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General Bank Management (CAIIB) International Banking (Module A) – PART-I Foreign Exchange

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  1. General Bank Management(CAIIB)International Banking (Module A) – PART-IForeign Exchange R N Hirve Chief Manager International Division Mumbai 29th November 2008

  2. Contents of Module A • RBI and exchange control in India • ICC, FEDAI, ECGC, EXIM Bank# • Exchange rates • Risk management and basics of derivatives# • Documentary letters of credit • Facilities for exporters and importers# • Correspondent Banking

  3. EXCHANGE CONTROL IN INDIA • FEMA 1999- W.E.F. 1ST JUNE 2000 • ORIGIN IN DEFENSE OF INDIA RULES (DIR) 1935 • CONTROL TO CONSERVE FEX DUE TO SEVERE CONSTRAINTS ON FOREX RESERVES DUE TO II ND WORLD WAR • 23 MAR 1947 THESE RULES BECAME FERA 1947 • MODIFIED/AMENDED-FERA 1973 W.E.F 1.1.1974 • FURTHER RALAXATIONS SINCE 1994. • FCRA 1976- [permission from Min.Of Home Affairs to receive FC – HC/DC Judge, Newspaper Editor, Publisher, Columnist, Printer, Political party leader, Office Bearer, Candidate for election, Charitable Trust]

  4. FEMA (49 Sections) Plays a role of facilitator which regulates & manages of FE transactions Civil Act.- prosecution to prove guilt NRI status Penalty Regulation, Discretion & Permission FERA (81 sections) Acted as controller for Conservation of FE Criminal Act- accused to prove innocence NRI status not compatible with IT Act Penalty & prosecution Only regulation FEMA V/S FERA

  5. FOREX TRANSACTIONS • 4 D – TRADE CONTROL, EXCHANGE CONTROL, BANK’S INTERNAL GUIDELINES, KYC • IMPORTANT SOURCE OF OTHER INCOME FOR BANKS – INTEREST/COMMISSION/EXCHANGE • IMPORTS • EXPORTS • INWARD/OUTWARD REMITTANCES • FC A/CS: EEFC/RFC/ESCROW/FCNR-B • FCLS • FOREX DEALING/TRADING OPERATIONS • Receipt/Payment/Borrowing/Lending in FX

  6. FEMA 1999 • How to receive FX : • Exports + IRS + Borrowings + Inbound Investments • How to remit FX: • Imports + ORS + Lending + Outbound Investments

  7. Capital Account • Residents • Creation of Assets/Liab. Outside INDIA • Non Residents • Creation of Assets/Liab. In INDIA

  8. Capital A/C ( Contd.) • Inflow -- Equity Debt &Assistance • ECB/ADR/GDR/FDI/FII/NR INV.EXT..assistance to INDIA • Out flow • Repayment of loans,Repatriation of capital,Foreign investments by Residents./EXT. Assistance by INDIA

  9. Current A/C ( Full convertible since 19/08/1994- Trade a/c flows, Misc payments, annual accruals- intt, dividend & profit) • Inflow • Export of goods & services – travel, insurance, investment , transport income, compensation to employees etc Outflow • Import of goods & services travel, insurance, investment , transport income, compensation to employees etc

  10. CURRENT A/C TRANSACTIONS • SCHDULE I- Prohibited • Eg. Remittance of lottery winnings, Racing, purchase of lottery tickets etc. • SCHDULE II- Permitted by Ministry/Deptt .Eg. Cultural tours-HRD-Dept of Education & Culture, Remittance of freight of vessel chartered by a PSU- Min of Surface Transport etc • SCHDULE III - Permitted by RBI • Eg. Gift /Donation exceeding USD 5000, release of exchange in excess of USD 10,000 or eq. in one financial year( April-March) [i/o one calendar year] for one or more visits to any country except Nepal & Bhutan, etc.

