Treasury connects a bank’s assets, funding and payment obligations. It makes sure that cash is available where and when it is needed, manages the reliability and cost of funding, and considers how interest rates and exchange rates affect the balance sheet. These responsibilities interact: a decision that improves earnings can increase refinancing risk, while a useful hedge can create a cash margin call.

The path begins with a simple bank balance sheet and the distinction between liquidity and solvency. It then develops cash forecasting, deposit behaviour, maturity concentration and funds transfer pricing. The regulatory liquidity lessons explain HQLA, LCR and NSFR before the path turns to intraday payments, collateral, interest-rate exposure, FX funding and counterparty dependencies.

The final stages explain stress testing, contingency funding, internal limits and the Internal Liquidity Adequacy Assessment Process. The ALCO exercise brings these ideas together in a balanced example bank. You will choose an asset and funding mix, observe earnings and stressed liquidity, and consider the resulting economic-value exposure.

Follow the stages in order, and explain each decision in terms of cash flows, timing, currency and ownership of the risk. The objective is to develop a reasoned treasury judgement rather than optimise a single dashboard number. The examples use synthetic data and link to Basel principles and PRA guidance; their limitations remain visible beside the calculations.

Continue your learning: Liquidity and funding risk · Interest-rate risk in the banking book · Yield curves and bootstrapping · The Standard Initial Margin Model

Look up a term as you work through the examples. Definitions explain the terminology; the source references and assumptions beside each lesson explain the scope of its calculation.

94 definitions

ALCO

The Asset and Liability Committee considers balance-sheet risks and trade-offs such as funding, liquidity, earnings and economic value. Its precise authority and reporting responsibilities depend on the organisation’s governance.

Asset

An asset is a resource or contractual right with economic value. For a bank, examples include cash, securities and loans that customers are expected to repay.

Backtesting

Backtesting compares model outputs with subsequent or historical outcomes under a defined testing convention. A breach or exceedance occurs when the observed loss is beyond the relevant model threshold; count, size and data dependence all affect interpretation.

Basel, BCBS and IOSCO

The Basel Committee on Banking Supervision develops international prudential standards for banks. IOSCO is the International Organization of Securities Commissions. International standards require the relevant jurisdictional implementation before they can be treated as local rules.

Basis point

One basis point is one hundredth of a percentage point. A rise from 4.00% to 4.01% is a one-basis-point increase.

Basis risk

Basis risk arises when two related prices or rates do not move together as assumed. A hedge tied to one benchmark may therefore leave exposure to a different benchmark, location or contract specification.

Bond

A bond is a debt security under which an issuer promises specified payments to investors. Its value depends on the timing of those payments, discount rates and the risk of non-payment.

Calibration

Calibration selects model parameters to match chosen data, market prices or target risk properties. A calibrated model can still be inappropriate if its structure or the selected evidence does not suit the task.

Call and put

A call gives the holder the right to buy the underlying on the contract’s terms. A put gives the right to sell it. The holder’s exercise choice makes the payoff asymmetric.

Carry and opportunity cost

Carry is the ongoing income or expense from holding and financing a position. Opportunity cost compares that choice with a specified alternative, whose credit, capital and liquidity risks may differ.

Cash flow

A cash flow is a payment or receipt at a specified time. Its amount, date, currency and legal owner affect both valuation and liquidity.

Collateral

Collateral is cash or another eligible asset provided to secure an obligation. Its protection depends on value, legal enforceability, availability and the time required to realise it.

Concentration

Concentration means that a large share of exposure or funding depends on a small number of sources or common drivers. The Herfindahl–Hirschman Index, or HHI, sums squared shares to measure size concentration but does not by itself measure behavioural dependence.

Contingency funding plan

A contingency funding plan identifies actions, owners and triggers for dealing with liquidity stress. A broader recovery plan addresses restoration of financial viability under the applicable framework; the two plans must be consistent but are not identical.

Counterbalancing capacity

Counterbalancing capacity is the liquidity that credible management actions can generate under the relevant scenario and constraints. Capacity should not be treated as settled cash before the action can actually be completed.

Counterparty credit risk

Counterparty credit risk is the risk of loss when the other party to a financial contract fails to perform. For derivatives, exposure can change with market conditions and may be positive for either party at different times.

Coupon

A coupon is an interest payment on a bond or loan. The coupon rate determines the contractual payment; it is not necessarily the yield available to an investor at the current market price.

Credit spread

A credit spread is the additional yield or premium associated with credit exposure relative to a reference rate. It can reflect default risk, liquidity and other market effects, so it is not a direct default probability.

