Treasury Management

False. The statutory liquidity ratio is the minimum, not the maximum, proportion of liquid assets that a bank must hold against its liabilities, as required by the regulator.

False. Diversifying the loan portfolio reduces unsystematic (specific or concentration) risk. Systematic (market-wide) risk cannot be removed by diversification.

True. Competing through gifts, free services and other non-price benefits instead of interest rates leads to inefficient use of resources, because deposit funds are not priced by their real cost and so are not allocated to their best use.

False. A positive duration gap means the duration of assets exceeds the duration of liabilities (adjusted for leverage). When interest rates rise, assets fall in value by more than liabilities, so the market value of equity decreases. Equity rises with rising rates only if the gap is negative.

$\Delta E\approx -DGAP\times A\times\frac{\Delta i}{1+i}$

False. Effective risk management identifies, measures, monitors and controls risk, so it can reduce both the probability of threats occurring and their impact. Risk can never be eliminated completely.

True. A positive mismatch means liabilities are longer in maturity than the assets they fund, giving a liquidity surplus (excess funds) rather than a funding shortfall.

The Asset Liability Management Committee (ALCO) is a senior committee of the bank, usually headed by the CEO and including heads of treasury, credit, finance, risk, operations and business, which is responsible for overseeing the bank's ALM and balance-sheet risks.

Roles and responsibilities

• Review and approve ALM policy, limits and risk appetite for liquidity, interest rate and exchange rate risk.
• Monitor the liquidity position, gaps and the maturity profile of assets and liabilities.
• Decide the pricing of loans and deposits (interest rate and spread policy).
• Review interest rate risk, net interest margin and the effect of rate changes.
• Decide funding strategy and the use of surplus funds, including investment policy.
• Review foreign exchange exposure and open positions.
• Ensure compliance with NRB regulatory ratios (CRR, SLR, LCR, NSFR, CCD).
• Approve contingency funding plans and stress tests.
• Review the balance-sheet structure and projections, and report to the board.
• Meet regularly (monthly or more often) and record decisions.

False. Treasury invests mainly in safe, liquid assets such as government securities and treasury bills, because the bank must protect depositors' money and maintain liquidity. Risky assets are limited by regulation and risk policy, so profit is sought within acceptable risk.

True. The front office (dealers and traders) takes positions in the market and monitors the open currency (foreign exchange) position, so that exposure stays within the set limits.

False. A revolving (rolling or recurring) deposit is not a traditional savings deposit. Traditional savings deposits are ordinary savings accounts with free deposit and withdrawal, while revolving deposits are a special, structured product.

False. Interbank borrowing is short-term (often overnight) borrowing from other banks, not long-term funds from the central bank.

True. An overdraft is a revolving short-term facility, which the account holder can draw and repay within a limit, and it is normally reviewed and renewed each year.

True. If interest rates are expected to fall, longer-duration assets gain more in value and keep earning the higher locked-in rate, while shorter-duration liabilities reprice downward quickly, so the funding cost falls. This widens the margin and gives a profit from the decline.

False. The Asset-Liability Committee (ALCO) manages the balance sheet, liquidity and interest rate and other market risks in the bank. It is not called "surplus management".

The treasury department manages the bank's funds, liquidity and market risks. Its main roles and functions are:

1. Liquidity management: ensures the bank can meet deposit withdrawals and obligations, and maintains CRR and SLR with the central bank.
2. Funding management: raises funds from the interbank market, deposits and borrowings at the lowest cost.
3. Investment management: invests surplus funds in government securities, treasury bills and other safe instruments to earn income.
4. Foreign exchange management: buys and sells currencies, manages the open position and serves customers' forex needs.
5. Asset-liability and market risk management: manages interest rate, exchange rate and liquidity risk, with ALCO.
6. Money market and capital market dealing: trades in call money, repos, bonds and similar instruments.
7. Internal fund transfer pricing and profit support: transfers funds between business units and contributes to profit.
8. Compliance and reporting: follows central bank rules and reports positions to management and the regulator.

The two are kept separate (with a middle office for risk monitoring) so that no person can both conduct and conceal a deal, which reduces fraud and error.

Liquidity risk is the risk that a bank will not be able to meet its payment obligations (withdrawals, loan commitments, settlements) when they fall due without incurring unacceptable losses, because of a shortage of cash or liquid assets, or inability to raise funds at a reasonable cost.

Mitigating liquidity risk

1. Hold adequate liquid assets (cash, balances with the central bank, treasury bills) and keep CRR and SLR.
2. Keep a diversified and stable deposit base, reducing dependence on a few large depositors or volatile funds.
3. Match the maturities of assets and liabilities, and monitor gaps through a maturity ladder (gap analysis).
4. Arrange standby lines of credit, interbank borrowing limits, repo facilities and access to the central bank's standing facility.
5. Set limits on liquidity ratios (such as loan-to-deposit and liquidity coverage ratios) and monitor them regularly.
6. Prepare a contingency funding plan and run stress tests.
7. Form an ALCO to review liquidity regularly.

Loan pricing means setting the interest rate and fees on loans. It has a direct effect on profit and goodwill.

Profitability

• The loan rate must cover the cost of funds, operating costs, the risk premium (expected loss from defaults) and a target profit margin. If it is too low, income falls and the bank may lose money. If it is too high, good borrowers go to competitors, volume falls and only risky borrowers remain (adverse selection).
• Correct risk-based pricing increases the net interest margin and return on assets.
• Loans are the main earning asset, so small changes in pricing change total income considerably.

Goodwill

• Fair, transparent and competitive pricing builds trust and a good image, leading to customer loyalty and referrals.
• Unreasonably high rates or hidden charges harm reputation and invite regulatory attention.

Therefore pricing must balance profit, competition, risk and customer relationships, and this is why the statement is correct.

Nepal Rastra Bank (NRB) regulates asset-liability management and treasury through its directives to banks and financial institutions. The main requirements are:

• Cash reserve ratio (CRR): a minimum percentage of deposit liabilities must be held as balance with NRB.
• Statutory liquidity ratio (SLR): a minimum percentage of liabilities must be held in liquid assets such as cash, balances with NRB and government securities.
• Capital adequacy: minimum core and total capital against risk-weighted assets (Basel framework).
• Credit-deposit and investment limits: limits on the credit to core capital plus deposit ratio, sectoral and single-obligor limits, and a spread-rate limit.
• Foreign exchange exposure limits: limits on the open foreign currency position.
• ALCO and policies: banks must form an ALCO and have approved liquidity, investment and risk-management policies, with regular reporting of liquidity and maturity gaps.
• Reporting and monitoring: periodic returns to NRB, stress tests and supervision through ICAAP.

The aim is to protect depositors, ensure liquidity and solvency, and keep the banking system stable. (Exact ratios are revised by NRB from time to time.)

