INTERNATIONAL BANKING – MODULE A

INTERNATIONAL BANKING – MODULE A Prof. B.B. Bhattacharyya Welingkar Institute of Management Development & Research, Mumbai

What is an exchange rate ? • Factors determining exchange rates DEMAND SUPPLY S VALUE OF $ $1.75 $1.75 $1.65 VALUE OF $ $1.65 $1.60 $1.60 D x X-1 X + 1 X-1 X X + 1 International Banking QUANTITY OF £ QUANTITY OF £

What is an exchange rate ? • Factors determining exchange rates S $1.75 VALUE OF $ $1.65 $1.60 D X-1 X X-1 International Banking QUANTITY OF £

Why do Exchange Rates change? INFLATION S1 S VALUE OF $ 1.70 1.67 $1.65 $1.60 D1 D QUANTITY OF £ International Banking

Interest rate • Investment in foreign securities – demand and supply of currencies - exchange rates. • Relative income levels • Government controls • Expectations • Strength of the economy • Political factors • Central bank interventions • Technical factors International Banking

Direct quote – Foreign currency constant, home currency varies.eg. USD 1 = Rs. 39.50 • Indirect quote – Home currency constant, foreign currency varies. Eg. Rs. 100 = USD 2.53. • Two-way quotes International Banking

Cash /TOM/ SPOT – date on which the exchange of currencies actually take place. • Forward Transaction – Beyond Spot date • Value date International Banking

Derivatives • Forwards, Futures, Options, Swaps • Financial contract whose value is derived from or depends on the price of some underlying asset. Value of derivative changes when there is a change in the price of the underlying related asset. International Banking

Forward – to buy a specified asset on a specified date at a specified price. • Both right and obligation. • Future Contract – similar to forward contract. • A Currency futures contract is an agreement to buy or sell at ‘futures exchange’ a standard quantity of a foreign currency at a future date at the price agreed to between the parties to the contract • Difference – Contracts standardized, price negotiated. International Banking

Differences contd. • Exchange traded – no default risk –clearing house becomes the opposite party to both buyer and seller. • Most contracts are eventually offset.Only a small portion results in actual delivery. • Profits/ Losses on forward contracts are realized only on the delivery day, the change in the value of a futures contract results in cash flow every day- hence less default risk International Banking

Option • Gives the buyers right but no obligation to buy or sell the underlying at the agreed rate on or before an agreed date, • Premium • Call Option • Put Option • Seller (Writer) • American style options – on or before the expiration date • European Style options – only on the expiration date International Banking

Swaps • Contractual agreements between two parties to exchange flows -very common and popular product in derivative markets. • IRS – No exchange of principal but periodic exchange of streams of interest payments in terms of predetermined terms on a notional agreed principal. • Currency Swap – two parties agree to exchange specific amounts of two different currencies in the beginning and make periodic payments over time in accordance with predetermined terms. International Banking

IRS – Plain Vanilla International Banking

LIBOR COMPANY A COMPANY B 6.15% FLOATING RATE FUNDING LIBOR + 50 bps FIXED RATE FUNDING 6% International Banking

International Banking

Documentary L/C • LC is an arrangement whereby a bank acting at the request of the customer undertakes to pay a third party by a given date acording to agreed stipulations and against presentation of documents the counter-value of goods and services supplied • Banks deal only in documents and not in goods. International Banking

DIAGRAMATIC EXPLANATION OF VARIOUS STEPS IN THE OPERATION OF A L/C CONTRACT 1 IMPORTER BUYER APPLICANT EXPORTER SELLER BENEFICIARY SHIP GOODS 5 11 TAKE DELIVERY OF GOODS 6 2 NEGOTIATION OF EXPORT BILLS PREPARE & PASS DOCUMENTS ADVISE L/C RELEASE DOCUMENTS AGAINST CASH OR T/R APPLY L/C MAKE PAYMENT 7 4 10 9 ADVISING BANK / CONFIRMING BANK OR NEGOTIATING BANK ISSUING BANK SEND DOCUMENTS 8 3 L/C International Banking

Factoring • An arrangement for financing a company’s Business against the unpaid invoices drawn in favour of the customers and in which the factor becomes responsible for all credit control, sales ledger administration and debt collection activities. • Debt Administration • Credit Protection • Factor Financing International Banking

Factoring can be defined as • A continuing legal relationship between a financial institution (the Factor ) and a business concern (the client ) selling goods or providing services to trade customers (the Customer ) on open account basis whereby the Factor purchases the client’s book debts (receivables) either with or without recourse to the client and in relation thereto controls the credit extended to customers and administers the sales ledgers. International Banking

Forfaiting • A mechanism of financing exports by - discounting export receivables - evidenced by bills of exchange or promissory notes - without recourse to the seller - carrying medium to long term maturities - on a fixed rate basis - upto 100 percent of the contract value Simply put, forfaiting is the non-recourse discounting of export receivables. The exporter surrenders, without recourse to him, his rights to claim for payment on goods delivered to an importer, in return for immediate cash payment from a forfaiter. As a result, an exporter in India can convert a credit sale in to a cash sale, with no recourse to him / his banker International Banking

All exports of capital goods and other goods made on medium to long term credit are eligible to be financed through forfaiting International Banking

