, under the duration method, PDs with the necessary capability may,
with Reserve Bank of India’s permission use a more accurate method of
measuring all of their general market risks by calculating the price sensitivity
of each position separately. PDs must select and use the method on a
consistent basis and the system adopted will be subjected to monitoring by
Reserve Bank of India. The mechanics of this method are as follows:
i. First calculate the price sensitivity of all instruments in terms of a
change in interest rates of between 0.6 and 1.0 percentage points
depending on the duration of the instrument (as per Table 1 given
below );
ii.
Slot the resulting sensitivity measures into a duration-based ladder
with the thirteen time-bands set out in Table 1;
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
iii.
iv.
Subject the lower of the long and short positions in each time-band to
a 5% capital charge towards vertical disallowance designed to capture
basis risk;
Carry forward the net positions in each time-band for horizontal
offsetting across the zones subject to the disallowances set out in
Table 2.
Note : Points iii and iv above are applicable only where opposite positions
exist as explained at Note above.
Table 1
Duration time-bands and assumed changes in yield
Assumed change in yield (%) Assumed change in yield (%)
Zone 1 Zone 3
0 to 1month 1.00 4 to 5 years 0.85
1 to 3 months 1.00 5 to 7 years 0.80
3 to 6 months 1.00 7 to 10 years 0.75
6 to 12 months 1.00 10 to 15 years 0.70
15 to 20 years 0.65
Zone 2
1to2 years 0.95
2 to 3 years 0.90
3 to 4 years 0.85
Over 20 years 0.60
286

Annexure – G
Horizontal disallowances
Table 2
Zones Time-band Within the
zone
Zone 1
Zone 2
Zone 3
0 – month
1 – 3 months
3 – 6 months
6 – 12 months
1 – 2 years
2 – 3 years
3 – 4 years
4 – 5 years
5 – 7 years
7 – 10 years
10 – 15 years
15 – 20 years
Over 20 years
40%
30%
30%
Between
adjacent
zones
Between
zones 1
and 3
40% 100%
The gross positions in each time-band will be subject to risk weighting as per
the assumed change in yield set out in Table 1, with no further offsets.
A1.1. Capital charge for interest rate derivatives:
The measurement system should include all interest rate derivatives and off
balance-sheet instruments in the trading book which react to changes in
interest rates, (e.g. forward rate agreements (FRAs), other forward contracts,
bond futures, interest rate positions).
A1.2. Calculation of positions
The derivatives should be converted into positions in the relevant underlying
and become subject to market risk charges as described above. In order to
calculate the market risk as per the standardized method described above,
the amounts reported should be the market value of the principal amount of
the underlying or of the notional underlying.
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
A1.3. Futures and forward contracts, including forward rate
agreements
These instruments are treated as a combination of a long and a short
position in a notional government security. The maturity of a future or a FRA
will be the period until delivery or exercise of the contract, plus - where
applicable - the life of the underlying instrument. For example, a long position
in a June three-month interest rate future taken in April is to be reported as a
long position in a government security with a maturity of five months and a
short position in a government security with a maturity of two months. Where
a range of deliverable instruments may be delivered to fulfill the contract, the
PD has flexibility to elect which deliverable security goes into the maturity or
duration ladder but should take account of any conversion factor defined by
the exchange. In the case of a future on a corporate bond index, positions
will be included at the market value of the notional underlying portfolio of
securities.
A1.4. Swaps
Swaps will be treated as two notional positions in government securities with
relevant maturities. For example, an interest rate swap under which a PD is
receiving floating rate interest and paying fixed will be treated as a long
position in a floating rate instrument of maturity equivalent to the period until
the next interest fixing and a short position in a fixed-rate instrument of
maturity equivalent to the residual life of the swap. For swaps that pay or
receive a fixed or floating interest rate against some other reference price,
e.g. a stock index, the interest rate component should be slotted into the
appropriate repricing maturity category, with the equity component being
included in the equity framework.
A1.5. Calculation of capital charges
(a)
Allowable offsetting of matched positions
PDs may exclude from the interest rate maturity framework altogether (long
and short positions (both actual and notional) in identical instruments with
exactly the same issuer, coupon and maturity. A matched position in a future
or forward and its corresponding underlying may also be fully offset, and thus
excluded from the calculation. When the future or the forward comprises a
range of deliverable instruments, offsetting of positions in the future or
forward contract and its underlying is only permissible in cases where there is
a readily identifiable underlying security which is most profitable for the trader
288

289
Annexure – G
with a short position to deliver. The leg representing the time to expiry of the
future should, however, be reported. Security, sometimes called the
"cheapest-to-deliver", and the price of the future or forward contract should in
such cases move in close alignment. In addition, opposite positions in the
same category of instruments can in certain circumstances be regarded as
matched and allowed to offset fully. To qualify for this treatment the positions
must relate to the same underlying instruments can be of the same nominal
value. In addition:
(i)
(ii)
(iii)
for futures: offsetting positions in the notional or underlying
instruments to which the futures contract relates must be for identical
products and mature within seven days of each other;
for swaps and FRAs: the reference rate (for floating rate positions)
must be identical and the coupon closely matched (i.e. within 15 basis
points); and
for swaps, FRAs and forwards: the next interest fixing date or, for
fixed coupon positions or forwards, the residual maturity must
correspond within the following limits:
• less than one month hence: same day;
• between one month and one year hence: within seven days;
• over one year hence: within thirty days.
PDs with large swap books may use alternative formulae for these swaps to
calculate the positions to be included in the duration ladder. One method
would be to first convert the payments required by the swap into their present
values. For that purpose, each payment should be discounted using zero
coupon yields, and a single net figure for the present value of the cash flows
entered into the appropriate time-band using procedures that apply to zero
(or low) coupon bonds; these figures should be slotted into the general
market risk framework as set out earlier. An alternative method would be to
calculate the sensitivity of the net present value implied by the change in
yield used in the duration method and allocate these sensitivities into the
time-bands set out in Table 1. Other methods which produce similar results
could also be used. Such alternative treatments will, however, only be
allowed if:
• the supervisory authority is fully satisfied with the accuracy of the
systems being used;

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
• the positions calculated fully reflect the sensitivity of the cash flows to
interest rate changes and are entered into the appropriate time-bands;
General market risk applies to positions in all derivative products in the same
manner as for cash positions, subject only to an exemption for fully or very
closely-matched positions in identical instruments as defined in above
paragraphs. The various categories of instruments should be slotted into the
maturity ladder and treated according to the rules identified earlier.
A 2.
Capital charge for equity positions:
A2.1. Equity positions
This section sets out a minimum capital standard to cover the risk of holding
or taking positions in equities by the PDs. It applies to long and short
positions in all instruments that exhibit market behavior similar to equities,
but not to nonconvertible preference shares (which will be covered by the
interest rate risk requirements). Long and short positions in the same issue
may be reported on a net basis. The instruments covered include equity
shares, convertible securities that behave like equities, i.e., units of MF and
commitments to buy or sell equity securities. The equity or equity like
positions including those arrived out in relation to equity /index derivatives as
described below may be included in the duration ladder below one month.
A2.2. Equity derivatives
Equity derivatives and off balance-sheet positions which are affected by
changes in equity prices should be included in the measurement system.
This includes futures and swaps on both individual equities and on stock
indices. The derivatives are to be converted into positions in the relevant
underlying.
A2.3. Calculation of positions
In order to calculate the market risk as per the standardized method for credit
and market risk, positions in derivatives should be converted into notional
equity positions:
• futures and forward contracts relating to individual equities should in
principle be reported at current market prices;
• futures relating to stock indices should be reported as the markedtomarket
value of the notional underlying equity portfolio;
290

• equity swaps are to be treated as two notional positions
Annexure – G
Note: As per the circular IDMD. PDRS./26/03.64.00/2006-07 dated July 4,
2006 on "Diversification of PD Activities", PDs have been allowed to calculate
the capital charge for market risk on equity and equity derivatives using the
Internal Models approach only.
A.3 Capital Charge for Foreign Exchange Position (if permitted):
PDs normally would not be dealing in foreign exchange transactions.
However, by virtue of they having been permitted to raise resources under
FCNR(B) loans route, subject to prescribed guidelines, may end up holding
open foreign exchange position. This open position in equivalent rupees
arrived at by marking to market at FEDAI rates will be subject to a flat market
risk charge of 15%.
B. Internal risk model (VaR) based method
The PDs should calculate the capital requirement based on their internal
Value at Risk (VaR) model for market risk, as per the following minimum
parameters:
(a)
(b)
(c)
(d)
(e)
"Value-at-risk" must be computed on a daily basis.
In calculating the value-at-risk, a 99th percentile, one-tailed
confidence interval is to be used.
An instantaneous price shock equivalent to a 15-day movement in
prices is to be used, i.e. the minimum "holding period" will be fifteen
trading days.
Interest rate sensitivity of the entire portfolio should be captured on an
integrated basis by including all fixed income securities like
Government securities, Corporate/PSU bonds, CPs and derivatives
like IRS, FRAs, Interest rate futures etc., based on the mapping of the
cash flows to work out the portfolio VaR. Wherever data for calculating
volatilities is not available, PDs may calculate the volatilities of such
instruments using the G-Securities curve with appropriate spread.
However, the details of such instruments and the spreads applied
have to be reported and consistency of methodology should be
ensured.
Instruments which are part of trading book, but found difficult to be
subjected to measurement of market risk may be applied a flat market
291

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
(f)
(g)
(h)
risk measure of 15%. The instruments likely to be applied the flat
market risk measure are units of MF, Unquoted Equity, etc., and
added arithmetically to the measure obtained under VaR in respect of
other instruments.
Underwriting commitments as explained at the beginning of the Annex
should also be mapped into the VaR framework for risk measurement
purposes.
The unhedged foreign exchange position arising out of the foreign
currency borrowings under FCNR(B) loans scheme would carry a
market risk of 15% as hitherto and the measure obtained will be added
arithmetically to the VaR measure obtained for other instruments.
The choice of historical observation period (sample period) for
calculating value-at-risk will be constrained to a minimum length of
one year and not less than 250 trading days. For PDs who use a
weighting scheme or other methods for the historical observation
period, the "effective" observation period must be at least one year
(that is, the weighted average time lag of the individual observations
cannot be less than 6 months).
(i) The capital requirement will be the higher of :
(j)
(k)
i. the previous day's value-at-risk number measured according to
the above parameters specified in this section and
ii.
the average of the daily value-at-risk measures on each of the
preceding sixty business days, multiplied by a multiplication
factor prescribed by Reserve Bank of India (3.3 presently).
No particular type of model is prescribed. So long as the model used
captures all the material risks run by the PDs, they will be free to use
models, based for example, on variance-covariance matrices,
historical simulations, or Monte Carlo simulations or EVT etc.
The criteria for use of internal model to measure market risk capital
charge are given in Annex E.
292

Annexure – G
SUMMATION OF CAPITAL ADEQUACY REQUIREMENTS
The capital adequacy requirements for the PDs will comprise
Annex C
• the capital charge for credit risk requirements as indicated in Annex A,
plus
• the capital charge for market risk requirements as indicated in Annex B
• In working out the eligible capital, the PDs are required to first calculate
their minimum capital requirements for credit risk and only afterwards
the capital charge towards market risk requirements. The total capital
funds will represent the capital available to meet both the credit as also
the market risks.
• Of the 15% capital charge for credit risk, at least 50% should be met by
Tier I capital, that is the total of Tier II Capital, if any, shall not exceed
one hundred per cent of Tier I Capital, at any point of time, for meeting
the capital charge for credit risk.
• Subordinated debt as capital should not exceed 50% of tier II capital.
• The total of Tier III Capital, if any, shall not exceed two hundred and fifty
per cent of the Tier I Capital that is available for meeting market risk
capital charge i.e. excess over the credit risk capital requirements.
• The total of Tier II and Tier III capital eligible for working out the total
capital funds should not exceed 100% of Tier I capital.
• The overall capital adequacy ratio will be calculated by establishing an
explicit numerical link between the credit risk and the market risk
factors, by multiplying the market risk capital charge with 6.67 i.e. the
reciprocal of the minimum credit risk capital charge of 15 %. The
resultant figure is added to the sum of risk weighted assets worked out
for credit risk purpose. The numerator for calculating the overall ratio
will be the PD’s Tier I, Tier II and the Tier III Capital after head room
deductions, if any. The calculation of capital charge is illustrated in PDR
III format, which is enclosed as Annex D.
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
PDR III Return
Statement of Capital Adequacy - Quarter ended -
Name of the Primary Dealer :
Statement - 1 ( Summary)
Annex D
(i) Total of Risk Weighted Assets for Credit Risk (Annex I) Rs.
(ii) (a) Tier I Capital funds (after deductions) Rs.
(b) Tier II Capital funds eligible Rs.
(c) Total of available Tier I & II capital funds Rs.
(iii) Minimum credit risk capital required Rs.
i.e. (i) x 15 per cent
(iv) Excess of Tier I & II capital funds available Rs.
For market risk capital charge i.e. (ii) (c) – (iii)
(v) The Market Risk capital charge worked Rs.
out as the higher of the amounts under the
Standardised method and the one as per
Internal Risk Management (VaR) Model
(Appendices II and III)
(vi) Capital funds available to meet (v) Rs.
i.e: excess of Tier I and Tier II as at (iv) above,
Plus
eligible Tier III capital funds [maximum
up to 250 % of surplus Tier I capital]
Rupees
(vii) Over all Capital Adequacy
(a) Total RWA for credit risk i.e. (i) Rs.
(b) Capital charge for market risk i.e. (v) Rs.
(c) Numerical Link for (b) = 6.67
i.e.(reciprocal of credit risk capital ratio of 15%)
(d) Risk Weighted Assets relating to
Market Risk i.e. (b) x (c)
Rs.
(e) Total Risk Weighted Assets i.e. (a) + (d) Rs.
(f) Minimum capital required i.e. (e) x 15% Rs.
(g) Total Capital funds available i.e. (ii) + (vi) Rs.
294

Annexure – G
(h) less : Capital funds prescribed by other regulators/ Rs.
licensors e.g. SEBI/ NSE/ BSE/OTCEI
(i) Net capital funds available (g – h) Rs.
for PD business
(viii) Surplus Tier III Capital funds, if any
Rs.
(ix) Capital Adequacy Ratio (CRAR) % (i / e) * 100
Following Appendices are to be sent along with the return*:
Appendix I - Details of the various on-balance sheet and off-balance sheet
items, the risk weights assigned and the risk adjusted value of assets have to
be reported in this format. The format enclosed is purely illustrative. PDs are
required to adhere to the guidelines on activities permitted to be undertaken
by PDs while diversifying business activities.
Appendix II - Details of the market risk charge using the standardised model
are required to be reported in the format enclosed.
Appendix III - Details of market risk using the internal model should be
reported as per the format enclosed.
Appendix IV - Details of back-testing results for the previous quarter, giving
the details of VaR predicted by the model, the actual change in the value of
the portfolio and the face value of the portfolio should be reported.
Appendix V - Details of stress testing, giving details of the change in the
value of the portfolio for a given change in the yield, should be reported in the
format enclosed.
* The above Appendices (in printable form) may be sent by e-mail to
pdrsidmc@rbi.org.in
295

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
Appendix I
CREDIT RISK
A. ALANCE SHEET
TEMS
FUNDED RISK ASSET
I. Cash balances and balances in current
account with RBI 0%
II. Amounts lent in call/ notice money
market and balances in current account
with banks 20%
III. Investments
(a) Government and Approved
securities, guaranteed by
Central/state governments other than
at (e) below 0%
(b) Fixed deposits, Bonds and
Certificates of Deposit of banks, PDs
and public Financial Institutions as
specified by DBOD 20%
(c) Bonds issued by banks/PDs/ public
financial Institutions ( as specified by
DBOD) as Tier II capital 100%
(d) Shares of all companies and
debentures/ bonds/ commercial
papers of companies other than in
(b) above/ Units of mutual funds
100%
(e) Securities of Public sector
Undertakings guaranteed by
Central/state govts. but issued
BOOK
VALUE
Rupees
RISK
WEIGHT
%
RISK
ADJ
VALUE
296

Annexure – G
outside the market borrowing
programme 20% Note : In case
where the guarantee has been
invoked and the concerned state
government has remained in default,
PDs should assign 100% risk weight.
(f) Securities of and other exposures on
Primary Dealers in the Government
100% Securities market including
bills rediscounted
(g) Bills discounted by banks / FIs that
are 20% rediscounted
IV. Current Assets
(a) Inter-corporate deposits 100%
(b) Loans to staff 100%
(c) Other secured loans and advances
considered good 100%
(d) Bills purchased/discounted 100%
(e) Others (to be specified) 100%
V. Fixed Assets (net of depreciation)
(a) Assets leased out 100%
(b) Fixed Assets 100%
VI. Other assets
(a) Income-tax deducted at source (net
of provision) 0%
(b) Advance tax paid (net of provision)
0%
(c) Interest due on Government
securities 0%
(d) Others (to be specified and risk
weight indicated as per the counter
party) X%
AA.
OTAL RISK-WEIGHTED BALANCE SHEET ASSETS
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
B. FF-BALANCE SHEET ITEMS
FUNDED RISK ASSET
I. Financial guarantees considered as credit
substitutes
II.
III.
IV.
• Government/ any exposure guaranteed by
Government
• Banks/ Financial Institutions (as specified
by DBOD)
• Primary Dealers in the Government
securities market
BOOK
VALUE
Rupees
CREDIT
CONV
FACTOR
%
RISK
WEIGHT
%
100% 0%
100% 20%
100% 100%
• All others 100% 100%
Other guarantees
• Government/ any exposure guaranteed by
Government
• Banks/ Financial Institutions (as specified
by DBOD)
• Primary Dealers in the Government
securities market
50% 0%
50% 20%
50% 100%
• All others 50% 100%
Share/ debenture/ auction stock
underwritten
• Government/ any exposure guaranteed by
Government
• Banks/ Financial Institutions (as specified
by DBOD)
• Primary Dealers in the Government
securities market
100% 0%
100% 20%
100% 100%
• All others 100% 100%
Partly - paid shares/ debentures including
actual devolvement and other securities
• Government/ any exposure guaranteed by
Government
100% 0%
RISK
ADJ
VALUE
298

Annexure – G
FUNDED RISK ASSET
• Banks/ Financial Institutions (as specified
by DBOD)
• Primary Dealers in the Government
securities market
BOOK
VALUE
Rupees
CREDIT
CONV
FACTOR
%
RISK
WEIGHT
%
100% 20%
100% 100%
• All others 100% 100%
V. Notional Equity/Index Positions underlying
the equity derivative
VI.
VII.
Bills discounted/ rediscounted
• Government/ any exposure guaranteed by
Government
• Banks/ Financial Institutions (as specified
by DBOD)
• Primary Dealers in the Government
securities market
100% 100%
100% 0%
100% 20%
100% 100%
• All others 100% 100%
Repurchase agreements where the credit
risk remains with the PD
• Government/ any exposure guaranteed by
Government
• Banks/ Financial Institutions (as specified
by DBOD)
• Primary Dealers in the Government
securities market
100% 0%
100% 20%
100% 100%
• All others 100% 100%
VIII. Other contingent liabilities/ commitments like
standby
• Government/ any exposure guaranteed by
Government
• Banks/ Financial Institutions (as specified
by DBOD)
• Primary Dealers in the Government
securities market
50% 0%
50% 20%
50% 100%
RISK
ADJ
VALUE
299

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
IX.
FUNDED RISK ASSET
BOOK
VALUE
Rupees
CREDIT
CONV
FACTOR
%
RISK
WEIGHT
%
• All others 50% 100%
Interest Rate swaps
Original maturity of less than 1 year 0.5% 100%
Original maturity of 1 year and above but
less than 2 years
Original maturity of 2 years and above but
less than 3 years
Original maturity of 3 years and above but
less than 4 years
Original maturity of 4 years and above but
less than 5 years
Original maturity of 5 years and above but
less than 6 years
Original maturity of 6 years and above but
less than 7 years
( Every additional year - CCF increases by
1%)
X. Foreign Exchange Forward Contract
1% 100%
2% 100%
3% 100%
4% 100%
5% 100%
6% 100%
Original maturity of less than 1 year$ 2% 20 -
100%
Original maturity of more than 1 year and
less than 2 years$
(Every additional year – CCF increases by
3%)
$ Risk depends on the counter party
5% 20 -
100%
RISK
ADJ
VALUE
Note: Cash margins/ deposits should be deducted before applying the credit conversion
factor
BB.
TOTAL RISK-WEIGHTED OFF-BALANCE SHEET ASSETS
CC. TOTAL RISK-WEIGHTED BALANCE SHEET & OFF-BALANCE
SHEET ASSETS
300

Appendix II
PDR-III
Statement 3 Quarterly
Return
MARKET RISK CAPITAL STATEMENT(Correlations i.e. appreciation not recognised)
(i) Standardised Method
A. Interest rate Instruments & Equity /Equity like instruments
Maturity Date
POSITION
(FV)
BOOK
PRICE
BOOK
VALUE
MODIFIED
DURATION
DURATION
BUCKET
ZONE
YIELD
CHANGED
YIELD
CHANGED
PRICE
INSTRUMENT
ASSUMED
CHANGE
IN YIELD
(bps)
CHANGE
IN
PRICE
MARKET
RISK
CHARGE
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) (13)
(Including equity
positions)
Total of A
B. Unhedged Foreign Exchange Position 15%
Total (A+B)
Position Market Risk Measure
(Marked to Market value) (15% of the position)

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
B. Unhedged Foreign Exchange Position
C. Asset items subjected to flat charge of 15% for market risk measurement
Memo items:
Items of assets which, with the approval of RBI, have been classified as investment items and not subjected to market risk measure:
Asset Book Value MTM/NAV
1.
2.
3.
302

Details of the VaR calculation - for the last 60 days
Appendix III
Total
Date Portfolio Value (Rs.) VaR (Rs.) one day VaR with holding
period
(a) Average of 60 day Var (with holding period)
(b) 3.3 times the 60 day average VaR (with holding period)
(c) Last day's VaR
(d) Market Risk Measure (higher of ( b ) and (c ) above)
303
Annexure – G
VaR with holding period as a
Percentage of portfolio

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
Appendix IV
Back Testing of VaR Model
For the last 250 trading days
Back testing Report as part of PDR III for Quarter ended __________________
Actual Hypothetical
No of observations (excluding holidays) 250 250
No of failures ie no of times VaR underpredicted the actual trading/ hypothetical MTM losse 0 0
Sr.
No.
1
2
3
4
.
250
.
.
.
.
Date
1 day VaR Entire
Portfolio Rs. crs
Mkt Value Entire
Portfolio
Mkt Value Next
Day Same
Portfolio
Difference
Rs. crs
Failure
(Y/N)
Actual P/(L)
Rs. crs
Failure (Y/N)
The daily VaR preceding holidays should be upscaled by the square root of number of intervening holidays. For example if the
Friday is followed by 2 holidays, then the one VaR figure for Friday should be multiplied by square root of 2.
304

Appendix V
Details of stress testing
Name of the PD:
STRESS TEST AS
ON:
ASSETS (All tradable interest rate related
assets)
1 G-Secs and T-Bills
2 Corporate/PSU/FI Bonds
3 Receiving leg in respect of FRA/IRS
4 Other tradable interest rate instruments
MTM Value (Rs.
Crore)
Weighted Average
Mod. Duration
(years)
Total MTM value of assets (Va)
Weighted Average Mod. Duration of the assets
(Da)
LIABILITES (excluding NOF)
1 Net borrowing Call, notice & term money
2 Net borrowing in Repo (including LAF of RBI)
3 Net Borrowing through CBLO
4 Borrowing through ICDs
5 Borrowing through CPs
6 Borrowing through Bond issuances
7 Credit lines from banks/FIs
8 Paying leg in respect of FRA/IRS
9 Other tradable interest rate liabilites
MTM Value (Rs.
Crore)
Weighted Average
Mod. Duration
(years)
Total MTM value of liabilities (Vl)
Weighted Average Mod. Duration of Liabilites (Dl)

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
Mod. Duration of NOF (Dn) = (Va*Da - Vl*Dl)/(Va-Vl)
Percentage change in NOF = (-) Dn*Change in interest rates (1%)
Change in NOF = (-) Dn* Change in Interest rates (1%)*NOF
Other details:
Net interest income in the current year so far
Trading profits/loss in the current year so far
Unrealised MTM (Net gain/loss on cash
positions)
Unrealised MTM (Net gain/loss on derivative
positions)
Other income, if any (Details to be specified) ***
NOF deployed in fixed income and related
instruments
Total NOF (Break-up to be furnished)
Note: NOF should be determined as per the definition prescribed in this
regard. The MTM gains or losses should be adjusted in the NOF.
***Details of Other Income
306

Annexure – G
Capital funds of the firm as on the date of stress test
(Rs.in crore)
i. Tier I captial
ii.
Tier II Capital
iii. Tier III Capital
iv.
Details of Deductions
investment in subsidiaries
intangible assets
losses in current accounting period
deferred tax assets
losses brought forward from previous accounting periods
Capital funds prescribed by other regulator
v. Net total capital funds
Less
vi.
change in NOF due to one percent increase in yields
vii. Net capital funds available after providing for change
in NOF
viii. Risk-weighted assets for the credit risk of the firm
ix.
Risk-weighted assets for the market risk of the firm
x. Total risk-weighted assets
xi. Capital adequacy ratio as on the date of stress test
(vii/x)
307

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
A. General criteria
Criteria for use of internal model to
measure market risk capital charge
Annex E
1. In order that the internal model is effective, it should be ensured that :
- the PD's risk management system is conceptually sound and its
implementation is certified by external auditors;
- the PD has sufficient numbers of staff skilled in the use of
sophisticated models not only in the trading area but also in the risk
control, audit, and back office areas;
- the PD has a proven track record of reasonable accuracy in
measuring risk (back testing);
- the PD regularly conducted stress tests along the lines discussed in
Para B.4 below
2. In addition to these general criteria, PDs using internal models for
capital purposes will be subject to the requirements detailed in
Sections B.1 to B.5 below.
B.1 Qualitative standards
The extent to which PDs meet the qualitative criteria contained herein will
influence the level at which the RBI will ultimately set the multiplication factor
referred to in Section B.3 (b) below, for the PD. Only those PDs, whose
models are in full compliance with the qualitative criteria, will be eligible for
use of the minimum multiplication factor. The qualitative criteria include:
a) The PD should have an independent risk control unit that is
responsible for the design and implementation of the system. The unit
should produce and analyse daily reports on the output of the PD's
risk measurement model, including an evaluation of the relationship
between measures of risk exposure and trading limits. This unit must
be independent from trading desks and should report directly to senior
management of the PD.
b) The unit should conduct a regular back testing programme, i.e. an expost
comparison of the risk measure generated by the model against
308