Investment portfolio

The investment portfolio is the collection of securities and other financial assets held by a bank to earn income and to provide liquidity, apart from its loans. It includes government securities (treasury bills, development bonds), shares, debentures and placements with other banks. It is managed for returns, liquidity and risk diversification, subject to regulatory limits.

Open market operation (OMO)

OMO is the central bank's buying and selling of government securities in the open market to control the money supply and liquidity of the banking system.

• When NRB sells securities (or conducts reverse repo or deposit collection), banks pay for them and liquidity falls.
• When NRB buys securities (or conducts repo or lending), liquidity increases.

OMO helps to control inflation and interest rates, and banks use it to manage their own liquidity.

Interbank transaction

Interbank transactions are short-term borrowing and lending of funds between banks, usually overnight or for a few days, in the money (call money) market, normally unsecured. Banks with surplus liquidity lend to banks with a deficit, at an interbank rate. It helps banks meet CRR and SLR needs and use idle funds, and it also includes inter-bank foreign exchange dealing.

Deregulation has removed interest rate ceilings on deposits, so banks must price deposits themselves to attract funds at an acceptable cost. The main deposit pricing models are:

1. Cost-plus pricing The deposit rate is based on the cost of providing the service: $\text{Deposit rate} = \text{Cost of funds (interest)} + \text{Operating cost} + \text{Desired margin}$ It makes sure that each product is profitable, but it ignores competitors and customer demand.

2. Marginal cost pricing The bank offers the rate such that the additional (marginal) cost of the new funds is no greater than the marginal revenue they earn. It is applied to raise extra funds, because the average cost does not show the real cost of additional funds.

3. Conventional (relationship or customer) pricing Deposit rates are set on the basis of the overall relationship with the customer, such as the total balance and number of services used, with higher rates or lower fees for larger and more loyal customers.

4. Competitive (market) pricing Rates are set equal to, or slightly above or below, those of competing banks, depending on the strategy for market share. It follows the market but may squeeze margins.

5. Marginal pricing and the pool-of-funds approach Under the pool-of-funds method, the average cost of all funds is calculated and the cost is used to decide the minimum loan rate. Under the marginal cost method, the cost of the latest source of funds is used.

6. Tiered (balance-based) and promotional pricing Different rates apply to different balance levels or maturities, and special rates are offered for a short period to attract new deposits.

7. Non-price competition The bank gives gifts, services and convenience instead of rates. It may distort resource allocation, as noted by regulators.

A bank selects its pricing model by considering its funding needs, costs, competition, customer elasticity and regulations, and usually combines several approaches.

Estimating liquidity means forecasting the amount of liquid funds the bank will need and will have, so that sources and uses of funds can be matched. The common approaches are:

1. Sources and uses of liquidity approach Liquidity needs are estimated by analysing deposit withdrawals, loan demand and other commitments (uses) against the cash inflows from loan repayments, maturing investments and new deposits (sources). The net difference gives the liquidity surplus or deficit.

2. Liquidity gap (maturity ladder) approach Assets and liabilities are placed in time buckets (1 day, 2-7 days, 8-30 days, and so on) according to their maturity. For each bucket: $\text{Liquidity gap} = \text{Cash inflows} - \text{Cash outflows}$ A negative gap means that funds must be raised, and limits are set on cumulative gaps.

3. Structure of funds (volatile/stable funds) approach Deposits are classified as hot money (volatile), vulnerable and stable core deposits. A large share of liquid assets is held against volatile funds and a smaller share against stable funds. Loan demand is also divided into expected and contingent needs.

4. Liquidity indicators (ratio approach) Ratios such as: $\text{Liquid assets to total deposits}, \quad \text{Loans to deposits}, \quad \text{Core deposits to total assets}$ are compared with internal and regulatory benchmarks (CRR, SLR, liquidity coverage ratio, net stable funding ratio).

5. Scenario and stress testing The liquidity need is estimated under normal, adverse and crisis scenarios (deposit run, market closure), and a contingency funding plan is prepared.

The estimated shortage can be met by selling liquid assets, borrowing in the interbank market or from the central bank, or raising deposits, while a surplus is invested short-term to earn income.

True. Treasury management mainly concerns an organisation's financial assets and liabilities, including cash, liquidity, investments, funding and financial risks.

False. Dealers and traders form the front office. The back office consists of the settlement, accounting and reconciliation staff.

False. Term (fixed) deposits are locked for a fixed period and therefore pay the highest interest among deposit types. Low interest is characteristic of current and ordinary savings deposits.

True. Funds raised are used for investment (loans, securities), development expenses, administrative and operating expenses, and profit distribution (dividends, reserves). Fund management allocates sources among these uses.

True. Counterparty (credit) risk is the risk that the other party to a trade or contract fails to perform its obligation, for example by not paying or not delivering on the due date.

False. Core deposits are a stable base of funds that is relatively insensitive to market interest-rate movements, and they are rarely withdrawn. Volatile (hot-money) funds are the rate-sensitive ones.

False. In a negative mismatch, liabilities mature earlier than assets, so the bank must refinance maturing liabilities while its assets are still locked up. Assets maturing earlier than liabilities is a positive mismatch.

False. The larger the duration, the more sensitive the price of an asset or liability is to interest-rate changes. Percentage price change is approximately $-D_{mod}\times\Delta i$.

True. A derivative is a financial instrument whose value is derived from an underlying asset, rate or index. Forwards, futures, options and swaps are the main categories.

False. The Treasury bill discount rate is quoted on a 360-day year (bank discount basis), not a 365-day year. The bond-equivalent yield is the one that uses 365 days.

$d=\frac{F-P}{F}\times\frac{360}{t}$

Treasury management is the management of a bank's or company's liquidity, funds, investments and financial risks (interest-rate, currency and liquidity risk) so as to ensure that funds are available when needed and surplus funds earn the best safe return.

Functions

• Liquidity and cash management: forecasting cash flows, meeting statutory reserve (CRR/SLR) requirements and daily settlement needs.
• Fund management: raising funds from deposits, borrowings and the interbank market at the lowest cost and deploying them in loans and investments.
• Investment management: investing surplus funds in treasury bills, bonds and other money and capital market instruments with a balance of safety, liquidity and return.
• Foreign exchange management: buying and selling currencies, managing the foreign exchange position and servicing customers.
• Risk management: measuring and hedging interest-rate, exchange-rate, liquidity and counterparty risks, including by derivatives.
• Asset-liability management: matching maturities and rate sensitivity of assets and liabilities, often through ALCO.
• Pricing and regulatory compliance: setting internal transfer prices, deposit and loan rates, and meeting central bank rules.

Sources of funds are the channels from which a bank or firm obtains money.

Internal sources (generated within the institution)

• Paid-up capital and retained earnings (undistributed profit).
• Reserves and provisions such as general reserve and other funds.
• Depreciation funds and other internally generated cash.

They are cost-free or cheap, carry no repayment obligation and do not dilute control (retained earnings), but the amount is limited.

