72533276 CAIIB Super Notes Bank Financial Management Module a International Banking Exchange Rates and Forex Business

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Exchange Rates and Forex Business Module A: International Banking

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CAIIB – SUPER NOTES Bank Financial Management: Exchange Rates and Forex Business

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Contents Coverage: 1.Foreign Exchange – Definition and Markets 2.Factors Determining Exchange Rates 3.Exchange Rate Mechanism 4.Foreign Exchange Dealing Room Operations 5.RBI/FEDAI Guidelines

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FOREIGN EXCHANGE – DEFINITION AND MARKETS 1.

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Foreign ExchangeDefinition •Conversion of currencies from the currency of invoice to the home currency of the exporters – generally required for cross border trade •A For Ex Transaction is a contract to exchange funds in one currency for funds in another currency at an agreed rate and arranged basis. •All claims payable abroad, whether consisting funds held in foreign currency with banks abroad or bills, checks payable abroad.

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For Ex - FEMA Definition Foreign Exchange means foreign currency and includes: i)All deposits, credits and balances payable in foreign currency, and any drafts, traveler’s cheques, letters of credit and bills of exchange, expressed or drawn in Indian currency and payable in any foreign currency, ii)Any instrument payable at the option of the drawee or holder thereof or any other party thereto, either in Indian currency or in foreign currency, or partly in one and partly in other.

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ForEx Market Participants •Central Banks •Commercial Banks •Investment funds/banks •ForEx brokers •Corporations •Individuals

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Foreign Exchange Markets Characteristics: •24 hour market

•an over the counter market •a global market with no barriers/no specific location •supports large capital and trade flows •highly liquid markets •high fluctuations in currency rates •settlements affected by time zone factor •markets affected by governmental policies and controls

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FACTORS DETERMINING EXCHANGE RATES 2.

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Factors Determining Exchange Rates

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EXCHANGE RATE MECHANISM 3.

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Types of Transactions

•Date on which exchange of currencies actually takes place

Value date

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Forward Margins – Premium and Discounts •Forward Rate = Spot Rate + Premium (or - Discount) –Premium: Forward Value of Currency > Spot Value –Discount: Spot Value of Currency > Forward Value

•In a perfect market, with no restriction on Finance and Trade, the interest factor is the basic factor in arriving at the forward rate •Forward price of a currency can be worked out on the basis of: –Spot price of the currencies involved –The interest rate differentials for the currencies –The term, i.e., the future period for which the price is worked out

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Type of Quotes

Internationally, all currencies other than GBP, Euro, AUD and NZD are quoted as direct rates.

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Cross Rates •When rates for a particular currency pair are not directly available •Ex: –USD/INR Rate is 49.10/11 –GBP/USD Rate is 1.5000/10 –GBP/INR Rate will be: 49.10 x 1.5000/49.11 x 1.5010

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Fixed vs. Floating Rates •Fixed Rate: Official rate set by the monetary authorities for one or more currencies •Floating Rate: Value of the currency decided by supply and demand factors •The floating rate system is prevalent in the world market since 1973. India adopted the same in 1993.

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Bid and Offered Rates •Bid rate: Buying Rate •Offered Rate: Selling Rate

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Terminology •1 Per Mille: 1 part in every thousand •Valuer Compensee payments: Where value date is same in both centers •Arbitrage: –Simple/Direct Arbitrage: Between 2 centers only –Compound/Three (or more) Point Arbitrage: Where additional centers are involved

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FOREIGN EXCHANGE DEALING ROOM OPERATIONS 4.

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Functions 1.To meet requirements of customers of other branches/divisions to buy or sell foreign currency. 2.Manage Foreign currency assets and liabilities. 3.Fund and manage Nostro accounts 4.Undertake proprietary trading in currencies.

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3 Parts of a Dealing Room

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Positions

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Terminology

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Major Risks associated with ForEx Dealing Operations

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RBI/FEDAI GUIDELINES 5.

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Categorisation of Authorised Persons

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FEDAI Guidelines/Rules 1.Standard transit period for export bills

2.Crystallisation of bills in foreign currency in case of delay in realisation within 60 days 3.Sight bills for Import LC would crystallise on 10 th day after date of receipt 4.Forward contracts to have definite amounts and specific delivery dates 5.Delivery period under option contract shall not exceed one month 6.All forward contracts to be automatically cancelled on the 7th working day after maturity if not picked up

7.All cancellation at Bank’s opposite TT rates

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FEDAI Guidelines/Rules

8.Interest @ 2% above the prime rate of the currency to be charged in event of delay in payment of interbank foreign currency funds 9.Interest @ 2% above the NSE MIBOR to be charged in event of delay in payment of rupee settlement funds 10.All currencies to be quoted as: –Per unit of Foreign currency =INR. Ex: $1 = Rs 45.67 –Except JPY, Indonesian Rupaih and Kenyan Schilling. To be quoted as 100 units of Foreign currency = INR.

FEDAI also prescribes code of conduct for FOREX dealers, as also guidelines with regard to dealings with forex brokers.

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RBI Guidelines •Guidelines related to: –Open positions –Gaps –Borrowing and Lending in Foreign currencies –Interbank dealings in India and overseas markets –Hedging of bank’s own exposures as well as that of its resident and non-resident clients

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RBI Guidelines 1.AD CAT 1 Banks allowed to open/close rupee accounts 1.In names of overseas branches or correspondents without prior reference to RBI 2.In names of exchange houses with prior reference to RBI

2.AD CAT 1 Banks allowed to open/close foreign currency accounts abroad 3.AD CAT 1 Banks can undertake investments in overseas markets in money market instruments and/or debt instruments, issued by foreign state, maturity < 1 yr, rated as per guidelines 4.Surplus funds in Nostro accounts can be used for 1.Granting Loans to resident constituents 2.Extending credit facilities to Wholly Owned Subsidiaries/JVs of Indian companies abroad

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RBI Guidelines 5.All borrowings in Nostro accounts (including ECB and Temp. Overdraft) not adjusted within 5 days shall not exceed 50% of their unimpaired Tier 1 Capital or USD 10 million whichever is higher 6.Banks can allow banks to book Forward Exchange contracts to hedge their exchange risk exposure -The genuineness of the underlying documentary evidence and exposure must be ascertained

7.Banks can allow importers/exporters to book Fwd. Contract on basis of declaration of the exposure with limit based on past performance 8.SME customers may be allowed to book forward contracts in alignment with the credit facilities availed by it from the bank

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RBI Guidelines

9.Banks can allow resident individuals to book Forward contracts on deliverable basis with tenors up to 1 year up to a limit of USD $ 100,000. 10.Banks can offer other derivative contracts to resident entities who have borrowed foreign exchange in accordance with the provisions of FEMA 1999 11.Banks can also offer Foreign currency Rupee Swap to resident entities that have a forex or rupee liability to hedge long term exposure 12.Banks can enter into cross currency options and foreign currency-rupee options with their customers on back to back basis

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