  11. BOT & BOP • BOT • Current a/c inflows – outflows • BOP • Current a/c + Capital a/c

  12. BALANCE OF TRADE

  13. Growing Foreign Exchange Reserves Foreign Exchange Reserves (US$billion) Exchange Rate (Rs/US$)

  14. RBI - IECD/FED/DBOD • FEMA 99 • Inflow & Outflow of F/C • Maintenance of FC reserves • Issue of license to A.D. • Inspection & Supervision • Monitoring – R returns, XOS,BEF etc • Master Circulars • AP (DIR) Circulars • Intt. Rates on Export Credit

  15. Guidelines & Rules for FX Business (FEDAI Rule book) • Training of Bk personnel in areas of FX Business • Accreditation of Forex Brokers • Code of Ethics & Conduct for Forex Dealers & Brokers • Advising/assisting member banks in settling issues/matters in their dealings • Code on Bank’s Commitment to Customers (CBCC)- Intt for delay in payment of Inward remittance beyond 10 days @ 2% over Savings rate ( USD 5000/USD 5000 and above) • Represent member banks on Govt/RBI/other bodies • Accounting standards/Closing Rates/ Revaluation of Mirror a/cs & outstanding cont

  16. CONCERNED MINISTRIES • Ministry of Commerce • Inflow and outflow of goods & Services (DGFT- FT Policy) • Ministry of Finance • Inflow and outflow of F/C (Customs/Excise/ED/RBI/Exim Bank/ECGC/Banks/0FIs) • Ministry of I.T. • Accreditation of software units • Promotion of software exports/STP/HTP

  17. Export Credit Guarantee Corporation of India Ltd. (ECGC) • It was set up for the promotion of exports in the year 1957. • To protect the exporters from any financial loss. • Primary goal of ECGC : To support & strengthen the export promotion drive in India by providing a range of credit risk insurance covers to exporters against loss in export of goods and service also by offering guarantee covers to banks and financial institutions to enable exporters to obtain better facilities from them.

  18. ECGC • Credit Guarantee cover • WTPCG- in f/o banks • WTPSG- in f/o banks • POLICIES- in f/o exporters • Status Report on overseas buyers

  19. Other market players • Insurance companies • Transporters • Chamber of commerce • Exporters/Importers

  20. Interest Rates • PCFC:LIBOR + 100 BP • PC:BPLR- 2.5% Upto 270 days • ECB: 3 to 5 yrs: LIBOR + 300 bps more than 5 yrs+500bps • FCNR interest ceiling : LIBOR/SWAP rates prevailing on the last working day of the previous month plus 100 basis points** w.e.f. 15th Nov 2008 • FCNR now in 6 currencies- USD/GBP/EUR/JPY/AUD/CAD* • Max 5 years* (* Ref DBOD cir 26/07/2005) • NRE interest rate ceiling: LIBOR/SWAP RATES FOR USD of corresponding maturities prevailing on the last working day of the previous month plus 175 bps w.e.f 15th Nov 2008 –** FEDAI would quote/display these rates fm FEB 2006 –Ref DBOD circular dtd 8 Feb 2006 • NRE SAVINGS: At the rate applicable to domestic deposit rates w.e.f. 17 Nov 2005

  21. Correspondent Banking • Relationship to be established by approval of the Board or delegated by Board headed by Chairman/CEO. • To be placed before the Board in next Board meeting for post facto approval • To understand details about Bank’s management, Major Business Activity, level of AML compliance, purpose of opening account, regulatory/supervisory frame work in the country of correspondent bank etc.

  22. USA PATRIOT ACT & Correspondent Banking Guidelines United and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism • Prohibition on Correspondent Accounts for Foreign Shell Accounts , for Foreign Shell Banks - Section 313 • Requirements – Terminate relationship no later than ten days after receipt of notice that the foreign bank has 􀁺 Failed to comply with a summons or subpoena 􀁺 Initiate proceedings in a US court to contest the summons or subpoena

  23. USA PATRIOT ACT & Correspondent Banking Guidelines • 120 hour rule – Not later than 120 hours after receiving a request 􀁺 Related to anti-money laundering compliance at a covered institution or, 􀁺 Regarding a customer at a covered institution - Covered institution shall provide • information and documentation for account opened, maintained, administered, or managed in the US

  24. PECULARITIES OF FOREX MARKETS • An Over The Counter Market • Only market open 24 hour a day • SYD/TOK/TAIPEI-S’PORE-HK/INDIA/EUR/LON/NY • 1.30PM/12.30PM/11.30AM/9.00AM/5.30AM//4.30AM/11.30PM-PREVIOUSDAY • No single location – no barriers • Exchange rates fluctuate almost every four second • Other markets- money, capital, & debt – also affect forex market • Controls/policies of respective governments also affect forex markets • Settlement of forex transactions normally do not take place simultaneously.