External sources (raised from outside)

• Deposits: current, savings, fixed and call deposits from the public, the main source for banks.
• Borrowings: from the central bank (refinance, standing liquidity facility), interbank (call) market, and other banks and institutions.
• Debentures and bonds issued to investors.
• Fresh equity through public or right share issue.
• Foreign borrowing and grants/credit lines from international institutions.

External funds are larger and more flexible but carry interest cost, repayment obligations and, in the case of equity, dilution.

Banks offer credit products to meet different customer needs.

• Term loans: funds for a fixed period (short, medium or long term) repaid in instalments, used for fixed assets and projects.
• Working capital loans: overdraft, cash credit, demand/revolving loans, and trust receipt loans to finance day-to-day operations.
• Trade finance: letters of credit, bills discounting/purchase, export and import loans.
• Non-fund facilities: bank guarantees (bid, performance, advance payment) and letters of credit, where the bank lends its credit, not cash.
• Consumer/retail loans: home loans, auto loans, personal, education and hire-purchase loans, credit cards.
• Agriculture and priority-sector loans: crop, livestock, small business, microfinance and deprived-sector loans.
• Project and syndicated loans: large loans for hydropower, infrastructure and industry, sometimes shared among several banks.
• Lease financing and hire purchase of equipment and vehicles.
• Real estate and housing loans and margin loans against shares.

An option is a contract that gives the buyer (holder) the right, but not the obligation, to buy or sell an underlying asset at a fixed price (the strike or exercise price) on or before a specified date, in return for a premium paid to the seller (writer).

Types

• Call option: the right to buy the underlying at the strike price.
• Put option: the right to sell the underlying at the strike price.
• European option: exercisable only on the expiry date.
• American option: exercisable at any time up to expiry.
• By underlying: stock, index, currency, interest-rate and commodity options.

Characteristics

• The buyer has the right but no obligation; the writer has an obligation if the buyer exercises.
• The buyer pays a premium upfront, which is the maximum loss; profit potential is unlimited for a call and large for a put.
• The writer's loss can be large while gain is limited to the premium.
• Fixed strike price, expiry date and contract size.
• Value depends on the underlying price, strike, time to expiry, volatility and interest rate.
• Options can be in-the-money, at-the-money or out-of-the-money.
• Used for hedging, speculation and arbitrage.

Money market instruments are short-term (up to one year), highly liquid, low-risk securities in which treasury places surplus funds.

• Treasury bills: government securities of 28, 91, 182 and 364 days, sold at a discount and redeemed at face value. They are virtually risk-free and the main instrument of Nepalese banks.
• Call/interbank lending: overnight or very short placements with other banks, earning a market rate.
• Certificates of deposit: negotiable time-deposit certificates issued by banks.
• Commercial paper: short-term unsecured notes issued by creditworthy companies.
• Repurchase agreements (repo) and reverse repo: sale of securities with an agreement to repurchase; the central bank uses these in open market operations.
• Bankers' acceptances and bills of exchange: short-term trade bills guaranteed by banks.
• Short-term deposits and fixed deposits with other banks and foreign currency placements with correspondent banks.
• Central bank deposit auction / standing deposit facility instruments.

They are chosen for liquidity, safety and a modest return, matching the treasury's liquidity objective.

Nepal Kastra Bank is not a standard body of Nepal's financial system, so the answer below treats the question in terms of the usual rights, duties and functions of a bank of this kind, as stated in a bank's governing Act and regulations.

Rights

• To accept deposits, raise capital and borrow from other institutions.
• To lend, invest and charge interest and fees at rates determined under central bank rules.
• To open branches and hold and dispose of property, and to sue and be sued as a corporate body.
• To take collateral and recover loans through legal means.

Duties

• To maintain the required capital, cash reserve and liquidity set by Nepal Rastra Bank.
• To follow the central bank's directives, prudential norms and provisioning rules.
• To protect depositors' funds and keep customer information confidential.
• To maintain proper accounts, have them audited and publish financial statements.
• To pay taxes and meet corporate governance and anti-money-laundering requirements.

Functions

• Mobilising savings through deposits.
• Providing credit and investing in government securities.
• Offering payment, remittance, foreign exchange and guarantee services.
• Supporting economic development through productive lending.
• Treasury functions: managing liquidity and investment portfolio.

The treasury department is the bank/company's financial control centre. Its aim is to make sure that cash is available at the right time and place for operations, while surplus funds are not left idle and risks are controlled.

Roles of the treasury department

1. Cash and liquidity management: forecasts cash inflows and outflows daily, weekly and monthly; keeps enough cash and near-cash to pay suppliers, salaries, depositors and debts; avoids both shortage and idle balances.
2. Funding and capital structure: decides how to raise funds (equity, debt, bank lines, deposits), negotiates with lenders, and keeps the cost of funds low and the maturity profile balanced.
3. Investment of surplus funds: places excess cash in treasury bills, deposits, commercial paper and other liquid instruments, balancing safety, liquidity and return.
4. Banking relationships and payment systems: manages bank accounts, cash pooling, collections and disbursements, and speeds the cash conversion cycle.
5. Risk management: identifies and hedges interest-rate, foreign exchange, commodity, liquidity and counterparty risk using forwards, futures, options and swaps.
6. Foreign exchange management: handles conversion and exposure for imports, exports and foreign borrowing.
7. Working capital management: works with finance on receivables, payables and inventory financing to free up cash.
8. Financial planning, forecasting and reporting: prepares cash budgets, monitors covenants and reports liquidity to management.
9. Control and compliance: sets internal policies, limits and segregation of duties between front, middle and back office, and meets regulatory requirements.

Through these roles treasury protects the firm from liquidity crises, lowers financing costs, adds return on idle funds and supports strategic decisions.

Risk is the possibility of loss or adverse deviation from expected results. Institutional risks are commonly divided into financial and non-financial risks.

A. Financial risks

• Credit risk: borrowers or counterparties fail to repay principal or interest on time.
• Market risk: losses from movements in market variables. It includes interest-rate risk (rate changes affect income and asset values), foreign exchange risk (currency movements) and equity/commodity price risk.
• Liquidity risk: the institution cannot meet payment obligations when due, or can do so only at high cost; includes funding liquidity and market liquidity risk.
• Counterparty / settlement risk: the trading partner does not perform.
• Capital/solvency risk: capital is insufficient to absorb losses.
• Concentration risk: exposure is too heavily concentrated in one sector, borrower or currency.
• Inflation and reinvestment risk: reductions in the real value of returns or lower reinvestment rates.

B. Non-financial risks

• Operational risk: loss from failed processes, people, systems or external events (fraud, errors, system failure).
• Legal and regulatory (compliance) risk: penalties or unenforceable contracts from violating laws or changes in law.
• Reputational risk: loss of public trust and business from negative publicity or misconduct.
• Strategic and business risk: wrong decisions or failure to adapt to competition and the environment.
• Technology and cyber risk: system breakdown, hacking and data loss.
• Political, environmental and country risk: political instability, natural disasters and policy changes.
• Human resource/governance risk: key-person dependence, weak governance and ethics.

