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FOREIGN EXCHANGE RISK MANAGEMENT

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In today’s world, both business & financial risk are linked to each other. As for significant risk of loss/
uncertainty & excessive volatility of Foreign Currencies/ traditional products/instruments in the
Financial Market, Islamic Financial Products are becoming fast darling in the Global & Local banking
industry attracting Muslims and non Muslims due to Risk sharing, ethical provision and non interest
policies.

Foreign Exchange (Forex) Treasury Overview:

Today’s financial institutions engage in activities starting from merchant transactions (import, export and
remittance) to complex derivatives involving basic foreign exchange complex structured/customize
products. in order to aggregate & minimize the foreign exchange risks at a single department and to bring
expertise in such functions a separate Division is established namely as Treasury Division. The Forex
Treasury usually consists of DEALERS (Officials appointed/engaged in doing transactions with other
Banks/Clients) under Chief Dealer(s) and the Head of this Treasury Division is called TREASURER.
However, each transaction initiated by dealers is called as “DEAL”.

Shariah rulings regarding Forex Treasury: AAOIFI Standard:

 Both parties must take possession of the counter values before dispersing, such
possession being either actual or constructive
 The counter values of the same currency must be of equal amount, even if one of them is
in paper money and other is in coin of the same country, like a note on one pound for a
coin of one pound
 The contract shall not contain any conditional option or deferment clauses regarding the
delivery of one or both counter values
 The dealing in currencies shall not aim at establishing a monopoly position, nor should it
entail any evil consequences to the interest of individual or societies.
 It is permissible for the institution to hedge against the future devaluation of currency by
recourses to -back to back interest free loans and the exposure is account payable.
 Execution of trade by appointing agent to execute the contract.
 It is also permissible to execute deals on bilateral exchange in settlements of the two
debts which is called as AL MUQASAH (Set off/netting arrangement)
Forex Treasury Set UP:

Sl Name of Department/Offices Policy Guidelines

01. Treasury Front Office(Dealing Room) Policy on Exchange rate quotations, adherence of
limits, Dealing hour, after hour, Off premises
Dealing procedure and other Dealing activities
control and Reporting
02. Treasury Mid Office Watchdog for Treasury Front & Back Office,
Setting up prudent limits & renewal of limits,
Risk Reporting.
03. Treasury Back Office Transactions(Deal) Checking, confirmation,
Delivery, Settlements, FC position,
 Reconciliation, Valuation etc.

Present Areas of Forex Treasury activities:

Treasury Product Spot Foreign Exchange transactions(date of deal plus Two working day
= date of settlement)

Principle Bai –as sarf (Spot under Hukmi –eadin –biaden i.e. and to hand)
Functions/activities • Merchant transactions
o Pricing & settlements of import, export & remittances
related fund based transactions.
o Allowing Special Rates to Valued Clients.
o Attraction/Induction of Other Banks/Inter-Bank
Corporate
o Sale/buy currencies to/from Loca Inter-Bank l Market.
• Trading in Currencies in Global Markets.
• Overseas Investment of Customers Funds with IDB.
Market analysis • Foreign Exchange Market
• Money, Stock & Commodity Market.
• Central Bank behavior

Risks in Forex Treasury & Its Management Strategy:

Sl Risk Causes Risk Management strategy

01. Market Risk External events ( Financial Crises inProper Market Analysis,
market), Profit/Interest rate Daylight limit ( buy/sale limit during
Currency exchange rate dealing hour) , Overnight Limit
Commodity prices in the globe (allowing maximum Currency holding
Equity/Stock Market overnight)Stop Loss limit ( Certain
boundaries to cut los per deal & per day)
02. Credit risk Insolvency of the counterparty. CollapseFixation of Counterparty(other BanksFI)
of parents/subsidiary company Credit Limit to do Foreign exchange
transactions considering Net worth/Paid
up capital/Crediting rating, ,Review of
counterparty limit with the market
change, ongoing investment evaluation
and monitoring and following sound
operating procedure
03. Operational Risk Any Operational Difficulties. Segregation of duties, Deal slips
monitoring Deal recording /Real time
Blotter Reconciliation Daily risk report
etc
04. Liquidity Risk Surplus & shortage of Foreign currencyProper maintenance of Open Position
liquidity limit fixed by Central bank.
Dealers Code of conduct
a) Dealers will develop high standard of professionalism, integrity and ethical conduct.
b) Troubles that arose during dealing activities, which might cause serious setback, must
immediately be reported to the Management through Head of Treasury.
c) Dealers never enter into an argument with the counterparties.
d) Dealers operating in the market are responsible for maintaining confidentiality. Dealers
are not permitted to pass on information within the institution until otherwise permitted by the
management.
e) Dealers will employ their full attention to the growth of the Bank business activities and
not be distracted by their own interest.
f) Dealers should pay great vigilance to protect any fraud attempt.
g) Dealers will not receive entertainment, gifts and any other benefit from the Counter
party(s).
h) No misleading information will be provided to FX Market by FX Dealers.
i) Market terminology should be clear.
j) All conversation on the Reuters Dealing system must be in English and conversation over
phone must be restricted either in Bengali or in English.
k) Communication should not be vague. Dealers should be precise and to the point.
l) Dealers should not visit other Bank’s dealing room until permission of the Management
of the both counterparties.
m) All other code of conduct as issued time to time by BAFEDA, Bangladesh Bank and
standard practice in FX Dealing.
Treasury Auditing:
Purpose Areas of Auditing Policy guidelines
As a check point to a) Treasury front office ensures that all A concurrent audit process is in place
review the adequacy deals are executed promptly captured by the Management to check Treasury
of the key control by the Treasury Back office. functions in an appropriate manner on a
issue set my b) Reconciliation of foreign Exchange day to day basis. Head of Back office
Management. position between Dealers records and will monitor the Audit job to be done
that of Treasury Back office Position. by the designated officer and would
c) Review of Deal confirmations and submit the report to the Executive
counter confirmations. president on monthly basis. Besides,
d) Completeness, correctness and The Bank’s internal audit to be
timeliness of the internal & regulatory conducted twice in a year on FX
Reporting system. Treasury.The Central Bank also
e) Functional Separation. conducts special inspection on Forex
f) Valuation of F.C(s). Treasury time to time.
g) Different Dealing Limits.
h) Periodic/concurrent audit on
reconciliation of Nostro A/Cs