Credit-spread risk

Credit-spread risk is the risk of value changes caused by movements in credit spreads. FRTB distinguishes non-securitisation, securitisation outside the alternative correlation trading portfolio and alternative correlation trading portfolio treatments.

Currency codes

GBP denotes pounds sterling, USD denotes US dollars, EUR denotes euros and JPY denotes Japanese yen. Currency labels matter because values and thresholds must be converted consistently before they are compared or combined.

Deposit beta and lag

Deposit beta measures the proportion of a market-rate change passed into the customer deposit rate. Lag measures the delay before that repricing occurs; neither is a deposit withdrawal rate.

Distribution

A probability distribution assigns probabilities to possible values or outcomes. It describes a range of possibilities rather than one realised observation.

Diversification

Diversification is the reduction in aggregate risk that can arise when positions do not experience adverse outcomes together. Its benefit depends on the chosen risk measure, dependence assumptions and any regulatory aggregation rules.

Duration

Duration summarises the timing of cash flows or their sensitivity to rates, depending on the definition. Macaulay duration is a present-value-weighted time, while modified duration estimates proportional price sensitivity to yield.

DV01

DV01 measures the value effect associated with a one-basis-point interest-rate move. Some systems report a signed price change and others report a positive loss magnitude, so the lesson’s sign convention must be checked.

Economic value of equity

Economic value of equity compares the present value of the relevant asset and liability cash flows under the chosen measurement convention. Delta EVE is the scenario change in that value and is not the same as a short-term earnings change.

Encumbrance

An encumbered asset is pledged or otherwise restricted in a way that limits its availability. An unencumbered asset is not automatically usable immediately; eligibility, location and operational readiness still matter.

Equity

Equity represents an ownership interest. On a bank balance sheet, equity is the residual interest in assets after liabilities; in a market-risk example, an equity position usually means shares in a company.

Expected credit loss

Expected credit loss is a probability-weighted estimate of credit cash shortfalls measured under IFRS 9’s applicable requirements. Timing, discounting, reasonable and supportable information, and the relevant measurement horizon matter.

Expected loss

Expected loss is the probability-weighted average loss over a defined set of outcomes. In a simple single-period credit example it is PD multiplied by LGD and EAD, but richer models also account for timing and dependence.

Floating rate

A floating rate resets according to a benchmark or contractual rule. Repricing occurs when the rate used to calculate a payment is updated, which need not coincide with repayment of principal.

Forward contract

A forward contract fixes today the terms of a transaction to occur at a future date. The value of an existing forward changes as current market prices and financing conditions change.

Funding and rollover risk

Funding supports assets and payment obligations through deposits, borrowing and other sources. Rollover risk is the risk that maturing funding cannot be replaced at an acceptable cost or at all.

Funds transfer pricing

Funds transfer pricing allocates funding costs and benefits internally to the businesses that create them. It helps reflect tenor, currency, liquidity and optionality but does not create additional profit for the consolidated bank.

FX swap and forward points

An FX swap exchanges currencies now and reverses the exchange at a later date. Forward points express the difference between forward and spot exchange rates; basis and market conventions affect the all-in funding interpretation.

Gamma

Gamma measures how delta changes as the underlying changes. Convexity describes curvature more generally; bond convexity usually refers to the second-order relationship between price and yield.

Haircut

A haircut reduces the recognised value of collateral or an asset pool for a specified calculation. It accounts for the relevant risk or rule and is not necessarily the price discount obtained in an actual sale.

Hedge

A hedge is a position intended to offset part of another exposure. It can leave basis, timing, legal or non-linear risks and can introduce its own funding and counterparty demands.

HQLA

High-quality liquid assets are assets meeting the relevant liquidity-standard eligibility and operational criteria. Level 1, Level 2A and Level 2B classifications carry different prescribed haircuts and composition constraints.

Idiosyncratic and systematic risk

Idiosyncratic risk is specific to a name or position, while systematic risk is driven by factors shared across many positions. The distinction affects diversification assumptions and some regulatory aggregation treatments.

IFRS 9

IFRS 9 is the financial reporting standard covering relevant classification, measurement, impairment and hedge-accounting requirements for financial instruments. The credit module focuses on its expected-credit-loss concepts and distinguishes them from regulatory capital rules.

ILAAP and ICAAP

The Internal Liquidity Adequacy Assessment Process evaluates liquidity and funding adequacy. The Internal Capital Adequacy Assessment Process evaluates capital adequacy. Both connect risk assessment, evidence and governance to management decisions.

