Q1. Role of Commercial Banks in the Financial System (Page 11)

TREASURY MANAGEMENT NOV 2012

MODEL SOLUTIONS

SECTION A

Q1. Role of commercial banks in the financial system (page 11)

Article Format: Essay

Written by: XXX YYY, chief dealer, GBH House

Define a commercial bank

· It is an institution that accepts deposits, makes business loans and offer related services such as electronic payments, custodial services, etc.

Roles of commercial banks

i. Issue of money, in the form of banknotes and current accounts subject to cheque or payment at the customers’ order.

ii. Netting and settlement of payments – banks act as both collection and paying agents for customers, participating in the interbank and settlement systems to collect, present, be presented with, and pay payment instruments.

iii. Credit intermediation – banks borrow and lend back-to-back on their own account as middle men.

iv. Credit quality improvement – banks lend money to ordinary commercial and personal borrowers (ordinary credit quality) but are high quality borrowers, due to diversification of bank assets and capital.

v. Maturity transformation – banks borrow more on demand debt and short term debt, but provide more long term loans.

vi. Money creation – whenever a bank gives out a loan in a fractional reserve banking system, a new sum of virtual money is created.

vii. Banks are also important for corporate governance, particularly in countries like Germany where bankers sit on boards and control a significant number of proxy votes.

viii. Underwriting securities. A process that a large financial service provider (bank) uses to assess the eligibility of a customer to receive their products. Ex FMB were underwriters of TNM shares for their IPO.

ix. Custodial services of valuable items, such as certificates, etc.

Q2. (a) seven elements that can be found in a trading policy document (page 208)

· Delegation of duty

· Delegation of dealing limits

· Authorised currencies and countries

· Positions, mismatched daylight and overnight also covering positions

· Counterparty dealings

· Client dealings

· Derivative dealings, authority constraints

· Spot and forward dealings

· Operational policy

· Reporting discrepancies/ adverse positions

(b) Eight fundamental principles that members of the Banking council undertake to uphold as stipulated by the code of banking practice (page 212)

· Fairly and reasonably in all our dealings

· Unsure that all services and products comply to the code

· Give information on services and products in paling language

· Help clients to choose a service or product to fit his needs

· Help client understand the basic financial implications of products

· Help client understand how his account works

· Ensure that the procedures staff follow reflect commitment set in the code

· Correct errors and handle complaints speedily

· Take care to understand client’s financial difficulties and mortgage arrears when approached

· Ensure that all services and products comply with relevant laws and regulations

· Act with compromising integrity and fairness so as to promote complete trust and confidence in the company, individuals and industry.

· Ensure products and services are based and applied on commercial principles and criteria without any discrimination

· Only charge interest on the money being owed.

Q3. Defining financial terms

i. OMO – open market operations entails the buying and selling of government securities by the reserve bank in the open market at the bank’s discretion in order to influence conditions in the money market or level and pattern of interest rates. (page 119)

ii. Negotiable Certificate of deposit – a fixed deposit receipt issued by a bank that is negotiable in the secondary money market as a financial asset. The issuer undertakes to pay the amount deposited plus interest to the holder of the certificate on maturity date. (page 102)

iii. Promissory notes – unconditional promise in writing made by one person to another, signed by the maker, and engaging to pay on demand or at a fixed or determinable future time, a sum certain in money to a specified person or his order, to a bearer. (page 114)

iv. Commercial paper – promissory notes with specified maturity and usually large amounts, issued by reputable corporate enterprises in order to obtain short term financing, usually for periods of up to three months. Amounts and periods are negotiated between the parties. (page 114)

v. Repurchase Agreement – is a sale of securities with an undertaking by the seller to repurchase the same securities after a stipulated period of time at a prior yield determined at the time of the sale. The essence of a repurchase agreement is to adjust the original maturity of a particular money market asset to suit needs of an investor. (page 104)

Q4. (a) (i) JPY100,000 to MWK

Rate = 163.6180/76.99

= 2.1252

MWK = 2.1252 X 100,000

= MWK212,520.00

(ii) GPY7,452 to MWK

Rate = 163.6180 X 1.5403

= 252.0208

MWK = 252.0208 X 7,452

= MWK1,878,059.00

(iii) CHF79,587 to MWK

Rate = 163.6180/0.9569

= 170.9876

MWK = 170.9876 X 79,587

= MWK13,608,390.12

(b) AUD600,000

(i) A third of it to CHF

Rate = 0.9807/0.9569

= 1.0249

CHF = 1/3 X 600,000 / 1.0249

= CHF195,140.99

(ii) The rest into JPY

Rate = 0.9807/76.9900

= 0.0127

JPY = 2/3 X 600,000 / 0.0127

= JPY31,496,062.99

SECTION B

Q5. Report to the CEO

(i) Factors that have caused the rise of the treasury function since 1960 (page 14)

· Financial, commodity and other markets experienced expanded international involvement due to globalization.