Financial risks can usually be measured and hedged with instruments, while non-financial risks are managed mainly by controls, policy, training and insurance.

False. Correspondent banking offers a wide range of services to other banks: payment clearing and settlement, foreign exchange, trade finance and letters of credit, cash management, custody and information, as well as credit lines. It is not limited to credit services.

False. A non-interest-bearing demand deposit is a current (checking) account. A revolving deposit is not defined by being non-interest-bearing; it is a deposit arrangement that is renewed or rolled over, and it can earn interest.

True. The front office (dealing room) is where dealers quote and set exchange rates and interest rates and trade money and capital market securities and foreign exchange with the market and customers.

True. Call deposits are placed for very short notice periods, usually large and from institutional clients, so the interest rate is generally negotiated between the client and the bank, based on market conditions.

True. Consumer loans are granted to individuals to meet personal financial needs such as buying a house, vehicle, durable goods, education or medical expenses, and are repaid from personal income.

True. Relationship pricing sets prices based on the customer's entire relationship with the bank (total balances and products used), giving better rates and fees to those with more business, which builds customer loyalty and retention.

False. In open market operations, when the central bank buys securities it injects money, so loanable funds increase and interest rates tend to fall. Loanable funds and interest rates move in opposite directions in this case, not together.

False. Funding gap is the difference (not a ratio) between rate-sensitive assets and rate-sensitive liabilities, that is, variable-rate assets minus variable-rate liabilities. The ratio form is the gap ratio or the relative gap.

Treasury management is the process of managing an institution's liquidity, funding, investments and financial risks in order to maximise return and ensure that obligations are met on time. In banks it deals with the management of the balance sheet, reserves, securities and foreign exchange positions.

Scope of treasury management

• Liquidity (cash) management: maintaining statutory reserves and daily settlement funds.
• Fund management: raising funds and allocating them to loans and investments.
• Investment and portfolio management: investing in government securities, bonds and money market instruments.
• Foreign exchange management: dealing, position management and exposure control.
• Asset-liability management: managing maturity and rate mismatches (gap, duration).
• Risk management: interest-rate, currency, liquidity and counterparty risk, with hedging through derivatives.
• Pricing and funds transfer pricing: setting deposit and loan rates and internal transfer prices.
• Capital management and regulatory compliance: meeting capital adequacy and Nepal Rastra Bank directives.
• Trading and customer dealing: treasury products for corporate clients, handled through front, middle and back offices.

Banks borrow to cover liquidity needs and fund asset growth.

Short-term sources (up to one year)

• Interbank (call) money market: overnight or short placements from other banks.
• Central bank facilities: Nepal Rastra Bank's standing liquidity facility, repo and refinance windows.
• Repurchase agreements on government securities.
• Certificates of deposit and commercial paper issued to the market.
• Overdrafts and short-term lines from other banks and correspondent banks.
• Short-term deposits such as call and current/savings deposits (core funding).

Long-term sources (more than one year)

• Fixed (term) deposits of long maturity.
• Debentures and subordinated bonds issued to the public or institutions.
• Long-term borrowings from development banks, the government, and foreign lenders such as ADB, World Bank and credit lines.
• Fresh equity capital and retained earnings as permanent funds.
• Refinance and long-term loans from the central bank for priority sectors.

Short-term funds are cheaper but must be rolled over, while long-term funds are more stable and costlier; a bank should match them to the maturity of its assets.

Interbank lending is the lending and borrowing of funds between banks and financial institutions, mostly for overnight or short terms, to manage daily liquidity. Banks with surplus reserves lend to banks with a shortfall at the interbank (call money) rate, usually without collateral (unsecured) or with securities as collateral (repo). It helps banks meet reserve requirements, settle payments and manage liquidity without disturbing the loan portfolio.

Reserve requirement provisions of the central bank

Reserve requirements are rules under which commercial banks must hold a certain proportion of their deposits as reserves. In Nepal, Nepal Rastra Bank prescribes:

• Cash Reserve Ratio (CRR): a percentage of deposit liabilities (for example 3 to 4 per cent) kept in cash with the central bank, usually earning no interest.
• Statutory Liquidity Ratio (SLR): a percentage of deposits held in liquid assets, such as cash, balances with NRB and government securities (for example 10 to 12 per cent).

Reserve ratios are tools of monetary policy: raising them reduces banks' lendable funds and money supply, while lowering them increases credit. The exact percentages change under NRB's monetary policy, and shortfalls attract penalties. Banks with a deficit borrow in the interbank market or from the central bank; those with surplus lend.

Loan pricing is the process of determining the interest rate and fees a bank charges on a loan, so as to cover the cost of funds, operating costs, credit risk premium and desired profit.

Methods of loan pricing in Nepalese commercial banks

1. Cost-plus pricing: the rate is the sum of cost of funds, operating cost, a risk premium for default and a target profit margin. $\text{Loan rate}=\text{Cost of funds}+\text{Operating cost}+\text{Risk premium}+\text{Profit margin}$
2. Base rate pricing: NRB requires banks to compute a base rate from the cost of funds, CRR/SLR cost, operating cost and a return, and loans are priced as base rate plus a spread (premium) according to the borrower's risk.
3. Price leadership (market-based) pricing: the rate is set following the rate of leading banks or the market, with adjustments by borrower.
4. Risk-based pricing: the spread varies with the borrower's credit rating, collateral and loan tenor; higher risk means higher premium.
5. Below-market (competitive) pricing: a lower rate offered to preferred, high-quality borrowers to win business.
6. Relationship (customer profitability) pricing: the rate reflects the customer's total relationship (deposits, fees and other business).
7. Fixed versus floating rates: floating rates are linked to the base rate and reset, while fixed rates remain for a set period.

NRB also sets an interest-rate spread cap that limits the gap between lending and deposit rates.

Asset liability management (ALM) is the process of planning, organising and controlling the volume, mix, maturity, yield and cost of a bank's assets and liabilities so as to achieve its objectives of profitability, liquidity and safety while keeping interest-rate and liquidity risks within acceptable limits. It covers liquidity management, interest-rate risk management (gap and duration analysis), currency risk and capital planning.

Asset Liability Committee (ALCO) is the senior management committee that oversees ALM, usually chaired by the CEO or CFO and including heads of treasury, credit, risk, finance and operations.

Major roles and responsibilities of ALCO

• Formulate the ALM policy and set limits for gap, liquidity, duration and exposure.
• Review the balance sheet structure, maturity mismatches and liquidity position regularly.
• Monitor interest-rate sensitivity and decide actions, such as repricing assets and liabilities, to protect net interest income and equity value.
• Decide on deposit and loan pricing and funding strategy.
• Approve the investment and funding plan and contingency funding plan.
• Ensure compliance with regulatory ratios (CRR, SLR, capital adequacy, liquidity coverage).
• Review stress tests and risk reports and take corrective action.
• Report to the board and communicate decisions to business units.

