Treasury Operations, Liquidity Management and Asset–Liability Management

Treasury operations, liquidity management, and Asset–Liability Management (ALM) together form the core of a bank’s balance sheet management and financial risk control framework. These functions ensure that a bank remains liquid, solvent, profitable, and compliant with regulatory requirements, while effectively managing market, interest rate, and funding risks. Although closely linked, treasury and ALM perform distinct but complementary roles within a bank.

Treasury Operations

The treasury department manages the bank’s own funds and undertakes market-related activities on behalf of the institution. It is primarily responsible for short-term fund management and market execution.
Key functions of treasury include:

• Liquidity management: Ensuring availability of cash and near-cash assets to meet depositor withdrawals and payment obligations.
• Statutory compliance: Maintaining regulatory reserves such as the Cash Reserve Ratio and investing in approved securities to meet the Statutory Liquidity Ratio, as prescribed by the Reserve Bank of India.
• Deployment of surplus funds: Investing excess funds in money market instruments, government securities, or short-term lending to optimise returns.
• Raising funds: Managing borrowings through interbank markets, repos, and other short-term funding instruments during liquidity shortfalls.
• Market operations: Conducting trading and hedging in bonds, foreign exchange, and derivatives, both for income generation and risk mitigation.

Treasury operations are largely tactical and day-to-day in nature, focused on managing immediate cash flows and market positions efficiently.

Liquidity Management

Liquidity management is a critical subset of treasury operations and focuses on ensuring that the bank can meet its obligations at all times without incurring excessive cost.
Key aspects include:

• Daily monitoring of cash inflows and outflows through cash flow forecasting.
• Maintenance of liquidity buffers in the form of high-quality liquid assets.
• Regulatory liquidity standards, particularly the Liquidity Coverage Ratio (LCR), which requires banks to hold sufficient liquid assets to withstand stressed net cash outflows over a 30-day horizon.
• Use of liquidity tools such as maturity laddering of investments, committed credit lines, and access to interbank and repo markets.

The objective is to keep funds available when needed while avoiding excessive idle liquidity, which can reduce profitability.

Asset–Liability Management (ALM)

Asset–Liability Management is a strategic, medium- to long-term function that deals with risks arising from mismatches between assets and liabilities on the bank’s balance sheet.
The primary risks addressed under ALM are:

• Interest rate risk: Risk arising from differences in the re-pricing of assets and liabilities.
• Liquidity risk: Risk that the bank may not be able to meet obligations when due over the medium to long term.
• Currency risk: Risk arising from foreign currency assets and liabilities.

Key ALM techniques include:

• Gap analysis: Measuring maturity and re-pricing mismatches across different time buckets.
• Duration and sensitivity analysis: Assessing the impact of interest rate changes on earnings and economic value.
• Use of derivatives: Interest rate swaps and other instruments to hedge exposures.
• Structural liquidity management, supported by measures such as the Net Stable Funding Ratio (NSFR), which promotes stable funding of long-term assets.

ALM policies and limits are typically set and monitored by the Asset–Liability Committee (ALCO), which aligns balance sheet strategy with the bank’s risk appetite.

Relationship Between Treasury and ALM

Treasury and ALM work in close coordination:

• ALM defines strategy: Risk appetite, maturity profiles, interest rate sensitivity limits, and funding structure.
• Treasury executes strategy: Through market transactions, fund deployment, borrowing, and hedging operations.

While treasury focuses on short-term liquidity and market execution, ALM ensures balance sheet stability and earnings sustainability over the medium and long term.

Significance for Banks

An efficient treasury and robust ALM framework are essential for:

• Maintaining continuous liquidity and depositor confidence
• Stabilising earnings amid interest rate and market volatility
• Ensuring regulatory compliance and financial resilience
• Enabling banks to withstand liquidity shocks and economic stress

Together, treasury operations and ALM play a vital role in safeguarding a bank’s financial health and supporting sustainable banking operations.