Home Banking Navigating Through the Known and Unknown Vulnerabilities of Treasury Management

Navigating Through the Known and Unknown Vulnerabilities of Treasury Management

by internationalbanker

By Manoj Reddy, Head of BFSI Risk & Treasury Practice, TATA Consultancy Services (TCS)





The banking and financial-services industry was largely fortified and stabilized in the last decade on the back of a slew of regulations implemented following the Global Financial Crisis (GFC) of 2008—until recently, when market and customer confidences were abraded following the collapses of some major global financial institutions. Geopolitical dynamics, inflationary pressures, rising-rate environments and transition risks posed by the adoption of the climate agenda have all created an unprecedented situation that will require banks and financial institutions (FIs) to re-look at how they fund themselves, deploy these funds, manage their investments and ensure adequate liquidity to ward off unforeseen challenges while remaining stable, competitive and profitable.

What are the known and unknown vulnerabilities?

Treasury management, which has been progressively elevated from being a facilitating function to a strategic business unit within banks and FIs, now finds itself in the eye of the storm in this current period of financial uncertainty but is expected to navigate through the known and unknown vulnerabilities to build a more robust and resilient financial system.

Governance and oversight (risk-appetite statement): Although most financial institutions have an ALCO (asset-liability committee) and specific risk committees in place, which monitor most of the key treasury and liquidity-specific metrics used, such as net interest income (NII) sensitivity, earnings at risk (EaR) or economic value of equity (EVE), some of these key metrics may not be monitored by the board as they may not be called out in the risk-appetite statement of the institution—especially the longer-term measures such as EVE, which can have a significant bearing on the investment strategy and portfolio mix in the medium to long term.

Recommendation: Have a comprehensive and clearly articulated risk-appetite statement that emphasizes not only the types or levels of risks but also the specific metrics that would help objectively monitor the pertinent material risks in not just the short and medium-term metrics, such as NII or EaR, but also the longer-term measures, such as EVE, for the safety and soundness of the institution.

Lags in investment management: Investment management in most larger banks and FIs might be supported by robust systems and analytical frameworks, but the smaller Tier 2 institutions may still have manually intensive investment-management functions through which coupon and interest payments, valuations and profitability are manually computed, grossly limiting their ability to derive timely insights on the performances and vulnerabilities of current investments in order to review their investment strategies dynamically and revise them if needed. Even in larger institutions, there may be lags in discovering interest-rate trends or patterns and subsequently communicating them to the investment-management function, which could not only lead to declines in investment values but also mean missing out on gains on short-term arbitrage opportunities that may exist in the markets.

Recommendation: Smaller institutions must completely automate and systemize their investment books of records, ideally on their integrated treasury management systems (TMSs). Larger institutions, on the other hand, should consider building alerts, notifications and workflow capabilities between balance sheets and fund-transfer pricing systems over to investment-management functions to communicate market-related insights and progressive trends on a real-time basis, making investment management as dynamic as possible.

Hedge management of tactical solutions: Most banks and FIs, irrespective of their sizes, will have hedge-management processes in place to mitigate their primary financial risks, largely emanating from interest rates and forex (foreign exchange) exposures. However, challenges exist in documenting this hedge-management strategy and automating the designation and retrieval of hedging and hedged positions. Also, hedge-effectiveness tests are still foundational, with not all institutions having factored in this prospective testing method but instead still relying largely on retrospective means. To compound the overall problem further, the overall hedge management is managed manually or through business-managed applications, making it not fully traceable and auditable.

Recommendation: It is recommended that overall hedge management be implemented on a robust treasury management system to enable broader frameworks for testing, including the ability to document the hedging strategy, cover the dimensions of both qualitative and quantitative testing in addition to prospective and retrospective testing, and enable traceability and auditability for regulatory disclosure and accounting purposes.

Limited regulatory oversight over smaller regional and community banks: Although the industry has witnessed several regulatory reforms aimed at ensuring adequate liquidity (LCR, or liquidity coverage ratio) and stability in funding (NSFR, or net stable funding ratio) in the financial system, these regulations at this point are primarily mandated for global and large national banks. Also, the Basel (Basel Committee on Banking Supervision, or BCBS) regulation BCBS–368 (IRRBB, or interest rate risk in the banking book) has again been mandated only for large global banks, with some national regulators issuing guidance only on managing interest-rate risk as opposed to mandating regulations with disclosures of key metrics such as NII and EVE. This has meant that there has been little regulatory oversight and few disclosures for smaller banks in the context of liquidity and interest-rate risk management, making them vulnerable to the intricacies of an uncertain interest-rate environment.

Recommendation: Although regulators are considering extending liquidity and interest-rate regulations to smaller banks, these banks should compute these regulatory metrics on liquidity and interest rates at their own behest, maybe with lower frequencies and granularity, and include them in their internal-governance frameworks and management reports to remain safe and sound.