Nepalese commercial banks are the dominant part of the financial system, and treasury has become more significant for them.

Opportunities

• Growing liquidity and remittance inflows give a large pool of funds to manage.
• Government securities market: treasury bills, development bonds and other securities provide safe investment options.
• Development of interbank, repo and foreign exchange markets allows active liquidity and currency management.
• Derivative and hedging products and cross-border services are slowly emerging.
• Technology such as core banking, real-time gross settlement and digital platforms improves dealing, risk monitoring and efficiency.
• Regulatory support: NRB's ALM guidelines, Basel-based capital rules and base rate regime promote professional treasury practice.
• Fee income from treasury products to corporate customers.

Challenges

• Liquidity volatility: frequent surplus or shortage and a heavy concentration of credit in real estate and shares.
• Limited and shallow capital markets with few hedging instruments and investment choices.
• Interest-rate and exchange-rate volatility, with the Nepalese rupee pegged to the Indian rupee giving limited flexibility.
• Shortage of skilled treasury professionals and weak risk-management systems.
• Regulatory restrictions on foreign investment, derivatives and foreign exchange.
• Mismatch of long-term assets with short-term liabilities.
• Political and economic uncertainty, cyber risk and operational risk.

Banks can seize the opportunities by building capacity, strengthening ALM and using technology, while pushing for deeper markets.

An investment portfolio is the collection of financial assets, such as securities, loans and other investments, held by an investor or a bank to earn return while managing risk and liquidity. A bank's investment portfolio is made up chiefly of securities held for liquidity, income and statutory requirements, and is built on diversification across instruments, maturities and issuers.

Investment instruments available to Nepalese commercial banks

1. Government securities
   • Treasury bills: 28, 91, 182 and 364 days, sold at a discount, risk-free and the main liquidity instrument.
   • Development bonds and national savings bonds: medium to long term, paying a fixed coupon; also used for SLR.
2. Central bank instruments: deposits with Nepal Rastra Bank, reverse repo and deposit auctions, standing deposit facility.
3. Corporate securities
   • Shares (equity) of listed companies, subject to NRB limits.
   • Debentures and corporate bonds of other companies and banks.
   • Mutual fund units.
4. Interbank placements and call money: short-term lending to other banks.
5. Certificates of deposit and fixed deposits with other banks.
6. Foreign investments: placements with overseas banks, foreign government and rated securities, within NRB's foreign exchange rules.
7. Other instruments: repos, commercial paper, bankers' acceptances, and venture or infrastructure bonds where permitted.

Investment is guided by NRB limits on equity exposure, concentration limits and the need to balance safety, liquidity and return.

The Foreign Exchange Dealers Association of Nepal (FEDAN) is the association of authorised foreign exchange dealers, formed to promote the interests of its members and the orderly, ethical conduct of the foreign exchange business in Nepal. Its members are commercial banks and other authorised dealers, such as money changers and remittance companies.

Functions

• To promote and develop a healthy, orderly and transparent foreign exchange market.
• To act as a link between members, Nepal Rastra Bank, the government and other stakeholders.
• To set and publish guidelines and a code of conduct for dealing.
• To share market information, exchange-rate information and rules.
• To represent members' interests and put forward suggestions on foreign exchange policy.
• To organise training, seminars and capacity building for dealers.

Duties and responsibilities

• To ensure members comply with foreign exchange laws, NRB directives and international practice, including anti-money-laundering rules.
• To maintain discipline and ethical standards among dealers and settle disputes between members.
• To encourage fair competition and avoid unhealthy rate quoting.
• To cooperate with the regulator in monitoring the market and reporting irregularities.
• To protect the reputation of the profession and the interests of the customers.
• To coordinate in setting indicative rates and standardised practices where agreed.

False. A bank's treasury invests the majority of its funds in safe, liquid assets, such as government securities and money market instruments, because depositors' money must be protected and liquidity maintained. Risk is limited, with only a moderate share in higher-yield assets, so earnings are balanced against safety.

False. The front office deals and trades; it takes market positions. Analysing and controlling the risk of treasury dealings is the job of the middle office, which independently monitors limits, exposure and compliance.

True. Call deposits are short-notice funds that banks use to adjust their liquidity and meet reserve needs, so they serve asset-liability management by balancing mismatches between assets and liabilities.

True. Counterparty risk is the risk of loss because the other party to a transaction fails to fulfil its obligations (non-performance), for example not paying or not delivering.

True. Deposit pricing is the process of fixing the interest rates and fees on deposit products and services of banks and other depository institutions, considering funding cost, competition, regulation and profitability.

True. A derivative derives its value from an underlying asset; the market price of the underlying securities (or rates, indices) determines the value of the derivative, which moves as the underlying price changes.

False. FEDAN is an association of authorised foreign exchange dealers (commercial banks, money changers and remittance companies licensed for foreign exchange), not of all banks and financial institutions. Many financial institutions have no foreign exchange licence.

Treasury management is the planning, organising and controlling of a bank's liquidity, funds, investments, foreign exchange and market risks so that the bank can meet its obligations at all times and earn the best return on its surplus funds.

Roles of the treasury department

• Keeps the bank liquid by meeting cash reserve (CRR) and statutory liquidity (SLR) requirements and daily payment needs.
• Acts as the bank's central funding unit, balancing surplus and deficit funds across branches.
• Manages market risks: interest rate, exchange rate and liquidity risk.
• Supports ALCO and top management with market views and pricing.

Functions

• Liquidity and cash management: forecasting cash flows, maintaining balances with NRB, interbank lending and borrowing.
• Investment management: investing in government bonds, treasury bills, NRB bonds, shares and other securities.
• Foreign exchange management: buying and selling currencies, managing the open position and quoting rates to customers.
• Funds transfer pricing and balance-sheet management: pricing funds for business units and managing gaps.
• Risk management: setting limits, hedging with forwards, swaps and options.
• Compliance and reporting to NRB.

Credit products are the loans and advances that commercial banks offer to borrowers. The major types in Nepal are:

1. Term loans: medium or long-term loans for fixed assets, machinery or projects, repaid in instalments.
2. Working capital loans: overdraft, cash credit, short-term demand loans and trust receipt loans for day-to-day business needs.
3. Trade finance: letters of credit, bills discounting/purchase, import loans and export credit.
4. Guarantees: bid bond, performance bond and advance payment guarantees (non-funded credit).
5. Retail and consumer loans: home loan, auto loan, education loan, personal loan and credit cards.
6. Hire purchase loans: vehicles and equipment financed with the asset kept as security.
7. Deprived sector and priority loans: loans for agriculture, small and cottage industry, energy and the poor, as required by NRB.
8. Real estate and margin-type loans: loans against shares (margin lending), and home equity or property-backed loans.
9. Syndicated or consortium loans for large projects.