309
Annexure – G
actual daily changes in portfolio value over longer periods of time, as
well as hypothetical changes based on static positions.
c) Board of Directors and senior management should be actively
involved in the risk control process and must regard risk control as an
essential aspect of the business to which significant resources need to
be devoted. In this regard, the daily reports prepared by the
independent risk control unit must be reviewed by a level of
management with sufficient seniority and authority to enforce both
reductions in positions taken by individual traders and reductions in
the PD’s overall risk exposure.
d) The PD’s internal risk measurement model must be closely integrated
into the day-to-day risk management process of the institution. Its
output should accordingly be an integral part of the process of
planning, monitoring and controlling the PD’s market risk profile.
e) The risk measurement system should be used in conjunction with
internal trading and exposure limits. In this regard, trading limits
should be related to the PD’s risk measurement model in a manner
that is consistent over time and that it is well-understood by both
traders and senior management.
f) A routine and rigorous programme of stress testing should be in place
as a supplement to the risk analysis based on the day-to-day output of
the PD’s risk measurement model. The results of stress testing should
be reviewed periodically by senior management and should be
reflected in the policies and limits set by management and the Board
of Directors. Where stress tests reveal particular vulnerability to a
given set of circumstances, prompt steps should be taken to manage
those risks appropriately.
g) PDs should have a routine in place for ensuring compliance with a
documented set of internal policies, controls and procedures
concerning the operation of the risk measurement system. The risk
measurement system must be well documented, for example, through
a manual that describes the basic principles of the risk management
system and that provides an explanation of the empirical techniques
used to measure market risk.
h) An independent review of the risk measurement system should be
carried out regularly in the PD’s own internal auditing process. This

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
review should include both the activities of the trading desks and of
the risk control unit. A review of the overall risk management process
should take place at regular intervals (ideally not less than once a
year) and should specifically address, at a minimum:
• the adequacy of the documentation of the risk management system
and process;
• the organisation of the risk control unit ;
• the integration of market risk measures into daily risk
management;
• the approval process for risk pricing models and valuation systems
used by front and back-office personnel;
• the validation of any significant change in the risk measurement
process;
• the scope of market risks captured by the risk measurement
model;
• the integrity of the management information system;
• the accuracy and completeness of position data;
• the verification of the consistency, timeliness and reliability of data
sources used to run internal models, including the independence of
such data sources;
• the accuracy and appropriateness of volatility and other
assumptions;
• the accuracy of valuation and risk transformation calculations;
• the verification of the model's accuracy through frequent back
testing as described in (b) above and in the Annex G.
i) The integrity and implementation of the risk management system in
accordance with the system policies/procedures laid down by the
Board of Directors should be certified by the external auditors as
outlined at Para B.5.
j) A copy of the back testing result should be furnished to Reserve Bank
of India.
310

Annexure – G
B.2 Specification of market risk factors
An important part of a PD’s internal market risk measurement system is the
specification of an appropriate set of market risk factors, i.e. the market rates
and prices that affect the value of the PD’s trading positions. The risk factors
contained in a market risk measurement system should be sufficient to
capture the risks inherent in all the PD’s portfolio of on-and-off-balance sheet
positions. The following guidelines should be kept in view:
(a)
(b)
For interest rates, there must be a set of risk factors corresponding to
interest rates in each portfolio in which the PD has interest-ratesensitive
on-or-off-balance sheet positions.
The risk measurement system should model the yield curve using one
of a number of generally accepted approaches, for example, by
estimating forward rates of zero coupon yields. The yield curve should
be divided into various maturity segments in order to capture variation
in the volatility of rates along the yield curve. For material exposures
to interest rate movements in the major instruments, PDs must model
the yield curve using all material risk factors, driven by the nature of
the PD’s trading strategies. For instance, a PD with a portfolio of
various types of securities across many points of the yield curve and
that engages in complex arbitrage strategies, would require a greater
number of risk factors to capture interest rate risk accurately.
The risk measurement system must incorporate separate risk factors
to capture spread risk (e.g. between bonds and swaps), i.e. risk
arising from less than perfectly correlated movements between
Government and other fixed-income instruments.
For equity prices, at a minimum, there should be a risk factor that is
designed to capture market-wide movements in equity prices (e.g. a
market index). Position in individual securities or in sector indices
could be expressed in "beta-equivalents" relative to this market-wide
index. More detailed approach would be to have risk factors
corresponding to various sectors of the equity market (for instance,
industry sectors or cyclical, etc.), or the most extensive approach,
wherein, risk factors corresponding to the volatility of individual equity
issues are assessed. The method could be decided by the PDs
corresponding to their exposure to the equity market and
concentrations.
311

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
B.3.
(a)
(b)
Quantitative standards
PDs should update their data sets at least once every three months
and should also reassess them whenever market prices are subject to
material changes. Reserve Bank of India may also require a PD to
calculate their value-at-risk using a shorter observation period if, in it’s
judgement, this is justified by a significant upsurge in price volatility.
The multiplication factor will be set by Reserve Bank of India on the
basis of the assessment of the quality of the PD’s risk management
system, as also the back testing framework and results, subject to an
absolute minimum of 3. The document `Back testing’ mechanism to be
used in conjunction with the internal risk based model for market risk
capital charge’, enclosed as Annex-F, presents in detail the back
testing mechanism.
PDs will have flexibility in devising the precise nature of their models, but the
parameters indicated at Annex-E are the minimum which the PDs need to
fulfill for acceptance of the model for the purpose of calculating their capital
charge. Reserve Bank of India will have the discretion to apply stricter
standards.
B.4 Stress testing
1. PDs that use the internal models approach for meeting market risk
capital requirements must have in place a rigorous and
comprehensive stress testing program to identify events or influences
that could greatly impact them.
2. PD’s stress scenarios need to cover a range of factors than can create
extraordinary losses or gain in trading portfolios, or make the control
of risk in those portfolios very difficult. These factors include lowprobability
events in all major types of risks, including the various
components of market, credit and operational risks.
3. PD’s stress test should be both of a quantitative and qualitative
nature, incorporating both market risk and liquidity aspects of market
disturbances. Quantitative criteria should identify plausible stress
scenarios to which PDs could be exposed. Qualitative criteria should
emphasize that two major goals of stress testing are to evaluate the
capacity of the PD’s capital to absorb potential large losses and to
identify steps the PD can take to reduce its risk and conserve capital.
312

Annexure – G
This assessment is integral to setting and evaluating the PD’s
management strategy and the results of stress testing should be
regularly communicated to senior management and, periodically, to
the PD’s Board of Directors.
4. PDs should combine the standard stress scenarios with stress tests
developed by PDs themselves to reflect their specific risk
characteristics. Specifically, Reserve Bank of India may ask PDs to
provide information on stress testing in three broad areas, which are
discussed below.
(a)
Scenarios requiring no simulations by the PD
PDs should have information on the largest losses experienced during the
reporting period available for Reserve Bank of India’s review. This loss
information could be compared to the level of capital that results from a PD’s
internal measurement system. For example, it could provide Reserve Bank of
India with a picture of how many days of peak day losses would have been
covered by a given Value-at-Risk estimate.
(b)
Scenarios requiring a simulation by the PD
PDs should subject their portfolios to a series of simulated stress scenarios
and provide Reserve Bank of India with the results. These scenarios could
include testing the current portfolio against past periods of significant
disturbance, incorporating both the large price movements and the sharp
reduction in liquidity associated with these events. A second type of scenario
would evaluate the sensitivity of the PD’s market risk exposure to changes in
the assumptions about volatilities and correlations. Applying this test would
require an evaluation of the historical range of variation for volatilities and
correlations and evaluation of the PD’s current positions against the extreme
values of the historical range. Due consideration should be given to the sharp
variation that at times has occurred in a matter of days in periods of
significant market disturbance.
(c)
Scenarios developed by the PD itself to capture the specific
characteristics of its portfolio
In addition to the scenarios prescribed by Reserve Bank of India under (a)
and (b) above, a PD should also develop its own stress tests which it
identified as most adverse based on the characteristics of its portfolio. PDs
should provide Reserve Bank of India with a description of the methodology
313

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
used to identify and carry out stress testing under the scenarios, as well as
with a description of the results derived from these scenarios.
The results should be reviewed periodically by senior management and
should be reflected in the policies and limits set by management and the
Board of Directors. Moreover, if the testing reveals particular vulnerability to
a given set of circumstances, Reserve Bank of India would expect the PD to
take prompt steps to manage those risks appropriately (e.g. by reducing the
size of its exposures).
B.5 External Validation
PDs should get the internal model’s accuracy validated by external auditors,
including at a minimum, the following:
(a)
(b)
(c)
(d)
(e)
verifying that the internal validation processes described in B.1(h) are
operating in a satisfactory manner;
ensuring that the formulae used in the calculation process as well as
for the pricing of complex instruments are validated by a qualified unit,
which in all cases should be independent from the trading desks;
Checking that the structure of internal models is adequate with respect
to the PD’s activities and geographical coverage;
Checking the results of the PD’s back testing of its internal
measurement system (i.e. comparing Value-at-Risk estimates with
actual profits and losses) to ensure that the model provides a reliable
measure of potential losses over time. PDs should make the results as
well as the underlying inputs to their value-at-risk calculations
available to the external auditors;
Making sure that data flows and processes associated with the risk
measurement system are transparent and accessible. In particular, it
is necessary that auditors are in a position to have easy access,
wherever they judge it necessary and under appropriate procedures,
to the models’ specifications and parameters.
314

Annexure – G
315
Annex F
“BACK TESTING” mechanism to be used in conjunction with the
internal risk based model for market risk capital charge
The following are the parameters of the back testing framework for
incorporating into the internal models approach to market risk capital
requirements.
Primary Dealers that have adopted an internal model-based approach to
market risk measurement are required routinely to compare daily profits and
losses with modelgenerated risk measures to gauge the quality and accuracy
of their risk measurement systems. This process is known as "back testing".
The objective of the back testing efforts is the comparison of actual trading
results with model-generated risk measures. If the comparison uncovers
sufficient differences, problems almost certainly must exist, either with the
model or with the assumptions of the back test.
Description of the back testing framework
The back testing program consists of a periodic comparison of the Primary
Dealer’s daily Value-at-Risk measures with the subsequent daily profit or loss
(“trading outcome”). The Value-at-Risk measures are intended to be larger
than all but a certain fraction of the trading outcomes, where that fraction is
determined by the confidence level of the Value-at-Risk measure. Comparing
the risk measures with the trading outcomes simply means that the Primary
Dealer counts the number of times that the risk measures were larger than
the trading outcome. The fraction actually covered can then be compared
with the intended level of coverage to gauge the performance of the Primary
Dealer’s risk model.
Under the Value-at-Risk framework, the risk measure is an estimate of the
amount that could be lost on a set of positions due to general market
movements over a given holding period, measured using a specified
confidence level.
The back tests to be applied compare whether the observed percentage of
outcomes covered by the risk measure is consistent with a 99% level of
confidence.
That is, they attempt to determine if a PD’s 99th percentile risk measures
truly cover 99% of the firm’s trading outcomes.

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
i) Significant changes in portfolio composition relative to the initial
positions are common at trading day end. For this reason, the back testing
framework suggested involves the use of risk measures calibrated to a oneday
holding period.
A more sophisticated approach would involve a detailed attribution of income
by source, including fees, spreads, market movements, and intra-day trading
results.
Primary Dealers should perform back tests based on the hypothetical
changes in portfolio value that would occur were end-of-day positions to
remain unchanged.
ii) Back testing using actual daily profits and losses is also a useful
exercise since it can uncover cases where the risk measures are not
accurately capturing trading volatility in spite of being calculated with
integrity.
Primary Dealers should perform back tests using both hypothetical and actual
trading outcomes. The steps involve calculation of the number of times that
the trading outcomes are not covered by the risk measures (“exceptions”).
For example, over 200 trading days, a 99% daily risk measure should cover,
on average, 198 of the 200 trading outcomes, leaving two exceptions.
The back testing framework to be applied entails a formal testing and
accounting of exceptions on a quarterly basis using the most recent twelve
months of date. Primary Dealers may however base the back test on as
many observations as possible. Nevertheless, the most recent 250 trading
days' observations should be used for the purposes of back testing. The
usage of the number of exceptions as the primary reference point in the back
testing process is the simplicity and straightforwardness of this approach.
Normally, in view of the 99% confidence level adopted, a level of 4
exceptions in the observation period of 250 days would be acceptable to
consider the model as accurate. Exceptions above this, would invite
supervisory actions. Depending on the number of exceptions generated by
the Primary Dealer’s back testing model, both actual as well as hypothetical,
Reserve Bank of India may initiate a dialogue regarding the Primary Dealer’s
model, enhance the multiplication factor, may impose an increase in the
capital requirement or disallow use of the model as indicated above
depending on the number of exceptions.
316

Annexure – G
In case large number of exceptions are being noticed, it may be useful for the
PDs to dis-aggregate their activities into sub sectors in order to identify the
large exceptions on their own. The reasons could be of the following
categories:
Basic integrity of the model
1) The PD’s systems simply are not capturing the risk of the positions
themselves (e.g. the positions of an office are being reported
incorrectly).
2) Model volatilities and/or correlations were calculated incorrectly (e.g.
the computer is dividing by 250 when it should be dividing by 225).
Model’s accuracy could be improved
3) The risk measurement model is not assessing the risk of some
instruments with sufficient precision (e.g. too few maturity buckets or
an omitted spread).
Bad luck or markets moved in fashion unanticipated by the model
4) Random chance (a very low probability event).
5) Markets moved by more than the model predicted was likely (i.e.
volatility was significantly higher than expected).
6) Markets did not move together as expected (i.e. correlations were
significantly different than what was assumed by the model).
Intra-day trading
7) There was a large (and money-losing) change in the PD’s positions or
some other income event between the end of the first day (when the risk
estimate was calculated) and the end of the second day (when trading results
were tabulated).
317

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
Annex G
Annex
Monthly Return on Interest Rate Risk of Rupee Derivatives
As at end-month
Name of the Bank/Institution:
1. Cash Bonds Market Value (Rs. In PV01 (Rs. In Crore)
Crore)
(a) (b) (c)
(a) HFT (See Note 1)
(b) AFS (See Note 1)
(c) HTM (See Note 1)
Total [(a) to (c) above]
2. Rupee Interest Rate Derivatives Notional Amount (Rs.
in Crore)
PV01(Rs. in
Crore)
(a) Bond Futures (See Note 1)
(b) MIBOR (OIS) (See Note 2)
(c) MIFOR (See Note 2)
(d) G-Sec benchmarks
(See Note2)
(e) Other benchmarks (Please report separately)
(See Note 2&4)
(f) Forward Rate Agreements (See Note 3)
Total [(a) to (f) above]
3. Grand Total of (1) & (2)
4. Tier I Capital
Note 1. PV01 may be taken as POSITIVE for long positions and NEGATIVE for short
positions.
Note 2. PV01 may be taken as POSITIVE if receiving a swap and NEGATIVE if paying a
swap.
Note 3. For FRAs, use the PVO1 of the underlying deposit/instrument.
Note 4. In 2 (e) above, swaps on other benchmarks such as LIBOR may be reported
separately for each benchmark
318

Annexure – G
Annex H
List of circulars Consolidated
No Circular No Date Subject
1 IDMD.1 / (PDRS) 03.64.00 /
2003-04
2 IDMD.PDRS.No.06 /03.64.00
/ 2004-05
January 07,
2004
October 15,
2004
Capital Adequacy Standards and Risk
Management <strong>Guide</strong>lines for Primary
Dealers
Capital Adequacy Standards – <strong>Guide</strong>lines
on Issue of Subordinated Debt
Instruments – Tier II and Tier III Capital
3 IDMD. PDRS.26 /03.64.00
/2006-07
4 IDMD.PDRS.No.148 /
03.64.00 / 2006-07
July 4, 2006 Diversification of activities by standalone
Primary Dealers – Operational
<strong>Guide</strong>lines
July 10, 2006 Risk reporting of derivatives business
5 RBI / 2008-09 / 424
IDMD.PDRD.No. 4878 /
03.64.00 /2008-09
April 1, 2009
Issue of Tier II and Tier III Capital
319

ANNEXURE – H
RBI MC CALLMONEY 2009
RBI/2009-10/46
FMD. MSRG. No. 36/02.08.003/2009-10 July 1, 2009
Aashadha 9, 1931 (S)
The Chairmen/Chief Executives of
all Scheduled Commercial Banks (excluding RRBs) /
Co-operative Banks / Primary Dealers
Dear Sirs,
Master Circular on Call/Notice Money Market Operations
As you are aware, the Reserve Bank of India has, from time to time, issued a
number of guidelines/instructions/directives to banks in regard to matters relating
to call/notice money market. To enable eligible institutions to have current
instructions at one place, a Master Circular incorporating all the existing
guidelines/instructions/directives on the subject has been prepared. It may be
noted that this Master Circular consolidates and updates all the
instructions/guidelines contained in the circulars issued up to June 30, 2009, in
so far as they relate to operations of eligible institutions in the call/notice money
markets. This Master Circular has been placed on the RBI website at
www.mastercirculars.rbi.org.in.
Yours faithfully,
Encls.: As above
(Chandan Sinha)
Chief General Manager

Annexure – H
Master Circular
Call/Notice Money Market Operations
Table of Contents
1. Introduction
2. Participants
3. Prudential Limits
4. Interest Rate
5. Dealing Session
6. Documentation
7. Reporting requirement
8. Annexes
I. List of institutions permitted in Call/Notice Money Market
II. Reporting Format
III. Definitions
9. Appendix: List of Circulars
321

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
Master Circular on Call / Notice Money Market Operations
1. Introduction
1.1 The money market is a market for short-term financial assets that are
close substitutes of money. The most important feature of a money market
instrument is that it is liquid and can be turned over quickly at low cost and
provides an avenue for equilibrating the short-term surplus funds of lenders and
the requirements of borrowers. The call/notice money market forms an important
segment of the Indian Money Market. Under call money market, funds are
transacted on overnight basis and under notice money market, funds are
transacted for the period between 2 days and 14 days.
2. Participants
2.1 Participants in call/notice money market currently include banks
(excluding RRBs) and Primary Dealers (PDs), both as borrowers and lenders
(Annex I).
3. Prudential Limits
3.1 The prudential limits in respect of both outstanding borrowing and lending
transactions in call/notice money market for banks and PDs are as follows:-
Table 1: Prudential Limits for Transactions in Call/Notice Money Market
Sr.
No.
Participant Borrowing Lending
1 Scheduled
Commercial Banks
On a fortnightly average basis,
borrowing outstanding should not
exceed 100 per cent of capital funds
(i.e., sum of Tier I and Tier II capital) of
latest audited balance sheet.
However, banks are allowed to borrow
a maximum of 125 per cent of their
capital funds on any day, during a
fortnight.
2 Co-operative Banks Borrowings outstanding by State Cooperative
Banks/District Central Cooperative
Banks/Urban Co-op. Banks
in call/notice money market on a daily
basis should not exceed 2.0 per cent
of their aggregate deposits as at end
March of the previous financial year.
No Limit.
On a fortnightly average
basis, lending outstanding
should not exceed 25 per
cent of their capital funds;
however, banks are allowed
to lend a maximum of 50 per
cent of their capital funds on
any day, during a fortnight.
322

Annexure – H
3. Primary Dealers
(PDs)
PDs are allowed to borrow, on
average in a reporting fortnight, up to
200 per cent of their net owned funds
(NOF) as at end- March of the
previous financial year.
PDs are allowed to lend in
call/notice money market, on
average in a reporting
fortnight, up to 25 per cent of
their NOF.
3.2 Non-bank institutions are not permitted in the call/notice money market
with effect from August 6, 2005.
4. Interest Rate
4.1 Eligible participants are free to decide on interest rates in call/notice
money market.
4.2 Calculation of interest payable would be based on FIMMDA’s (Fixed
Income Money Market and Derivatives Association of India) Handbook of Market
Practices.
5. Dealing Session
5.1 Deals in the call/notice money market can be done upto 5.00 pm on
weekdays and 2.30 pm on Saturdays or as specified by RBI from time to time.
6. Documentation
6.1 Eligible participants may adopt the documentation suggested by FIMMDA
from time to time.
7. Reporting Requirement
7.1 All dealings in call/notice money on screen-based negotiated quote-driven
system (NDS-CALL) launched since September 18, 2006 do not require separate
reporting. It is mandatory for all Negotiated Dealing System (NDS) members to
report their call/notice money market deals (other than those done on NDS-
CALL) on NDS. Deals should be reported within 15 minutes on NDS, irrespective
of the size of the deal or whether the counterparty is a member of the NDS or
not. In case there is repeated nonreporting of deals by an NDS member, it will be
considered whether non-reported deals by that member should be treated as
invalid.
7.2 The reporting time on NDS is upto 5.00 pm on weekdays and 2.30 pm on
Saturdays or as decided by RBI from time to time.
323

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
7.3 With the stabilisation of reporting of call/notice money transactions over
NDS as also to reduce reporting burden, the practice of reporting of
call/notice/term money transactions by fax to RBI has been discontinued with
effect from December 11, 2004. However, deals between non-NDS members will
continue to be reported to the Financial Markets Department (FMD) of RBI by fax
as hitherto (Annex II).
7.4 In case the situation so warrants, Reserve Bank may call for information
in respect of money market transactions of eligible participants by fax.
8. Annexes
Annex I
I. List of Institutions Permitted to Participate in the Call/Notice Money
Market both as Lenders and Borrowers
a) All Scheduled Commercial Banks (excluding RRBs).
b) All Co-operative Banks other than Land Development Banks.
c) All Primary Dealers ( PDs ).
324

To
Annex - II
Annexure – H
Daily Return on Call/Notice/Term Money Market Transactions
The Chief General Manager,
Financial Markets Department,
23rd Fl oor NCOB, RBI,
Mumbai-400001
Fax-91-22-22630981
Name of the Bank/Institution
: _____________________________________
Code No.(As specified by RBI) : _____________________________________
Date
: _____________________________________
Borrowed
Lent
Amount
(Rs.
crore)
Range
of
Interest
Rates
(% p.a.)
Weighted
Average
Interest
Rates (%
p.a.)
Amount
(Rs.
crore)
Range
of
Interest
Rates
(% p.a.)
Weighted
Average
Interest
Rates (%
p.a.)
1. Call Money (Overnight)
2. Notice Money (2-14 Days)
(a) Transacted on the day
(b) Outstanding * (including
day's transactions)
3. Term Money @
(a) Transacted on the day
(15 Days
(1 Month
(3 Months
(6 Months
(b) Outstanding *(Including
day's transactions) Amount
325

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
Borrowed Amount Lent
(15 Days
(1 Month
(3 Months
(6 Months
*In case of outstandings, rates need not be given.
@ Where applicable.
_____________________
Authorised Signatories
Phone No. :
326

Annexure – H
Annex III
Definitions
In these guidelines, unless the context otherwise requires:
1. "Call Money" means deals in overnight funds
2. "Notice Money" means deals in funds for 2 - 14 days
3. "Fortnight" shall be on a reporting Friday basis and mean the period from
Saturday to the second following Friday, both days inclusive
4. "Bank” or “banking company" means a banking company as defined in
clause (c) of Section 5 of the Banking Regulation Act, 1949 (10 of 1949)
or a "corresponding new bank", "State Bank of India" or "subsidiary bank"
as defined in clause (da), clause (nc) and clause (nd) respectively thereof
and includes a "co-operative bank" as defined in clause (cci) of Section 5
read with Section 56 of that Act
5. “Scheduled bank” means a bank included in the Second Schedule of the
Reserve Bank of India Act, 1934
6. "Primary Dealer" means a financial institution which holds a valid letter of
authorisation as a Primary Dealer issued by the Reserve Bank, in terms of
the "<strong>Guide</strong>lines for Primary Dealers in Government Securities Market"
dated March 29, 1995, as amended from time to time
7. "Capital Funds" means the sum of the Tier I and Tier II capital as
disclosed in the latest audited balance sheet of the entity.
9. Appendix
Sr.
No.
Circular Number
1. CPC.BC.103/279A 90 dated.12
List of Circulars
2. Ref.DBOD.No.Dir.BC.97/C.347 90 dated
April 18, 1990
Subject
Access to the Call Money Market
3. CPC.BC.111/279A-91 dated.12-4-1991 Call/Notice Money and Bills
Rediscounting Market.
4. CPC.BC.144/07.01.279/94-95 dated.17-
4-1995
Widening Access to Call/Notice
Money Market
327

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
Sr.
No.
Circular Number
5. Ref.DBOD.No.FSC.BC.68/24.91.001-95
dated June 27, 1995
6. CPC.BC.162/07.01.279/96-97 dated April
15, 1997
7. CPC.BC.165/07.01.279/97-98 dated.
April 21, 1997
8. CPC.BC.175/07.01.279/97-98 dated April
29, 1998
9. CPC.BC.185/07.01.279/98-99 dated April
20, 1999
10. Ref.No.MPD.2785/279A(MM)/98-99
dated April 24, 1999
11. CPC.BC.190/07.01.279/99-2000 dated
October 29, 1999
12. CPC.BC.196/07.01.279/99-2000 dated
April 27, 2000
13. Ref.No.MPD.3513/279A(MM)/1999- 2000
dated April 28, 2000
Subject
Money Market - Routing of
Transactions through DFHI
Money Market - Routing of
Transactions through Primary
Dealers
Money Market
Measures for Developing the
Money Market - Call/Notice
Money Market
Call/Notice Money and Bills
Rediscounting Markets - Routing
of Transaction
Money Market
Money Market
Call/Notice Money and Bills
Rediscounting Markets - Routing
of Transactions - Extract from
the Statement on Monetary and
Credit Policy for the Year 2000-
01 dated April 27, 2000
14. MPD.BC.201/07.01.279/2000-01 dated
October 10, 2000
15. MPD.BC.206/07.01.279/2000-01 dated
April 19, 2000
16. DS.PCB.CIR.40/13.01.00/2000-01 dated
April 19, 2001
17. MPD.2991/03.09.01/2000-01 dated April
21, 2001
18. MPD.3173/03.09.01/2000-01 dated May
8, 2001
19. Ref.DBOD.No.FSC.BC.125/24.92.001
/2000-01 dated May 25, 2001
Permission to non-banks to lend
in the call money market
Moving towards Pure Inter-bank
Call Money Market
Operations in call/notice money
market
Participation in Call/Notice
Money Market
Participation in Call/Notice
Money Market
Permission to participate in
Call/Notice/Term Money Market
328

