Banks in emerging markets and their counterparts in developed ones have different philosophies about the role of treasury units, McKinsey research finds. The former tend to encourage risk taking and regard the function as a profit center; the latter typically restrict the scope and activities of treasuries to hedging and traditional balance sheet management.

Our findings, from a McKinsey survey of senior executives at 30 leading global financial institutions, show how different organizational models for treasuries have evolved in response to the growing sophistication and depth of financial markets—notably, higher volumes of interest rate derivatives. More recently, we have noted signs of convergence between these approaches, though the credit and liquidity crunch of mid-2007 may generate further evolution.

Exhibit 1 summarizes three types of organizational and governance structures in treasury units. Thirty years ago, virtually all banks were at stage one; indeed, many still are. The integrated model—stage two—became popular 10 to 15 years ago as many banks expanded the scope of their treasuries to include the broader management of the balance sheet (for instance, managing interest rate risk) and the capital markets business,¹ as well as liquidity management. Stage three, treasuries as specialized service centers separate from the capital markets division, is a phenomenon only of the past decade.

Our interviews with executives indicate that different banks now occupy a number of points along this spectrum. Treasuries in emerging markets typically manage balance sheets actively and sell treasury products to the customer base—an opportunity that started with products related to foreign exchange and blossomed when governments increased their issuance of tradable debt securities. Meanwhile, treasuries in developed markets have become highly specialized, broadening their funding sources around secured financing, in particular, and improving their approaches to modeling interest rate risk management.

What really stands out from the research is the underlying difference in management philosophies (Exhibit 2). Banks in emerging markets have become more active risk takers and regard treasuries as profit centers.² By contrast, leading players in developed markets increasingly have set up treasury units as service centers focused on liquidity and managing interest rate risk and governed as independent businesses.

Banks in emerging markets typically identify three sources of value creation. Many take outright interest rate positions in their own banking books³—a development resulting from not only the lack of adequate hedging instruments in many developing markets but also the need to contribute to the banks’ income. Some treasuries in these markets, notably capital-rich institutions in places such as the Middle East, manage investment portfolios actively. But the vast majority of treasuries in the developing world see themselves as the banks’ experts on capital market products and build their own customer franchises.

In developed markets, by contrast, treasuries tend to distinguish the traditional asset- and liability-management function from the client-related capital markets business. In general, the former function reports directly to the chief executive or to a bank’s chief financial officer; the latter function is separated and housed in the bank’s wholesale or investment-banking division. Treasuries in developed markets have become independent service centers, with at most very small P&Ls, focused on three types of services to the divisions. The first is the management of interest rate risk on a bank’s balance sheets, including the modeling of and transfer pricing for nonmaturing products, noninterest-bearing items (say, current accounts or credit cards), or both. Then there is the management of the bank’s funding sources and liquidity—especially vital during the recent market turmoil. The third is the execution of transactions, including securitizations and placements, relating to the bank’s own capital structure.

These dissimilarities in philosophy and organization are mirrored in the wide difference between the bottom-line contribution of the treasury and the asset- and liability-management units in developed and emerging markets, respectively. According to our research, that contribution amounts to an average of 18 percent of total income for banks in emerging markets, against 9 percent in developed ones. Much of that difference results from interest rate gapping⁴ and investment portfolios (Exhibit 3).

Management philosophies influence the perceptions of bank executives. Those in emerging markets think that treasuries have a strong influence on a bank’s overall management—for example, by using transfer pricing⁵ as an incentive mechanism to promote specific businesses. Treasury units in developed markets, our research shows, have a more "resource-controlling" focus, since their executives regard themselves as managers of the balance sheet, funding, and liquidity.

Will a fourth stage emerge in the next few years, with treasuries in developed markets again assuming an increasingly active role within the overall business models of banks? (If so, they wouldn’t necessarily be integrated in the same way that the banks of emerging markets have been during stage two.) Some treasuries have already embarked on this path. In the new approach, the asset- and liability-management function develops, among other things, structured on-balance-sheet products, using advanced techniques more actively to manage nonmaturing products (say, current accounts or credit cards) and the linkage of funding needs and customer products. In developed markets, banks that take deposits over the Internet (direct banks) have already shown that if the treasury function is more engaged in capital markets business, a bank can enhance its market position. What’s more, the recent turmoil has reminded everyone that liquidity is a critical resource that can never be taken for granted: incentives and other mechanisms should be in place to ensure that it is professionally managed when market conditions get tough.