  25. Factors Influencing Currency Value Economic Factors 1. Balance of Payment 2. Interest Rates 3. Inflation 4. Monetary and Fiscal Policy 5. International Competitiveness 6. Monetary Reserves 7. Government Controls and Incentives 8. Importance of Currency in World Political Factors 9. Political Party and Leader Philosophies 10. Proximity of Elections or Change in Leadership Expectation Factors 11. Expectations 12. Forward Exchange Market Prices

  26. FX Rates • What is Exchange Rate ? • Exchange Rate is a rate at which one currency can be exchanged into another currency. • Foreign Exchange Deal • Involves the sale of one currency and the purchase of another at an agreed exchange rate

  27. How Banks quote spot rates to customers? • Ascertain the ongoing market rate • Load a margin • Quote • Cover • One of the party to the transaction must be a bank i.e. AD

  28. SPREAD THE DIFFERENCE BETWEEN THE BUYING AND SELLING RATE (BID AND OFFER RATES) IS KNOWN AS SPREAD

  29. Calculating Cross Rates • India is a market maker for Indian Rupee • Dollar/ Rupee trading ( the first quotes) start in the Mumbai Market • BUT WHAT ABOUT OTHER CURRENCIES ? • WHERE DO RATES FOR CHF, GBP, EUR ETC COME FROM? HOW ARE THEY CALCULATED? • A CHF/RUPEE RATE IS A CROSS OF DOLLAR/RUPEE & DOLLAR / CHF. • DOLLAR / RUPEE = 45.35/36 • DOLLAR / CHF = 1.3440 / 45 • CHF / RUPEE = 33.73 / 75 • In other words, 45.36 / 1.3440= 33.75AND • 45.35 / 1.3445= 33.73

  30. Calculating Cross Rates … 2 • FOR GBP ( EUR , AUD ) / RUPEE RATE • CROSS RATE IS ARRIVED AT BY MULTIPLICATION • DOLLAR / RUPEE = 45.35 / 45.36 x x • GBP / USD = 1.7960 / 1.7965 • GBP/ RUPEE = 81.45 / 81.49

  31. Forward Rates • What is a Forward Rate? • Rate agreed for settlement on an agreed date in the future • All rates are derived from Spot rates • Forward rate is the spot rate adjusted for the premium / discount • Forward Rate=Spot Rate+ / -premium or discount • Forward calculation ( examples ) • Is the forward rate, the market’s expectation of future spot rates ?

  32. FOREX FORWARDS • CONTRACT BETWEEN TWO PARTIES TO EXCHANGE CURRENCIES AT AN AGREED RATE ON AN AGREED DATE • FOR EXAMPLE : • Bank A agrees to buy from RIL USD 1 mio at 43.73 INR per $ ON 29th SEP 2005

  33. Determining Forward Rates • Forward rates are determined by adding/subtracting the premium/discount from the spot rates • E.g The Dollar is at a PREMIUM to the Rupee • Hence, the Dollar is more expensive to buy at a future date • If the Spot USD = 43.70 • ADD 3 months fwd Premium = 00.06 • USD/INR 3 MTH FWD = 43.76 • The USD is at a DISOCUNT to the JPY • Hence, the Dollar is cheaper to buy at a forward date • If the Spot USD/JPY = 108.80 • DEDUCT 3 months fwd discount = 0.40 • USD/JPY 3 month forward = 108.40

  34. FOREX FORWARDS • As per FEMA 1999 one of the parties has to be an AD • The contract could then be between an AD & its customer • OR between two ADs • The former is theRETAILsegment while the lateris theWHOLESALEsegment

  35. VALUE DATE • IN FOREIGN EXCHANGE MARKET IT TAKES SOME TIME TO PROCESS THE TRANSACTION AND SEND INSTRUCTION TO THE CORRESPONDENT BANK/BRANCH ABROAD. • THEREFORE IT IS CUSTOMARY TO QUOTE A RATE TO DO THE DEAL EVEN THOUGH EXCHANGE OF THE CURRENCIES DOES NOT TAKE PLACE ON THE SAME DAY.

  36. VALUE DATEIS THE DATE ON WHICH THE EXCHANGE OF CURRENCIES ACTUALLY TAKES PLACE. THIS IS IRRESPECTIVE OF THE DATE OF DEAL.