Annexure – H
Sr.
No.
Circular Number
20. MPD.BC.214/07.01.279/2001-02 dated
April 29, 2002
21. DS.PCB.CIR.52/13.01.00/2001-02 dated
June 24, 2002
22. MPD.217/07.01.279/2001-02 dated June
27, 2002
23. MPD.220/07.01.279/2002-03 dated July
31, 2002
24. MPD.222/07.01.279/2002-03 dated
October 29, 2002
25. MPD.225/07.01.279/2002-03 dated
November 14, 2002
26. MPD.226/07.01.279/2002-03 dated
December 11, 2002
27. DBOD.FSC.BC.85/24.91.001/2002-03
dated March 26, 2003
28. DBOD.FSC.BC.86/24.91.001/2002-03
dated March 26, 2003
29. MPD.BC.230/07.01.279/2002-03 dated
April 29, 2002
30. MPD.BC.234/07.01.279/2002-03 dated
April 29, 2003
31. MPD.BC.235/07.01.279/2002-03 dated
April 29, 2003
32. MPD.BC.241/07.01.279/2003-04 dated
November 3, 2003
Subject
and Bills Rediscounting Scheme
- Primary Dealers
Money Market - Moving towards
Pure Interbank Call Money
Market
Reporting of Call Money
Transactions
Reliance on Call/Notice Money
Market: Prudential Norm
Access to Call/Notice Money
Market for Primary Dealers:
Prudential Norms.
Money Market
Reliance on Call/Notice Money
Market: Prudential Norm
Reliance on Call/Notice Money
Market: Prudential Norm
Permission to participate in
Call/Notice Money Market and
Bills Rediscounting Scheme -
Private Sector Mutual Funds
Permission to participate in
Call/Notice/Term Money Market
and Bills Rediscounting Scheme
- Primary Dealers
Money Market - Moving towards
Pure Interbank Call Money
Market
Participation of Non-bank
Entities in Call/Notice Money
Market
Reporting of Call/Notice Money
Market Transactions on NDS
Platform.
Money Market - Moving towards
Pure Interbank Call/Notice
Money Market
329

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
Sr.
No.
Circular Number
33. MPD.BC.244/07.01.279/2003-04 dated
November 5, 2003
34. MPD.BC.242/07.01.279/2003-04 dated
November 5, 2003
35. MPD.BC.250/07.01.279/2003-04 dated
May 25, 2004
36. MPD.BC.253/07.01.279/2004-05 dated
July 3, 2005.
37. MPD.BC.259/07.01.279/2004-05 dated
October 26, 2004.
38. MPD.BC.260/07.01.279/2004-05 dated
December 10, 2004.
39. MPD.BC.265/07.01.279/2004-05 dated
April 29, 2005.
40. MPD.BC.266/07.01.279/2004-05 dated
April 29, 2005.
Subject
Primary Dealers' Access to
Call/Notice Money Market
Moving towards Pure Inter-bank
Call/Notice Money Market
Moving towards Pure Inter-bank
Call/Notice Money Market
Master Circular on Call/Notice
Money Market Operations
Moving towards Pure Inter-bank
Call/Notice Money Market
Reporting of Call/Notice Money
Market Transactions.
Call/Notice Money Market –
Review of Benchmark.
Participation in Call/Notice
Money Market.
330

ANNEXURE – I
RBI MC CD 2009
RBI/2009-10/47
FMD.MSRG.No. 38/02.08.003/2009-10 July 1, 2009
The Chairmen / Chief Executives of
All Scheduled Banks (excluding RRBs and LABs)
and All-India Term Lending and Refinancing Institutions
Dear Sirs,
<strong>Guide</strong>lines for Issue of Certificates of Deposit
As you are aware, with a view to further widening the range of money market
instruments and giving investors greater flexibility in deployment of their shortterm
surplus funds, Certificates of Deposit (CDs) were introduced in India in
1989. <strong>Guide</strong>lines for issue of CDs are presently governed by various directives
issued by the Reserve Bank of India, as amended from time to time.
A Master Circular incorporating all the existing guidelines / instructions /
directives on the subject has been prepared. It may be noted that this Master
Circular consolidates and updates all the instructions / guidelines contained in
the circulars listed in the Appendix, in so far as they relate to 'guidelines for issue
of CDs'. This master circular has been placed on RBI website at
www.mastercircular.rbi.org.in
Yours faithfully,
(Chandan Sinha)
Chief General Manager

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
Master Circular on <strong>Guide</strong>lines for Issue of Certificates of Deposit (CDs)
(as Amended up to June 30, 2009)
Introduction
Eligibility
Aggregate Amount
Minimum Size of Issue and Denominations
Who can Subscribe
Maturity
Discount
Reserve Requirements
Transferability
Loans / Buy-backs
Format of CDs
Payment of Certificate
Issue of Duplicate Certificates
Accounting
Standardised Market Practice and Documentation
Reporting
Annex I
Annex II
Appendix
332

Annexure – I
Introduction
Certificates of Deposit (CDs) is a negotiable money market instrument and
issued in dematerialised form or as a Usance Promissory Note, for funds
deposited at a bank or other eligible financial institution for a specified time
period. <strong>Guide</strong>lines for issue of CDs are presently governed by various directives
issued by the Reserve Bank of India, as amended from time to time. The
guidelines for issue of CDs incorporating all the amendments issued till date are
given below for ready reference.
Eligibility
2. CDs can be issued by (i) scheduled commercial banks excluding
Regional Rural Banks (RRBs) and Local Area Banks (LABs); and (ii) select all-
India Financial Institutions that have been permitted by RBI to raise short-term
resources within the umbrella limit fixed by RBI.
Aggregate Amount
3. Banks have the freedom to issue CDs depending on their requirements.
4. An FI may issue CDs within the overall umbrella limit fixed by RBI, i.e.,
issue of CD together with other instruments, viz., term money, term deposits,
commercial papers and inter-corporate deposits should not exceed 100 per cent
of its net owned funds, as per the latest audited balance sheet.
Minimum Size of Issue and Denominations
5. Minimum amount of a CD should be Rs.1 lakh, i.e., the minimum
deposit that could be accepted from a single subscriber should not be less than
Rs. 1 lakh and in the multiples of Rs. 1 lakh thereafter.
Who can Subscribe
6. CDs can be issued to individuals, corporations, companies, trusts,
funds, associations, etc. Non- Resident Indians (NRIs) may also subscribe to
CDs, but only on non-repatriable basis which should be clearly stated on the
Certificate. Such CDs cannot be endorsed to another NRI in the secondary
market.
Maturity
7. The maturity period of CDs issued by banks should be not less than 7
days and not more than one year.
333

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
8. The FIs can issue CDs for a period not less than 1 year and not
exceeding 3 years from the date of issue.
Discount / Coupon Rate
9. CDs may be issued at a discount on face value. Banks / FIs are also
allowed to issue CDs on floating rate basis provided the methodology of
compiling the floating rate is objective, transparent and market-based. The
issuing bank / FI are free to determine the discount / coupon rate. The interest
rate on floating rate CDs would have to be reset periodically in accordance with a
pre-determined formula that indicates the spread over a transparent benchmark.
Reserve Requirements
10. Banks have to maintain the appropriate reserve requirements, i.e., cash
reserve ratio (CRR) and statutory liquidity ratio (SLR), on the issue price of the
CDs.
Transferability
11. Physical CDs are freely transferable by endorsement and delivery.
Dematted CDs can be transferred as per the procedure applicable to other demat
securities. There is no lock-in period for the CDs.
Loans / Buy-backs
12. Banks / FIs cannot grant loans against CDs. Furthermore, they cannot
buyback their own CDs before maturity. However, the Reserve Bank may relax
these restrictions for temporary periods through a separate notification.
Format of CDs
13. Banks / FIs should issue CDs only in the dematerialised form. However,
according to the Depositories Act, 1996, investors have the option to seek
certificate in physical form. Accordingly, if investor insists on physical certificate,
the bank / FI may inform the Chief General Manager, Financial Markets
Department, Reserve Bank of India, Central Office, Fort, Mumbai - 400 001
about such instances separately. Further, issuance of CDs will attract stamp
duty. A format (Annex I) is enclosed for adoption by banks / FIs. There will be no
grace period for repayment of CDs. If the maturity date happens to be holiday,
the issuing bank should make payment on the immediate preceding working day.
Banks / FIs may, therefore, so fix the period of deposit that the maturity date
does not coincide with a holiday to avoid loss of discount / interest rate.
334

Security Aspect
Annexure – I
14. Since physical CDs are freely transferable by endorsement and
delivery, it will be necessary for banks to see that the certificates are printed on
good quality security paper and necessary precautions are taken to guard
against tampering with the document. They should be signed by two or more
authorised signatories.
Payment of Certificate
15. Since CDs are transferable, the physical certificate may be presented
for payment by the last holder. The question of liability on account of any defect
in the chain of endorsements may arise. It is, therefore, desirable that banks take
necessary precautions and make payment only by a crossed cheque. Those who
deal in these CDs may also be suitably cautioned.
16. The holders of dematted CDs will approach their respective depository
participants (DPs) and have to give transfer / delivery instructions to transfer the
demat security represented by the specific ISIN to the 'CD Redemption Account'
maintained by the issuer. The holder should also communicate to the issuer by a
letter / fax enclosing the copy of the delivery instruction it had given to its DP and
intimate the place at which the payment is requested to facilitate prompt
payment. Upon receipt of the Demat credit of CDs in the "CD Redemption
Account", the issuer, on maturity date, would arrange to repay to holder /
transferor by way of Banker's cheque / high value cheque, etc.
Issue of Duplicate Certificates
17. In case of the loss of physical certificates, duplicate certificates can
be issued after compliance with the following:
(a)
(b)
(c)
A notice is required to be given in at least one local newspaper
Lapse of a reasonable period (say 15 days) from the date of the notice
in the newspaper; and
Execution of an indemnity bond by the investor to the satisfaction of the
issuer of CDs.
18. The duplicate certificate should only be issued in physical form. No
fresh stamping is required as a duplicate certificate is issued against the original
lost CD. The duplicate CD should clearly state that the CD is a Duplicate one
stating the
335

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
original value date, due date, and the date of issue (as "Duplicate issued on
________").
Accounting
19. Banks / FIs may account the issue price under the Head "CDs issued"
and show it under deposits. Accounting entries towards discount will be made as
in the case of "cash certificates". Banks / FIs should maintain a register of CDs
issued with complete particulars.
Standardised Market Practices and Documentation
20. Fixed Income Money Market and Derivatives Association of India
(FIMMDA) may prescribe, in consultation with the RBI, for operational flexibility
and smooth functioning of the CD market, any standardised procedure and
documentation that are to be followed by the participants, in consonance with the
international best practices. Banks / FIs may refer to the detailed guidelines
issued by FIMMDA in this regard on June 20, 2002.
Reporting
21. Banks should include the amount of CDs in the fortnightly return under
Section 42 of the Reserve Bank of India Act, 1934 and also separately indicate
the amount so included by way of a footnote in the return.
22. Further, banks / FIs should submit a fortnightly return, as per the format
given in Annex II, to the Chief General Manager, Financial Markets Department,
Reserve Bank of India, Central Office Building, Fort, Mumbai - 400 001, Fax: 91-
22-22630981 / 22634824 within 10 days from the end of the fortnight date.
-------------------------------
336

Annexure – I
Name of the Bank / Institution
No.
Annex - I
Rs. ___________
Dated ___________
NEGOTIABLE CERTIFICATE OF DEPOSIT
___________ months / days after the date hereof, ___________ ___________, at ___________
___________, hereby promise to pay to ___________
___________ or order the sum of Rupees ___________
___________ only, upon presentation and surrender of this instrument at the
said place, for deposit received. For ___________
___________ Date of maturity ___________ without days of grace.
Instructions Endorsements Date
1. 1.
2.
3.
4.
5.
337

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
Annex - II
Fortnightly Return on Certificates of Deposit (CDs)
(SFR III – D)
Name of the Bank/Institution
For the Fortnight ended
Issue of Certificates of Deposit (CDs)
Total amount of CDs outstanding as at the end of the fortnight
(1) On Discount Value Basis (Rs. Crore)
Face Value
Discounted Value
(2) On Coupon Bearing Basis (Rs. Crore)
Face Value
Particulars of CDs issued during the fortnight
I CDs issued on Discount value basis
Sr.
No.
Discounted value of
CDs issued (Amount in
Rs.)
Maturity
period (in
days)
Effective
interest rate
(per cent per
annum)
Demat or
Physical CDs
issued (D/P)
1.
2.
3.
4.
5.
6.
338

Annexure – I
II
CDs issued on Floating Rate Basis
Sr.
No.
Face value of CDs
issued
(Amount in Rs.)
Maturity
period
(in days)
Benchmark
Spread
Demat or
Physical
CDs issued
(D/P)
1.
2.
3.
4.
5.
6.
339

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
Appendix
List of Circulars
Sr.
No
Reference No. Date Subject
1. DBOD.No.BP.BC.134/65-89 June 6, 1989 Certificates of Deposit (CDs)
2. DBOD.No.BP.BC.112/65-90 May 23, 1990 Certificates of Deposit (CDs)
3. DBOD.No.BP.BC.60/65-90 December 20,
1990
Certificates of Deposit (CDs)
4. DBOD.No.BP.BC.113/65-91 April 15, 1991 Certificates of Deposit (CDs)
5. DBOD.No.BP.BC.83/65-92 February 12,
1992
Certificates of Deposit (CDs)
6. DBOD.No.BC.119/12.021.001/92 April 21, 1992 Section 42(1) of the Reserve
Bank of India Act 1934 -
Cash Reserve Ratio on
incremental Certificates of
Deposit - Exemption
7. DBOD.No.BC.106/21.03.053/93 April 7, 1993 Certificates of Deposit (CDs)
- Enhancement of Limit
8. DBOD.No.BC.171/21.03.053/93 October 11,
1993
Certificates of Deposit (CDs)
Scheme
9. DBOD.No.BP.BC.109./21.03.053/96 August 9, 1996 Certificates of Deposit (CDs)
Scheme
10. DBOD.No.BP.BC.49/21.03.053/97 April 22, 1997 Certificates of Deposit (CDs)
11. DBOD.No.BP.BC.128/21.03.053/97 October 21,
1997
Certificates of Deposit (CDs)
12. DBOD.No.Dir.BC.96/13.03.00/2001-02 April 29, 2002 Issue of Certificates of
Deposit (CDs) in
dematerialised form
13. DBOD.No.BP.BC.115/21.03.053/2001-02 June 15, 2002 Certificates of Deposit (CDs)
340

Annexure – I
14. DBOD.No.BP.BC.43/21.03.053/2002-03 November 16,
2002
Mid-Term Review of
Monetary and Credit Policy
2002-03: Certificates of
Deposit
15. MPD.No.254/07.01.279/2004-05 July 12, 2004 <strong>Guide</strong>lines for Issue of
Certificates of Deposit
16. MPD.No.263/07.01.279/2004-05 April 28, 2005 Certificates of Deposit
341

ANNEXURE – J
RBI MC COMLPAPER 2009
RESERVE BANK OF INDIA
FINANCIAL MARKETS DEPARTMENT
Market Surveillance & Research Group
------------------------------------------------------------------------------------------------------------
Master Circular
on
<strong>Guide</strong>lines for Issue of Commercial Paper
RBI/2009-10/ 45
Ref.No. FMD.MSRG.No.37/02.08.003/2009-10
The Chairmen/Chief Executives of
All Scheduled Banks, Primary Dealers
and All-India Financial Institutions
July 1, 2009
Ashadha 09, 1931 (S)
Dear Sir,
<strong>Guide</strong>lines for Issue of Commercial Paper
As you are aware, Commercial Paper (CP), an unsecured money market
instrument issued in the form of a promissory note, was introduced in India in
1990 with a view to enabling highly rated corporate borrowers to diversify their
sources of short-term borrowings and to provide an additional instrument to
investors. <strong>Guide</strong>lines for issue of CP are presently governed by various directives
issued by the Reserve Bank of India, as amended from time to time.
A Master Circular incorporating all the existing guidelines/instructions/ directives
on the subject has been prepared. It may be noted that this Master Circular

Annexure – J
consolidates and updates all the instructions/guidelines contained in the circulars
listed in the Appendix, in so far as they relate to ‘guidelines for issue of CP’. This
master circular has been placed on RBI website at www.mastercirculars.rbi.org.in
Yours faithfully,
(Chandan Sinha)
Chief General Manager
343

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
Master Circular
on
<strong>Guide</strong>lines for Issue of Commercial
Paper (CP) as amended up to June 30, 2009
Introduction
Who can issue CP
Rating Requirement
Maturity
Denominations
Limits & Amount of Issue of CP
Who can be IPA
Investments in CP
Mode of Issuance
Preference for Dematerialised form
Payment of CP
Stand-by Facility
Procedure for Issuance
Role and Responsibilities
Documentation Procedure
Defaults in CP market
Non-applicability of Certain Other Directions
Schedule I
Schedule II
Schedule III
Annex I
Annex II
Appendix
344

Annexure – J
Introduction
Commercial Paper (CP) is an unsecured money market instrument issued in the
form of a promissory note. CP, as a privately placed instrument, was introduced
in India in 1990 with a view to enabling highly rated corporate borrowers to
diversify their sources of short-term borrowings and to provide an additional
instrument to investors. Subsequently, primary dealers, satellite dealers*and all-
India financial institutions were also permitted to issue CP to enable them to
meet their short-term funding requirements for their operations. <strong>Guide</strong>lines for
issue of CP are presently governed by various directives issued by the Reserve
Bank of India, as amended from time to time. The guidelines for issue of CP
incorporating all the amendments issued till date is given below for ready
reference.
Who can Issue Commercial Paper (CP)
2. Corporates, primary dealers (PDs) and the all-India financial institutions
(FIs) that have been permitted to raise short-term resources under the
umbrella limit fixed by the Reserve Bank of India are eligible to issue CP.
3. A corporate would be eligible to issue CP provided: (a) the tangible net
worth of the company, as per the latest audited balance sheet, is not less
than Rs.4 crore; (b) company has been sanctioned working capital limit by
bank/s or all- India financial institution/s; and (c) the borrowal account of
the company is classified as a Standard Asset by the financing bank/s/
institution/s.
Rating Requirement
4. All eligible participants shall obtain the credit rating for issuance of
Commercial Paper from either the Credit Rating Information Services of
India Ltd. (CRISIL) or the Investment Information and Credit Rating
Agency of India Ltd. (ICRA) or the Credit Analysis and Research Ltd.
(CARE) or the FITCH Ratings India Pvt. Ltd. or such other credit rating
agencies as may be specified by the Reserve Bank of India from time to
time, for the purpose. The minimum credit rating shall be P-2 of CRISIL or
such equivalent rating by other agencies. The issuers shall ensure at the
time of issuance of CP that the rating so obtained is current and has not
fallen due for review.
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
Maturity
5. CP can be issued for maturities between a minimum of 7 days and a
maximum up to one year from the date of issue. The maturity date of the
CP should not go beyond the date up to which the credit rating of the
issuer is valid.
Denominations
6. CP can be issued in denominations of Rs.5 lakh or multiples thereof.
Amount invested by a single investor should not be less than Rs.5 lakh
(face value).
Limits and the Amount of Issue of CP
7. CP can be issued as a "stand alone" product. The aggregate amount of
CP from an issuer shall be within the limit as approved by its Board of
Directors or the quantum indicated by the Credit Rating Agency for the
specified rating, whichever is lower. Banks and FIs will, however, have the
flexibility to fix working capital limits duly taking into account the resource
pattern of companies’ financing including CPs.
8. An FI can issue CP within the overall umbrella limit fixed by the RBI, i.e.,
issue of CP together with other instruments, viz., term money borrowings,
term deposits, certificates of deposit and inter-corporate deposits should
not exceed 100 per cent of its net owned funds, as per the latest audited
balance sheet.
9. The total amount of CP proposed to be issued should be raised within a
period of two weeks from the date on which the issuer opens the issue for
subscription. CP may be issued on a single date or in parts on different
dates provided that in the latter case, each CP shall have the same
maturity date.
10. Every issue of CP, including renewal, should be treated as a fresh issue.
Who can Act as Issuing and Paying Agent (IPA)
11. Only a scheduled bank can act as an IPA for issuance of CP.
Investment in CP
12. CP may be issued to and held by individuals, banking companies, other
corporate bodies registered or incorporated in India and unincorporated
bodies, Non-Resident Indians (NRIs) and Foreign Institutional Investors
346

Annexure – J
(FIIs). However, investment by FIIs would be within the limits set for their
investments by Securities and Exchange Board of India (SEBI).
Mode of Issuance
13. CP can be issued either in the form of a promissory note (Schedule I) or
in a dematerialised form through any of the depositories approved by and
registered with SEBI.
14. CP will be issued at a discount to face value as may be determined by the
issuer.
15. No issuer shall have the issue of CP underwritten or co-accepted.
Preference for Dematerialisation
16. While option is available to both issuers and subscribers to issue/hold CP
in dematerialised or physical form, issuers and subscribers are
encouraged to prefer exclusive reliance on dematerialised form of
issue/holding. However, with effect from June 30, 2001, banks, FIs and
PDs are required to make fresh investments and hold CP only in
dematerialised form.
Payment of CP
17. The initial investor in CP shall pay the discounted value of the CP by
means of a crossed account payee cheque to the account of the issuer
through IPA. On maturity of CP, when CP is held in physical form, the
holder of CP shall present the instrument for payment to the issuer
through the IPA. However, when CP is held in demat form, the holder of
CP will have to get it redeemed through the depository and receive
payment from the IPA.
Stand-by Facility
18. In view of CP being a 'stand alone' product, it would not be obligatory in
any manner on the part of the banks and FIs to provide stand-by facility to
the issuers of CP. Banks and FIs have, however, the flexibility to provide
for a CP issue, credit enhancement by way of stand-by assistance/credit,
back-stop facility etc. based on their commercial judgement, subject to
prudential norms as applicable and with specific approval of their Boards.
19. Non-bank entities including corporates may also provide unconditional
and irrevocable guarantee for credit enhancement for CP issue provided:
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
(i)
(ii)
(iii)
Procedure for Issuance
the issuer fulfils the eligibility criteria prescribed for issuance of CP;
the guarantor has a credit rating at least one notch higher than the
issuer given by an approved credit rating agency; and
the offer document for CP properly discloses the net worth of the
guarantor company, the names of the companies to which the
guarantor has issued similar guarantees, the extent of the
guarantees offered by the guarantor company, and the conditions
under which the guarantee will be invoked.
20. Every issuer must appoint an IPA for issuance of CP. The issuer should
disclose to the potential investors its financial position as per the standard
market practice. After the exchange of deal confirmation between the
investor and the issuer, issuing company shall issue physical certificates
to the investor or arrange for crediting the CP to the investor's account
with a depository. Investors shall be given a copy of IPA certificate to the
effect that the issuer has a valid agreement with the IPA and documents
are in order (Schedule III).
Role and Responsibilities
21. The role and responsibilities of issuer, issuing and paying agent (IPA) and
credit rating agency (CRA) are set out below:
(a)
(b)
Issuer
With the simplification in the procedures for CP issuance, issuers would
now have more flexibility. Issuers would, however, have to ensure that the
guidelines and procedures laid down for CP issuance are strictly adhered
to.
Issuing and Paying Agent (IPA)
(i)
(ii)
IPA would ensure that issuer has the minimum credit rating as
stipulated by RBI and amount mobilised through issuance of CP is
within the quantum indicated by CRA for the specified rating or as
approved by its Board of Directors, whichever is lower.
IPA has to verify all the documents submitted by the issuer, viz.,
copy of board resolution, signatures of authorised executants
(when CP in physical form) and issue a certificate that documents
348

(c)
(iii)
(iv)
(v)
(vi)
Annexure – J
are in order. It should also certify that it has a valid agreement with
the issuer (Schedule III).
Certified copies of original documents verified by the IPA should
be held in the custody of IPA.
Every CP issue should be reported to the Chief General Manager,
Financial Markets Department, Reserve Bank of India, Central
Office, Fort, Mumbai- 400001.
IPAs, which are NDS member, should report the details of CP
issue on NDS platform within two days from the date of completion
of the issue.
Further, all scheduled banks, acting as an IPA, will continue to
report CP issuance details as hitherto within three days from the
date of completion of the issue, incorporating details as per
Schedule II till NDS reporting stabilises to the satisfaction of RBI.
Credit Rating Agency (CRA)
(i)
(ii)
(iii)
Code of Conduct prescribed by the SEBI for CRAs for undertaking
rating of capital market instruments shall be applicable to them
(CRAs) for rating CP.
Further, the credit rating agency would henceforth have the
discretion to determine the validity period of the rating depending
upon its perception about the strength of the issuer. Accordingly,
CRA shall at the time of rating, clearly indicate the date when the
rating is due for review.
While the CRAs can decide the validity period of credit rating, they
would have to closely monitor the rating assigned to issuers vis-avis
their track record at regular intervals and would be required to
make their revision in the ratings public through their publications
and website.
Documentation Procedure
22. Fixed Income Money Market and Derivatives Association of India
(FIMMDA) may prescribe, in consultation with the RBI, for operational
flexibility and smooth functioning of CP market, any standardised
procedure and documentation that are to be followed by the participants,
in consonance with the international best practices. Issuer / IPAs may
349

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
refer to the detailed guidelines issued by FIMMDA in this regard on July 5,
2001.
23. Violation of these guidelines will attract penalties and may also include
debarring of the entity from the CP market.
Defaults in CP market
24. In order to monitor defaults in redemption of CP, scheduled banks which
act as IPAs, are advised to immediately report, on occurrence, full
particulars of defaults in repayment of CPs to the Financial Markets
Department, Reserve Bank of India, Central Office, Fort, Mumbai-400001,
Fax: 022- 22630981/ 22634824 in the format as given in Annex I.
Non-applicability of Certain Other Directions
25. Nothing contained in the Non-Banking Financial Companies Acceptance
of Public Deposits (Reserve Bank) Directions, 1998 shall apply to any
non-banking financial company (NBFC) insofar as it relates to acceptance
of deposit by issuance of CP, in accordance with these <strong>Guide</strong>lines.
26. Definitions of certain terms used in the <strong>Guide</strong>lines are provided in the
Annex II.
350

Annexure – J
Schedule I
(NAME OF THE ISSUING COMPANY/INSTITUTION)
SERIAL NO.
Stamp to be
Affixed as in force
in the State in which
it is to be issued
Issued at :_______________________ Date of issue :_____________________
(PLACE)
Date of Maturity:___________________________without days of grace.
(If such date happens to fall on a holiday, payment shall be made on the
immediate preceding working day)
For value received ___________________________________________hereby
(NAME OF THE ISSUING COMPANY/ INSTITUTION)
Promises to pay _______________________________________or order on the
(NAME OF THE INVESTOR)
maturity date as specified above the sum of Rs._________________________
(in words) upon presentation and surrender of this Commercial Paper to
________________________________________________________________
(NAME OF THE ISSUING AND PAYING AGENT)
For and on behalf of ________________________________________
(NAME OF THE ISSUING COMPANY/INSTITUTION)
AUTHORISED
SIGNATORY
AUTHORISED
SIGNATORY
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
ALL ENDORSEMENTS UPON THIS COMMERCIAL PAPER MUST BE CLEAN
AND DISTINCT.
EACH ENDORSEMENT SHOULD BE WRITTEN WITHIN THE SPACE
ALLOTTED.
Pay to ____________________________________________________ or order
the amount within named.
(NAME OF TRANSFEREE)
For and on behalf of
________________________________________________________________
(NAME OF THE TRANSFEROR)
________________________________________________________________
1. "
2. "
3. "
4. "
5 . "
6. "
7. "
8. "
352

