Subject Name – Treasury Management

Q.1 Explain how organization structure of commercial bank treasury facilitates in handling
various treasury operations.

The organization structure of commercial bank treasury is a type of financial institution and
intermediary. It is a bank that provides transactional, savings, and money market
accounts and that accepts time deposits.[1]

After the implementation of the Glass–Steagall Act, the U.S. Congress required that
banks engage only in banking activities, whereas investment banks were limited to
capital market activities. As the two no longer have to be under separate ownership under
U.S. law, some use the term "commercial bank" to refer to a bank or a division of a bank
primarily dealing with deposits and loans from corporations or large businesses. In some
other jurisdictions, the strict separation of investment and commercial banking never
applied. Commercial banking may also be seen as distinct from retail banking, which
involves the provision of financial services direct to consumers. Many banks offer both
commercial and retail banking services

Commercial banks engage in the following activities:

• processing of payments by way of telegraphic transfer, EFTPOS, internet

banking, or other means
• issuing bank drafts and bank cheques
• accepting money on term deposit
• lending money by overdraft, installment loan, or other means
• providing documentary and standby letter of credit, guarantees, performance
bonds, securities underwriting commitments and other forms of off balance sheet
exposures
• safekeeping of documents and other items in safe deposit boxes
• sale, distribution or brokerage, with or without advice, of insurance, unit trusts
and similar financial products as a “financial supermarket”
• cash management and treasury services
• merchant banking and private equity financing
• traditionally, large commercial banks also underwrite bonds, and make markets in
currency, interest rates, and credit-related securities, but today large commercial
banks usually have an investment bank arm that is involved in the mentioned
activities.

Secured loan
A secured loan is a loan in which the borrower pledges some asset (e.g., a car or
property) as collateral (i.e., security) for the loan.

Mortgage loan

A mortgage loan is a very common type of debt instrument, used to purchase real estate.
Under this arrangement, the money is used to purchase the property. Commercial banks,
however, are given security - a lien on the title to the house - until the mortgage is paid
off in full. If the borrower defaults on the loan, the bank would have the legal right to
repossess the house and sell it, to recover sums owing to it.

In the past, commercial banks have not been greatly interested in real estate loans and
have placed only a relatively small percentage of assets in mortgages. As their name
implies, such financial institutions secured their earning primarily from commercial and
consumer loans and left the major task of home financing to others. However, due to
changes in banking laws and policies, commercial banks are increasingly active in home
financing.

Changes in banking laws now allow commercial banks to make home mortgage loans on
a more liberal basis than ever before. In acquiring mortgages on real estate, these
institutions follow two main practices. First, some of the banks maintain active and well-
organized departments whose primary function is to compete actively for real estate
loans. In areas lacking specialized real estate financial institutions, these banks become
the source for residential and farm mortgage loans. Second, the banks acquire mortgages
by simply purchasing them from mortgage bankers or dealers.

In addition, dealer service companies, which were originally used to obtain car loans for
permanent lenders such as commercial banks, wanted to broaden their activity beyond
their local area. In recent years, however, such companies have concentrated on acquiring
mobile home loans in volume for both commercial banks and savings and loan
associations. Service companies obtain these loans from retail dealers, usually on a
nonrecourse basis. Almost all bank/service company agreements contain a credit
insurance policy that protects the lender if the consumer defaults.

Unsecured loan

Unsecured loans are monetary loans that are not secured against the borrowers assets
(i.e., no collateral is involved). These may be available from financial institutions under
many different guises or marketing packages:

• bank overdrafts
• corporate bonds
• credit card debt
• credit facilities or lines of credit
• personal loans
Q 2 } Bring out in a table format the features of certificate of deposits and commercial papers.

Those who invest in fixed income securities such as Bank Fixed Deposits (FDs) and
small savings schemes are constantly looking out for new alternatives that will provide
better post tax returns without significantly compromising on security. One alternative
that they can definitely consider are Fixed Maturity Plans or FMPs offered by mutual
funds that typically mature in around 1 to 36 months. Sometimes they are also called
FTPs or Fixed Term Plans. The monies collected under such schemes are typically
invested in debt products like commercial papers (CPs), Corporate Debentures,
Certificate of Deposit (CDs), Bonds, Government Securities and even bank deposits.
Typically the investment is in paper that has a minimum rating (normally not less than
AA) that is mentioned in the offer document and hence the safety of the money is
reasonably ensured.

How these plans can improve your post tax returns?

The reasons are below:

1)Even if the fund was to invest in bank fixed deposit it gets a much better rate as they
are able to place a bulk deposit. As an individual you cannot get such interest rates from
the banks. Also they have the fund managers and the bulk funds to get much better yields
from the debt market than you have as an individual.
2)The mutual fund structure is very tax efficient for such plans. Typically they do not
declare any dividends and are redeemed only on maturity that is longer than a year. Thus
the interest earned by the fund is returned as appreciation in the value of the units to you.
Since the units are held for more than 12 months these are long-term capital assets and
you pay tax at a maximum rate of 10% (or 20% after indexation if that is more beneficial
for you) .

Here is an example to illustrate the point:

If you have Rs. 50,000 to invest for around 12 months (and one day) you will at most get
around 8% p.a. from a good bank which means your deposit of Rs. 50,000 will give you a
return of Rs. 4,000. If you are a tax payer your net post tax return will work out to
Rs.2,764, Rs. 3,176 or Rs. 3,588 if your marginal tax rate is 30.90%, 20.60% or 10.30%
respectively. Now if you put it in a FMP and the fund house accumulates the savings of
many investors such as yours and invests it back in the same bank or in other equally safe
instruments for a period that matches the tenure of the fund (12 months and 1 day in our
example) . They are likely to be able to get a return of 8.50% which means they will
make a return of around Rs. 4,250 on your money. Even after reducing the fund
management charge of around 0.25% the return left will still be higher at Rs. 4,125 which
is still higher than if you had invested on your own. The real value of course comes from
the tax treatment. Since this will be taxed as a long-term capital gain the maximum tax
you will pay is at 10.30% which means the post tax return in this example will be Rs.
3,700 which is higher for all categories of tax payers than what they could have managed
on their own. The actual tax liability could be even less if the indexation benefit is high
but since that is a complicated exercise we will ignore the possible benefits from that
exercise.

Even in the dividend option where they declare dividends the fund pays a dividend
distribution tax of 12.875% for individuals and the dividends are not thereafter taxable in
the hands of the recipients. Thus if you pay a higher rate of tax even the dividend option
can be beneficial to you.