Major risks faced by Nepalese commercial banks:

• Credit risk: borrowers fail to repay principal or interest, leading to non-performing loans.
• Market risk: losses from changes in interest rates, exchange rates and security prices.
• Interest rate risk: mismatch in repricing of assets and liabilities reduces net interest income.
• Liquidity risk: inability to meet withdrawals and other obligations when due.
• Foreign exchange risk: loss from exchange rate movements on open currency positions.
• Operational risk: losses from failed processes, people, systems, fraud or external events.
• Compliance and legal risk: penalties from breaching NRB directives and laws.
• Reputational risk: loss of public trust.
• Concentration risk: heavy exposure to a sector, such as real estate or share-backed lending.

Deposit pricing is the process of fixing the interest rate (and fees) that a bank pays on each type of deposit so that it attracts enough funds at an acceptable cost while keeping profit and competitiveness.

Deposit-pricing models

1. Cost-plus pricing: the rate is set from the cost of funds, operating costs and the required margin. Rate = cost of funds + operating cost + profit margin (the bank works backward from required yield).
2. Marginal cost pricing: the rate is based on the extra (marginal) cost of raising additional funds, compared with the marginal return from using them. Funds are raised only while marginal return exceeds marginal cost.
3. Conventional (competitive/market) pricing: rates follow those of competitor banks and the market rate.
4. Relationship pricing: customers with larger or multiple accounts with the bank receive higher rates or lower fees.
5. Target pricing models:
   • Up-scale (high-price) target pricing: aimed at service-sensitive, high-value customers.
   • Low-price target pricing: aimed at price-sensitive customers.
6. Penetration pricing: a high rate at launch to win market share, reduced later.
7. Risk-based pricing: the rate reflects the risk and liquidity cost of the deposit.

Asset-liability management (ALM) is the continuous process of planning, organising and controlling the volumes, maturities, rates and yields of a bank's assets and liabilities so that the bank can earn a stable net interest income and keep adequate liquidity while managing market risks.

Objectives of the ALM system

• Manage and control interest rate risk and protect net interest income and the economic value of equity.
• Ensure adequate liquidity at all times (liquidity risk management).
• Maintain an optimal balance between profitability, liquidity and risk.
• Match maturity and repricing of assets and liabilities (gap management).
• Manage foreign exchange and other market risks.
• Maximise shareholders' wealth and meet capital adequacy.
• Comply with regulatory limits (NRB directives).
• Provide a basis for pricing of loans and deposits and for strategic decisions on the balance sheet.

A credit default swap (CDS) is a derivative contract in which a protection buyer pays a periodic premium (spread) to a protection seller. In return, the seller compensates the buyer if a specified reference entity or loan defaults or suffers a credit event (bankruptcy, failure to pay, restructuring). It works like insurance against credit risk, and banks use it to transfer the credit risk of their loans or bonds.

For example, a bank holding a Rs 100 million bond pays 2% a year (Rs 2 million) to a counterparty. If the issuer defaults, the seller pays the bank the loss.

Risks associated with a CDS

• Counterparty risk: the protection seller may be unable to pay when default occurs.
• Credit (reference entity) risk: the reference entity's default causes large payouts to the seller.
• Market/pricing risk: the CDS spread changes and gives mark-to-market losses.
• Liquidity risk: difficulty in exiting the contract.
• Basis risk: the contract's reference obligation does not match the hedged exposure.
• Operational and legal risk: documentation disputes and dispute over what counts as a credit event.
• Systemic risk: interconnected exposures can spread failure, as in the 2008 crisis.

A bank's investment portfolio is the collection of securities and other financial assets that the bank holds to earn income, maintain liquidity and meet regulatory requirements, apart from loans. It balances return, liquidity and risk.

Investment instruments available to Nepalese commercial banks

1. Government securities:
   • Treasury bills (91, 182, 364-day): short-term, zero-risk instruments sold at a discount.
   • Development bonds and national savings bonds issued by the Government of Nepal: medium-to-long-term coupon-bearing securities.
2. NRB instruments: NRB bonds and deposit-collection auction / open market operation instruments, used for liquidity management.
3. Corporate bonds and debentures: issued by companies and banks, higher yield but more credit risk.
4. Equity shares: shares of listed companies, subject to NRB limits on investment.
5. Mutual fund units: units of closed-end or open-end funds.
6. Interbank placements and call money: short-term lending to other banks.
7. Foreign investments: placements with foreign banks and foreign securities within NRB limits (e.g. foreign treasury, deposits with correspondent banks).
8. Other instruments: commercial papers, fixed deposits with other BFIs, and securities held for CRR/SLR.

Investments are classified as held for trading, held to maturity and available for sale, with different valuation and accounting treatments.

Since the global financial crisis, regulators have introduced tighter rules (Basel III capital and liquidity standards, NRB directives on CRR/SLR, LCR, NSFR, CCD ratio, spread rate limits and single obligor limits). This has made treasury a more strategic function.

Scope of treasury functions

• Liquidity and cash management, including CRR/SLR compliance.
• Funding and balance-sheet (ALM) management.
• Investment in government and other securities.
• Money market operations: interbank lending, borrowing and repo/reverse repo.
• Foreign exchange dealing and management of the open position.
• Market risk management and hedging through forwards and swaps.
• Pricing support (funds transfer pricing) and regulatory reporting.

Opportunities

• Income from securities, foreign exchange margins and trading.
• Cheaper and more stable funding through better liquidity planning.
• Use of hedging products and new instruments (repo, swaps, derivatives) as the market develops.
• Digital treasury systems and automation improve decision speed.
• Growing remittance and trade inflows increase foreign exchange business.
• A central role in strategy gives treasury a higher profit contribution.

Challenges

• Frequent changes in NRB regulations and rising compliance costs.
• Liquidity shortages and volatile interest rates in the money market.
• Limited depth of the financial market and few hedging instruments.
• Exchange rate and interest rate volatility.
• Shortage of skilled dealers and risk managers.
• Weak technology and integration between front, mid and back offices.
• Excess liquidity or credit-deposit imbalance, and political and economic instability.

True. Longer deposits tie up funds for longer and carry more interest-rate and liquidity risk for the depositor, so banks pay a term premium. Fixed deposits for 2-3 years usually earn more than 3-month ones.

True. ALM matches the maturity and repricing of assets and liabilities (gap and duration analysis, rate sensitivity limits), which controls interest rate risk and liquidity risk.

True. Capital, reserves, retained profit and long-term borrowings (debentures, subordinated debt) are stable, long-term sources, unlike demand and short-term deposits.

True. Deposits (current, savings and fixed) provide the largest share of a commercial bank's funds, far more than capital or borrowings.

True. Transaction deposits (such as NOW accounts and interest-bearing current accounts) allow withdrawals or payments by cheque at any time while also paying interest.

True. A derivative (forward, future, option, swap) has no value of its own. Its value is derived from an underlying asset, rate or index, so it is a risk-management or trading contract rather than a core (real) banking product such as a deposit or loan.