Annexure – J
Schedule II
Proforma of information to be submitted by the
Issuer for issue of Commercial Paper
(To be submitted to the Reserve Bank through the Issuing and Paying Agent
(IPA) within 3 days of the completion of issue of CP to the GGM, FMD, RBI,
Mumbai)
To:
The Chief General Manager
Financial Markets Department
Reserve Bank of India
Central Office, Fort
Mumbai - 400 001.
Through: (Name of IPA)
Dear Sir
Issue of Commercial Paper
In terms of the guidelines for issuance of commercial paper issued by the
Reserve Bank dated August 19, 2003, we have issued Commercial Paper as per
details furnished hereunder:
i) Name of the Issuer :
ii) Registered Office and Address :
iii) Business activity :
iv)
Name/s of Stock Exchange/s
with whom shares of the :
issuer are listed (if applicable)
v) Tangible net worth as per latest
audited balance sheet :
vi) Total Working Capital Limit :
vii) Outstanding Bank Borrowings :
viii)
(a) Details of Commercial Paper
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
issued (Face Value) : Date of Date of Amount Rate
Issue Maturity
i)
ii)
(b) Amount of CP outstanding
(Face Value) including the :
present issue
ix) Rating(s) obtained from the i)
Credit Rating Information
Services of India Ltd.(CRISIL) ii)
or any other agency as specified
by the Reserve Bank iii)
x) Whether stand-by facility has
been provided in respect of
CP issue?
xi)
xii)
xiii)
If yes
i) the amount of the : Rs. crore
stand-by facility
ii) provided by
(Name of bank/FI)
Whether unconditional and irrevocable
guarantee has been provided in
respect of CP issue?
If yes
i) the amount of the guarantee : Rs. Crore
ii) provided by
(Name of guarantor)
iii) Credit rating of the guarantor
For and on behalf of
_________________
(Name of the issuer)
354

Annexure – J
Schedule III
CERTIFICATE
We have a valid IPA agreement with the ________________________________
(Name of Issuing Company/Institution)
2. We have verified the documents viz., board resolution and certificate issued by
Credit Rating Agency submitted by ____________________________________
(Name of the Issuing Company/Institution)
and certify that the documents are in order. Certified copies of original
documents are held in our custody.
3.* We also hereby certify that the signatures of the executants of the attached
Commercial Paper bearing Sr. No. ______________ dated _______________
for Rs._______________ (Rupees ____________________________________)
(in words)
tally with the specimen signatures filed by _______________________________
( Name of the issuing Company/Institution)
(Authorised Signatory/Signatories)
(Name and address of Issuing and Paying Agent)
Place :
Date :
* (Applicable to CP in physical form)
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
Name of the issuer
Annex I
Details of Defaults on Repayment of CP
Date
of
issue
of CP
Amount
Due date of repayment
Initial Rating
Latest Rating
Whether
the CP
issue
enjoyed a
standby
assistance/
credit back
stop facility/
guarantee
If so, the
name of
the entity
providing
the facility
indicated
at Col. (7)
Whether
the facility
at Col (7)
has been
honoured
and
payment
made.
(1) (2) (3) (4) (5) (6) (7) (8) (9)
356

Annexure – J
Definitions
Annex II
In these guidelines, unless the context otherwise requires:
(a)
(b)
(c)
(d)
(e)
(f)
(g)
"bank” or “banking company" means a banking company as defined in
clause (c) of Section 5 of the Banking Regulation Act, 1949 (10 of
1949) or a "corresponding new bank", "State Bank of India" or
"subsidiary bank" as defined in clause (da), clause (nc) and clause
(nd) respectively thereof and includes a "co-operative bank" as
defined in clause (cci) of Section 5 read with Section 56 of that Act.
“scheduled bank” means a bank included in the Second Schedule of
the Reserve Bank of India Act, 1934.
“All-India Financial Institutions (FIs)” mean those financial institutions
which have been permitted specifically by the Reserve Bank of India
to raise resources by way of Term Money, Term Deposits, Certificates
of Deposit, Commercial Paper and Inter-Corporate Deposits, where
applicable, within umbrella limit.
"Primary Dealer" means a non-banking financial company which holds
a valid letter of authorisation as a Primary Dealer issued by the
Reserve Bank, in terms of the "<strong>Guide</strong>lines for Primary Dealers in
Government Securities Market" dated March 29, 1995, as amended
from time to time.
"corporate” or “company" means a company as defined in Section 45 I
(aa) of the Reserve Bank of India Act, 1934 but does not include a
company which is being wound up under any law for the time being in
force.
"non-banking company" means a company other than banking
company.
“non-banking financial company” means a company as defined in
Section 45 I
(f) of the Reserve Bank of India Act, 1934.
(h)
“working capital limit” means the aggregate limits, including those by
way of purchase/discount of bills sanctioned by one or more banks/FIs
for meeting the working capital requirements.
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
(i)
(j)
"Tangible net worth" means the paid-up capital plus free reserves
(including balances in the share premium account, capital and
debentures redemption reserves and any other reserve not being
created for repayment of any future liability or for depreciation in
assets or for bad debts or reserve created by revaluation of assets) as
per the latest audited balance sheet of the company, as reduced by
the amount of accumulated balance of loss, balance of deferred
revenue expenditure, as also other intangible assets.
words and expressions used but not defined herein and defined in the
Reserve Bank of India Act, 1934 (2 of 1934) shall have the same
meaning as assigned to them in that Act.
358

Annexure – J
Appendix
List of Circulars
Sr.
No
Reference No. Date Subject
IECD.No.PMD.15/87 (CP)- 89/90
IECD.No.PMD.19/87 (CP)-89/90
January
3,1990
January
23,1990
Issue of Commercial paper
(CP)
Issue of Commercial paper
(CP)
IECD.No.PMD.28/87 (CP)- 89/90 April 24,1990 Commercial Paper (CP) -
Amendment to Directions.
IECD.No.PMD.1/08.15.01/93-94 July 2,1990 <strong>Guide</strong>lines for provision of
factoring services
IECD.No.PMD.2/87 (CP)-90/91 July 7,1990 Commercial Paper (CP) -
Renewal of existing issue.
IECD.No.PMD.57/87 (CP)-90/91 May 30,1991 Commercial Paper (CP) -
Amendment to Directions.
IECD.No.16/PMD/87 (CP)-91/92 August 20,
1991
IECD.No.39/PMD/87 (CP)-91/92 December 20,
1991
IECD.No.49/CC&MIS/87/91-92 February 7,
1992
Issue of Commercial paper
(CP)
Commercial Paper (CP) -
Amendment to Directions.
Issue of Commercial paper
(CP) - Submission of
Returns etc.
IECD.No.63/08.15.01/91-92 May 13,1992 Commercial Paper (CP) -
Amendment to Directions.
IECD.No.34/08.15.01/92-93 May 19,1993 Commercial Paper (CP) –
Application of Stamp Duty
IECD.No.13/08.15.01/93-94 October 5,
1993
IECD.No.17/08.15.01/93-94 October 18,
1993
IECD.No.25/08.15.01/93-94 December 17,
1993
IECD.No.19/08.15.01/94-95 October 20,
1994
IECD.No.28/08.15.01/95-96 June 20,
1996
Commercial Paper (CP) -
Amendment to Directions.
Commercial Paper (CP)-
Amendment to Directions.
Issue of Commercial Paper
(CP)
Commercial Paper - Stand
by Arrangement
Commercial Paper (CP)-
IECD.No.3/08.15.01/96-97 July 25, 1996 Commercial Paper (CP) -
Amendment to Directions.
359

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
Sr.
No
Reference No. Date Subject
IECD.No.14/08.15.01/96-97 November 5,
1996
Commercial Paper
IECD.No.25/08.15.01/96-97 April 15, 1997 Commercial Paper
IECD.No.14/08.15.01/97-98 October 27,
1997
Commercial Paper
IECD.No.43/08.15.01/97-98 May 25, 1998 Commercial Paper
MPD.48/07.01.279/2000-01 July 6, 2000 <strong>Guide</strong>lines for Issue of
Commercial Paper
IECD. No. 15/08.15.01/2000-01 April 30, 2001 <strong>Guide</strong>lines for Issue of
Commercial Paper
IECD.No.2/08.15.01/2001-02 July 23, 2001 <strong>Guide</strong>lines for Issue of
Commercial Paper
IECD.No.11/08.15.01/2002-03 November 12,
2002
<strong>Guide</strong>lines for Issue of
Commercial Paper
IECD. No. 19/08.15.01/2002-03 April 30, 2003 <strong>Guide</strong>lines for Issue of
Commercial Paper
IECD. No. /08.15.01/2003-04 August 19,
2003
<strong>Guide</strong>lines for Issue of
Commercial Paper –
Defaults in Commercial
Paper market
MPD. NO. 251/07.01.279/2004-05 July 1, 2004 <strong>Guide</strong>lines for Issue of
Commercial Paper
MPD. NO. 258/07.01.279/2004-05 October 26,
2004
<strong>Guide</strong>lines for Issue of
Commercial Paper
MPD. NO. 261/07.01.279/2004-05 April 13, 2005 Reporting of Commercial
Paper (CP) issuance on NDS
Platform
* The system of satellite dealers has since been discontinued with effect from
June 1, 2002.
360

ANNEXURE – K
RBI MC PRUNORMSINVESTT 2009
RBI/ 2009-10/20
DBOD No. BP. BC.3 / 21.04.141 / 2009-10 July 1, 2009
All Commercial Banks
(excluding Regional Rural Banks)
Dear Sir,
Master Circular – Prudential norms for classification, valuation and
operation of investment portfolio by banks
Please refer to the Master Circular No. DBOD. BP. BC.5 / 21.04.141/ 2007-08
dated July 1, 2008, containing consolidated instructions/guidelines issued to
banks till June 30, 2008, on matters relating to prudential norms for classification,
valuation and operation of investment portfolio by banks. The above Master
Circular has since been suitably updated by incorporating instructions/guidelines
issued between July 1, 2008 and June 30, 2009, and furnished in the Annex.
This updated version has also been placed on the RBI web-site
(http://www.rbi.org.in).
2. An appendix containing a list of circulars referred for the purpose of the
current Master circular is furnished at the end of the Annex.
Yours faithfully,
(B.Mahapatra)
Chief General Manager
Encl: As above
Department of Banking Operations and Development, Central Office, 12th Floor, Central Office
Building, Shahid Bhagat Singh Marg,, Mumbai,400001
Tel No:22661602 Fax No:22705691 Email ID:cgmicdbodco@rbi.org.in

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
1.
MASTER CIRCULAR – PRUDENTIAL NORMS FOR
CLASSIFICATION, VALUATION AND OPERATION OF
INVESTMENT PORTFOLIO BY BANKS
Table of Contents
Introduction 4
1.1 Investment Policy 4
1.1.1 Ready forward contracts in Government
Securities
1.1.2 Transactions through SGL account 9
1.1.3 Use of Bank Receipts (BR) 11
1.1.4 Retailing of Government Securities 12
1.1.5 Internal Control System 13
1.1.6 Engagement of brokers 16
1.1.7 Audit, review and reporting of investment
transactions
1.2 Non-SLR investment 18
1.3 General 25
1.3.1 Reconciliation of holdings of Govt. securities,
etc
1.3.2 Transactions in securities - Custodial functions 25
1.3.3 Portfolio Management on behalf of clients 25
1.3.4 Investment Portfolio of bank - Transactions in
Government Securities
2. Classification 27
2.1 Held to Maturity 28
2.2 Available for Sale & Held for Trading 30
2.3 Shifting among categories 30
3. Valuation 31
7
17
25
26
362

Annexure – K
3.1 Held to Maturity 31
3.2 Available for Sale 31
3.3 Held for Trading 32
3.4 Investment Fluctuation Reserve 32
3.5 Market Value 34
3.6 Unquoted SLR securities 35
3.6.1 Central Government Security 35
3.6.2 State Government Security 35
3.6.3 Other Approved Security 35
3.7 Unquoted Non-SLR Securities 35
3.7.1 Debentures/Bonds 35
3.7.2 Zero Coupon Bonds 36
3.7.3 Preference Share 36
3.7.4 Equity Share 37
3.7.5 Mutual Fund Units 38
3.7.6 Commercial Paper 38
3.7.7 Investment in RRBs 38
3.8 Investment in securities Issued by SC/RC 38
3.9 Valuation & classification of bank’s investment in
VCF
3.10 Non Performing investments 41
4. Uniform Accounting for Repo/Non-Repo Transactions 42
5. General 47
5.1 Income Recognition 47
5.2 Broken period Interest 48
5.3 Dematerialized Holding 48
Annexures 49
Appendix 76
39
363

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
MASTER CIRCULAR – PRUDENTIAL NORMS FOR
CLASSIFICATION, VALUATION AND OPERATION OF
INVESTMENT PORTFOLIO BY BANKS
1. Introduction
With the introduction of prudential norms on capital adequacy, income
recognition, asset classification and provisioning requirements, the financial
position of banks in India has improved in the last few years. Simultaneously,
trading in securities market has improved in terms of turnover and the range of
maturities dealt with. In view of these developments and taking into consideration
the evolving international practices, Reserve Bank of India (RBI) has issued
guidelines on classification, valuation and operation of investment portfolio by
banks from time to time as detailed below:
1.1 Investment Policy
i) Banks should frame Internal Investment Policy <strong>Guide</strong>lines and obtain the
Board’s approval. The investment policy may be suitably framed/
amended to include Primary Dealer (PD) activities also. Within the overall
framework of the investment policy, the PD business undertaken by the
bank will be limited to dealing, underwriting and market–making in
Government Securities. Investments in Corporate/ PSUs/ FIs bonds,
Commercial Papers, Certificate of Deposits, debt mutual funds and other
fixed income securities will not be deemed to be part of PD business. The
investment policy guidelines should be implemented to ensure that
operations in securities are conducted in accordance with sound and
acceptable business practices. While framing the investment policy, the
following guidelines are to be kept in view by the banks:
(a)
Banks may sell a government security already contracted for purchase,
provided:
(i)
(ii)
(iii)
The purchase contract is confirmed prior to the sale,
The purchase contract is guaranteed by CCIL or the security is
contracted for purchase from the Reserve Bank and,
The sale transaction will settle either in the same settlement cycle
as the preceding purchase contract, or in a subsequent settlement
cycle so that the delivery obligation under the sale contract is met
by the securities acquired under the purchase contract (e.g. when
364

Annexure – K
(b)
(c)
(d)
(e)
(f)
a security is purchased on T+0 basis, it can be sold on either T+0
or T+1 basis on the day of the purchase; if however it is purchased
on T+1 basis, it can be sold on T+1 basis on the day of purchase
or on T+0 or T+1 basis on the next day). For purchase of
securities from RBI through Open Market Operations (OMO), no
sale transactions should be contracted prior to receiving the
confirmation of the deal/advice of allotment from the RBI.
• In addition to the above, the Scheduled Commercial Banks
(other than RRBs and LABs) and Primary Dealers have been
permitted to short sell Government securities in accordance
with the requirements specified in Annexure I-A.
• Further, the NDS-OM members have been permitted to
transact on ‘When Issued’ basis in Central Government
dated securities, subject to the guidelines specified in
Annexure I-B.
Banks successful in the auction of primary issue of government may enter
into contracts for sale of the allotted securities in accordance with the
terms and conditions as per Annexure I-C.
The settlement of all outright secondary market transactions in
Government Securities will be done on a standardized T+1 basis effective
May 24, 2005.
All the transactions put through by a bank, either on outright basis or
ready forward basis and whether through the mechanism of Subsidiary
General Ledger (SGL) Account or Bank Receipt (BR), should be reflected
on the same day in its investment account and, accordingly, for SLR
purpose wherever applicable.
The brokerage on the deal payable to the broker, if any, (if the deal was
put through with the help of a broker) should be clearly indicated on the
notes/ memoranda put up to the top management seeking approval for
putting through the transaction and a separate account of brokerage paid,
broker-wise, should be maintained.
For issue of BRs, the banks should adopt the format prescribed by the
Indian Banks' Association (IBA) and strictly follow the guidelines
prescribed by them in this regard. The banks, subject to the above, could
issue BRs covering their own sale transactions only and should not issue
365

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
(g)
(h)
(i)
ii)
BRs on behalf of their constituents, including brokers.
The banks should be circumspect while acting as agents of their broker
clients for carrying out transactions in securities on behalf of brokers.
Any instance of return of SGL form from the Public Debt Office of the
Reserve Bank for want of sufficient balance in the account should be
immediately brought to Reserve Bank's notice with the details of the
transactions.
Banks desirous of making investment in equity shares/ debentures should
observe the following guidelines:
(i)
(ii)
(iii)
Build up adequate expertise in equity research by establishing a
dedicated equity research department, as warranted by their scale
of operations;
Formulate a transparent policy and procedure for investment in
shares, etc., with the approval of the Board; and
The decision in regard to direct investment in shares, convertible
bonds and debentures should be taken by the Investment
Committee set up by the bank's Board. The Investment Committee
should be held accountable for the investments made by the bank.
With the approval of respective Boards, banks should clearly lay down the
broad investment objectives to be followed while undertaking transactions
in securities on their own investment account and on behalf of clients,
clearly define the authority to put through deals, procedure to be followed
for obtaining the sanction of the appropriate authority, procedure to be
followed while putting through deals, various prudential exposure limits
and the reporting system. While laying down such investment policy
guidelines, banks should strictly observe Reserve Bank's detailed
instructions on the following aspects:
(a) Ready Forward (buy back) deals (Paragraph 1.1.1)
(b) Transactions through Subsidiary General (Paragraph 1.1.2)
Ledger A/c
(c) Use of Bank Receipts (Paragraph 1.1.3)
(d) Retailing of Government Securities (Paragraph 1.1.4)
(e) Internal Control System (Paragraph 1.1.5)
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Annexure – K
(f) Dealings through Brokers (Paragraph 1.1.6)
(g) Audit, Review and Reporting (Paragraph 1.1.7)
(h) Non- SLR investments (Paragraph 1.1.8)
The aforesaid instructions will be applicable mutatis mutandis, to the
subsidiaries and mutual funds established by banks, except where they
are contrary to or inconsistent with, specific regulations of Securities and
Exchange Board of India (SEBI) and RBI governing their operations.
1.1.1 Ready Forward Contracts in Government Securities.
The terms and conditions subject to which ready forward contracts (including
reverse ready forward contracts) may be entered into are as under:
(a)
(b)
Ready forward contracts may be undertaken only in (i) Dated Securities
and Treasury Bills issued by Government of India and (ii) Dated Securities
issued by State Governments.
Ready forward contracts in the above-mentioned securities may be
entered into by:
i) persons or entities maintaining a Subsidiary General Ledger (SGL)
account with RBI, Mumbai and
ii)
the following categories of entities who do not maintain SGL
accounts with the RBI but maintain gilt accounts (i.e gilt account
holders) with a bank or any other entity (i.e. the custodian)
permitted by the RBI to maintain Constituent Subsidiary General
Ledger (CSGL) account with its Public Debt Office, Mumbai:
(a)
(b)
(c)
(d)
(e)
(f)
Any scheduled bank,
Any primary dealer authorised by the RBI,
Any non-banking financial company registered with the
RBI, other than Government companies as defined in
Section 617 of the Companies Act, 1956,
Any mutual fund registered with the SEBI,
Any housing finance company registered with the National
Housing Bank,
Any insurance company registered with the Insurance
Regulatory and Development Authority,

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
(c)
(d)
(g)
(h)
Any non-scheduled Urban Co-operative bank,
Any listed company, having a gilt account with a scheduled
commercial bank, subject to the following conditions:
(1) The minimum period for Reverse Repo (lending of funds) by listed
companies is seven days. However, listed companies can borrow
funds through repo for shorter periods including overnight;
(2) Where the listed company is a 'buyer' of securities in the first leg of
the repo contract (i.e. lender of funds), the custodian through
which the repo transaction is settled should block these securities
in the gilt account and ensure that these securities are not further
sold or re-repoed during the repo period but are held for delivery
under the second leg; and
(3) The counterparty to the listed companies for repo / reverse repo
transactions should be either a bank or a Primary Dealer
maintaining SGL Account with the RBI.
All persons or entities specified at (ii) above can enter into ready forward
transactions among themselves subject to the following restrictions:
i) An SGL account holder may not enter into a ready forward
contract with its own constituent. That is, ready forward contracts
should not be undertaken between a custodian and its gilt account
holder,
ii)
iii)
Any two gilt account holders maintaining their gilt accounts with
the same custodian (i.e., the CSGL account holder) may not enter
into ready forward contracts with each other, and
Cooperative banks may not enter into ready forward contracts with
the non-banking financial companies. This restriction would not
apply to repo transactions between Urban Co-operative banks and
authorised Primary Dealers in Government Securities.
All ready forward contracts shall be reported on the Negotiated Dealing
System (NDS). In respect of ready forward contracts involving gilt account
holders, the custodian (i.e., the CSGL account holder) with whom the gilt
accounts are maintained will be responsible for reporting the deals on the
NDS on behalf of the constituents (i.e. the gilt account holders).
(e) All ready forward contracts shall be settled through the SGL Account /
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(f)
(g)
(h)
(i)
(j)
(k)
369
Annexure – K
CSGL Account maintained with the RBI, Mumbai, with the Clearing
Corporation of India Ltd. (CCIL) acting as the central counter party for all
such ready forward transactions.
The custodians should put in place an effective system of internal control
and concurrent audit to ensure that:
i) ready forward transactions are undertaken only against the clear
balance of securities in the gilt account,
ii)
iii)
all such transactions are promptly reported on the NDS, and
other terms and conditions referred to above have been complied
with.
The RBI regulated entities can undertake ready forward transactions only
in securities held in excess of the prescribed Statutory Liquidity Ratio
(SLR) requirements.
No sale transaction shall be put through, in the first leg of a ready forward
transaction by CSGL constituent entities, without actually holding the
securities in the portfolio.
Securities purchased under the ready forward contracts shall not be sold
during the period of the contract except by entities permitted to undertake
short selling.
Double ready forward deals in any security are strictly prohibited.
The guidelines for uniform accounting for Repo / Reverse Repo
transactions are furnished in paragraph 4.
1.1.2 Transactions through SGL account
The following instructions should be followed by banks for purchase / sale of
securities through SGL A/c, under the Delivery Versus Payment (DvP) System
wherein the transfer of securities takes place simultaneously with the transfer of
funds. It is, therefore, necessary for both the selling bank and the buying bank to
maintain current account with the RBI. As no ‘Overdraft facility’ in the current
account would be extended, adequate balance in current account should be
maintained by banks for effecting any purchase transaction.
i) All transactions in Govt. securities for which SGL facility is available
should be put through SGL A/cs only.
ii)
Under no circumstances, a SGL transfer form issued by a bank in favour

