Bank Treasury Management: ALCO, Capital Risk, Securitization, Interest Rate Hedging

Part A

Answer ALL three (3) questions in Part A

The Asset Liability Committee (ALCO) guides treasury management function in any bank. The committee plays an important role in the functioning of the Treasury Department. Discuss in detail the make-up, functions and the role of ALCO in managing banks’ assets and liabilities. (20 Marks) 

Severe financial crises results in systemic risks in banking and financial markets which highlights the importance of the banking sector to maintain sufficiently high level of risk-based capital to withstand financial losses.

(i) Why capital risk management is one of the main concerns for treasury management?

(ii) Is capital risk isolated from other risks? Explain based on any financial crisis.

(iii) What are the components of Tier 2 capital under Basel 3 guidelines?  

Financial institutions face a variety of risks and one method employed to manage these risks is by securitizing assets. In this context explain the following.

Define securitization and state the type of assets that are used in the process.

Illustrate in detail the process of securitization of assets.

Explain the advantages and benefits of securitization to financial institutions.

Answer ALL three (3) questions in Part B

The assets and liabilities structure of Greezy Bank as at 30^th June is presented in Table 1 below:

Table 1: Asset and Liability Structure

Based on the data provided in Table, 1, answer the following questions:

What is the weighted average duration of the assets and liabilities of Greezy Bank as at 30thJune?                                                          
What is the leverage adjusted duration gap of Greezy Bank?

What is the expected net interest income for Greezy Bank for the period ending 30thJune?                                                                                                                  
What would be the change in the Economic value of Equity of Greezy Bank’s as at 30thJune if interest rates were to fall by 1%?

What is your inference on the duration gap and EVE of Greezy Bank during these periods?                                                                                

Make-up, functions and role of ALCO in banks' asset and liability management

From the results obtained in (b) in what way can you immunize the portfolio?

The loan growth of a Bank is outpacing its deposit growth and the bank is facing a liquidity shortage to fund its loan activities. The loan and deposit position as at 31/12/2019 is as in Table 2 below. The Asset Liability Committee of this Bank has directed the Treasury Department to come up with a mechanism to encourage the branches to solicit deposits to meet loan demand and to measure the branches fairly. Currently the loan branches are using the deposits without compensating the deposit branches. This Bank is organized along the lines of only deposit and loan branches each conducting only one particular activity.

Table 2: The loan and deposit data for the Bank as at 31/12/2019 are as follows

Using the data provided above, calculate the net revenue and loss of the loan and deposit branches without the intervention of the Treasury Department?

Construct a charge/reward mechanism based on the data provided above, if Treasury Department of this Bank decides to buy all deposits at 4.5 percent per annum and sells funds to branches for loan activities at 5.5 percent per annum.

Explain how the mechanism implemented by the Treasury Department would assist in meeting the direction given by ALCO?

Its end of September now and Middleton Bank’s Commercial Deposits (CD) would be maturing in three months and intends to issue a 180 - day banker accepted bills amounting to AUD150 million.  Middleton Bank decides to use 180 - day futures contract to hedge against the interest rate exposure. The futures contract is currently trading at 93.60. Current rate quoted is 6.1% per annum. Six months later in March when the bank closes out its futures position, the contract is trading at 92.80 and the bank issues banker accepted bills at a rate of 7.30% per annum.  (Contract size = AUD 1,000,000/contract.)

State four (4) distinguishing features of a Futures Trading exchangeas opposed to a trade Over the Counter (OTC)? (4 Marks)

Determine the number of banker accepted bill future contracts to transact in this hedging process and indicate which position to take in the futures market. (2 Marks)

Show the strategies taken by the manager to hedge the interest rate exposure and  calculate the effective the interest cost to the bank on this short-term debt (show all calculations). (4 Marks)

Is this a perfect hedge? Why? (2 Marks)