False. Upscale target pricing aims at customers who value service quality, convenience and prestige and who accept higher fees and lower deposit rates. Price-sensitive customers are targeted by low-price or penetration pricing.

Principles of treasury management:

1. Liquidity: the bank must always hold enough liquid funds to meet obligations and regulatory requirements (CRR, SLR).
2. Safety and security of funds: investments should protect principal, avoiding undue risk.
3. Profitability (yield): surplus funds should be employed to earn the best return consistent with risk.
4. Risk management: market, credit, interest rate and exchange risks should be identified, measured and limited.
5. Matching of assets and liabilities: maturity and rate should be matched (ALM).
6. Centralisation of funds: pooling cash in one place lowers idle balances and borrowing costs.
7. Segregation of duties: front, mid and back office are separated for control.
8. Compliance with NRB directives and internal policy.
9. Planning and forecasting of cash flows, and diversification.

Sources of funds are the means by which a bank raises money to lend and invest.

Internal sources (from within the bank)

• Share capital: paid-up capital from shareholders.
• Reserves and surplus: general reserve and other statutory reserves.
• Retained earnings / undistributed profit.
• Provisions and other internal accruals. These are stable and long term, with no interest burden, but limited in amount.

External sources (from outside the bank)

• Deposits: current, savings, fixed and call deposits. This is the largest source.
• Borrowings: from NRB (refinance, standing liquidity facility), other banks (interbank/call money), and foreign institutions.
• Debentures and bonds (including subordinated debt).
• Repo and other short-term money market funds.
• Other liabilities such as bills payable and payables. External sources are larger and flexible but carry interest cost and repayment obligations.

Interbank lending is the lending and borrowing of short-term funds (overnight to a few days or weeks) between banks and financial institutions to manage liquidity, CRR and SLR positions. Banks with surplus funds lend to those in deficit at the interbank rate.

Major credit products of Nepalese commercial banks and features

• Term loan: fixed period, repaid in instalments, for project or fixed assets.
• Overdraft / cash credit: withdrawals up to a limit against security, interest on the used amount, for working capital.
• Demand / short-term loan: repayable on demand within a short period.
• Trade finance (LC, bill purchase/discounting, trust receipt loan): finances imports and exports.
• Guarantees: a contingent liability (bid, performance, advance payment) for fee income.
• Hire purchase loan: vehicles/equipment financed, with ownership transferred after payment.
• Home loan and auto loan: long-term retail loans against property or vehicle.
• Personal / education / consumer loans: lent to individuals, often against salary or collateral.
• Credit card and gold/silver loan: small unsecured or asset-backed loans.
• Deprived sector and priority sector loans: loans mandated by NRB, at concessional rates.
• Margin lending: against shares as security.

Forward contract: a customised over-the-counter agreement between two parties to buy or sell an asset at a fixed price on a future date. Example: A Nepali importer expects to pay USD 100,000 in three months. He enters a forward contract with a bank to buy USD at Rs 135 per dollar, so he pays Rs 13.5 million regardless of the spot rate on that date.

Futures contract: a standardised exchange-traded agreement to buy or sell an asset at a fixed price on a future date, marked to market daily. Example: An investor buys a gold futures contract on an exchange at Rs 100,000 per unit for delivery in three months. The profit or loss is settled daily in the margin account.

Characteristics

A bank's investment portfolio is the group of securities and financial assets held by the bank to earn income, maintain liquidity and satisfy regulatory requirements, other than its loan book.

Investment securities of commercial banks in Nepal

• Treasury bills: short-term (91, 182, 364 day) government securities issued at a discount, risk-free, highly liquid.
• Government (development) bonds: medium and long-term bonds issued by the Government of Nepal paying fixed coupons.
• National savings bonds and citizen savings certificates.
• NRB bonds and instruments: issued by Nepal Rastra Bank for liquidity management.
• Corporate bonds / debentures: issued by companies and banks, higher yield but credit risk.
• Equity shares: shares of listed companies, within NRB limits.
• Mutual fund units.
• Interbank placements and fixed deposits with other BFIs.
• Foreign securities and placements with foreign banks, subject to NRB limits.

Securities are held as trading, held to maturity or available for sale.

Foreign Exchange Dealers' Association of Nepal (FEDAN) is an association of commercial banks and other authorised foreign exchange dealers in Nepal, set up to promote orderly dealing in foreign exchange within the framework laid down by Nepal Rastra Bank.

Major roles and responsibilities

• Bridge between members and NRB: presents members' views and issues to NRB and conveys NRB's policy to members.
• Code of conduct: establishes and enforces the rules and ethics for foreign exchange dealings by members.
• Rate coordination: guides on exchange rate practices and consistent quotation of buying and selling rates, limiting unhealthy competition.
• Market development: promotes the foreign exchange market and training and capacity building of dealers.
• Dispute resolution among members regarding forex transactions.
• Implementation of regulations: supports compliance with FEMA, NRB's foreign exchange regulations and international standards (e.g. UCP, ISDA/FX practices).
• Information sharing: circulates market information and research.
• Representation of the sector before the government and other agencies.
• Safeguarding the interests of members and the national interest by supporting stability in the foreign exchange market.

Risk is the possibility of loss due to uncertain events that can damage an institution's income, capital or reputation.

Types of risk in treasury operations

1. Market risk: loss from adverse movements in market prices. It includes:
   • Interest rate risk: changes in rates affect net interest income and security values.
   • Foreign exchange risk: exchange rate movements on open positions.
   • Equity and commodity price risk.
2. Liquidity risk: inability to meet obligations when they fall due, or to sell assets without loss. It can be funding liquidity risk or market liquidity risk.
3. Credit risk: loss from a borrower or issuer failing to pay (default).
4. Counterparty / settlement risk: the other party fails to deliver or pay in a treasury deal.
5. Operational risk: losses from errors, fraud, system failure, and weak controls.
6. Legal and compliance risk: breach of law, NRB rules or defective contracts.
7. Reputational risk: loss of public confidence.
8. Concentration risk: too much exposure to one sector, counterparty or currency.
9. Country / sovereign and political risk.
10. Model risk: errors in pricing and valuation models.

Treasury manages these through limits, hedging, diversification, stop-loss, ALM and internal controls.

False. The treasury department manages the bank's liquidity, investment, foreign exchange, funding and market risk. Extending credit to clients is the job of the credit/lending department.

True. The front office consists of dealers and traders who deal with the market and counterparties, quote prices and take positions. Risk control is the mid office and settlement the back office.

False. This describes the back office, which handles confirmation, settlement, accounting, record keeping and compliance support. The front office is concerned with dealing and trading.

False. NRB directives restrict savings accounts to individuals (and certain non-profit/social bodies). Institutional customers such as companies and business firms are generally expected to use current or fixed accounts.

True. A home equity loan or line of credit lets a homeowner borrow against the equity (market value less the mortgage balance) of the property, which is pledged as collateral.