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
iii)
iv)
of another bank should bounce for want of sufficient balance of securities
in the SGL A/c of seller or for want of sufficient balance of funds in the
current a/c of the buyer.
The SGL transfer form received by purchasing banks should be deposited
in their SGL A/cs. immediately i.e. the date of lodgement of the SGL Form
with RBI shall be within one working day after the date of signing of the
Transfer Form. While in cases of OTC trades, the settlement has to be
only on 'spot' delivery basis as per Section 2(i) of the Securities Contracts
(Regulations) Act, 1956, in cases of deals on the recognised Stock
Exchanges; settlement should be within the delivery period as per their
rules, bye laws and regulations. In all cases, participants must indicate the
deal/trade/contract date in Part C of the SGL Form under 'Sale date'.
Where this is not completed the SGL Form will not be accepted by the
RBI.
No sale should be effected by way of return of SGL form held by the bank.
v) SGL transfer forms should be signed by two authorised officials of the
bank whose signatures should be recorded with the respective PDOs of
the RBI and other banks.
vi)
vii)
The SGL transfer forms should be in the standard format prescribed by
the RBI and printed on semi-security paper of uniform size. They should
be serially numbered and there should be a control system in place to
account for each SGL form.
If a SGL transfer form bounces for want of sufficient balance in the SGL
A/c, the (selling) bank which has issued the form will be liable to the
following penal action against it :
a) The amount of the SGL form (cost of purchase paid by the
purchaser of the security) would be debited immediately to the
current account of the selling bank with the RBI.
b) In the event of an overdraft arising in the current account following
such a debit, penal interest would be charged by the RBI, on the
amount of the overdraft, at a rate of 3 percentage points above the
SBI Discount and Finance House of India's (SBIDFHI) call money
lending rate on the day in question. However, if the SBIDFHI's
closing call money rate is lower than the prime lending rate of
banks, as stipulated in the RBI's interest rate directive in force, the
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Annexure – K
applicable penal rate to be charged will be 3 percentage points,
above the prime lending rate of the bank concerned, and
c) If the bouncing of the SGL form occurs thrice, the bank will be
debarred from trading with the use of the SGL facility for a period
of 6 months from the occurrence of the third bouncing. If, after
restoration of the facility, any SGL form of the concerned bank
bounces again, the bank will be permanently debarred from the
use of the SGL facility in all the PDOs of the RBI.
d) The bouncing on account of insufficient balance in the current
account of the buying bank would be reckoned (against the buying
bank concerned) for the purpose of debarment from the use of
SGL facility on par with the bouncing on account of insufficient
balance in SGL a/c. of the selling bank (against selling bank).
Instances of bouncing in both the accounts (i.e SGL a/c and
current a/c) will be reckoned together against the SGL account
holder concerned for the purpose of debarment (i.e three in a halfyear
for temporary suspension and any bouncing after restoration
of SGL facility, for permanent debarment.)
1.1.3 Use of Bank Receipt (BR)
The banks should follow the following instructions for issue of BRs:
a) No BR should be issued under any circumstances in respect of
transactions in Govt. securities for which SGL facility is available.
b) Even in the case of other securities, BR may be issued for ready
transactions only, under the following circumstances:
(i)
(ii)
(iii
The scrips are yet to be issued by the issuer and the bank is
holding the allotment advice.
The security is physically held at a different centre and the bank is
in a position to physically transfer the security and give delivery
thereof within a short period.
The security has been lodged for transfer / interest payment and
the bank is holding necessary records of such lodgements and will
be in a position to give physical delivery of the security within a
short period.
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
c) No BR should be issued on the basis of a BR (of another bank) held by
the bank and no transaction should take place on the basis of a mere
exchange of BRs held by the bank.
d) BRs could be issued covering transactions relating to banks' own
Investments Accounts only, and no BR should be issued by banks
covering transactions relating to either the Accounts of Portfolio
Management Scheme (PMS) Clients or Other Constituents' Accounts,
including brokers.
e) No BR should remain outstanding for more than 15 days.
f) A BR should be redeemed only by actual delivery of scrips and not by
cancellation of the transaction/set off against another transaction. If a BR
is not redeemed by delivery of scrips within the validity period of 15 days,
the BR should be deemed as dishonoured and the bank which has issued
the BR should refer the case to the RBI, explaining the reasons for which
the scrips could not be delivered within the stipulated period and the
proposed manner of settlement of the transaction.
g) BRs should be issued on semi-security paper, in the standard format
(prescribed by IBA), serially numbered and signed by two authorised
officials of the bank, whose signatures are recorded with other banks. As
in the case of SGL forms, there should be a control system in place to
account for each BR form.
h) Separate registers of BRs issued and BRs received should be maintained
and arrangements should be put in place to ensure that these are
systematically followed up and liquidated within the stipulated time limit.
i) The banks should also have a proper system for the custody of unused
B.R. Forms and their utilisation. The existence and operations of these
controls at the concerned offices/ departments of the bank should be
reviewed, among others, by the statutory auditors and a certificate to this
effect may be forwarded every year to the Regional Office of Department
of Banking Supervision (DBS), RBI, under whose jurisdiction the Head
Office of the bank is located.
j) Any violation of the instructions relating to BRs would invite penal action,
which could include raising of reserve requirements, withdrawals of
refinance facility from the RBI and denial of access to money markets.
The RBI may also levy such other penalty as it may deem fit in
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Annexure – K
accordance with the provisions of the Banking Regulation Act, 1949.
1.1.4 Retailing of Government Securities
The banks may undertake retailing of Government securities with non-bank
clients subject to the following conditions:
i) Such retailing should be on outright basis and there is no restriction on
the period between sale and purchase.
ii)
The retailing of Government securities should be on the basis of ongoing
market rates/ yield curve emerging out of secondary market transactions.
1.1.5 Internal Control System
The banks should observe the following guidelines for internal control system in
respect of investment transactions:
(a)
(b)
(c)
There should be a clear functional separation of (i) trading, (ii) settlement,
monitoring and control and (iii) accounting. Similarly, there should be a
functional separation of trading and back office functions relating to banks'
own Investment Accounts, Portfolio Management Scheme (PMS) Clients'
Accounts and other Constituents (including brokers') accounts. The
Portfolio Management service may be provided to clients, subject to
strictly following the guidelines in regard thereto (covered in paragraph
1.3.3). Further, PMS Clients Accounts should be subjected to a separate
audit by external auditors.
For every transaction entered into, the trading desk should prepare a deal
slip which should contain data relating to nature of the deal, name of the
counter-party, whether it is a direct deal or through a broker, and if
through a broker, name of the broker, details of security, amount, price,
contract date and time. The deal slips should be serially numbered and
controlled separately to ensure that each deal slip has been properly
accounted for. Once the deal is concluded, the dealer should immediately
pass on the deal slip to the back office for recording and processing. For
each deal there must be a system of issue of confirmation to the
counterparty. The timely receipt of requisite written confirmation from the
counterparty, which must include all essential details of the contract,
should be monitored by the back office.
With respect to transactions matched on the NDS-OM module, since
CCIL is the central counterparty to all deals, exposure of any counterparty
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
(d)
(e)
(f)
for a trade is only to CCIL and not to the entity with whom a deal matches.
Besides, details of all deals on NDS-OM are available to the
counterparties as and when required by way of reports on NDS-OM itself.
In view of the above, the need for counterparty confirmation of deals
matched on NDS-OM does not arise. However, all government securities
transactions, other than those matched on NDS-OM, will continue to be
physically confirmed by the back offices of the counterparties, as hitherto.
Once a deal has been concluded, there should not be any substitution of
the counter party bank by another bank by the broker, through whom the
deal has been entered into; likewise, the security sold/purchased in the
deal should not be substituted by another security.
On the basis of vouchers passed by the back office (which should be
done after verification of actual contract notes received from the broker/
counterparty and confirmation of the deal by the counterparty), the
Accounts Section should independently write the books of account.
In the case of transaction relating to PMS Clients' Accounts (including
brokers), all the relative records should give a clear indication that the
transaction belongs to PMS Clients/ other constituents and does not
belong to bank's own Investment Account and the bank is acting only in
its fiduciary/ agency capacity.
(g) (i) Records of SGL transfer forms issued/ received, should be
maintained.
(ii)
(iii)
(iv)
(v)
Balances as per bank's books should be reconciled at quarterly
intervals with the balances in the books of PDOs. If the number of
transactions so warrant, the reconciliation should be undertaken
more frequently, say on a monthly basis. This reconciliation should
be periodically checked by the internal audit department.
Any bouncing of SGL transfer forms issued by selling banks in
favour of the buying bank, should immediately be brought to the
notice of the Regional Office of Department of Banking
Supervision of RBI by the buying bank.
A record of BRs issued/ received should be maintained.
A system for verification of the authenticity of the BRs and SGL
transfer forms received from the other banks and confirmation of
authorised signatories should be put in place.
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Annexure – K
(h)
(i)
(j)
(k)
(l)
(m)
(n)
Banks should put in place a reporting system to report to the top
management, on a weekly basis, the details of transactions in securities,
details of bouncing of SGL transfer forms issued by other banks and BRs
outstanding for more than one month and a review of investment
transactions undertaken during the period.
Banks should not draw cheques on their account with the RBI for third
party transactions, including inter-bank transactions. For such
transactions, bankers' cheques/ pay orders should be issued.
In case of investment in shares, the surveillance and monitoring of
investment should be done by the Audit Committee of the Board, which
shall review in each of its meetings, the total exposure of the bank to
capital market both fund based and non- fund based, in different forms as
stated above and ensure that the guidelines issued by RBI are complied
with and adequate risk management and internal control systems are in
place;
The Audit Committee should keep the Board informed about the overall
exposure to capital market, the compliance with the RBI and Board
guidelines, adequacy of risk management and internal control systems;
In order to avoid any possible conflict of interest, it should be ensured that
the stockbrokers as directors on the Boards of banks or in any other
capacity, do not involve themselves in any manner with the Investment
Committee or in the decisions in regard to making investments in shares,
etc., or advances against shares.
The internal audit department should audit the transactions in securities
on an on going basis, monitor the compliance with the laid down
management policies and prescribed procedures and report the
deficiencies directly to the management of the bank.
The banks' managements should ensure that there are adequate internal
control and audit procedures for ensuring proper compliance of the
instructions in regard to the conduct of the investment portfolio. The banks
should institute a regular system of monitoring compliance with the
prudential and other guidelines issued by the RBI. The banks should get
compliance in key areas certified by their statutory auditors and furnish
such audit certificate to the Regional Office of DBS, RBI under whose
jurisdiction the HO of the bank falls.
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
1.1.6 Engagement of brokers
i) For engagement of brokers to deal in investment transactions, the banks
should observe the following guidelines:
(a)
(b)
(c)
(d)
(e)
(f)
Transactions between one bank and another bank should not be
put through the brokers' accounts. The brokerage on the deal
payable to the broker, if any (if the deal was put through with the
help of a broker), should be clearly indicated on the
notes/memorandum put up to the top management seeking
approval for putting through the transaction and separate account
of brokerage paid, broker-wise, should be maintained.
If a deal is put through with the help of a broker, the role of the
broker should be restricted to that of bringing the two parties to the
deal together.
While negotiating the deal, the broker is not obliged to disclose the
identity of the counterparty to the deal. On conclusion of the deal,
he should disclose the counterparty and his contract note should
clearly indicate the name of the counterparty. It should also be
ensured by the bank that the broker note contains the exact time
of the deal. Their back offices may ensure that the deal time on the
broker note and the deal ticket is the same. The bank should also
ensure that their concurrent auditors audit this aspect.
On the basis of the contract note disclosing the name of the
counterparty, settlement of deals between banks, viz. both fund
settlement and delivery of security should be directly between the
banks and the broker should have no role to play in the process.
With the approval of their top managements, banks should prepare
a panel of approved brokers which should be reviewed annually or
more often if so warranted. Clear-cut criteria should be laid down
for empanelment of brokers, including verification of their
creditworthiness, market reputation, etc. A record of broker-wise
details of deals put through and brokerage paid, should be
maintained.
A disproportionate part of the business should not be transacted
through only one or a few brokers. Banks should fix aggregate
contract limits for each of the approved brokers. A limit of 5% of
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ii)
(g)
Exceptions:
Annexure – K
total transactions (both purchase and sales) entered into by a bank
during a year should be treated as the aggregate upper contract
limit for each of the approved brokers. This limit should cover both
the business initiated by a bank and the business offered/ brought
to the bank by a broker. Banks should ensure that the transactions
entered into through individual brokers during a year normally do
not exceed this limit. However, if for any reason it becomes
necessary to exceed the aggregate limit for any broker, the
specific reasons therefor should be recorded, in writing, by the
authority empowered to put through the deals. Further, the board
should be informed of this, post facto. However, the norm of 5%
would not be applicable to banks' dealings through Primary
Dealers.
The concurrent auditors who audit the treasury operations should
scrutinise the business done through brokers also and include it in
their monthly report to the Chief Executive Officer of the bank.
Besides, the business put through any individual broker or brokers
in excess of the limit, with the reasons therefor, should be covered
in the half- yearly review to the Board of Directors/ Local Advisory
Board. These instructions also apply to subsidiaries and mutual
funds of the banks. [Certain clarifications on the instructions are
furnished in the Annexure II.]
Inter-bank securities transactions should be undertaken directly between
banks and no bank should engage the services of any broker in such
transactions.
Note (i) Banks may undertake securities transactions among themselves or with
non- bank clients through members of the National Stock Exchange (NSE), OTC
Exchange of India (OTCEI) and the Stock Exchange, Mumbai (BSE). If such
transactions are not undertaken on the NSE, OTCEI or BSE, the same should be
undertaken by banks directly, without engaging brokers.
Note (ii) Although the Securities Contracts (Regulation) Act, 1956 defines the
term `securities' to mean corporate shares, debentures, Govt. securities and
rights or interest in securities, the term `securities' would exclude corporate
shares. The Provident / Pension Funds and Trusts registered under the Indian
Trusts Act, 1882, will be outside the purview of the expression `non-bank clients'
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
for the purpose of note (i) above.
1.1.7 Audit, review and reporting of investment transactions
The banks should follow the following instructions in regard to audit, review and
reporting of investment transactions:
a) Banks should undertake a half-yearly review (as of 30 September and 31
March) of their investment portfolio, which should, apart from other
operational aspects of investment portfolio, clearly indicate amendments
made to the Investment Policy and certify adherence to laid down internal
investment policy and procedures and RBI guidelines, and put up the
same before their respective Boards within a month, i.e by end-April and
end-October.
b) A copy of the review report put up to the Bank's Board, should be
forwarded to the RBI (concerned Regional Office of DBS, RBI) by 15 May
and 15 November respectively.
c) In view of the possibility of abuse, treasury transactions should be
separately subjected to concurrent audit by internal auditors and the
results of their audit should be placed before the CMD of the bank once
every month. Banks need not forward copies of the above mentioned
concurrent audit reports to RBI of India. However, the major irregularities
observed in these reports and the position of compliance thereto may be
incorporated in the half yearly review of the investment portfolio.
1.2 Non- SLR investments
1.2.1
(i)
Appraisal
Banks have made significant investment in privately placed unrated bonds and,
in certain cases, in bonds issued by corporates who are not their borrowers.
While assessing such investment proposals on private placement basis, in the
absence of standardised and mandated disclosures, including credit rating,
banks may not be in a position to conduct proper due diligence to take an
investment decision. Thus, there could be deficiencies in the appraisal of
privately placed issues.
(ii)
Disclosure requirements in offer documents
The risk arising from inadequate disclosure in offer documents should be
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Annexure – K
recognised and banks should prescribe minimum disclosure standards as a
policy with Board approval. In this connection, RBI had constituted a <strong>Technical</strong>
Group comprising officials drawn from treasury departments of a few banks and
experts on corporate finance to study, inter alia, the methods of acquiring, by
banks, of non-SLR investments in general and private placement route, in
particular, and to suggest measures for regulating these investments. The Group
had designed a format containing the minimum disclosure requirements as well
as certain conditionalities regarding documentation and creation of charge for
private placement issues, which may serve as a 'best practice model' for the
banks. The details of the Group’s recommendations are given in the Annexure III
and banks should have a suitable format of disclosure requirements on the lines
of the recommendations of the <strong>Technical</strong> Group with the approval of their Board.
(iii)
Internal assessment With a view to ensuring that the investments by
banks in issues through private placement, both of the borrower
customers and non-borrower customers, do not give rise to systemic
concerns, it is necessary that banks should ensure that their investment
policies duly approved by the Board of Directors are formulated after
taking into account the following aspects:
(a)
(b)
(c)
(d)
The Boards of banks should lay down policy and prudential limits
on investments in bonds and debentures including cap and on
private placement basis, sub limits for PSU bonds, corporate
bonds, guaranteed bonds, issuer ceiling, etc.
Investment proposals should be subjected to the same degree of
credit risk analysis as any loan proposal. Banks should make their
own internal credit analysis and rating even in respect of rated
issues and should not entirely rely on the ratings of external
agencies. The appraisal should be more stringent in respect of
investments in instruments issued by non-borrower customers.
Strengthen their internal rating systems which should also include
building up of a system of regular (quarterly or half-yearly) tracking
of the financial position of the issuer with a view to ensuring
continuous monitoring of the rating migration of the issuers/issues.
As a matter of prudence, banks should stipulate entry-level
minimum ratings/ quality standards and industry-wise, maturitywise,
duration-wise, issuer-wise etc. limits to mitigate the adverse
impacts of concentration and the risk of illiquidity.
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
(iv)
(e)
The banks should put in place proper risk management systems
for capturing and analysing the risk in respect of these investments
and taking remedial measures in time.
Some banks / FIs have not exercised due precaution by reference to the
list of defaulters circulated / published by RBI while investing in bonds,
debentures, etc., of companies. Banks may, therefore, exercise due
caution, while taking any investment decision to subscribe to bonds,
debentures, shares etc., and refer to the ‘Defaulters List’ to ensure that
investments are not made in companies / entities who are defaulters to
banks / FIs. Some of the companies may be undergoing adverse financial
position, turning their accounts to sub- standard category due to recession
in their industry segment, like textiles. Despite restructuring facility
provided under RBI guidelines, the banks have been reported to be
reluctant to extend further finance, though considered warranted on merits
of the case. Banks may not refuse proposals for such investments in
companies whose director’s name(s) find place in the ‘Defaulter
Companies List’ circulated by RBI, at periodical intervals and particularly
in respect of those loan accounts, which have been restructured under
extant RBI guidelines, provided the proposal is viable and satisfies all
parameters for such credit extension.
Prudential guidelines on investment in Non-SLR securities
1.2.2 Coverage
These guidelines cover banks’ investments in non-SLR securities issued by
corporates, banks, FIs and State and Central Government sponsored institutions,
SPVs etc, including, capital gains bonds, bonds eligible for priority sector status.
The guidelines will apply to investments both in the primary market as well as the
secondary market.
1.2.3 The guidelines on listing and rating pertaining to non-SLR securities vide
paragraphs 1.2.7 to 1.2.16 are not applicable to banks’ investments in:
(a)
(b)
(c)
Securities directly issued by the Central and State Governments, which
are not reckoned for SLR purposes.
Equity shares
Units of equity oriented mutual fund schemes, viz. those schemes where
any part of the corpus can be invested in equity
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(d)
(e)
(f)
Equity/debt instruments/Units issued by Venture capital funds
Commercial Paper
Certificates of Deposit
Annexure – K
1.2.4 Definitions of a few terms used in these guidelines have been furnished in
Annexure IV with a view to ensure uniformity in approach while
implementing the guidelines.
Regulatory requirements
1.2.5 Banks should not invest in Non-SLR securities of original maturity of less
than one-year, other than Commercial Paper and Certificates of Deposits,
which are covered under RBI guidelines.
1.2.6 Banks should undertake usual due diligence in respect of investments in
non- SLR securities. Present RBI regulations preclude banks from
extending credit facilities for certain purposes. Banks should ensure that
such activities are not financed by way of funds raised through the non-
SLR securities.
Listing and rating requirements
1.2.7 Banks must not invest in unrated non-SLR securities. However, the banks
may invest in unrated bonds of companies engaged in infrastructure
activities, within the ceiling of 10 per cent for unlisted non-SLR securities
as prescribed vide paragraph 1.2.10 below.
1.2.8 The Securities Exchange Board of India (SEBI) vide their circular dated
September 30, 2003(amended vide circular dated May 11, 2009) have
stipulated requirements that listed companies are required to comply with,
for making issue of debt securities on a private placement basis and listed
on a stock exchange. According to this circular, any listed company,
making issue of debt securities on a private placement basis and listed on
a stock exchange, has to make full disclosures (initial and continuing) in
the manner prescribed in Schedule II of the Companies Act 1956, SEBI
(Disclosure and Investor Protection) <strong>Guide</strong>lines, 2000 and the Listing
Agreement with the exchanges. Furthermore, the debt securities shall
carry a credit rating of not less than investment grade from a Credit Rating
Agency registered with the SEBI.
1.2.9 Accordingly, while making fresh investments in non-SLR debt securities,
banks should ensure that such investment are made only in listed debt
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securities of companies which comply with the requirements of the SEBI
circular dated September 30, 2003(amended vide circular dated May 11,
2009), except to the extent indicated in paragraph 1.2.10 and 1.2.11
below.
Fixing of prudential limits
1.2.10 Bank’s investment in unlisted non-SLR securities should not exceed 10
per cent of its total investment in non-SLR securities as on March 31, of the
previous year, and such investment should comply with the disclosure
requirements as prescribed by the SEBI for listed companies.
1.2.11 Bank’s investment in unlisted non-SLR securities may exceed the limit of
10 per cent, by an additional 10 per cent, provided the investment is on account
of investment in securitisation papers issued for infrastructure projects, and
bonds/debentures issued by Securitisation Companies (SCs) and Reconstruction
Companies (RCs) set up under the Securitisation and Reconstruction of
Financial Assets and Enforcement of Security Interest Act, 2002 (SARFEASI Act)
and registered with RBI. In other words, investments exclusively in securities
specified in this paragraph could be up to the maximum permitted limit of 20 per
cent of non-SLR investment.
1.2.12 Investment in the following will not be reckoned as ‘unlisted non-SLR
securities’ for computing compliance with the prudential limits prescribed in the
above guidelines:
(i)
(ii)
(iii)
Security Receipts issued by SCs / RCs registered with RBI.
Investment in Asset Backed Securities (ABS) and Mortgage Backed
Securities (MBS), which are rated at or above the minimum investment
grade. However, there will be close monitoring of exposures to ABS on a
bank specific basis based on monthly reports to be submitted to RBI as
per proforma being separately advised by the Department of Banking
Supervision.
Investments in unlisted convertible debentures. However, investments in
these instruments would be treated as “Capital Market Exposure”.
1.2.13 The investments in RIDF / SIDBI Deposits may not be reckoned as part of
the numerator as well as denominator for computing compliance with the
prudential limit of 10 per cent of its total non-SLR securities as on March
31, of the previous year.
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1.2.14 With effect from January 1, 2005, only investment in units of such mutual
fund schemes, which have an exposure to unlisted securities of less than
10 per cent of the corpus of the fund, will be treated on par with listed
securities for the purpose of compliance with the prudential limits
prescribed in the above guidelines. While computing the exposure to the
unlisted securities for compliance with the norm of less than 10 percent of
the corpus of the mutual fund scheme, Treasury Bills, Collateralised
Borrowing and Lending Obligations (CBLO), Repo/Reverse Repo and
Bank Fixed Deposits may not be included in the numerator.
1.2.15 For the purpose of the prudential limits prescribed in the guidelines, the
denominator viz., 'non-SLR investments', would include investment under
the following four categories in Schedule 8 to the balance sheet viz.,
'shares', 'bonds & debentures', 'subsidiaries/joint ventures' and 'others'.
1.2.16 Banks whose investment in unlisted non-SLR securities are within the
prudential limit of 10 per cent of its total non-SLR securities as on March
31, of the previous year may make fresh investment in such securities
and up to the prudential limits.
Role of Boards
1.2.17 Banks should ensure that their investment policies duly approved by the
Board of Directors are formulated after taking into account all the relevant
issues specified in these guidelines on investment in non-SLR securities.
Banks should put in place proper risk management systems for capturing
and analysing the risk in respect of non-SLR investment and taking
remedial measures in time. Banks should also put in place appropriate
systems to ensure that investment in privately placed instruments is made
in accordance with the systems and procedures prescribed under
respective bank’s investment policy.
1.2.18 Boards of banks should review the following aspects of non-SLR
investment at least at quarterly intervals:
a) Total business (investment and divestment) during the reporting
period.
b) Compliance with the prudential limits prescribed by the Board for
non-SLR investment.
c) Compliance with the prudential guidelines issued by RBI on non-
SLR securities.