  37. Basic Terms used • Nostro a/c • Vostro a/c • Mirror a/c- reflection of Nostro a/c – maintained in FC and eq. rupees of the same- reconciliation of nostro a/c • Card Rates/ Notional Rate/ Indicative Rate • Opening/ Closing/High/Low Rates • Interbank Rate/ Screen Rate • Revaluation Rate/ Closing Rate ( FEDAI ) • LIBOR • Pipeline Transactions • Overdue contracts • Nostro/Vostro Reconcilaition

  38. Basic Terms Used • Exchange Position: The difference between the amount of a currency bought and the amount of the same currency sold is known as “position” in that currency. • Overbought Position: If the amount of FC bought by a bank is more than the amount sold, the difference between the two is “Overbought/Long/Plus” position • Oversold Position: If the amount of FC sold by a bank is more than the amount bought, the difference between the two is “Oversold/Short/Minus” position. • Square Position: If the amount of FC bought by a bank equals the amount sold, then the bank is said to have “square” position. If there is a small difference, it is known as “Near Square position” • Open Position: Exchange position at given point of time • O/N Position : Open Exchange position at the end of the day

  39. ORGANISATION OF DEALING ROOM • FX dealing – a highly specialised function • Need to have well trained personnel for front office to deal with branches, customers & other banks • Back office responsible for the follow-up of the deals made by the dealers • Effective control over the dealing operations is of great importance as possibilities exists for manipulation of exchange rates, dealing positions, mismatches etc.

  40. RBI’S ICG – FX BUSINESSSEGREGATION OF DUTIES • Front Office- Dealing Room • Mid- Office- Risk Management, Accounting Policies & MIS • Back Office- Settlement, Reconciliation, Accounting

  41. Exchange traded currency futures • U S $ - INR currency futurescontract • Contract to be quoted in rupee terms. Outstanding position in dollar terms • Minimum contract size $1000 • Maximum maturity of 12 months • Available contracts maturities from 1 to 12 months • Settlement in cash in Indian rupee at Reserve Bank reference rate • Settlement date: last working day (excluding Saturdays) of the month • Trading time 9 to 5 p.m. • Convenient lot size and standardized contracts

  42. Currency futures segment – in a recognized exchange • Eligible Net worth Rs.100 crore for exchange. • At least 50 members for currency derivatives segment • Operations, structure and capability • A distinct company as independent clearing corporation • Nationwide trading terminal • Online screen based trading system with disaster recovery site • Separate trading and order driven platform from other segments • Separate governing council • Trading membership • Net worth Rs. 1 crore for trading member, • Rs. 10 crore for clearing member • Trading members and sales persons to be accredited by certification • FIIs and NRIs would not be permitted to trade • Three exchanges in the initial stage • NSE, MCX,BSE.

  43. Advance Payment Open Account / On Account Sales – Consignment Basis Collection Method - Documentary Collection * Demand Bills * Usance Bills - Clean collection Documentary Credit / Letters of Credit INTERNATIONAL TRADE SETTLEMENT AND PAYMENT SYSTEM 44

  44. Factoring V/s Forfaiting • On going arrangement Single transaction based • Open account sale LC or bank acceptance required • Provides other than financing Primarily a financing service services • Used for offering short term credit For medium / long term transaction to regular buyers (up to 180 days) which could be “one-off” (90 days to 7years) • Both with and without recourse Is without recourse • For domestic and export receivables Usually for export receivables • No minimum size Transaction should be minimum USD 100,000

  45. An arrangement at the request and on instructions of a customer To make payment / authorise other bank to pay or negotiate Against stipulated documents Provided terms and conditions are complied with DOCUMENTARY CREDITS 46

  46. ART 4: TRIANGULAR CONTRACTUAL ARRANGEMENT SALE CONTRACT DEFINING TERMS IMPORTER EXPORTER L/C APPLICATION ADVICE OF OPENING LETTER OF CREDIT ISSUING BANK ADVISING BANK ISSUANCE OF THE LETTER OF CREDIT 47

  47. Applicant (Opener / Importer) Issuing Bank Beneficiary (Exporter) Advising Bank Confirming Bank Negotiating Bank Reimbursing Bank PARTIES TO DOCUMENTARY CREDIT 48

  48. Revocable / Irrevocable Confirmed Restricted / Unrestricted Transferable Back-to-back Revolving Deferred Red Clause / Green Clause Standby TYPES OF CREDIT 49

  49. INTERNATIONAL TRADE –ICC’S PUBLICATIONS International Standard Banking Practice (ISBP) – for the examination of documents under Documentary Credits – Publication No.681 International Standby Practices (ISP 98) – Publication No.590 50