Federated, manually intensive and aging treasury infrastructure: Integrated treasury management is largely a work in progress for most banks and financial institutions, as the application landscape is federated across balance-sheet management, interest-rate risk management, investment management, cash and liquidity management, and overall hedging and trade management. In larger financial institutions, although robust applications and systems are in place for each of the core clusters of processes, these processes are often not integrated seamlessly and can have a bearing and impact on aspirations of attaining the state of dynamic treasury management. For instance, the interest-rate gaps identified in an ALM (asset liability management) system need to be tactically carried over to trade-management systems to be able to take the required interest-rate swap positions, then subsequently measured in a hedge-analytics system for its effectiveness, a collateral-management system for margin needs and, finally, payment and settlement systems—making the process federated and prone to errors due to the process of manually compiling and stitching together information across key systems.

Recommendation: At this point, there may not be any end-to-end treasury-management solution in the industry that can cover everything a treasury function needs. Hence, it is advisable to build governance frameworks and workflow capabilities that capture the key metrics and outcomes and call for action from one key system to another. This will make the overall process auditable, transparent and nimble to derive timely insights and alerts, maximizing returns and avoiding potential losses. Also, it is highly recommended that treasury teams have enterprise-level, integrated treasury dashboards and view metrics across interest-rate risk, liquidity risk, capital management and investment management to draw cross-functional insights and inferences for enhanced decision-making capabilities.

Implementation of contingency funding plans: Contingency funding plans (CFPs) are expected to be the lifelines for organizations in deep liquidity crises; to be fair, most banks and FIs have CFPs that can be activated in theory based on a few quantitative limits being breached. The issue, however, within some institutions could be around their CFPs not being adequately tested for them to be operational in actual liquidity crises. Some institutions with fairly stable funding sources may not necessarily test their capacities to borrow or ensure they have the appropriate collateral and operational arrangements to obtain liquidity in times of crisis.

Recommendation: Banks and FIs should test their CFPs frequently to ensure they have practical applications beyond their theoretical constructs. Also, to remediate the rapid effects of negative news on institutions’ creditworthiness and robustness, as seen in the recent past, institutions should incorporate a few qualitative triggers through negative news screenings from unstructured data to augment the quantitative measures that trigger the activation of a contingency funding plan.

Inadequate model governance: Non-contractual cash flows are forecasted based on behavioral models for deposit run-offs, utilization of committed lines of credit and other contingent liabilities. These models’ accuracy is critical to forecasting correctly liquidity and cash positions. However, given that model-risk management is more of a regulatory guidance and control measure than a specific mandated regulation in itself, there could be inadequate model governance across the board, including treasury models. Incorrect modeling assumptions and insufficient model validation can hamper the effectiveness of liquidity monitoring and overall balance-sheet management.

Recommendation: Irrespective of the maturity of their model-risk frameworks, the treasury teams of banks and FIs should work toward operationalizing model governance for key treasury models and, at the least, conduct back-testing to ensure there are rudimentary levels of model governance and validation in place.

Stress testing is not deep and rigorous enough: Globally, regulators have mandated that internal liquidity stress testing (LST) frameworks be implemented to enable the holding of liquidity buffers to confront unanticipated liquidity crunches and tightening. The challenge, however, is that the scenarios are sometimes largely standardized, with inadequate coverage of idiosyncratic risks specifically posed by concentration in a specific customer base, industry type or financial instrument. This can lead to inaccurate assessments, resulting in inadequate liquidity buffers.

Recommendation: Treasury teams should engage with the lines of businesses to understand the underlying risks, such as concentration risks or strategic and business risks, and factor these into their scenario-design processes to make stress testing as practical and effective as possible. Additionally, even though there is no regulatory mandate to include stress testing for managing interest-rate risks, banks and FIs should explore the possibility of augmenting their liquidity stress tests with a few interest-rate risk scenarios (combinations of shocks, ramps and shifts) to create truly integrated treasury stress-testing frameworks.


The current financial crisis has exposed several vulnerabilities in the financial industry attributable to treasury and liquidity management. Some regulatory remediations and actions are anticipated. But irrespective of those, treasury teams would be well advised to conduct business-driven and holistic due diligence on their overall treasury frameworks to assess their resilience to adverse business impacts from an uncertain interest-rate environment, geopolitical developments and increasing rigor in regulatory mandates.



Manoj Reddy is the Head of BFSI (Banking, Financial Services and Insurance) Risk and Treasury Practice at TATA Consultancy Services (TCS), with more than 20 years of experience in the areas of risk, finance and treasury, business consulting and solution design in the banking and financial-services industry. Reddy has led several risk and regulatory consulting and implementation engagements for financial firms globally.


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