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
Disclosures
d) Rating migration of the issuers/ issues held in the bank’s books
and consequent diminution in the portfolio quality.
e) Extent of non-performing investments in the non-SLR category.
1.2.19 In order to help in the creation of a central database on private placement
of debt, a copy of all offer documents should be filed with the Credit
Information Bureau (India) Ltd. (CIBIL) by the investing banks. Further,
any default relating to interest/ instalment in respect of any privately
placed debt should also be reported to CIBIL by the investing banks along
with a copy of the offer document.
1.2.20 Banks should disclose the details of the issuer composition of non-SLR
investments and the non-performing non-SLR investments in the ‘Notes
on Accounts’ of the balance sheet, as indicated in Annexure V.
Trading and settlement in debt securities
1.2.21 As per the SEBI guidelines, all trades with the exception of the spot
transactions, in a listed debt security, shall be executed only on the
trading platform of a stock exchange. In addition to complying with the
SEBI guidelines, banks should ensure that all spot transactions in listed
and unlisted debt securities are reported on the NDS and settled through
the CCIL from a date to be notified by RBI.
1.2.22 Limits on Banks' Exposure to Capital Markets
A. Solo Basis
The aggregate exposure of a bank to the capital markets in all forms (both fund
based and non- fund based) should not exceed 40 per cent of its net worth as on
March 31 of the previous year. Within this overall ceiling, the bank’s direct
investment in shares, convertible bonds / debentures, units of equity-oriented
mutual funds and all exposures to Venture Capital Funds (VCFs) [both registered
and unregistered] should not exceed 20 per cent of its net worth.
B. Consolidated Basis
The aggregate exposure of a consolidated bank to capital markets (both fund
based and non- fund based) should not exceed 40 per cent of its consolidated
net worth as on March 31 of the previous year. Within this overall ceiling, the
aggregate direct exposure by way of the consolidated bank’s investment in
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Annexure – K
shares, convertible bonds / debentures, units of equity- oriented mutual funds
and all exposures to Venture Capital Funds (VCFs) [both registered and
unregistered] should not exceed 20 per cent of its consolidated net worth.
The above-mentioned ceilings are the maximum permissible and a bank’s Board
of Directors is free to adopt a lower ceiling for the bank, keeping in view its
overall risk profile and corporate strategy. Banks are required to adhere to the
ceilings on an ongoing basis.
1.3 General
1.3.1 Reconciliation of holdings of Govt. securities – Audit Certificate
Banks should furnish a ‘Statement of the Reconciliation of Bank's Investments
(held in own Investment account, as also under PMS)’, as at the end of every
accounting year duly certified by the bank's auditors. The statement should reach
the Regional Office of the DBS, RBI, under whose jurisdiction the bank’s head
office is located within one month from the close of the accounting year. Banks in
the letters of appointment, issued to their external auditors, may suitably include
the aforementioned requirement of reconciliation. The format for the statement
and the instructions for compiling thereto are given in Annexure VI.
1.3.2 Transactions in securities - Custodial functions
While exercising the custodial functions on behalf of their merchant banking
subsidiaries, these functions should be subject to the same procedures and
safeguards as would be applicable to other constituents. Accordingly, full
particulars should be available with the subsidiaries of banks of the manner in
which the transactions have been executed. Banks should also issue suitable
instructions in this regard to the department/office undertaking the custodial
functions on behalf of their subsidiaries.
1.3.3 Portfolio Management on behalf of clients
i) The general powers vested in banks to operate PMS and similar schemes
have been withdrawn. No bank should, therefore, restart or introduce any
new PMS or similar scheme in future without obtaining specific prior
approval of the RBI. However, bank-sponsored NBFCs are allowed to
offer discretionary PMS to their clients, on a case-to-case basis.
Applications in this regard should be submitted to the Department of
Banking Operations and Development (DBOD), RBI, World Trade Centre,
Mumbai – 400 005.
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
ii)
iii)
iv)
The following conditions are to be strictly observed by the banks operating
PMS or similar scheme with the specific prior approval of RBI:
(a)
(b)
(c)
(d)
(e)
(f)
PMS should be entirely at the customer's risk, without
guaranteeing, either directly or indirectly, a pre-determined return.
Funds should not be accepted for portfolio management for a
period less than one year.
Portfolio funds should not be deployed for lending in call/notice
money; inter- bank term deposits and bills rediscounting markets
and lending to/placement with corporate bodies.
Banks should maintain client wise account/record of funds
accepted for management and investments made there against
and the portfolio clients should be entitled to get a statement of
account.
Bank's own investments and investments belonging to PMS clients
should be kept distinct from each other, and any transactions
between the bank's investment account and client's portfolio
account should be strictly at market rates.
There should be a clear functional separation of trading and back
office functions relating to banks’ own investment accounts and
PMS clients' accounts.
PMS clients' accounts should be subjected by banks to a separate audit
by external auditors as covered in paragraph 1.1.5 (a).
Banks should note that violation of RBI instructions will be viewed
seriously and will invite deterrent action against the banks, which will
include raising of reserve requirements, withdrawal of facility of refinance
from the RBI and denial of access to money markets, apart from
prohibition from undertaking PMS activity.
v) Further, the aforesaid instructions will apply, mutatis mutandis, to the
subsidiaries of banks except where they are contrary to specific
regulations of the RBI or SEBI, governing their operations.
vi)
Banks / merchant banking subsidiaries of banks operating PMS or similar
scheme with the specific prior approval of the RBI are also required to
comply with the guidelines contained in the SEBI (Portfolio Managers)
Rules and Regulations, 1993 and those issued from time to time.
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Annexure – K
1.3.4 Investment Portfolio of bank - transactions in Government Securities
In the light of fraudulent transactions in the guise of Government securities,
transactions in physical format by a few co-operative banks with the help of some
broker entities, it has been decided to accelerate the measures for further
reducing the scope of trading in physical forms. These measures are as under:
(i)
(ii)
(iii)
(iv)
(v)
For banks, which do not have SGL account with RBI, only one gilt account
can be opened.
In case the gilt accounts are opened with a scheduled commercial bank,
the account holder has to open a designated funds account (for all gilt
account related transactions) with the same bank.
The entities maintaining the gilt / designated funds accounts will be
required to ensure availability of clear funds in the designated funds
accounts for purchases and of sufficient securities in the gilt account for
sales before putting through the transactions.
No transactions by the bank should be undertaken in physical form with
any broker.
Banks should ensure that brokers approved for transacting in Government
securities are registered with the debt market segment of
NSE/BSE/OTCEI.
2. Classification
i) The entire investment portfolio of the banks (including SLR securities and
non-SLR securities) should be classified under three categories
viz. ‘Held to Maturity’,
‘Available for Sale’ and
‘Held for Trading’.
• However, in the balance sheet, the investments will continue to be
disclosed as per the existing six classifications:
viz. a)
Government securities,
b) Other approved securities, c) Shares,
d) Debentures & Bonds,
e) Subsidiaries/ joint ventures and
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
ii)
f) Others (CP, Mutual Fund Units, etc.).
Banks should decide the category of the investment at the time of
acquisition and the decision should be recorded on the investment
proposals.
2.1 Held to Maturity
i) The securities acquired by the banks with the intention to hold them up to
maturity will be classified under ‘Held to Maturity (HTM)’.
ii)
iii)
Banks are allowed to include investments included under HTM category
upto 25 per cent of their total investments.
The following investments are required to be classified under HTM but are
not accounted for the purpose of ceiling of 25 per cent specified for this
category:
(a)
(b)
(c)
Re-capitalisation bonds received from the Government of India
towards their re- capitalisation requirement and held in their
investment portfolio. This will not include re-capitalisation bonds of
other banks acquired for investment purposes.
Investment in subsidiaries and joint ventures (A Joint Venture
would be one in which the bank, along with its subsidiaries, holds
more than 25 percent of the equity).
The investments in debentures/bonds, which are deemed to be in
the nature of advance. [Refer sub-paragraph (vii) below]
Banks are, however, allowed since September 2, 2004 to exceed the limit
of 25 percent of total investment under HTM category provided:
(a)
the excess comprises only of SLR securities, and
(b) the total SLR securities held in the HTM is not more than 25
percent of their DTL as on the last Friday of the second preceding
fortnight.
iv) The non-SLR securities, held as part of HTM as on September 2, 2004
may remain in that category. No fresh non-SLR securities, are permitted
to be included in HTM, except the following:
(a)
Fresh re-capitalisation bonds, received from the Government of
India, towards their re-capitalisation requirement and held in their
investment portfolio. This will not include re-capitalisation bonds of
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(b)
(c)
other banks acquired for investment purposes.
Annexure – K
Fresh investment in the equity of subsidiaries and joint ventures.
RIDF / SIDBI deposits
v) To sum up, banks may hold the following securities under HTM:
(vi)
(vii)
(a)
SLR Securities upto 25 percent of their DTL as on the last Friday
of the second preceding fortnight.
(b) Non-SLR securities included under HTM as on September 2,
2004.
(c)
(d)
(e)
Fresh re-capitalisation bonds received from the Government of
India towards their re-capitalisation requirement and held in
Investment portfolio.
Fresh investment in the equity of subsidiaries and joint ventures
IDF/SIDBI deposits.
Profit on sale of investments in this category should be first taken to the
Profit & Loss Account, and thereafter be appropriated to the ‘Capital
Reserve Account’. Loss on sale will be recognised in the Profit & Loss
Account.
The debentures/ bonds must be treated in the nature of an advance
when:
• The debenture/bond is issued as part of the proposal for project finance
and the tenure of the debenture is for a period of three years and above
Or
The debenture/bond is issued as part of the proposal for working capital
finance and the tenure of the debenture/ bond is less than a period of one
year
And
• the bank has a significant stake i.e.10% or more in the issue
And
• the issue is part of a private placement, i.e. the borrower has approached
the bank/FI and not part of a public issue where the bank/FI has
subscribed in response to an invitation.
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
Since, no fresh non-SLR securities are permitted to be included in the HTM,
these investments should not be held under HTM category and they should be
subjected to mark- to-market discipline. They would be subjected to prudential
norms for identification of non-performing investment and provisioning as
applicable to investments.
2.2 Available for Sale & Held for Trading
i) The securities acquired by the banks with the intention to trade by taking
advantage of the short-term price/interest rate movements will be
classified under ‘Held for Trading (HFT)’.
ii)
iii)
iv)
The securities which do not fall within the above two categories will be
classified under ‘Available for Sale (AFS)’.
The banks will have the freedom to decide on the extent of holdings under
HFT and AFS. This will be decided by them after considering various
aspects such as basis of intent, trading strategies, risk management
capabilities, tax planning, manpower skills, capital position.
The investments classified under HFT would be those from which the
bank expects to make a gain by the movement in the interest rates/market
rates. These securities are to be sold within 90 days.
v) Profit or loss on sale of investments in both the categories will be taken to
the Profit & Loss Account.
2.3 Shifting among categories
i) Banks may shift investments to/from HTM with the approval of the Board
of Directors once a year. Such shifting will normally be allowed at the
beginning of the accounting year. No further shifting to/from HTM will be
allowed during the remaining part of that accounting year.
ii)
iii)
Banks may shift investments from AFS to HFT with the approval of their
Board of Directors/ ALCO/ Investment Committee. In case of exigencies,
such shifting may be done with the approval of the Chief Executive of the
bank/Head of the ALCO, but should be ratified by the Board of Directors/
ALCO.
Shifting of investments from HFT to AFS is generally not allowed.
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Annexure – K
However, it will be permitted only under exceptional circumstances like not being
able to sell the security within 90 days due to tight liquidity conditions, or extreme
volatility, or market becoming unidirectional. Such transfer is permitted only with
the approval of the Board of Directors/ ALCO/ Investment Committee.
iv) Transfer of scrips from one category to another, under all circumstances,
should be done at the acquisition cost/ book value/ market value on the date of
transfer, whichever is the least, and the depreciation, if any, on such transfer
should be fully provided for. Banks may apply the values as on the date of
transfer and in case, there are practical difficulties in applying the values as on
the date of transfer, banks have the option of applying the values as on the
previous working day, for arriving at the depreciation requirement on shifting of
securities.
3. Valuation
3.1 Held to Maturity
i) Investments classified under HTM need not be marked to market and will
be carried at acquisition cost, unless it is more than the face value, in
which case the premium should be amortised over the period remaining to
maturity. The banks should reflect the amortised amount in ‘Schedule 13
– Interest Earned : Item II – Income on Investments’, as a deduction.
However, the deduction need not be disclosed separately. The book value
of the security should continue to be reduced to the extent of the amount
amortised during the relevant accounting period.
ii)
Banks should recognise any diminution, other than temporary, in the
value of their investments in subsidiaries/ joint ventures, which are
included under HTM and provide therefore. Such diminution should be
determined and provided for each investment individually.
3.2 Available for Sale
The individual scrips in the Available for Sale category will be marked to market
at quarterly or at more frequent intervals. Domestic Securities under this category
shall be valued scrip-wise and depreciation/ appreciation shall be aggregated for
each classification referred to in item 2(i) above and foreign investments under
this category shall be valued scrip-wise and depreciation/ appreciation shall be
aggregated for five classifications (viz. Government securities (including local
authorities), Shares, Debentures & Bonds, Subsidiaries and/or joint ventures
abroad and Other investments (to be specified)). Further, the investment in a
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
particular classification, both in domestic and foreign securities, may be
aggregated for the purpose of arriving at net depreciation/appreciation of
investments under that category.Net depreciation, if any, shall be provided for.
Net appreciation, if any, should be ignored. Net depreciation required to be
provided for in any one classification should not be reduced on account of net
appreciation in any other classification. The banks may continue to report the
foreign securities under three categories (Government securities (including local
authorities), Subsidiaries and/or joint ventures abroad and Other investments (to
be specified)) in the balance sheet. The book value of the individual securities
would not undergo any change after the marking of market.
3.3 Held for Trading
The individual scrips in the Held for Trading category will be marked to market at
monthly or at more frequent intervals and provided for as in the case of those in
the Available for Sale category. Consequently, the book value of the individual
securities in this category would also not undergo any change after marking to
market.
3.4 Investment Fluctuation Reserve
(i)
(ii)
(iii)
With a view to building up of adequate reserves to guard against any
possible reversal of interest rate environment in future due to unexpected
developments, banks were advised to build up Investment Fluctuation
Reserve (IFR) of a minimum 5 per cent of the investment portfolio within a
period of 5 years.
To ensure smooth transition to Basel II norms, banks were advised in
June 24, 2004 to maintain capital charge for market risk in a phased
manner over a two year period, as under:
(a)
In respect of securities included in the HFT category, open gold
position limit, open foreign exchange position limit, trading
positions in derivatives and derivatives entered into for hedging
trading book exposures by March 31, 2005, and
(b) In respect of securities included in the AFS category by March 31,
2006.
With a view to encourage banks for early compliance with the guidelines
for maintenance of capital charge for market risks, it was advised in April
2005 that banks which have maintained capital of at least 9 per cent of
the risk weighted assets for both credit risk and market risks for both HFT
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(iv)
Annexure – K
(items as indicated at (a) above) and AFS category may treat the balance
in excess of 5 per cent of securities included under HFT and AFS
categories, in the IFR, as Tier I capital. Banks satisfying the above were
allowed to transfer the amount in excess of the said 5 per cent in the IFR
to Statutory Reserve.
Banks were advised in October 2005 that, if they have maintained capital
of at least 9 per cent of the risk weighted assets for both credit risk and
market risks for both HFT (items as indicated at (a) above) and AFS
category as on March 31, 2006, they would be permitted to treat the entire
balance in the IFR as Tier I capital. For this purpose, banks may transfer
the balance in the Investment Fluctuation Reserve ‘below the line’ in the
Profit and Loss Appropriation Account to Statutory Reserve, General
Reserve or balance of Profit & Loss Account.
Investment Reserve Account (IRA)
(v)
(vi)
In the event, provisions created on account of depreciation in the ‘AFS’ or
‘HFT’ categories are found to be in excess of the required amount in any
year, the excess should be credited to the Profit & Loss account and an
equivalent amount (net of taxes, if any and net of transfer to Statutory
Reserves as applicable to such excess provision) should be appropriated
to an IRA Account in Schedule 2 – “Reserves & Surplus” under the head
“Revenue and other Reserves”, and would be eligible for inclusion under
Tier-II within the overall ceiling of 1.25 per cent of total Risk Weighted
Assets prescribed for General Provisions/ Loss Reserves.
Banks may utilise IRA as follows:
The provisions required to be created on account of depreciation in the
AFS and HFT categories should be debited to the P&L Account and an
equivalent amount (net of tax benefit, if any, and net of consequent
reduction in the transfer to Statutory Reserve), may be transferred from
the IRA to the P&L Account. Illustratively, banks may draw down from the
IRA to the extent of provision made during the year towards depreciation
in investment in AFS and HFT categories (net of taxes, if any, and net of
transfer to Statutory Reserves as applicable to such excess provision). In
other words, a bank which pays a tax of 30% and should appropriate 25%
of the net profits to Statutory Reserves, can draw down Rs.52.50 from the
IRA, if the provision made for depreciation in investments included in the
AFS and HFT categories is Rs.100.
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
(vii)
(viii)
The amounts debited to the P&L Account for provision should be debited
under the head ‘Expenditure - Provisions & Contingencies’. The amount
transferred from the IRA to the P&L Account, should be shown as ‘below
the line’ item in the Profit and Loss Appropriation Account, after
determining the profit for the year. Provision towards any erosion in the
value of an asset is an item of charge on the profit and loss account, and
hence should appear in that account before arriving at the profit for the
accounting period. Adoption of the following would not only be adoption of
a wrong accounting principle but would, also result in a wrong statement
of the profit for the accounting period:
(a)
(b)
(c)
the provision is allowed to be adjusted directly against an item of
Reserve without being shown in the profit and loss account, OR
a bank is allowed to draw down from the IRA before arriving at the
profit for the accounting period (i.e., above the line), OR
a bank is allowed to make provisions for depreciation on
investment as a below the line item, after arriving at the profit for
the period,
Hence none of the above options are permissible.
In terms of our guidelines on payment of dividend by banks, dividends
should be payable only out of current year's profit. The amount drawn
down from the IRA will, therefore, not be available to a bank for payment
of dividend among the shareholders. However, the balance in the IRA
transferred ‘below the line’ in the Profit and Loss Appropriation Account to
Statutory Reserve, General Reserve or balance of Profit & Loss Account
would be eligible to be reckoned as Tier I capital.
3.5 Market value
The ‘market value’ for the purpose of periodical valuation of investments included
in the AFS and HFT would be the market price of the scrip as available from the
trades/ quotes on the stock exchanges, SGL account transactions, price list of
RBI, prices declared by Primary Dealers Association of India (PDAI) jointly with
the Fixed Income Money Market and Derivatives Association of India (FIMMDA)
periodically. In respect of unquoted securities, the procedure as detailed below
should be adopted.
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3.6 Unquoted SLR securities
3.6.1 Central Government Securities
Annexure – K
i) Banks should value the unquoted Central Government securities on the
basis of the prices/ YTM rates put out by the PDAI/ FIMMDA at periodical
intervals.
ii)
iii)
The 6.00 per cent Capital Indexed Bonds may be valued at “cost”, as
defined in circular DBOD.No.BC.8/12.02.001/ 97-98 dated January 22,
1998 and BC.18/12.02.001/ 2000-2001 dated August 16, 2000.
Treasury Bills should be valued at carrying cost.
3.6.2 State Government Securities
State Government securities will be valued applying the YTM method by marking
it up by 25 basis points above the yields of the Central Government Securities of
equivalent maturity put out by PDAI/ FIMMDA periodically.
3.6.3 Other ‘approved’ Securities
Other approved securities will be valued applying the YTM method by marking it
up by 25 basis points above the yields of the Central Government Securities of
equivalent maturity put out by PDAI/ FIMMDA periodically.
3.7 Unquoted Non-SLR securities
3.7.1 Debentures/ Bonds
All debentures/ bonds other than debentures/bonds, which are in the nature of
advance, should be valued on the YTM basis. Such debentures/ bonds may be
of different companies having different ratings. These will be valued with
appropriate mark-up over the YTM rates for Central Government securities as
put out by PDAI/ FIMMDA periodically. The mark-up will be graded according to
the ratings assigned to the debentures/ bonds by the rating agencies subject to
the following: -
(a)
The rate used for the YTM for rated debentures/ bonds should be at least
50 basis points above the rate applicable to a Government of India loan of
equivalent maturity.
NOTE:
The special securities, which are directly issued by Government of India
to the beneficiary entities, which do not carry SLR status, may be valued
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
(b)
(c)
at a spread of 25 basis points above the corresponding yield on
Government of India securities, with effect from the financial year 2008 -
09. At present, such special securities comprise: Oil Bonds, Fertiliser
Bonds, bonds issued to the State Bank of India (during the recent rights
issue), Unit Trust of India, Industrial Finance Corporation of India Ltd.,
Food Corporation of India, Industrial Investment Bank of India Ltd., the
erstwhile Industrial Development Bank of India and the erstwhile Shipping
Development Finance Corporation.
The rate used for the YTM for unrated debentures/ bonds should not be
less than the rate applicable to rated debentures/ bonds of equivalent
maturity. The mark-up for the unrated debentures/ bonds should
appropriately reflect the credit risk borne by the bank.
Where the debenture/ bonds is quoted and there have been transactions
within 15 days prior to the valuation date, the value adopted should not be
higher than the rate at which the transaction is recorded on the stock
exchange.
3.7.2 Zero coupon bonds (ZCBs)
ZCBs should be shown in the books at carrying cost, i.e., acquisition cost plus
discount accrued at the rate prevailing at the time of acquisition, which may be
marked to market with reference to the market value. In the absence of market
value, the ZCBs may be marked to market with reference to the present value of
the ZCB. The present value of the ZCBs may be calculated by discounting the
face value using the ‘Zero Coupon Yield Curve’, with appropriate mark up as per
the zero coupon spreads put out by FIMMDA periodically. In case the bank is still
carrying the ZCBs at acquisition cost, the discount accrued on the instrument
should be notionally added to the book value of the scrip, before marking it to
market.
3.7.3 Preference Shares
The valuation of preference shares should be on YTM basis. The preference
shares will be issued by companies with different ratings. These will be valued
with appropriate mark-up over the YTM rates for Central Government securities
put out by the PDAI/FIMMDA periodically. The mark-up will be graded according
to the ratings assigned to the preference shares by the rating agencies subject to
the following:
a) The YTM rate should not be lower than the coupon rate/ YTM for a GOI
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loan of equivalent maturity.
Annexure – K
b) The rate used for the YTM for unrated preference shares should not be
less than the rate applicable to rated preference shares of equivalent
maturity. The mark-up for the unrated preference shares should
appropriately reflect the credit risk borne by the bank.
c) Investments in preference shares as part of the project finance may be
valued at par for a period of two years after commencement of production
or five years after subscription whichever is earlier.
d) Where investment in preference shares is as part of rehabilitation, the
YTM rate should not be lower than 1.5% above the coupon rate/ YTM for
GOI loan of equivalent maturity.
e) Where preference dividends are in arrears, no credit should be taken for
accrued dividends and the value determined on YTM should be
discounted by at least 15% if arrears are for one year, and more if arrears
are for more than one year. The depreciation/provision requirement
arrived at in the above manner in respect of non- performing shares
where dividends are in arrears shall not be allowed to be set-off against
appreciation on other performing preference shares.
f) The preference share should not be valued above its redemption value.
g) When a preference share has been traded on stock exchange within 15
days prior to the valuation date, the value should not be higher than the
price at which the share was traded.
3.7.4 Equity Shares
The equity shares in the bank's portfolio should be marked to market preferably
on a daily basis, but at least on a weekly basis. Equity shares for which current
quotations are not available or where the shares are not quoted on the stock
exchanges, should be valued at break-up value (without considering ‘revaluation
reserves’, if any) which is to be ascertained from the company’s latest balance
sheet (which should not be more than one year prior to the date of valuation). In
case the latest balance sheet is not available the shares are to be valued at Re.1
per company.
3.7.5 Mutual Funds Units (MF Units)
Investment in quoted MF Units should be valued as per Stock Exchange
quotations. Investment in un-quoted MF Units is to be valued on the basis of the
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
latest re-purchase price declared by the MF in respect of each particular
Scheme. In case of funds with a lock-in period, where repurchase price/ market
quote is not available, Units could be valued at Net Asset Value (NAV). If NAV is
not available, then these could be valued at cost, till the end of the lock- in
period. Wherever the re-purchase price is not available, the Units could be
valued at the NAV of the respective scheme.
3.7.6 Commercial Paper
Commercial paper should be valued at the carrying cost.
3.7.7 Investments in Regional Rural Banks (RRBs)
Investment in RRBs is to be valued at carrying cost (i.e. book value) on a
consistent basis.
3.8 Investment in securities issued by SC/RC
When banks / FIs invest in the SRs / Pass-Through Certificates (PTCs) issued by
SCs / RCs, in respect of the financial assets sold by them to the SCs / RCs, the
sale shall be recognised in books of the banks / FIs at the lower of:
• the redemption value of the SRs /PTCs, and
• the net book value (NBV) (i.e. Book value less provisions held), of the
financial asset.
The above investment should be carried in the books of the bank / FI at the price
as determined above until its sale or realisation, and on such sale or realisation,
the loss or gain must be dealt with as under:
(i)
(ii)
if the sale to SC /RC is at a price below the NBV, the shortfall should be
debited to the profit and loss account of that year.
If the sale is for a value higher than the NBV, the excess provision will not
be reversed but will be utilised to meet the shortfall / loss on account of
sale of other financial assets to SC / RC. All instruments received by
banks / FIs from SC / RC as sale consideration for financial assets sold to
them and also other instruments issued by SC / RC in which banks / FIs
invest will be in the nature of non-SLR securities. Accordingly, the
valuation, classification and other norms applicable to investment in non-
SLR instruments prescribed by RBI from time to time would be applicable
to bank’s / FI’s investment in debentures / bonds / security receipts /
PTCs issued by SC / RC. However, if any of the above instruments issued
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399
Annexure – K
by SC / RC is limited to the actual realisation of the financial assets
assigned to the instruments in the concerned scheme the bank / FI shall
reckon the Net Asset Value (NAV), obtained from SC / RC from time to
time, for valuation of such investments.
3.9. Valuation and classification of banks’ investment in VCFs
3.9.1 The quoted equity shares / bonds/ units of VCFs in the bank's portfolio
should be held under AFS and marked to market preferably on a daily
basis, but at least on a weekly basis, in line with valuation norms for other
equity shares as per existing instructions.
3.9.2 Banks’ investments in unquoted shares/bonds/units of VCFs made after
August 23, 2006 (i.e issuance of guidelines on valuation, classification of
investments in VCFs) will be classified under HTM for initial period of
three years and will be valued at cost during this period. For the
investments made before issuance of these guidelines, the classification
would be done as per the existing norms.
3.9.3 For this purpose, the period of three years will be reckoned separately for
each disbursement made by the bank to VCF as and when the committed
capital is called up. However, to ensure conformity with the existing norms
for transferring securities from HTM, transfer of all securities which have
completed three years as mentioned above will be effected at the
beginning of the next accounting year in one lot to coincide with the
annual transfer of investments from HTM category.
3.9.4 After three years, the unquoted units/shares/bonds should be transferred
to AFS category and valued as under:
i) Units: In the case of investments in the form of units, the valuation
will be done at the NAV shown by the VCF in its financial
statements. Depreciation, if any, on the units based on NAV has to
be provided at the time of shifting the investments to AFS category
from HTM category as also on subsequent valuations which
should be done at quarterly or more frequent intervals based on
the financial statements received from the VCF. At least once in a
year, the units should be valued based on the audited results.
However, if the audited balance sheet/ financial statements
showing NAV figures are not available continuously for more than
18 months as on the date of valuation, the investments are to be
valued at Rupee 1.00 per VCF.

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
ii)
(iii)
Equity: In the case of investments in the form of shares, the
valuation can be done at the required frequency based on the
break-up value (without considering ‘revaluation reserves’, if any)
which is to be ascertained from the company’s (VCF’s) latest
balance sheet (which should not be more than 18 months prior to
the date of valuation). Depreciation, if any on the shares has to be
provided at the time of shifting the investments to AFS category as
also on subsequent valuations which should be done at quarterly
or more frequent intervals. If the latest balance sheet available is
more than 18 months old, the shares are to be valued at
Rupee.1.00 per company.
Bonds: The investment in the bonds of VCFs, if any, should be
valued as per prudential norms for classification, valuation and
operation of investment port- folio by banks issued by RBI from
time to time.
3.9.5 Valuation norms on conversion of outstanding
(a)
Equity, debentures and other financial instruments acquired by way of
conversion of outstanding principal and / or interest should be classified in
the AFS category, and valued in accordance with the extant instructions
on valuation of banks' investment portfolio, except to the extent that (a)
equity may be valued as per market value, if quoted, (b) in cases, where
equity is not quoted, valuation may be at breakup value in respect of
standard assets and in respect of substandard / doubtful assets, equity
may be initially valued at Re1 and at breakup value after restoration / up
gradation to standard category.
3.10 Non-Performing Investments (NPI)
3.10.1 In respect of securities included in any of the three categories where
interest/ principal is in arrears, the banks should not reckon income on the
securities and should also make appropriate provisions for the
depreciation in the value of the investment. The banks should not set-off
the depreciation requirement in respect of these non-performing securities
against the appreciation in respect of other performing securities.
3.10.2 An NPI, similar to a non performing advance (NPA), is one where :
(i)
Interest/ instalment (including maturity proceeds) is due and remains
unpaid for more than 90 days.
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(ii)
(iii)
(iv)
(v)
(vi)
401
Annexure – K
The above would apply mutatis-mutandis to preference shares where the
fixed dividend is not paid.
In the case of equity shares, in the event the investment in the shares of
any company is valued at Re.1 per company on account of the non
availability of the latest balance sheet in accordance with the instructions
contained in paragraph 28 of the Annex to the circular DBOD.BP.BC.32/
21.04.048/ 2000-01 dated October 16, 2000, those equity shares would
also be reckoned as NPI.
If any credit facility availed by the issuer is NPA in the books of the bank,
investment in any of the securities, including preference shares issued by
the same issuer would also be treated as NPI and vice versa. However, if
only the preference shares are classified as NPI, the investment in any of
the other performing securities issued by the same issuer may not be
classified as NPI and any performing credit facilities granted to that
borrower need not be treated as NPA.
The investments in debentures / bonds, which are deemed to be in the
nature of advance would also be subjected to NPI norms as applicable to
investments.
In case of conversion of principal and / or interest into equity, debentures,
bonds, etc., such instruments should be treated as NPA abinitio in the
same asset classification category as the loan if the loan's classification is
substandard or doubtful on implementation of the restructuring package
and provision should be made as per the norms.
3.10.3 State Government guaranteed investments
For the year ending March 31, 2005, investment in State Government
guaranteed securities would attract prudential norms for identification of NPI and
provisioning, if interest and/or principal or any other amount due to the bank
remains overdue for more than 180 days. With effect from the year ending March
31, 2006, investment in State Government guaranteed securities, including those
in the nature of ‘deemed advance’, will attract prudential norms for identification
of non- performing investments and provisioning, when interest/ instalment of
principal (including maturity proceeds) or any other amount due to the bank
remains unpaid for more than 90 days.
4. Uniform accounting for Repo / Reverse Repo transactions.
4.1 In order to ensure uniform accounting treatment for accounting repo

