How to do Forex Management ?

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

Forex was considered a rate commodity and was subject to strict control in almost all countries of the world till 1970s. Exchange control was the order of the day. Today we talk of Forex Management and not exchange control. But the fact is that Forex Management from the national point of view is only exchange control or regulation, though in a diluted form.

The term exchange control refers to the control, by the government or a centralized agency of transactions involving forex. In a broad sense, any stipulation or regulations which restrict the free play of forces in the forex market can be termed exercise of exchange control. The rate of exchange under exchange control regime tends to be different from the one that would exist in the absence of such control under Forex Management measures.

The origin of exchange control can be traced to nineteen-thirties. After the First World War, many countries of Europe found themselves with depleted gold reserves and forex. They imposed payment restrictions to prevent massive capital withdrawals and instill stability in the domestic economy. Since then exchange control has been adopted by a large number of countries and for different purposes within the framework of Forex Management measures.

With the onset of globalization and liberalization beginning at the commencement of 1990s, the tendency throughout the world has been that of relaxing exchange control. Even earlier, some countries like United States of America proclaimed that they had no exchange control. But the fact is even today exchange control exists in all countries, with varying intensity.

Thus, the Forex Management act seeks to bring the law on the subject up to date keeping in view the changed environment. This act aims at amending and consolidating the law involving forex for the purposes of facilitating payments and external trade as well as for promoting the orderly development and maintenance of forex markets. The important features noticed in the new act as compared with the previous one are:

1. The seriousness of non-compliance with the regulation is diluted. It is only of civil and no criminal consequence.
2. The nature of capital account and current account transactions has been clearly defined.
3. The new enactment if positive in the sense that all current account transactions not otherwise restricted can be freely carried on.
4. The definition of residents as well as non-residents takes into account the duration of their stay in the state, as in the case of federal tax act.

Risks in the Forex Management

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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.