In the dynamic landscape of commercial banking, effective treasury and risk management play a crucial role in ensuring financial stability and minimizing potential losses. Treasury and risk management encompass a range of strategies and practices that enable banks to manage liquidity, optimize cash flow, and mitigate risks associated with various financial activities. we will explore the key components of treasury and risk management in commercial banking and highlight their significance in maintaining a healthy and secure banking environment.
What is treasury management?
Accomplish an organization’s strategic and operational goals, treasury management involves controlling its financial resources. It covers a wide range of tasks, such as working capital management, risk management, funding and investment management, trade finance, and cash management.
Why is treasury management important?
Treasury management is crucial because it enables business to manage financial risks and resources more effectively. It ensures enough cash on hand to cover any short-term obligations as well as enough money available to invest in long-term growth prospects by maintaining the liquidity in the business. The management and mitigation of risk, such as that associated with foreign exchange risk, interest rate risk, liquidity risk, or risk associated with strategic investments, falls under the purview of treasury management.
Key functions of the treasury management department
- Minimizing financial risk: In an ideal scenario, treasury department knows exactly what your company’s risk exposure is at any point in time. However, a business’s financial success is constantly impacted by shifting internal and external conditions. One of the treasurer’s key responsibilities is to regularly assess and reduce financial risk to prevent any liquidity problems.
- Liquidity management: The treasury staff should always make sure they can fulfil their financial commitments. Analysis of cash inflows and outflows with a strong emphasis on working capital is used by liquidity management to determine if short- and long-term obligations can be satisfied.
- Cash flow forecasting: Cash flow forecasting is one of the treasurer’s primary responsibilities. This method is frequently used by departments to project the company’s financial status for a given time. Variance analysis (comparing actuals to forecasts) and scenario planning (creating many cash projection scenarios to account for all potential outcomes) are two procedures that are typically used in tandem with cash flow forecasting. When done correctly, cash flow forecasting can help to spot potential future financial surpluses or shortages, which can speed up and improve the quality of organisation strategic decisions.
- Trade finance: Most treasury teams take care of trade finance, which is managing trade between the firm and third parties and making sure there is no risk involved in international trade. Banks, importers, exporters, insurers, credit agencies, and trade finance companies are frequently involved in this process. As a result, many bigger businesses automate a lot of the trade finance operations using trade finance solutions. These technologies make it simpler to establish up intercompany loans and let you manage the entire guaranteed process on a single platform.
- Corporate finance: The treasurer’s role includes supporting business growth by making investment decisions based on pertinent financial information. Treasurers can help deliver value to the company and its shareholders by making decisions about where to deploy cash as well as short- and long-term investment.
- Payments: Payment processes are centralized by treasurers when companies are internationally present with several banks, entities, financial systems, and an ERP system. This way, it is easier to control and analyse all the payments.
Key benefits of treasury management
- Improved cash flow: By ensuring that money is used effectively and that immediate responsibilities are met, treasury management can boost an organization’s cash flow.
- Reduced risk: By properly controlling an organization’s exposure to foreign exchange and interest rate concerns, treasury management can also assist you in lowering risk.
- Increased profitability: The profitability of a company can be raised via treasury management by lowering risk and enhancing cash flow.
- Enhanced decision-making: Decision-makers can make more informed decisions about how to distribute financial resources by using the accurate and current information provided by treasury management.
- Increased efficiency and cost savings: Many manual operations can be automated and made less prone to error when treasury management is done correctly. As a result, you can save money and dramatically boost efficiency.
What is Risk management?
Risk is defined as a negative or unforeseen financial event that could lead to lost investments or lower earnings. It includes the potential for losing all or a portion of the investment. Why then do banks take a chance? Well, there is a direct correlation between risk and return because of the underlying relationship between the two. Therefore, the likelihood of profit increases with risk. However, this is not always the case, thus the risks that the banks assume must be effectively controlled.
Types Of Risks
- Liquidity Risk: This type of risk arises when an institution is unable to meet its financial commitments or can do so only by external borrowing. This may be due to the conversion of assets into NPAs. In the modern banking model, this is the most vulnerable risk that banks are subjected to.
- Market Risk: Market risk is the possibility of experiencing losses on financial assets due to unfavourable price changes. Changes in equities or commodity prices, shifts in interest rates, or changes in foreign exchange rates are a few examples of market risk.
- Credit or Default Risk: The likelihood that the borrower will not fulfil its commitments in line with the written contract is known as credit risk or default risk. For most banks, loans are the biggest and most evident source of credit or default risk.
- Operational Risk: Operational risk is the possibility of suffering a loss because of failures in internal processes, people, and systems, as well as external occurrences. It is important to manage operational risk for banks because banks are exposed to a higher volume of global financial interlinkages and an elevated level of automation is being used in rendering banking and financial services.
Current Challenges in Treasury, Risk management in Commercial Banks
- Regulatory Compliance: Commercial banks operate in a highly regulated environment, and adhering to various regulations poses a significant challenge. Banks need to ensure compliance with capital adequacy requirements, liquidity regulations, anti-money laundering (AML) laws, and other regulatory obligations. If there is any breach in regulatory compliance, then organisation will be penalised with heavy fines.
- Risk Assessment and Management: Assessing and managing risks is a critical aspect of treasury and risk management in commercial banks. Banks face challenges in identifying, measuring, and monitoring various risks, such as credit risk, market risk, liquidity risk, operational risk, and cybersecurity risk.
- Interest Rate and Market Volatility: Fluctuations in interest rates and market volatility can pose challenges to commercial banks. Managing interest rate risk, particularly for banks with large portfolios of loans and deposits, requires effective hedging strategies and risk mitigation techniques.
- Liquidity Management: Maintaining an optimal balance between liquidity and profitability is a challenge for banks. Adequate liquidity is necessary to meet depositors’ demands, fund loans, and withstand market disruptions. Balancing liquidity requirements with the cost of maintaining liquidity buffers can be complex.
- Capital Management: Banks need to manage their capital effectively to meet regulatory requirements, support business growth, and absorb losses. Optimizing capital allocation across different business lines, products, and geographies while considering risk-adjusted returns is a complex challenge.
- Changing Customer Expectations: Customers’ expectations and preferences are evolving rapidly, driven by technological advancements, and changing demographics. Commercial banks need to adapt to these changing expectations, provide seamless digital experiences, and deliver personalized products and services to meet customer demands.
How Brickendon can help?
- Brickendon can help the Financial Institution and bank to implement the various guidelines issued and framework issued by Central bank and other regulatory boards to maintain the proper liquidity.
- Brickendon can provide a tool which will compare the estimation of total income and expenditure so that the organization can make an effective budget in order to meet the optimum working capital requirements.
- Brickendon can help in various analysis which includes Trend Analysis of net interest income with proper forecast of NII and commentary on the same.
- Brickendon can help in Digital Transformation to develop a comprehensive digital transformation strategy for the bank, aligning it with the organization’s goals and objectives and to ensure its alignment with various treasury functions to meet liquidity requirement and to reduce the operational risk.
- Brickendon can help in implanting innovative technology/ systems in the business which further can help in managing the effective working capital requirements to reduce the recurring expenses on the Technology.
Brickendon can help Data Analytics and Risk Modelling advanced data analytics techniques, including machine learning and predictive analytics, can significantly enhance risk management capabilities.
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