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
/reverse repo transactions and to impart an element of transparency, uniform
accounting principles, have been laid down for repo / reverse repo transactions
undertaken by all the regulated entities. However, for the present, these norms
would not apply to repo / reverse repo transactions under the Liquidity
Adjustment Facility (LAF) with RBI.
4.2 The uniform accounting principles were made applicable from the
financial year 2003-04. The market participants may undertake repos from any of
the three categories of investments, viz., Held for Trading, Available For Sale and
Held to Maturity.
4.3 The securities sold under repo (the entity selling referred to as “seller”)
are excluded from the Investment Account of the seller of securities and the
securities bought under reverse repo (the entity buying referred to as “buyer”) are
included in the Investment Account of the buyer of securities. Further, the buyer
can reckon the approved securities acquired under reverse repo transaction for
the purpose of Statutory Liquidity Ratio (SLR) during the period of the repo.
4. 4 At present repo transactions are permitted in Central Government
securities including Treasury Bills and dated State Government securities. Since
the buyer of the securities will not hold it till maturity, the securities purchased
under reverse repo by banks should not be classified under Held to Maturity
category. The first leg of the repo should be contracted at prevailing market
rates. Further, the accrued interest received / paid in a repo / reverse repo
transaction and the clean price (i.e. total cash consideration less accrued
interest) should be accounted for separately and distinctly.
4.5 The other accounting principles to be followed while accounting for repos /
reverse repos will be as under:
4.5.1 Coupon
In case the interest payment date of the security offered under repo falls within
the repo period, the coupons received by the buyer of the security should be
passed on to the seller on the date of receipt as the cash consideration payable
by the seller in the second leg does not include any intervening cash flows. While
the buyer will book the coupon during the period of the repo , the seller will not
accrue the coupon during the period of the repo. In the case of discounted
instruments like Treasury Bills, since there is no coupon, the seller will continue
to accrue the discount at the original discount rate during the period of the repo.
The buyer will not therefore accrue the discount during the period of the repo.
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4.5.2 Repo Interest Income / Expenditure
After the second leg of the repo / reverse repo transaction is over,
(a)
(b)
(c)
Annexure – K
the difference in the clean price of the security between the first leg and
the second leg should be reckoned as Repo Interest Income /
Expenditure in the books of the buyer / seller respectively;
the difference between the accrued interest paid between the two legs of
the transaction should be shown as Repo Interest Income/ Expenditure
account, as the case may be; and
the balance outstanding in the Repo interest Income / Expenditure
account should be transferred to the Profit and Loss account as an
income or an expenditure.
As regards repo / reverse repo transactions outstanding on the balance sheet
date, only the accrued income / expenditure till the balance sheet date should be
taken to the Profit and Loss account. Any repo income / expenditure for the
subsequent period in respect of the outstanding transactions should be reckoned
for the next accounting period.
4.5.3 Marking to Market
The buyer will mark to market the securities acquired under reverse repo
transactions as per the investment classification of the security. To illustrate, for
banks, in case the securities acquired under reverse repo transactions have
been classified under Available for Sale category, then the mark to market
valuation for such securities should be done at least once a quarter. For entities
that do not follow any investment classification norms, the valuation for securities
acquired under reverse repo transactions may be in accordance with the
valuation norms followed by them in respect of securities of similar nature. In
respect of the repo transactions outstanding as on the balance sheet date
(a)
(b)
(c)
the buyer will mark to market the securities on the balance sheet date and
will account for the same as laid down in the extant valuation guidelines
issued by the respective regulatory departments of RBI.
the seller will provide for the price difference in the Profit & Loss account
and show this difference under “Other Assets” in the balance sheet if the
sale price of the security offered under repo is lower than the book value.
the seller will ignore the price difference for the purpose of Profit & Loss
account but show the difference under “Other Liabilities” in the Balance
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
(d)
Sheet, if the sale price of the security offered under repo is higher than
the book value; and
similarly the accrued interest paid / received in the repo / reverse repo
transactions outstanding on balance sheet dates should be shown as
"Other Assets" or "Other Liabilities" in the balance sheet.
4.5.4 Book value on re-purchase
The seller shall debit the repo account with the original book value (as existing in
the books on the date of the first leg) on buying back the securities in the second
leg.
4.5.5 Disclosure
The disclosures to be made by banks in the “Notes on Accounts’ to the Balance
Sheet is given in Annexure VII.
4.5.6 Accounting methodology
The accounting methodology to be followed is given below and illustrations are
furnished in Annexure VIII. While market participants, having different
accounting systems, may use accounting heads different from those used in the
illustration, there should not be any deviation from the accounting principles
enunciated above. Further, to obviate disputes arising out of repo transactions,
the participants may consider entering into bilateral Master Repo Agreement as
per the documentation finalized by FIMMDA.
4.5.7 Recommended Accounting Methodology for Uniform Accounting of Repo /
Reverse Repo transactions
a) The following accounts may be opened, viz. (i) Repo Account, (ii) Repo
Price Adjustment Account, (iii) Repo Interest Adjustment Account, (iv)
Repo Interest Expenditure Account, (v) Repo Interest Income Account,
(vi) Reverse Repo Account, (vii) Reverse Repo Price Adjustment Account,
and (viii) Reverse Repo Interest Adjustment Account.
b) The securities sold/ purchased under repo should be accounted for as an
outright sale / purchase.
c) The securities should enter and exit the books at the same book value.
For operational ease, the weighted average cost method whereby the
investment is carried in the books at their weighted average cost, may be
adopted.
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Annexure – K
d) In a repo transaction, the securities should be sold in the first leg at
market related prices and re-purchased in the second leg at the derived
price. The sale and repurchase should be accounted in the Repo
Account.
e) The balances in the Repo Account should be netted from the bank's
Investment Account for balance sheet purposes.
f) The difference between the market price and the book value in the first
leg of the repo should be booked in Repo Price Adjustment Account.
Similarly the difference between the derived price and the book value in
the second leg of the repo should be booked in the Repo Price
Adjustment Account.
Reverse repo
g) In a reverse repo transaction, the securities should be purchased in the
first leg at prevailing market prices and sold in the second leg at the
derived price. The purchase and sale should be accounted for in the
Reverse Repo Account.
h) The balances in the Reverse Repo Account should be part of the
Investment Account for balance sheet purposes and can be reckoned for
SLR purposes if the securities acquired under reverse repo transactions
are approved securities.
i) The security purchased in a reverse repo will enter the books at the
market price (excluding broken period interest). The difference between
the derived price and the book value in the second leg of the reverse repo
should be booked in the Reverse Repo Price Adjustment Account.
Other aspects relating to Repo / Reverse Repo
j) In case the interest payment date of the security offered under repo falls
within the repo period, the coupons received by the buyer of the security
should be passed on to the seller on the date of receipt as the cash
consideration payable by the seller in the second leg does not include any
intervening cash flows.
k) The difference between the amounts booked in the first and second legs
in the Repo / Reverse Repo Price Adjustment Account should be
transferred to the Repo Interest Expenditure Account or Repo Interest
Income Account, as the case may be.
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
l) The broken period interest accrued in the first and second legs will be
booked in Repo Interest Adjustment Account or Reverse Repo Interest
Adjustment Account, as the case may be. Consequently the difference
between the amounts booked in this account in the first and second legs
should be transferred to the Repo Interest Expenditure Account or Repo
Interest Income Account, as the case may be.
m) At the end of the accounting period the, for outstanding repos, the
balances in the Repo / Reverse Repo Price Adjustment Account and
Repo / Reverse repo Interest Adjustment account should be reflected
either under item VI - 'Others' under Schedule 11 - 'Other Assets' or under
item IV 'Others (including Provisions)' under Schedule 5 - 'Other Liabilities
and Provisions' in the Balance Sheet, as the case may be.
n) Since the debit balances in the Repo Price Adjustment Account at the end
of the accounting period represent losses not provided for in respect of
securities offered in outstanding repo transactions, it will be necessary to
make a provision therefore in the Profit & Loss Account.
o) To reflect the accrual of interest in respect of the outstanding repo/
reverse repo transactions at the end of the accounting period, appropriate
entries should be passed in the Profit and Loss account to reflect Repo
Interest Income / Expenditure in the books of the buyer / seller
respectively and the same should be debited / credited as an income /
expenditure accrued but not due. Such entries passed should be reversed
on the first working day of the next accounting period.
p) In respect of repos in interest bearing (coupon) instruments, the buyer
would accrue interest during the period of repo. In respect of repos in
discount instruments like Treasury Bills, the seller would accrue discount
during the period of repo based on the original yield at the time of
acquisition.
q) At the end of the accounting period the debit balances (excluding
balances for repos which are still outstanding) in the Repo Interest
Adjustment Account and Reverse Repo Interest Adjustment Account
should be transferred to the Repo Interest Expenditure Account and the
credit balances (excluding balances for repos which are still outstanding)
in the Repo Interest Adjustment Account and Reverse Repo Interest
Adjustment Account should be transferred to the Repo Interest Income
Account.
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Annexure – K
r) Similarly, at the end of accounting period, the debit balances (excluding
balances for repos which are still outstanding) in the Repo / Reverse
Repo Price Adjustment Account should be transferred to the Repo
Interest Expenditure Account and the credit balances (excluding balances
for repos which are still outstanding) in the Repo / Reverse Repo Price
Adjustment Account should be transferred to the Repo Interest Income
Account.
5. General
5.1 Income recognition
i) Banks may book income on accrual basis on securities of corporate
bodies/ public sector undertakings in respect of which the payment of
interest and repayment of principal have been guaranteed by the Central
Government or a State Government, provided interest is serviced
regularly and as such is not in arrears.
ii)
iii)
iv)
Banks may book income from dividend on shares of corporate bodies on
accrual basis provided dividend on the shares has been declared by the
corporate body in its Annual General Meeting and the owner's right to
receive payment is established.
Banks may book income from Government securities and bonds and
debentures of corporate bodies on accrual basis, where interest rates on
these instruments are pre- determined and provided interest is serviced
regularly and is not in arrears.
Banks should book income from units of mutual funds on cash basis.
5.2 Broken Period Interest
Banks should not capitalise the Broken Period Interest paid to seller as part of
cost, but treat it as an item of expenditure under Profit and Loss Account in
respect of investments in Government and other approved securities. It is to be
noted that the above accounting treatment does not take into account taxation
implications and hence the banks should comply with the requirements of Income
Tax Authorities in the manner prescribed by them.
5.3 Dematerialised Holding
Banks should settle the transactions in securities as notified by SEBI only
through depositories. After the commencement of mandatory trading in demat
form, banks would not be able to sell the shares of listed companies if they were
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
held in physical form. In order to extend the demat form of holding to other
instruments like bonds, debentures and equities, it was decided that, with effect
from October 31, 2001, banks, FIs, PDs and SDs would be permitted to make
fresh investments and hold bonds and debentures, privately placed or otherwise,
only in dematerialised form. Outstanding investments in scrip forms were
required to be converted into dematerialised form by June 30, 2002. As regards
equity instruments, banks were required to convert all their equity holding in scrip
form into dematerialised form by December 31, 2004.
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Annexure – K
Short sale in Government Securities
Annexure I-A
Banks may undertake short sale of Central Government dated securities, subject
to the short position being covered within a maximum period of five trading days,
including the day of trade. In other words, the short sale position initiated today
(trade date, T+0) will have to be covered on or before close of T+4 day. Such
short positions shall be covered only by outright purchase of an equivalent
amount of the same security. The short positions may be reflected in ‘Securities
Short Sold (SSS) A/c’, specifically created for this purpose. For the purposes of
this circular short sale and notional short sale are defined as under:
‘Short Sale’ is defined as sale of securities one does not own. A bank can also
undertake 'notional' short sale where it can sell a security short from HFT even if
the security is held under its AFS/HTM book. The resultant 'notional' short
position would be subject to the same regulatory requirements as in the case of a
short sale. For the purpose of these guidelines, short sale would include 'notional'
short sale as well. The short sale by banks and the cover transaction shall not
affect the holdings and valuation of the same security in AFS/HTM categories in
any way.
Short sale transactions can be undertaken by banks, subject to the following
conditions:
Minimum requirements:
In respect of short sales, banks shall ensure adherence to the following
conditions:
a) The sale leg of the transaction should be executed only on the Negotiated
Dealing System – Order Matching (NDS-OM) platform. The cover leg of
the short sale transaction can, however, be executed either on or outside
the NDS-OM platform.
b) The sale leg as well as the cover leg of the transaction should be
accounted in the HFT category.
c) Under no circumstances, should participants fail to deliver, on settlement
date, the securities sold short. Failures to deliver securities short sold
shall be treated as an instance of ‘SGL bouncing’ and the concerned
banks will be liable to disciplinary action prescribed in respect of SGL
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<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
bouncing, besides attracting such further regulatory action as may be
considered necessary.
d) At no point of time should a bank accumulate a short position (face value)
in any security in the HFT category in excess of the following limits:
i) 0.25% of the total outstanding stock issued of each security in
case of securities other than liquid securities.
ii)
0.50% of the total outstanding stock issued of each security in
case of liquid securities.
e) Banks shall be entirely responsible for ensuring strict compliance with the
above prudential limits on real time basis for which they may put in place
appropriate systems and internal controls. The controls provided in the
trading platform (NDS-OM) are merely in the nature of additional tools and
should not be cited as a reason for any breach of internal or regulatory
limits. The information regarding the outstanding stock of each
Government of India dated security is being made available on the RBI
website (URL: http://rbi.org.in/Scripts/NDSUserXsl.aspx). The list of liquid
securities for compliance with the limits shall be provided by FIMMDA
from time to time.
f) Banks which undertake short sale transactions shall mark-to-market their
entire HFT portfolio, including the short positions, on a daily basis and
account for the resultant mark-to-market gains / losses as per the relevant
guidelines for marking-to-market of the HFT portfolio.
g) Gilt Accounts Holders (GAHs), under CSGL facility, are not permitted to
undertake short sales. Entities maintaining CSGL Accounts are required
to ensure that no short sale is undertaken by the GAHs.
Borrowing security (through the repo market) to meet delivery obligations:
Since securities that are short sold are to be invariably delivered on the
settlement date, participants are permitted to meet their delivery obligations by
acquiring securities in the repo market. Accordingly, with a view to enable
participants to run short positions across settlement cycles, banks have been
permitted to use the securities acquired under a reverse repo to meet the
delivery obligation of the short sale transaction. While the reverse repos can be
rolled over, it is emphasised that the delivery obligations under the successive
reverse repo contracts are also to be invariably met, failing which the concerned
banks shall attract the regulatory action as specified above. It may, however, be
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Annexure – K
noted that the permission to use securities acquired under reverse repo as above
applies only to securities acquired under market repo and not to securities
acquired under RBI’s Liquidity Adjustment Facility.
Policy and internal control mechanisms:
Before actually undertaking transactions in terms of this circular, banks
shall put in place a written policy on short sale, which should be approved by
their respective Boards of Directors. The policy should lay down the internal
guidelines which should include, inter alia, risk limits on short position, an
aggregate nominal short sale limit (in terms of Face Value) across all eligible
securities, stop loss limits, the internal control systems to ensure adherence to
regulatory and internal guidelines, reporting of short selling activity to the Board
and the RBI, procedure to deal with violations, etc. Banks shall also put in place
a system to detect violations if any, immediately, certainly within the same trading
day.
In addition to the internal control mechanisms, the concurrent auditors should
specifically verify compliance with these instructions, as well as with internal
guidelines and report violations, if any, within a reasonably short time, to the
appropriate internal authority. As part of their monthly reporting, concurrent
auditors may verify whether the independent back/mid office has taken
cognizance of lapses, if any, and whether they have reported the same within the
required time frame to the appropriate internal authority. Any violation of
regulatory guidelines noticed in this regard should immediately be reported to the
respective Public Debt Office (PDO) where the SGL account is maintained and
Internal Debt Management Department, Reserve Bank of India, Mumbai.
411

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
Definition
Annexure I-B
When Issued Market - <strong>Guide</strong>lines
‘When, as and if issued’ (commonly known as ‘when-issued’ (WI)) security refers
to a security that has been authorized for issuance but not yet actually issued.
‘WI’ trading takes place between the time a new issue is announced and the time
it is actually issued. All 'when issued' transactions are on an 'if' basis, to be
settled if and when the actual security is issued.
Mechanics of Operation
Transactions in a security on a ‘When Issued’ basis shall be undertaken in the
following manner:
a) ‘WI’ transactions can be undertaken in the case of securities that are
being reissued as well as newly issued, on a selective basis.
b) ‘WI’ transactions would commence on the issue notification date and it
would cease on the working day immediately preceding the date of issue.
c) All ‘WI’ transactions for all trade dates will be contracted for settlement on
the date of issue.
d) At the time of settlement on the date of issue, trades in the ‘WI’ security
will be netted off with trades in the existing security, in the case of
reissued securities.
e) The originating transactions (sale or purchase of 'WI' securities) shall be
undertaken only on NDS-OM. Any reversal of a When Issued transaction
can, however, be undertaken on or outside the NDS-OM platform.
f) Only PDs can take a short position in the ‘WI’ market. In other words, non-
PD entities can sell the ‘WI’ security to any counterparty only if they have
a preceding purchase contract for equivalent or higher amount.
g) Open Positions in the ‘WI’ market are subject to the following limits:
412

Annexure – K
Category Reissued security Newly issued security
Non-PDs Long Position, not exceeding 5
per cent of the notified amount.
PD
Long or Short Position, not
exceeding 10 per cent of the
notified amount
Long Position, not exceeding 5
per cent of the notified amount.
Short Position, not exceeding 6
per cent and Long Position, not
exceeding 10 per cent of the
notified amount.
h) In the event of cancellation of the auction for whatever reason, all ‘WI’
trades will be deemed null and void ab initio on grounds of force majeure.
Internal Control
All banks participating in the ‘WI’ market are required to have in place a written
policy on ‘WI’ trading which should be approved by the Board of Directors. The
policy should lay down the internal guidelines which should include, inter alia, risk
limits on ‘WI’ position (including, in the case of reissued securities, overall
position in the security, i.e., ‘WI’ plus the existing security), an aggregate nominal
limit (in terms of Face Value) for ‘WI’ and in the case of reissued securities, ‘WI’
plus the existing security, the internal control arrangements to ensure adherence
to regulatory and internal guidelines, reporting of ‘WI’ activity to the top
management, procedure to deal with violations, etc. A system should be in place
to detect violations immediately, certainly within the trading day.
The concurrent auditors should specifically verify compliance with these
instructions and report violations on the date of trade itself, within a reasonably
short time, to the appropriate internal authority. As part of their monthly reporting,
concurrent auditors may verify whether the independent back/mid office has
taken cognizance of all such lapses and reported the same within the required
time frame. Any violation of regulatory guidelines noticed in this regard should
immediately be reported to the Public Debt Office (PDO), Mumbai and IDMD,
Reserve Bank of India.
413

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
Annexure I-C
Para 1.1 (i) (b)
Investment portfolio of banks – Transactions in securities –
Conditions subject to which securities allotted in the auctions for
primary issues can be sold
(i)
(ii)
(iii)
(iv)
(v)
(vi)
The contract for sale can be entered into only once by the allottee
bank on the basis of an authenticated allotment advice issued by
Reserve Bank of India. The buyer from an allottee in a primary auction
is also permitted to re-sell the security subject to compliance with the
terms and conditions stipulated in our circular No.IDMD.PDRS.05/
10.02.01/2003-04 dated March 29, 2004. Any sale of securities should
be only on a T + 0 or T + 1 settlement basis.
The contract for sale of allotted securities can be entered into by
banks with entities maintaining SGL Account with RBI as well as with
and between CSGL account holders for delivery and settlement on the
next working day through the Delivery versus Payment (DvP) system.
The face value of securities sold should not exceed the face value of
securities indicated in the allotment advice.
The sale deal should be entered into directly without the involvement
of broker/s.
Separate record of such sale deals should be maintained containing
details such as number and date of allotment advice, description and
the face value of securities allotted, the purchase consideration, the
number, date of delivery and face value of securities sold, sale
consideration, the date and details of actual delivery i.e. SGL Form
No., etc. This record should be made available to RBI for verification.
Banks should immediately report any cases of failure to maintain such
records.
Such type of sale transactions of Government securities allotted in the
auctions for primary issues on the same day and based on
authenticated allotment advice should be subjected to concurrent audit
and the relative audit report should be placed before the Executive
414

Annexure – K
(vii)
Director or the Chairman and Managing Director of the Bank once
every month. A copy thereof should also be sent to the Department of
Banking Supervision, RBI, Central Office, Mumbai.
Banks will be solely responsible for any failure of the contracts due to
the securities not being credited to their SGL account on account of
non-payment / bouncing of cheque etc.
415

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
Annexure – II
Para 1.1.6 (i) (g)
Investment portfolio of banks - Transactions in securities -
Aggregate contract limit for individual brokers
Sr.
No.
Issue Raised
1. The year should be calendar
year or financial year?
2. Whether the limit is to be
observed with reference to
total transactions of the
previous year as the total
transactions of the current
year should be known only at
the and of the year?
3. Whether to arrive at the total
transactions of the year,
transactions entered into
directly with counter-parties
i.e. where no brokers are
involved would also be taken
into account
4. Whether in case of ready
forward deals both the legs of
the deals i.e. purchase as
well as sale will be included
to arrive at the volume of total
transactions?
Response
Since banks close their accounts at the
end of March, it may be more
convenient to follow the financial year.
However, the banks may follow
calendar year or any other period of 12
months provided, it is consistently,
followed in future.
The limit has to be observed with
reference to the year under review.
While operating the limit, the bank
should keep in view the expected
turnover of the current year which may
be based on turnover of the previous
year and anticipated rise or fall in the
volume of business in the current year.
Not necessary. However, if there are
any direct deals with the brokers as
purchasers or sellers the same would
have to be included in the total
transactions to arrive at the limit of
transactions to be done through an
individual broker.
Yes. This is however only theoretical as
R/F transactions in Govt. security now
prohibited except in Treasury Bills and
the 3 year dated securities issued by
conversion of Treasury Bills recently
416

Annexure – K
Sr.
No.
Issue Raised
Response
5. Whether central loan /state No, as brokers are not involved as
loan /treasury bills etc. intermediaries.
purchased subscriptions/
auction will be, included in
the volume of total
transactions?
6. It is possible that even though
bank considers that a
particular broker has touched
the prescribed limit of 5% he
may come with an offer
during the remaining period of
the year which the bank may
find it to its advantage as
compared to offers
received from the other
brokers who have not yet
done business upto the
prescribed limit.
If the offer received is more
advantageous the limit for the broker
may be exceeded the reasons therefor
recorded and approval of the competent
authority / Board obtained post facto.
7. Whether the transactions Yes. If they are conducted through the
conducted on behalf of the brokers.
clients would also be included
in the total transactions of the
year?
8. For a bank which rarely deals
through brokers and
consequently the volume of
business is small maintaining
the broker-wise limit of 5%
may mean splitting the orders
in small values amongst
different brokers and there
may also arise price
differential.
There may be no need to split an order.
If any deal causes the particular
broker's share to exceed 5% limit, our
circular provides the necessary
flexibility in as much as Board's post
facto approval can be obtained.
417

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
Sr.
No.
Issue Raised
9. During the course of the year
it may not be possible to
reasonably predict what will
be the total quantum of
transactions through brokers
as a result of which there
could be deviation in
complying with the norm of
5% .
10. Some of the small private
sector banks have mentioned
that where the volume of
business particularly the
transaction done through
brokers is small the
observance of 5% limit may
be difficult. A suggestion has
therefore been made that the
limit may be required to be
observed if the business done
through a broker exceeds a
cut-off point of say Rs.10
crores
Response
The bank may get post facto approval
from the Board after explaining to it the
circumstances in which the limit was
exceeded.
As already observed the limit of 5% can
be exceeded subject to reporting the
transactions to the competent authority
post facto. Hence, no change in our
instructions is considered necessary.
418

Annexure – K
Annexure III
Para 1.2(ii)
Recommendations of the Group on Non-SLR Investments of Banks
Pro-forma of minimum disclosure requirements in respect of
private placement issues - Model Offer Document
All issuers must issue an offer document with terms of issue, authorised by
Board Resolution not older than 6 months from the date of issue. The offer
document should specifically mention the Board Resolution authorising the issue
and designations of the officials who are authorized to issue the offer document.
The offer document may be printed or typed "For Private Circulation Only". The
‘Offer Document’ should be signed by the authorised signatory. The offer
document should contain the following minimum information:
I. General Information
II.
1. Name and address of registered office of the company
2. Full names (expanded initials), addresses of Directors and the
names of companies where they are Directors.
3. Listing of the issue (If listed, name of the Exchange)
4. Date of opening of the issue
Date of closing of the issue
Date of earliest closing of the issue.
5. Name and addresses of auditors and Lead Managers /
arrangers
6. Name address of the trustee - consent letter to be produced (in
case of debenture issue)
7. Rating from any Rating Agency and / or copy of the rationale of
latest rating.
Particulars of the issue
(a)
(b)
Objects
Project cost and means of financing (including contribution of
promoters) in case of new projects.
419

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
III.
IV.
The model offer document should also contain the following
information:
(1) Interest rate payable on application money till the date of
allotment.
(2) Security: If it is a secured issue, the issue is to be secured, the
offer documents should mention description of security, type
of security, type of charge, Trustees, private charge-holders, if
any, and likely date of creation of security, minimum security
cover, revaluation, if any.
(3) If the security is collateralised by a guarantee, a copy of the
guarantee or principal terms of the guarantee are to be
included in the offer document.
(4) Interim Accounts, if any.
(5) Summary of last audited Balance Sheet and Profit & Loss
Account with qualifications by Auditors, if any.
(6) Last two published Balance Sheet may be enclosed.
(7) Any conditions relating to tax exemption, capital adequacy etc.
are to be brought out fully in the documents.
(8) The following details in case of companies undertaking major
expansion or new projects :- (copy of project appraisal may be
made available on request)
(a) Cost of the project, with sources and uses of funds
(b) Date of commencement with projected cash flows
(c) Date of financial closure (details of commitments by
other institutions to be provided)
(d) Profile of the project (technology, market etc)
(e) Risk factors
(9) If the instrument is of tenor of 5 years or more, projected cash
flows.
Banks may agree to insist upon the following conditionalities for
issues under private placements
All the issuers in particular private sector corporates, should be willing to
execute a subscription agreement in case of all secured debt issues, pending
420

421
Annexure – K
the execution of Trust Deed and charge documents. A standardised
subscription agreement may be used by the banks, inter-alia, with the
following important provisions:
(a)
(b)
(c)
(d)
(e)
(f)
Letter of Allotment should be made within 30 days of allotment.
Execution of Trust Deed and charge documents will be completed and
debentures certificates will be dispatched within the time limit laid
down in the Companies Act but not exceeding in any case, 6 months
from the date of the subscription agreement.
In case of delay in complying with the above, the company will refund
the amount of subscription with agreed rate of interest, or, will pay
penal interest of 2% over the coupon rate till the above conditions are
complied with, at the option of the bank.
Pending creation of security, during the period of 6 months (or
extended period), the principal Directors of the company should agree
to indemnify the bank for any loss that may be suffered by the bank on
account of the subscription to their debt issue. (This condition will not
apply to PSUs).
It will be the company's responsibility to obtain consent of the prior
charge-holders for creation of security within the stipulated period.
Individual banks may insist upon execution of subscription agreement
or a suitable letter to comply with the terms of offer such as
appointment of trustee, creation of security etc. on the above lines.
Rating: The Group recommends that the extant regulations of SEBI in
regard to rating of all debt instruments in public offers would be made
applicable to private placement also. This stipulation will also apply to
preference shares, which are redeemable after 18 months.
Listing: Currently, there is a lot of flexibility regarding listing required
by banks in private placement issues. However, the Group
recommends that listing of companies should be insisted upon,
(exceptions, if any, to this rule shall be provided in the Investment
Policy of the banks) which would in due course help develop
secondary market. The advantage of listing would be that the listed
companies would be required to disclose information periodically to
the Stock Exchanges which would also help develop the secondary
markets by way of investor information. In fact, SEBI has advised all
the Stock Exchanges that all listed companies should publish

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
(g)
unaudited financial results on a quarterly basis and that they should
inform the Stock Exchanges immediately of all events which would
have a bearing on the performance / operations of the company as
well as price sensitive information.
Security / documentation: To ensure that the documentation is
completed and security is created in time, the Group has made
recommendations, which is contained in this model offer document. It
may be noted that in case of delay in execution of Trust Deed and
Charge documents, the company will refund the subscription with
agreed rate of interest or will pay penal interest of 2% over the coupon
rate till these conditions are complied with at the option of the bank.
Moreover, Principal Directors of the company will have to agree to
indemnify the bank for any loss that may be suffered by the bank on
account of the subscription to the debt issue during the period of 6
months (or extended period) pending creation of security.
----------------------------------------------
422

Annexure – K
Annexure - IV
Para 1.2.4
<strong>Guide</strong>lines on Investments by Banks in Non-SLR Investment
Portfolio by Banks - Definitions
1. With a view to imparting clarity and to ensure that there is no
divergence in the implementation of the guidelines, some of the terms
used in the guidelines on non-SLR investments are defined below.
2. A security will be treated as rated if it is subjected to a detailed rating
exercise by an external rating agency in India, which is registered with
SEBI and is carrying a current or valid rating. The rating relied upon
will be deemed to be current or valid if
(i)
(ii)
(iii)
(iv)
The credit rating letter relied upon is not more than one month
old on the date of opening of the issue, and
The rating rationale from the rating agency is not more than
one year old on the date of opening of the issue, and
The rating letter and the rating rationale is a part of the offer
document.
In the case of secondary market acquisition, the credit rating of
the issue should be in force and confirmed from the monthly
bulletin published by the respective rating agency. Securities,
which do not have a current or valid rating by an external rating
agency, would be deemed as unrated securities.
3. The investment grade ratings awarded by each of the external rating
agencies operating in India would be identified by the IBA / FIMMDA.
These would also be reviewed by IBA / FIMMDA at least once a year.
4. A 'listed' security is a security which is listed in a stock exchange. If
not so, it is an 'unlisted' security.
----------------------------------------------
423

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
Annexure - V
Para 1.2.20
Prudential <strong>Guide</strong>lines on Management of the Non-SLR Investment
Portfolio by Banks - Disclosures Requirements
Banks should make the following disclosures in the 'Notes on Accounts' of
the balance sheet in respect of their non-SLR investment portfolio, with effect
from the financial year ending 31 March 2004.
(i)
Issuer composition of Non SLR investments
Sl.
No.
Issuer Amount Extent of
private
placement
Extent of
'below
investment
grade'
securities
Extent of
'unrated'
securities
(Rs. in crore)
Extent of
'unlisted'
securities
1 2 3 4 5 6 7
1. PSUs
2. FIs
3. Banks
4. Private
Corporates
5. Subsidiaries/
Joint ventures
6. Others
7. Provision held
towards
depreciation
Total *
XXX XXX XXX XXX
Note: 1. * Total under column 3 should tally with the total of investments
included under the following categories in Schedule 8 to the balance
sheet:
(a)
Shares
424

(b)
(c)
(d)
Debentures & Bonds
Subsidiaries / joint ventures
Others
Annexure – K
2. Amounts reported under columns 4, 5, 6 and 7 above may not be
mutually exclusive.
(ii)
Non-performing Non-SLR investments
Particulars
Opening balance
Additions during the year since 1st April
Reductions during the above period
Closing balance
Total provisions held
Amount
(Rs. Crore)
----------------------------------------------
425

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
RETURN / STATEMENT NO. 9
Annexure VI
Para 1.3.1
Proforma Statement showing the position of Reconciliation of Investment
Account as on 31 st March
Name of the bank/ Institution: ______________________________________
(Face value Rs. in crore)
Particulars of
securities
General
Ledger
Balance
SGL Balance
As per
As per
bank’s /
PDO
institution’s
Books
books
BRs held
SGL Forms held
Actual Scrips Held
Outstandin g
deliveries
Central Govt
State Government
1 2 3 4 5 6 7 8
Other approved
securities
Public Sector Bonds
Units of UTI (1964)
Others (Shares &
Debenture etc)
TOTAL
426
Signature of the Authorised Official
with the Name and Designation
Note : Similar statements may be furnished in respect of PMS client’s
Accounts and other constituents’ Accounts (including Brokers). In the case of
PMS/other constituents’ accounts, the face value and book value of
securities appearing in the relevant registers of the bank should be
mentioned under Column 2.