Incremental and standalone risk

Standalone risk measures a position by itself. Incremental risk is the change in portfolio risk when the position is added; it can be negative when the new position hedges an existing exposure.

Independence

Variables are independent when learning the value of one does not change the probability distribution of the other. This is stronger than having zero linear correlation.

Interest rate

An interest rate expresses the cost of borrowing or the return on lending over a stated period. Its meaning depends on the currency, term, compounding convention and credit or collateral conditions.

Interest-rate swap

An interest-rate swap exchanges interest payments calculated on a reference notional. A common swap exchanges fixed interest for floating interest, allowing the parties to change their exposure to future rates.

Intraday liquidity

Intraday liquidity is the ability to meet payment and settlement obligations during the day. A positive closing cash balance can hide an earlier shortage if outgoing payments precede incoming funds.

IRRBB and CSRBB

IRRBB is interest-rate risk in the banking book and concerns earnings and economic-value effects. CSRBB is credit-spread risk in the banking book and addresses relevant spread movements that are distinct from general interest-rate changes.

LCR

The liquidity coverage ratio compares adjusted HQLA with prescribed net cash outflows over a 30-day stress period. The general inflow cap limits how much expected inflow can reduce the denominator, subject to applicable exceptions.

Liability

A liability is an obligation to transfer money or another resource. Customer deposits and a bank’s own borrowings are liabilities because the bank owes those amounts.

Liquidity and solvency

Liquidity concerns the ability to meet obligations when due. Solvency concerns the ability of assets and loss-absorbing resources to cover liabilities and losses; a solvent institution can still face a timed cash shortage.

Long and short positions

A long position generally benefits from ownership or a rise in the relevant instrument’s value. A short position has the opposite exposure. For complex derivatives, the precise payment and sign convention should always be checked.

Maturity

Maturity is the date or remaining period until a contract ends or principal becomes due. It can differ from an instrument’s next interest-rate reset or an option’s expiry.

Modified duration

Modified duration measures the approximate proportional price response to a small yield change under its convention. It is distinct from contractual maturity and from supervisory duration used in SA-CCR.

Natural hedge

A natural hedge offsets exposure through underlying receipts and payments, such as cash flows in the same currency. Timing, amount and legal availability must align for the offset to be effective.

Net interest income

Net interest income is interest earned on assets minus interest paid on funding over a defined period. Delta NII is the change in that income under a specified scenario relative to a baseline.

Netting set

A netting set contains transactions that can be combined under the relevant legally recognised agreement and calculation rules. Economic offsets across different legal sets do not automatically qualify as regulatory or collateral offsets.

NSFR, ASF and RSF

The net stable funding ratio compares available stable funding with required stable funding. ASF weights funding sources by the applicable stability treatment, while RSF weights assets and other requirements by their need for stable funding.

Option

An option gives its holder a contractual choice, such as buying or selling an asset on specified terms. Optionality also occurs inside other products, for example when a borrower can repay early.

Payment versus payment

Payment versus payment makes settlement of one currency conditional on settlement of the other. It mitigates principal settlement risk but leaves liquidity, operational and replacement-cost risks to manage.

Poisson process

A Poisson process counts randomly timed events with a specified intensity under its assumptions. Adding jumps allows a model to represent discontinuous changes that a purely continuous diffusion cannot generate.

Population stability index

The population stability index compares the distribution of a variable or score across samples using defined bins. It is a diagnostic of distribution change, not a universal proof that model performance has deteriorated.

Portfolio

A portfolio is a collection of positions considered together. Its risk depends on their sizes, relationships and permitted offsets, not just the sum of their standalone risks.

Potential future exposure

Potential future exposure allows for an increase in exposure after the current snapshot. In SA-CCR it is calculated through a prescribed multiplier and aggregate add-on, which differs from a generic simulated exposure quantile.

PRA

The Prudential Regulation Authority is the UK prudential supervisor for the firms within its remit. PRA rules, supervisory statements and consultation proposals have different roles and legal status.

Prepayment and CPR

Prepayment occurs when principal is repaid earlier than the expected or contractual schedule. The conditional prepayment rate is an annualised measure applied to the surviving balance under the stated convention.

Present value

Present value is the value today of a future payment or stream of payments under the selected discounting assumptions. A payment received later is converted into today’s value using a discount factor.

Principal

Principal is the amount borrowed or invested before interest. A derivative’s notional principal is a reference amount used to calculate payments and may never be exchanged.

Probability of default

Probability of default is the probability that a borrower defaults over a defined horizon and under specified conditions. One-year, remaining-lifetime, market-implied and prudential PDs answer different questions.