True. ALM is the strategic, balance-sheet-wide management of assets and liabilities that considers market risks (interest rate, liquidity, foreign exchange) to protect net interest income and economic value.

True. Regulators such as NRB set minimum liquidity requirements (CRR, SLR, LCR, NSFR) to ensure the bank can meet obligations. The cost-effectiveness of holding liquidity is the bank's own concern.

True. FEDAN, the association of authorised foreign exchange dealers, represents its member banks before NRB and the government on foreign exchange and related banking issues, and helps implement NRB's policies.

Principles of treasury management:

1. Liquidity: the bank must always hold enough liquid funds to meet obligations and regulatory requirements (CRR, SLR).
2. Safety and security of funds: investments should protect principal, avoiding undue risk.
3. Profitability (yield): surplus funds should be employed to earn the best return consistent with risk.
4. Risk management: market, credit, interest rate and exchange risks should be identified, measured and limited.
5. Matching of assets and liabilities: maturity and rate should be matched (ALM).
6. Centralisation of funds: pooling cash in one place lowers idle balances and borrowing costs.
7. Segregation of duties: front, mid and back office are separated for control.
8. Compliance with NRB directives and internal policy.
9. Planning and forecasting of cash flows, and diversification.

The money market is the market for short-term funds (up to one year). The treasury department of a Nepali commercial bank has the following scope in it:

• Interbank (call) market: lending surplus funds and borrowing short-term to adjust daily liquidity and CRR positions.
• Treasury bills: investing in T-bills of 91, 182 and 364 days, and buying/selling them in the secondary market.
• NRB open market operations: taking part in repo, reverse repo, outright sale/purchase, deposit auction and standing liquidity facility (SLF) to manage liquidity.
• Repo transactions: raising or placing funds against government securities.
• Commercial papers, certificates of deposit and short-term bonds.
• Fixed deposits and placements with other BFIs.
• Foreign money market: placements with foreign banks and short-term foreign currency swaps.
• Liquidity forecasting and cash management to decide when to lend or borrow.
• Pricing and rate setting based on money market rates (e.g. interbank rate, T-bill rate).

The treasury department is organised into three offices with separate functions to ensure control.

Front office (dealers and traders)

• Deals in the money market, foreign exchange and securities.
• Quotes prices to customers, takes positions, and executes trades.
• Manages liquidity and funding positions within limits.
• Maintains relationships with counterparties and the market.

Mid office

• Independent risk monitoring: sets and monitors limits, positions, exposures and market risk.
• Measures profit and loss, prepares risk reports and ensures compliance with policy.
• Valuation of positions and checking that trades are within mandate.

Back office

• Confirms and settles trades, deals with payments and receipts, and reconciles accounts.
• Accounting, record keeping, documentation and statutory reporting to NRB.
• Ensures operations and systems run correctly and the staff are supported.

This separation prevents unauthorised dealing and fraud.

Forward contracts and futures contracts are agreements to buy or sell an asset at a fixed price on a future date, but they differ as shown below.

Example (forward): A bank agrees today to sell USD 1 million to an importer after 3 months at Rs 134.50. If the spot rate is Rs 136 at maturity, the importer still pays Rs 134.5 million.

Example (futures): An investor buys a futures contract on a stock index at 2,000. If the index closes at 2,050 the next day, the gain of 50 points per unit is credited to the margin account that day.

Counterparty default risk is the risk that the other party to a financial contract (loan, deposit placement, derivative, repo or foreign exchange deal) fails to fulfil its obligation, such as paying or delivering on the due date. The bank then loses the amount owed or the replacement cost of the contract.

Mitigation

• Counterparty limits: set exposure limits on each bank or client based on credit rating and financial strength.
• Credit assessment and regular monitoring of counterparties.
• Collateral and margin: taking security, margin and haircuts, and daily mark to market.
• Netting agreements (ISDA master agreements) to reduce exposure.
• Use of exchanges and clearing houses that guarantee settlement.
• Delivery versus payment (DVP) and payment versus payment settlement to cut settlement risk.
• Credit derivatives such as credit default swaps.
• Diversification across many counterparties.
• Credit enhancements: guarantees and letters of credit.
• Legal documentation, and maintaining adequate provisions and capital.

As the finance specialist, I would set the rate for the new deposit product through the following steps.

Steps to determine the rate

1. Analyse the environment: review the liquidity position of the banking system (excess or shortage), NRB policy and interest rate corridor, government spending (which adds liquidity), and remittance and FDI inflows. High liquidity allows lower deposit rates; tight liquidity needs higher rates to attract funds.
2. Study competitors: compare rates offered by peer banks on similar products.
3. Calculate the bank's cost of funds and the required lending yield. Add operating costs and the target margin to find the maximum affordable rate. For example, if the average lending rate is 11%, the target spread is 4.4% and operating cost is 1.1%, then the maximum deposit rate is $11 - 4.4 - 1.1 = 5.5\%$.
4. Check regulatory limits: NRB's maximum spread and interest rate rules on deposits, and the CCD ratio.
5. Assess customers: target segment, expected balance, term, and price sensitivity.
6. Consider the ALM position: the bank's gap and maturity structure, deciding which term deposits are needed.
7. Forecast volume and profit under alternative rates and run sensitivity and scenario analysis.
8. Set the rate with ALCO approval, review regularly and monitor the response.

Recommended method I recommend a combination of cost-plus (marginal cost) pricing with competitive and relationship adjustments. Cost-plus ensures every deposit covers its cost and margin, the marginal cost approach adds funds only while the extra return exceeds the extra cost, and relationship pricing rewards large or loyal customers with a slightly higher rate. This is better than copying competitors alone because it protects profitability while keeping the product competitive under volatile liquidity.

Definition of risk: From the statement, risk is the possibility that a financial decision, or a change in the environment (market, economy, regulation), will produce an adverse outcome, meaning uncertainty of loss that can damage the institution's income, capital and reputation.

Types of risk in the treasury department of Nepalese commercial banks

1. Interest rate risk: changes in interest rates reduce net interest income or the value of securities, because of repricing mismatches.
2. Foreign exchange risk: losses from exchange rate movements on open positions in foreign currencies, for example in remittance and trade business.
3. Liquidity risk: failing to meet withdrawals and obligations, or having to sell assets at a loss. It is serious in Nepal when credit growth exceeds deposits.
4. Credit risk: borrowers or issuers default on loans and bonds.
5. Counterparty and settlement risk: another bank or dealer fails to pay or deliver on a deal.
6. Market (price) risk: loss in the value of shares and securities in the investment portfolio.
7. Operational risk: fraud, errors, system failure and weak controls in dealing and settlement.
8. Legal and compliance risk: breach of NRB directives and contract defects.
9. Reputational risk: loss of public trust after any of the above events.
10. Concentration risk and political/country risk.

Banks manage them through limits, ALM, hedging, diversification, internal controls and compliance with NRB directives.