General instructions for compiling reconciliation statement
a) Column - 2 (GL balances)
Annexure – K
It is not necessary to give complete details of securities in the format. Only
aggregate amount of face value against each category may be mentioned.
The corresponding book value of securities may be indicated in bracket
under the amount of face value of securities under each category.
b) Column - 3 and 4 (SGL balances)
In the normal course balances indicated against item three and four should
agree with each other. In case of any difference on account of any
transaction not being recorded either in PDO or in the books of the bank this
should be explained giving full details of each transaction.
c) Column - 5 (BRs held)
If the bank is holding any BRs for purchases for more than 30 days from the
date of its issue, particulars of such BRs should be given in a separate
statement.
d) Column - 6 (SGL forms held)
Aggregate amount of SGL forms received for purchases, which have not
been tendered with PDO, should be given here.
e) Column - 7
Aggregate amount of all scrips held in the form of bonds, letters of
allotments, subscription receipts as also certificates of entries in the books of
accounts of the issuer (for other than government securities), etc. including
securities which have been sold but physical delivery has not been given
should be mentioned.
f) Column - 8 (outstanding deliveries)
This relates to BRs issued by the bank, where the physicals/scrips have not
been delivered but the balance in General Ledger has been reduced. If any
BR issued is outstanding for more than thirty days the particulars of such
BRs may be given in a separate list indicating reasons for not affecting the
delivery of scrips.
427

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
g) General
Face value of securities indicated against each item in column two should be
accounted for under any one of the columns from four to seven. Similarly,
amount of outstanding deliveries (BRs issued) which has been indicated in
column eight will have to be accounted for under one of the columns four to
seven. Thus the total of columns two and eight should tally with total of
columns four to seven.
428

Annexure – K
Disclosures
Annexure - VII
Para 4.5.5
The following disclosures should be made by banks in the ‘Notes on
Accounts' to the Balance Sheet.
(Rs. in crore)
Minimum
outstanding
during the
year
Maximum
outstanding
during the
year
Daily Average
outstanding
during the
year
As on
March
31
Securities sold under repos
Securities purchased under
reverse repos
429

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
Annexure - VIII
Para 4.5.6
Illustrative examples for uniform accounting of Repo /
Reverse repo transactions
A. Repo / Reverse Repo of Coupon bearing security
1. Details of Repo in a coupon bearing security:
Security offered under Repo 11.43% 2015
Coupon payment dates
Market Price of the security offered under
Repo (i.e. price of the security in the first
leg)
7 August and 7 February
Date of the Repo 19 January, 2003
Repo interest rate 7.75%
Tenor of the repo
3 days
Rs.113.00 (1)
Broken period interest for the first leg* 11.43%x162/360x100=5.1435 (2)
Cash consideration for the first leg (1) + (2) = 118.1435 (3)
Repo interest** 118.1435x3/365x7.75%=0.0753 (4)
Broken period interest for the second leg 11.43% x 165/360x100=5.2388 (5)
Price for the second leg (3)+(4)-(5) = 118.1435 + 0.0753 -
5.2388
= 112.98
Cash consideration for the second leg (5)+(6) = 112.98 + 5.2388 =
118.2188
* Computation of days based on 30 / 360 day count convention
** Computation of days based on Actual / 365 day count convention
applicable to money market instruments
2. Accounting for seller of the security
We assume that the security was held by the seller at the book value (BV) of
Rs.120.0000
(6)
(7)
430

Annexure – K
First leg Accounting
Debit
Credit
Cash Repo Account 118.1435 120.0000
(Book value)
Repo Price Adjustment account
7.0000 (Difference
between BV & repo
price)
Repo Interest Adjustment account 5.1435
Second Leg Accounting
Repo Account
Repo Price Adjustment account
Repo Interest Adjustment account
Cash account
Debit
Credit
120.0000 7.02 (the difference
between the BV and
2nd leg price)
5.2388 118.2188
The balances in respect of the Repo Price Adjustment Account and Repo
Interest Adjustment Account at the end of the second leg of repo transaction
are transferred to Repo Interest Expenditure Account. In order to analyse the
balances in these accounts, the ledger entries are shown below:
Repo Price Adjustment account
Debit
Difference in price for the 1st
leg
Balance carried forward to
Repo Interest Expenditure
account
Credit
7.00 Difference in price for the
2nd leg
0.02
7.02
Total 7.02 Total 7.02
431

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
Repo Interest Adjustment account
Debit
Broken period interest for
the 2nd leg
Credit
5.2388 Broken period interest for
the 1st leg
Balance carried forward to
Repo Interest Expenditure
account
5.1435
0.0953
Total 5.2388 Total 5.2388
Repo Interest Expenditure Account
Debit
Balance from Repo
Interest Adjustment
account
Credit
0.0953 Balance from Repo Price
Adjustment account
Balance carried forward to
P & L a/c.
0.0200
0.0753
Total 0.0953 Total 0.0953
3. Accounting for buyer of the security
When the security is bought, it will bring its book value with it. Hence market
value is the book value of the security.
First leg Accounting
Debit
Reverse Repo Account 113.0000
Reverse Repo Interest Adjustment account 5.1435
Credit
Cash account 118.1435
432

Annexure – K
Second Leg Accounting
Debit
Cash account 118.2188
Reverse Repo Price Adjustment account
(Difference between the 1st and 2 nd leg
prices)
0.0200
Credit
Reverse Repo account 113.0000
Reverse Repo Interest Adjustment account 5.2388
The balances in respect of the Reverse Repo Interest Adjustment Account
and Reverse Repo Price adjustment account at the end of the second leg of
reverse repo in these accounts are transferred to Repo Interest Income
Account. In order to analyse the balances in these two accounts, the ledger
entries are shown below:
Reverse Repo Price Adjustment Account
Debit
Difference in price of 1st &
2nd leg
Credit
0.0200 Balance to Repo Interest
Income a/c.
0.0200
Total 0.0200 Total 0.0200
Reverse Repo Interest Adjustment Account
Debit
Broken period interest for
the 1st leg
Balance carried forward to
Repo Interest Income
Account
Credit
5.1435 Broken period interest for
the 2nd leg
0.0953
5.2388
Total 5.2388 Total 5.2388
433

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
Reverse Repo Interest Income Account
Debit
Difference between the 1st
& 2nd leg prices
Balance carried forward to
P & L account
Credit
0.0200 Balance from Reverse
Repo Interest Adjustment
account
0.0753
0.0953
Total 0.0953 Total 0.0953
4. Additional accounting entries to be passed on a Repo / Reverse
Repo transaction on a coupon bearing security, when the
accounting period is ending on an intervening day
Transaction Leg --- > 1st leg End of accounting
period
2nd leg
Dates --- > 19 Jan 03 21 Jan 03* 22 Jan 03
The difference in the clean price of the security between the first leg and the
second leg should be apportioned upto the Balance Sheet date and should
be shown as Repo Interest Income / Expenditure in the books of the seller /
buyer respectively and should be debited / credited as an income /
expenditure accrued but not due. The balances under Income / expenditure
accrued but not due should be taken to the balance sheet
The coupon accrued by the buyer should also be credited to the Repo
Interest Income account. No entries need to be passed on "Repo / Reverse
Repo price adjustment account and Repo / Reverse repo interest adjustment
account". The illustrative accounting entries are shown below:
a) Entries in Seller's books on January 21, 2003
Account Head Debit Credit
Repo Interest Income account
[Balances under the account to
be transferred to P & L]
Repo interest Income accrued
but not due
0.0133
0.0133 (Notional credit balance 0.0133
in the Repo Price Adjustment Account by
way of apportionment of price difference
for two days i.e. upto the balance sheet
day)
* January 21, 2003 is assumed to be the balance sheet date
434

Annexure – K
b) Entries in Seller's books on January 21, 2003
Account Head Debit Credit
Repo interest income 0.0133
P & L a/c 0.0133
(c) Entries in Buyer's Books on January 21, 2003
Account Head Debit Credit
Repo interest income accrued
but not due
0.0502
Repo Interest Income account
[Balances under the account to
be transferred to P & L]
0.0502 (Interest
accrued for 3 days of
Rs. 0.0635* -
Apportionment of the
difference in the clean
price of Rs. 0.0133)
* For the sake of simplicity the interest accrual has been considered for 2
days.
(d) Entries in Buyer's Books on January 21, 2003
Account Head Debit Credit
Repo interest income account 0.0502
P& L a/c 0.0502
The difference between the repo interest accrued by the seller and the buyer
is on account of the accrued interest forgone by the seller on the security
offered for repo.
435

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
B. Repo / Reverse Repo of Treasury Bill
1. Details of Repo on a Treasury Bill
Security offered under Repo
Price of the security offered under
Repo
GOI 91 day Treasury Bill
maturing on 28 February,
2003
Rs.96.0000 (1)
Date of the Repo 19 January, 2003
Repo interest rate 7.75%
Tenor of the repo
Total cash consideration for the first
leg
3 days
96.0000 (2)
Repo interest 0.0612 (3)
Price for the second leg (2)+(3) = 96.0000 +
0.0612 = 96.0612
Cash consideration for the 2nd leg 96.0612
2. Accounting for seller of the security
We assume that the security was held by the seller at the book value
(BV) of Rs.95.0000
First leg Accounting
Cash Repo Account
Debit
Credit
96.0000 95.0000 (Book value)
Repo Price adjustment account 1.0000 (Difference
between BV & repo
price )
436

Annexure – K
Second Leg Accounting
Repo Account
Repo Price adjustment account
95.0000
1.0612
(the difference
between the BV
and 2nd leg price)
Cash account 96.0612
The balances in respect of the Repo Price Adjustment Account at the
end of the second leg of repo transaction are transferred to Repo
Interest Expenditure Account. In order to analyse the balances in this
account, the ledger entries are shown:
Repo Price Adjustment account
Debit
Difference in price for
the 2nd leg
Credit
1.0612 Difference in price for
the 1st leg
Balance carried forward
to Repo Interest
Expenditure account
1.0000
0.0612
Total 1.0612 Total 1.0612
Repo Interest Expenditure Account
Debit
Balance from Repo
Price Adjustment
account
Credit
0.0612 Balance carried
forward to P & L a/c.
0.0612
Total 0.0612 Total 0.0612
The Seller will continue to accrue the discount at the original discount
rate during the period of the repo.
437

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
3. Accounting for buyer of the security
When the security is bought, it will bring its book value with it. Hence
market value is the book value of the security.
First leg Accounting:
Debit
Reverse Repo Account 96.0000
Credit
Cash account 96.0000
Second Leg Accounting
Debit
Cash account 96.0612
Repo Interest Income account
(Difference between the 1st and 2nd
leg prices)
Credit
0.0612
Reverse Repo account 96.0000
The Buyer will not accrue for the discount during the period of the repo.
4. Additional accounting entries to be passed on a Repo /
Reverse Repo transaction on a Treasury Bill, when the
accounting period is ending on an intervening day
Transaction Leg - 1st leg B/S date 2 nd leg
Date - 19 Jan.03 21 Jan.03* 22 Jan.03
* 21 January, 2003 is assumed to be the balance sheet date
(a) Entries in Seller's books on January 21, 2003
Account Head Debit Credit
Repo Interest Expenditure account
(after apportionment of repo interest
for two days) [ Balances under the
account to be transferred to P & L]
Repo interest expenditure accrued
but not due
0.0408
0.0408
438

Annexure – K
(b) Entries in Seller's books on January 21, 2003
Account Head Debit Credit
Repo interest expenditure account 0.0408
P & L a/c 0.0408
(c) Entries in Buyer's Books on January 21, 2003
Account Head Debit Credit
Repo interest income accrued but
not due
Repo Interest Income account
[Balances under the account to be
transferred to P & L]
0.0408
(d) Entries in Buyer's Books on January 21, 2003
0.0408
Account Head Debit Credit
Repo interest income account 0.0408
P & L a/c 0.0408
439

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
Appendix
List of Circulars consolidated by the Master Circular
No. Circular No. Date
1. DBOD.No.FSC.BC.69/C
.469- 90/91
2. DO.DBOD.No.FSC.46/C
.469- 91/92
3. DBOD.No.FSC.BC.143
A/24.48. 001/ 91-92
4. DBOD.No.FSC.BC.11/2
4.01.009/ 92-93
5. DBOD.No.FMC/BC/17/2
4.48.001. 92/93
6. DBOD.FMC.BC.62/27.0
2.001/ 92-93
7. DBOD.No.FMC.1095/27
.01.002/93
8. DBOD.No.FMC.BC.141/
27.02.006/ 93/94
Jan 18,
1991
July 26,
1991
June 20,
1992
July 30,
1992
Aug 19,
1992
Dec 31,
1992
April 15,
1993
July 19,
1993
Relevant
para no. of
the circular
Subject
1,2,4 Portfolio Management
on behalf of clients
4(i), (ii),
(iii), (iv),
(v), (iv)
3(I), 3(I)-
(ii)- (iii)-
(iv)- (v)-
(xi)- (xii)-
(xvi)-
(xvii),
3(II),
3(III),
3(V)- (i)-
(ii)- (iii),
(3) & (4)
Investment portfolio of
banks- Transaction in
securities
Investment portfolio of
banks- Transaction in
securities
3,4,5,6 Portfolio Management
on behalf of clients
2 Investment portfolio of
banks- Transaction in
securities
1 Investment portfolio of
banks- Transaction in
securities
1 &
enclosed
format
Annex
Investment portfolio of
banks- Reconciliation
of holdings
Investment portfolio of
banks- Transaction in
securities- Aggregate
contract limit for
individual brokers-
Clarifications
Para no.
of the
master
circular
1.3. 3
1.2 (i)
1.2 (ii),
(iii)
& (iv),
1.2.2,
1.2.3,
1.2.5,
1.2.6,
1.2.7
1.3.3
1.3.2
1.2.6
1.3.1 &
Annexure
VI
Annexure
II
440

Annexure – K
No. Circular No. Date
9 DBOD.No.FMC.BC.1/27
.02.001/ 93-94
10 DBOD.No.FMC.73/27.0
7.001/ 94-95
11. DBOD.No.FSC.BC.130/
24.76.002/ 94-95
12. DBOD.No.FSC.BC.129/
24.76.002/ 94-95
13. DBOD.No.FSC.BC.142/
24.76.002/ 94-95
14. DBOD.No.FSC.BC.70/2
4.76.002/ 95-96
15. DBOD.No.FSC.BC.71/2
4.76.001/ 96
16. DBOD.No.BC.153/24.76
.002/96
17. DBOD.BP.BC.9/21.04.0
48/98
18. DBOD.BP.BC.32/21.04.
048/97
19. DBOD.FSC.BC.129/24.
76.002-97
20. DBOD.No.BC.112/24.76
.002/1997
Jan 10,
1994
June 7,
1994
Nov 15,
1994
Nov 16,
1994
Dec 9,
1994
June 8,
1996
June 11,
1996
Nov 29,
1996
29 Jan
1997
April 12,
1997
Oct 22,
1997
Oct 14,
1997
Relevant
para no. of
the circular
Subject
1 Investment portfolio of
banks- Transaction in
securities- Bouncing
of SGL transfer forms-
Penalties to be
imposed.
1,2 Acceptance of
deposits under
Portfolio Management
Scheme
1 Investment portfolio of
banks- Transaction in
securities-Bank
Receipts (BRs)
2 & 3 Investment portfolio of
banks- Transaction in
securities-Role of
brokers
Para no.
of the
master
circular
1.2.2
1.3.3
1.2.3
1.2.6
1& 2 Do 1.2.6
2 Retailing of
Government
Securities
1 Investment portfolio of
banks- Transaction in
securities
1.2.4
1.2.2
1 Do 1.2.6
3 Prudential norms -
capital adequacy,
income recognition,
asset classification
and provisioning.
5.1 (iii) &
(iv)
1&2 Do 5.1 (i)
&(ii)
1 Retailing of
Government
Securities
1 Investment portfolio of
banks- Transaction in
securities-Role of
1.2.4
1.2.6
441

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
No. Circular No. Date
21. DBOD.BP.BC.75/21.04.
048/98
22. DBS.CO.FMC.BC.1/22.
53.014/98-99
23. DBS.CO.FMC.BC.18/22
.53.014/ 99-2000
24. DBOD.No.FSC.BC.26/2
4.76.002/ 2000
25. DBOD.BP.BC.32/21.04.
048/ 2000-01
26 DBOD.FSC.BC.No.39/2
4.76.002/ 2000
27. Dir.BC.107/13.03.00/20
00-01
28. DBOD.BP.BC.119/21.04
.137/ 2000-2001
29. DBOD.BP.BC.127/21.04
.048/ 2000- 01
30. DBOD.BP.BC.61/21.04.
048/ 2001-02
4 Aug
1998
July 7,
1999
Oct 28,
1999
Oct 6,
2000
Oct 16,
2000
Oct 25,
2000
April 19,
2001
May 11,
2001
June 7,
2001
Jan 25,
2002
Relevant
para no. of
the circular
All
Subject
brokers
Acquisition of
Government and other
approved securities -
Broken Period
Interest, - Accounting
Procedure
1 Investment portfolio of
banks – Transactions
in securities
2, 3, 4 &
5
Para no.
of the
master
circular
5.2
1.3.1(i)
Do 1.2.2
2 Sale of Government
securities allotted in
the auctions for
Primary issues
All
<strong>Guide</strong>lines on
classification and
valuation of
investments.
1 Investment portfolio of
banks- Transaction in
securities-Role of
brokers
6 Monetary and Credit
Policy for the year
2000-
2002 - Interest
Rate Policy
Annex - 5
&12
All
All
Bank financing of
equities and
investments in shares
- Revised guidelines
Non- SLR Investments
of Banks
<strong>Guide</strong>lines for
investments by
banks/Fis and
<strong>Guide</strong>lines for
financing of
1.2(i)(b)
2 & 3
1.2.6
5.3
1.2, 1.2.5
1.3, 1.3.1
1.2.8
Annexure
III
1.2.8 (iv)
442

Annexure – K
No. Circular No. Date
31. DBOD.No.FSC.BC.113/
24.76.002/ 2001-
02
32. DBS.CO.FMC.BC.7/22.
53.014/ 2002-03
33. DBOD.No.FSC.BC.90/2
4.76.002/ 2002-03
34. IDMC.3810/11.08.10/20
02-03
35. DBOD.BP.BC.44/21.04.
141/03-04
36. DBOD.BP.BC.53/21.04.
141/03-04
37. DBOD.FSC.BC.59/24.7
6.002 /03-04
38 IDMD.PDRS.05/10.02.0
1/ 2003-04
39. IDMD.PDRS/4777/10.02
.01/ 2004-05
40. IDMD.PDRS/4779/10.02
.01/ 2004-05
June 7
2002
Nov 7,
2002
March 31
2003
March 24
2003
Nov 12,
2003
Dec 10,
2003
Dec 26,
2003
Mar 29,
2004
May 11,
2005
May 11,
2005
Relevant
para no. of
the circular
All
Para 2
All
All
All
Subject
restructured accounts
by banks/FIs
On Investment
Portfolio of Banks
Transaction in Govt.
Securities
Operation of
investment
portfolio by bankssubmission
of
concurrent audit
reports by banks
Ready Forward
Contracts
<strong>Guide</strong>lines for uniform
accounting for Repo /
Reverse
Repo transactions
Prudential guidelines
on banks' investment
in non-SLR securities
Para no.
of the
master
circular
1.3.4
1.2.7(c)
1.2.1(i),
(ii) and
(iii)
4, Annexure
VII &
Annexure
VIII
1.2.8
Annexure
IV, V
All do 1.2.8
All
3, 4, 6 &
7
Sale of Government
securities allotted in
the auctions for
primary issues on the
same day
Transactions in
Government
Securities
3 Sale of securities
allotted in primary
issues
2,3,4,5 Ready forward
contracts
Annexure
I C
1.2(i) (a)
1.2(i) (b)
1.2.1 (b),
1.2.1 (c)
443

<strong>Technical</strong> <strong>Guide</strong> on Internal Audit of Treasury Function in Banks
No. Circular No. Date
41. IDMD.PDRS/4783/10.02
.01/ 2004-05
42. DBOD.FSC.BC.28/24.7
6.002/ 2004-05
43. DBOD.BP.BC.
29/21.04.141/ 2004-05
44. DBOD.Dir.BC.32/13.07.
05/ 2004-05
45. DBOD.BP.BC.37/21.04.
141/ 2004-05
46. DBOD.FSD.BC.No.31/2
4.76.002/ 2005-06
47. DBOD.BP.BC.38/21.04.
141/ 2005-06
48. IDMD.No.03/11.01.01(B
)/2005-06
49. IDMD.No.3426
/11.01.01 (D)/ 2005-06
50 DBOD.No.BP.BC.27/21.
01.002/2006-07
51 IDMD.No.2130/11.01.01
(D)/2006-07
52 DBOD.No.FSD.BC.46/2
4.01.028/2006-07
May 11,
2005
Aug 12,
2004
Aug 13,
2004
Aug 17,
2004
Sep 2,
2004
Sep 1,
2005
Oct 10,
2005
Feb 28,
2006
May 3,
2006
Aug 23,
2006
Nov 16,
2006
Dec 12,
2006
Relevant
para no. of
the circular
Subject
3 Government securities
transactions - T+1
settlement
2 Transactions in
Government securities
2(b) of
Annex
Prudential norms -
State Government
guaranteed exposures
2 Dematerialisation of
banks' investment in
equity
1(i) & (ii)
Prudential norms on
classification of
investment
portfolio of banks
2, 3 NDS-OM -
Counterparty
Confirmation
All
Capital Adequacy
- Investment
Fluctuation Reserve
2,3,4,5 Secondary Market
transactions in
Government
Securities- Intra day
short selling
All
'When Issued'
transactions in Central
Government
Securities'
2, 4 Prudential guidelines
– Bank’s investments
in VCF
All
16B(ii)
When Issued
transactions in Central
Government
Securities
Financial Regulation
of Systemically
Important NBFCs and
Bank’s Relationship
Para no.
of the
master
circular
1.2(i) (c)
1.2(i)(a)
3.5.2
5.3
2.1 (ii) &
(iii)
1.2.5 (i)
(c)
3.4
1.2 (i) (a)
1.2 (i) (a)
3.9
1.2(i)(a)
1.3.3(i)
444

Annexure – K
No. Circular No. Date
53 IDMD.No.
/11.01.01(B)/2006-07
Jan 31,
2007
54 Mailbox Clarification July 11,
2007
55 DBOD.No.BP.BC.56/21.
04.141/2007-08
56. DBOD.No.BP.BC.86/21.
04.141/2007-08
December
6, 2007
May 22,
2008
57. Mailbox Clarification February
6,2009
58. Mailbox Clarification February
5,2009
59. Mailbox Clarification March
16,2009
60. Mailbox Clarification February
11,2009
Relevant
para no. of
the circular
All
Subject
with them
Secondary Market
transactions in
Government
Securities- Short
selling
Para no.
of the
master
circular
1.2.(i)a
All HTM Securities 3.1.(i)
All
Limits on investment
in unrated Non-SLR
securitiesinfrastructure
bonds
1.2.7
All Valuation of securities 3.7.1
All Non-SLR Securities 1.2.12
All
All
All
Unlisted Non-SLR
Securities
Classification of
Securities
Investment
Portfolio of Banks
1.2.13
3.2
Annexure
1(c )(i)
445