· New markets for companies being found outside the domicile markets that have brought in a multitude of risks.

· The move towards better corporate governance by companies to embrace enterprise wide risk management or cross corporate risk management

(ii) Two models that treasury function can operate (page 20)

Centralized treasury – where treasury activities, services provision, transaction execution and risk management are controlled and handled from a single central location or regionally centralized basis.

Decentralized treasury – groups or subsidiaries of treasury are allowed considerable strategic and operating responsibility to achieve their management goals.

(iii) Cost centre and profit centre (page 28)

A cost centre is treasury unit that typically eliminates risks as soon as they are identified. The operations do not generate profits for treasury function itself but on behalf of the other businesses within the enterprise and the costs of treasury are shared by those business operations

A profit centre treasury operates to produce profits from its treasury activities. Treasury charges individual business units a market rate for the services provided

(iv) Recommendation – cost centre is recommended as the costs are reflected in the books of the business unit. (page 30)

Q6.

(a) Five main functions of the Reserve Bank of Malawi – explain (page 116)

· Government’s banker

· Banker of other banks

· Custodian of banks’ cash reserves

· Clearance and settlement of inter-institutional claims

· Provision of accommodation and lender of last resort

· Open market operations

· Monetary policy and exchange rate policy

· Supervision of banks

(b) Distinguishing between market makers and brokers (page 89)

Market makers – institutions that are prepared to quote buying and selling prices simultaneously for certain securities and are prepared to deal in reasonable volumes. Example – any bank that trade in securities

Brokers – act on behalf of other financial market participants in return for a commission and as such cannot be regarded as financial intermediaries. Example - discount houses.

Money markets

· Interest rates are short term, up to one year

· RBM directly controls the interest rates

· Example – treasury bills

Capital markets

· Interest rates are long term

· It is a free market in which nobody interferes or sets the interests

· Example – mortgages

Q7. Notes for the meeting with banks’ representatives

(a) Functions of the Bank supervision Department at RBM – four functions (page 158)

· The licensing of banks

· The propagation of laws and amendments to current acts

· The prudential supervision of banks

· Adaptation of supervision standards to meet international benchmarks and best practices.

(b) The extent of supervision, inter alia (page 158)

· The establishment of certain capital and liquidity requirements

· Continuous monitoring of the institutions’ adherence to these legal requirements and other guidelines

· Measurements of individual institutions are done on an ongoing basis against the developments in the relevant sector as a whole.

· Appointment of inspectors to inspect affairs of any bank or institution that is deemed to be carrying out a business of banking

· Supervision and control over the activities of the non-banking financial services.

· Advisory capacity to Minister of Finance

· Control over insider trading

· Supervision of various fuel levies such as National Roads Authority Fund, etc.

· Investigate non-banking financial institutions whose conducts appear to transgress the law.

Q8. The dealing room appraisal - notes

(a) The forex market – describing the market behavior in the appraisal period

· Compressed margins on the spread due to a certain RBM directive

· Clients (FCDA holders) holding forex due to speculations of devaluation

· Poor tobacco sales affecting availability of forex

· Donors withholding funds

· Increased demand for imports payments

(b) Six other functions that the dealing room ably performed (page 42)

· Striking other foreign exchange deals like forward contracts and options

· Day to day liquidity management

· Tracking payment inflows and outflows

· Monitoring the balances periodically

· Ensuring compliance to LRR

· Borrowing short term funds on the interbank and lending if long

· Investing surplus funds in treasury bills

· Managing the investment profile to ensure that there are no mismatches

· Growing the investment profile in local currency, as well as depositing customers’ FCDA funds with other international financial institutions

· Traded and dealt in the best interest of the bank

· Complied to internal policies and procedures, statutory regulations, exchange control and RBM policies

· Maintained all the confidentiality required

· Deals requested outside the market rates were reported to management

· Bribes and unethical requests were not entertained

· Prices quoted were always fair and market related as well as competitive

· Problems experienced with counterparties and clients were recorded and reported to management

· All the dealers adhered to limits and authorizations

· All operational aspects were diligently and timorously performed

· The dealing team performed in accordance to Code of Banking practice

· Marketing, selling actions and explanations with regard to our services were done in plain language.

· All disciplinary measures were implemented with strict compliance view and in harmony with the Labour Act.