Risks in the Forex Management

Posted by admin on July 1, 2009 under Forex Trading | Be the First to Comment

The dealing room is rightly identified as a profit center for a bank. In these days of reducing spread between the lending and borrowing rates, banks have to look to other sources to improve their bottom lines. Foreign exchange is one area where the potential is vast. The progressive liberalization being introduced in the forex market has improved the scope for dealers to show their skills and earn for their banks. But, at the same time, it may not be forgotten that any scope for profits is associated with the Risks in the Forex Management.

The following are the major Risks in the Forex Managementdealings:

1. Open position risk – the position risk refers to the risk of change in exchange rates affecting the overbought or oversold position in foreign currency held by a bank. Hence, this can also be called the rate risk. The risk can be avoided by keeping the position in forex square.
2. Cash balance risk – cash balance refers to actual balances maintained in the nostro accounts at the end of each day. Balances in nostro accounts do not earn interest; while any overdraft involves payment of interest. The endeavor should, therefore, be to keep the minimum required balance in the nostro accounts. However, perfection on this count is not possible. Depending upon the requirement for a single currency more than one nostro account may be maintained.
3. Maturity mismatches risk – this risk arises on account of the maturity period of purchase and sale contracts in a foreign currency not matching or coinciding. The cash flows from sales and purchases mismatch thereby leaving a gap at the end of each period. Therefore, this risk is also known as liquidity risk or gap risk.
4. Fraud risk – frauds may be indulged in by the dealers or by other operational staff for personal gains or to conceal a genuine mistake committed earlier. Frauds may take the form of dealing for one’s own benefit without putting them through the bank, sharing benefits by quoting unduly better rates to some banks and customers, etc. The losses from such fraudulent deals can be substantial.

Thus, there are many more Risks in the Forex Management such as credit risk, country risk, over trading risk, and operational risks that are carefully analyzed.