Flow- Chart • Exporter finalizes contract with overseas buyer and opens LC through his bank. • Exporter ships the goods as per schedule agreed with buyer • Exporter draws series of bills of exchange and sends them along with the shipping documents, to his banker for presentation to importer for acceptance through latter’s bank. Bank returns avalised and accepted bills of exchange to exporter. • Exporter informs the importer’s bank about assignment of proceeds of transaction to the Forfaiting bank • Exporter endorses avalised Bill of Exchange (BOE) with the words “ Without Recourse” and forwards them to the Forfaiting Agency (FA) through his bank. • The FA effects payment of discounted value • Exporter’s bank credit exporter • On maturity of BOE, the FA presents the instruments to the Aval for payment International Banking

Correspondent Bank – The interbank market is a network of correspondent banking relationships with large commercial banks maintaining demand deposits account with one another, called correspondent banking accounts. The correspondent bank account network allows for the efficient functioniong of the foreign exchange market International Banking

SWIFT – a private non-profit message transfer system. Provides an exclusive telecommunication network throughout the world for transmission of financial messages among banks and financial institutions • CHIPS provides a clearinghouse for the interbank settlement of U S dollar payments between international banks. A net payment settlement system International Banking

FED WIRE – Communication network of the Federal Reserve Bank- An automated computer based message system which follows Gross settlement as compared to Net payment system in CHIPS. Mainly used for Interbank fund transfers, sale and purchase of certain securities among banks, settlement of large value commercial transactions, payments received from other countries in favour of U.S. Banks • CHAPS – In London, similar to CHIPS in New York International Banking

NRE and FCNR Accounts International Banking

Reserve Bank Of India • It is empowered under the statute to control and regulate • foreign exchange reserves and policies related to international trade, • Inflow/outflow of foreign exchange, • It also has supervisory powers over the persons authorized to deal in foreign exchange. International Banking

Reserve Bank Of India • An essential function of a central bank is to maintain the stability of the external value of the domestic currency corresponding to the economic strength of the country and the monetary and fiscal policies of the authorities concerned. International Banking

Reserve Bank Of India • The guidelines and directions by RBI, so issued relate to foreign exchange transactions relating to exports, imports, remittances, travel and tourism, investments in India, repatriation of funds, non-resident Indian segment, as also overseas investment by Indian residents. • One important function of RBI is compiling data related to export-import trade, forex markets, non-resident deposits, as also international assets and liabilities. International Banking

FEMA, 1999 • All transactions in Foreign exchange are governed by FEMA 1999. • FEMA replaced FERA,1976. • Important Provisions of FEMA related to exports, imports, exchange rates, currency of payments, NRIs, etc… • Provisions for Foreign Travel. • Other Remittances. • Foreign Currency A/C in India • Exchange Earners Foreign Currency (EEFC) A/Cs • Resident Foreign Currency (RFC) Accounts • Resident Foreign Currency (Domestic International Banking

EXPORT-IMPORT BANK OF INDIA • Established by an Act of Parliament in 1981. • Bank commenced operations on March 1, 1982. • Exim Bank's mission is to facilitate globalization of Indian business. International Banking

Objectives of EXIM Bank • To translate national foreign trade policies into concrete action points. • To provide alternate financing solutions to the Indian exporter, aiding him in his efforts to be internationally competitive. • To develop mutually beneficial relationships with the international financial community • To initiate and participate in debates on issues central to India's international trade • To forge close working relationships with other export development and financing agencies, multilateral funding agencies and national trade and investment promotion agencies. • To anticipate and absorb new developments in banking, export financing and information technology. • To be responsive to export problems of Indian exporters and pursue policy resolutions. International Banking

EXIM Bank • Financing Programmes • For Exporters and Importers • For Commercial Banks • For Foreign Governments, Foreign Importers and other Financial Institutions. • Deferred Payment Exports/Project Exports. • Assistance for Project Exports/Turnkey Projects/Construction Projects. • Other Services and Programmes International Banking

EXIM Bank International Banking

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. International Banking

Export Credit Guarantee Corporation of India Ltd. (ECGC) • ECGC issues various types of guarantees to banks, financing exporters, which protect banks in case of loss from their advances to exporters. • Guarantees to Banks • At pre-shipment stage • At post-shipment stage • ECGC is a backbone of Indian Project Exports. International Banking

ECGC provides cover to various types of risks, namely, • Risk of not receiving payment from foreign buyers, • Trading on short term credit, • Of not receiving payments in respect of deffered payment exports, and • In respect of services rendered and construction projects undertaken abroad. International Banking

FEDAI • Foreign Exchange Dealer's Association of India (FEDAI) was set up in 1958. International Banking

Role of FEDAI • It's major activities include - • framing of rules governing the conduct of inter-bank foreign exchange business among banks vis-à-vis public, and • liaison with RBI for reforms and development of forex market. International Banking

Role of FEDAI Functions: • Set guidelines and rules for forex business. • Training the bank Personnel • Accreditation of Forex Brokers • Advising/ assisting member banks in settling issues/ matters in their dealings. • Represent members on govt. / RBI/ other bodies. • Monitor developments • Identify problems/ difficulties • Ensure proper adherence. International Banking

Thank You International Banking

INTERNATIONAL BANKING – MODULE A