Transforming the bank’s Treasury

On Thursday 3 November 2016, the Egyptian Central Bank announced, in a surprise move, that it would let the market set the foreign exchange (FX) rate for the Egyptian Pound (EGP) and raised the interest rates by 300 basis points.

Transforming the bank’s Treasury

Changes ahead

These measures were designed to stop the currency being traded on the black market and reverse the currency shortage it created in its banking system.

This move has some benefits. First, the market will decide the real exchange rate and the ongoing black market for EGP should disappear. Second, more foreign investments will flow in, bringing in much needed US Dollars (USD). Third, Egyptian exports will be more competitive and some sectors, such as tourism, will get a significant boost. Last, it entails the release of the much needed International Monetary Fund (IMF) loan of USD 12 billion.

Given that the Egyptian banks, for the first time, have started to trade in the currency without any central bank restrictions, some exchange rate volatility is expected until the market finds an equilibrium price for the EGP during the price discovery phase.

However, the abolition of currency controls and the steep increase in interest rates are likely to have an impact on the Egyptian economy. For one, it will put an upward pressure on inflation and the subsequent interest rate increase would mean lower credit growth, potentially having an impact on the economic recovery.

For the banking industry in particular, the resulting volatility may leave Egyptian banks vulnerable to portfolio losses. It is especially true if they have not protected against such market shocks and left their exposures unhedged.

Such vulnerabilities can be found across the trading and banking book. Consider the following scenarios:

  • The bank does not have full visibility of the bank wide currency positions in real time or on an intra-day basis.
  • The bank wants to understand the impact on its liquidity profile if 10% of its small and medium enterprise (SME) customer portfolio defaults in the next six months, due to increase in the interest rates and lower economic activity.
  • The bank is expecting that 15% of its retail customers may decide to prepay - partially or fully - their debts in three months’ time, due to increasing interest rates.
  • The bank has a significant exposure to the counterparties who have a considerable USD-denominated debt portfolio.
  • The bank is not able to get a clear view of its interest rate gaps or liquidity gaps on an intra-day or at least on every end-of-day basis.
  • The banks is not able to stress-test its portfolio using a multi-dimensional scenario involving one or more risk factors , including FX, interest rates, credit and more.

In each of these scenarios, the lack of appropriate tools to carry out the required on-demand scenario analysis and take appropriate hedging measures could leave the bank exposed to significant risks.

The key to proactively and effectively manage these risks is for the bank’s Treasury to take a more integrated and enterprise-wide business approach and become a strategic business partner to the various internal business units. The Treasury would need to move towards taking a more holistic view of the business, get rid of fragmented systems, use a flexible cross-functional platform to facilitate fast, real-time data management, and ensure that a robust risk management framework is in place to identify and mitigate such risks.

When market volatility is so high, it is imperative that banks take concrete steps to address these inefficiencies. They must aim to optimise their Treasury processes and transform the underpinning technology infrastructure.

Adjusting to this “new normal” also means that Egyptian banks now have to focus even more on complying with local and global regulatory requirements around liquidity management, including Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratios (NSFR) and other liquidity ratios, as well as capital allocation.

As these regulatory reporting requirements become more and more demanding, the need for timely, be it intra-day or near real-time as opposed to end-of-day or end-of-week, and granular data access is crucial.

Building an efficient treasury

To achieve an enterprise-wide view of risk, liquidity and capital, the bank needs to optimise its Treasury environment. It must aim to deliver greater analysis, control and execution in one single integrated platform.

Such an integrated environment enables the Treasurer to have seamless access to data across trading, banking and lending books. It provides him with the necessary tools to analyse risks in a more real-time and on-demand basis, enabling the execution of appropriate trading strategies to hedge those risks.

Historically, many banks developed tactical and customised solutions to address specific requirements. These were often the results of short-term approaches rather than more strategic and long-term strategies to rationalise the solution’s architecture. While the former approach might have seem to be cost-effective in the past, changing market dynamics and ever evolving regulatory requirements are forcing banks to reconsider.

They must take a holistic view of their technology infrastructure and favour a flexible, future-proof and componentised architecture if they want to give their Treasury departments the required level of agility they need.

An open and flexible architecture delivers many benefits. Take for instance the increased clarity delivered by a having a holistic view of risk across the banking and trading book in a single framework. Or the optimisation of profits with an improved workflow across the enterprise, from source systems for Asset Liability Management (ALM) to board or financial reporting. Funds Transfer Pricing (FTP) could benefit from better capital allocation and optimised liquidity buffers. Another example would be achieving better decision-making with improved accuracy and proactive balance sheet modelling including behavioural and economic scenario analysis and business planning.

The bank’s Treasury must take an enterprise-wide view to drive profitability and optimise the allocation of capital to the business. In uncertain and volatile times, the Treasurer must be able to rely on a solution that is fully flexible and perfectly integrated if they want to be a proactive business partner within their organisation.