Rating migration

Rating migration is movement between credit-quality states. A transition matrix records the probabilities of those movements over a stated period, often including an absorbing default state in simplified examples.

Reconciliation

Reconciliation compares records or results and traces differences to their source. For risk calculations, this includes trade population, valuation time, units, currency, mapping, assumptions and model version.

Recovery and LGD

Recovery is the amount obtained after default, taking account of the relevant cash flows and costs. Loss given default, or LGD, is the fraction of exposure lost under the selected timing and discounting convention.

Regulatory capital and RWA

Regulatory capital is eligible loss-absorbing funding measured under the applicable rules. Risk-weighted assets express exposures or requirements on a risk-adjusted basis and are used with capital ratios; an exposure amount is not automatically a capital charge.

Reinvestment risk

Reinvestment risk is the risk that returned principal or income must be invested on less favourable terms. Early repayment can improve immediate liquidity while reducing future interest income.

Replication and no-arbitrage

Replication constructs a portfolio with the same payoffs as a claim in the modelled states. No-arbitrage requires matching attainable payoffs to have consistent prices under the relevant financing and trading assumptions.

Repo

A repurchase agreement raises cash against securities under an agreement to reverse the transaction. It creates a funding and repayment relationship and differs from an outright asset sale.

Risk appetite and limits

Risk appetite describes the types and amounts of risk an organisation is willing to accept under its governance. Limits and early-warning indicators translate that position into monitored measures and escalation triggers.

Risk-neutral measure

A risk-neutral measure is a pricing probability measure under which suitably discounted traded asset prices are martingales under the model’s conditions. Its probabilities are pricing weights and need not represent a real-world forecast.

Runoff

Runoff describes the amount or fraction of a funding balance assumed to leave over a specified period. A regulatory runoff rate and an internally chosen behavioural stress assumption are different inputs.

SA-CCR

SA-CCR is the standardised approach for counterparty credit risk. It combines replacement cost and potential future exposure, with the relevant alpha treatment, to produce a regulatory exposure-at-default amount.

Sensitivity

A sensitivity measures how a value changes when a specified input changes, under a stated bump and unit convention. Greeks are familiar option sensitivities such as delta, gamma and vega.

Settlement

Settlement is the completion of a payment or delivery obligation. A settlement lag separates the trade date from completion and can create cash needs and exposure before the exchange is final.

Spot price

The spot price is the price or exchange rate for a transaction with the usual near-term settlement convention. It differs from a forward price agreed for a later transaction.

SPPI and business model

SPPI asks whether contractual cash flows are solely payments of principal and interest under IFRS 9’s conditions. Classification also depends on the relevant business-model assessment, rather than on SPPI alone.

Standardised approach

A standardised approach uses prescribed calculation structures and parameters, although some inputs still come from the bank’s portfolio and systems. The precise meaning depends on whether the framework concerns market risk, counterparty exposure or another risk.

Stress and reverse stress testing

Stress testing examines the effect of specified adverse conditions. Reverse stress testing starts with an unacceptable outcome and asks what conditions could cause it, without automatically assigning those conditions a probability.

Stress calibration

Stress calibration uses a defined adverse market period or scenario to set a model’s risk scale. The data window, factor set and aggregation method determine what the resulting stressed measure represents.

Trapped liquidity

Trapped liquidity is cash or funding capacity that cannot reach the entity or currency with an obligation when needed. Legal restrictions, regulation, operational limits and settlement cut-offs can all reduce transferability.

Underlying

The underlying is the asset, rate, index or other reference quantity on which a derivative’s payments depend. A derivative can depend on more than one underlying risk factor.

Variation margin

Variation margin addresses changes in current exposure by transferring collateral according to the agreement. A received or posted amount is a cash or collateral flow, not an additional valuation profit by itself.

Wholesale and retail funding

Retail funding generally comes from individual customers or qualifying small businesses, while wholesale funding comes from financial markets and larger institutional sources. Regulatory classifications and stability assumptions require more detail than these broad labels.

Wrong-way risk

Wrong-way risk occurs when exposure increases in conditions associated with a greater likelihood or severity of counterparty loss. Right-way dependence moves in the opposite direction, but the model and evidence must establish the relationship.

Yield

Yield is a rate of return implied by a price and a specified set of cash flows under a stated convention. Different yield definitions and compounding conventions can produce different numerical rates.

Yield

A yield is a rate of return implied by a price and a specified cash-flow convention. Yield to maturity is the single discount rate that equates a bond’s promised payments to its price; realised returns can differ.