international banking - module a

INTERNATIONAL INTERNATIONAL BANKING – MODULE ABANKING – MODULE A

Prof. B.B. BhattacharyyaProf. B.B. Bhattacharyya

Welingkar Institute of Management Development & Welingkar Institute of Management Development & Research, MumbaiResearch, Mumbai

04/10/2304/10/23 International BankingInternational Banking 22

What is an exchange rate ?What is an exchange rate ?

Factors determining exchange ratesFactors determining exchange rates

VA

LU

E O

F $

QUANTITY OF £

D

X + 1 x X-1

$1.60

$1.65

$1.75

DEMAND

VA

LU

E O

F $

QUANTITY OF £

X-1 X X + 1

$1.60

$1.65

SUPPLY

$1.75

S


What is an exchange rate ?What is an exchange rate ?

Factors determining exchange ratesFactors determining exchange rates

QUANTITY OF £

VA

LU

E O

F $

D

S

X-1 X X-1

$1.75

$1.65

$1.60


Why do Exchange Rates change?Why do Exchange Rates change?

QUANTITY OF £

VA

LU

E O

F $

$1.60

$1.65

1.67

D

D1

S

S1INFLATION

1.70


Interest rate Interest rate Investment in foreign securities – demand and supply of Investment in foreign securities – demand and supply of

currencies - exchange rates.currencies - exchange rates. Relative income levelsRelative income levels Government controlsGovernment controls ExpectationsExpectations Strength of the economyStrength of the economy Political factorsPolitical factors Central bank interventionsCentral bank interventions Technical factorsTechnical factors


Direct quote – Foreign currency constant, Direct quote – Foreign currency constant, home currency varies.eg. USD 1 = Rs. 39.50home currency varies.eg. USD 1 = Rs. 39.50

Indirect quote – Home currency constant, Indirect quote – Home currency constant, foreign currency varies. Eg. Rs. 100 = USD foreign currency varies. Eg. Rs. 100 = USD 2.53.2.53.

Two-way quotesTwo-way quotes


Cash /TOM/ SPOT – date on which the Cash /TOM/ SPOT – date on which the exchange of currencies actually take place.exchange of currencies actually take place.

Forward Transaction – Beyond Spot dateForward Transaction – Beyond Spot date

Value dateValue date


DerivativesDerivatives

Forwards, Futures, Options, SwapsForwards, Futures, Options, Swaps

Financial contract whose value is derived from Financial contract whose value is derived from or depends on the price of some underlying or depends on the price of some underlying asset. Value of derivative changes when there asset. Value of derivative changes when there is a change in the price of the underlying is a change in the price of the underlying related asset.related asset.


Forward – to buy a specified asset on a specified date Forward – to buy a specified asset on a specified date at a specified price.at a specified price.

Both right and obligation.Both right and obligation. Future Contract – similar to forward contract.Future Contract – similar to forward contract. A Currency futures contract is an agreement to buy or A Currency futures contract is an agreement to buy or

sell at ‘futures exchange’ a standard quantity of a sell at ‘futures exchange’ a standard quantity of a foreign currency at a future date at the price agreed to foreign currency at a future date at the price agreed to between the parties to the contract between the parties to the contract

Difference – Contracts standardized, price negotiated.Difference – Contracts standardized, price negotiated.


Differences contd.Differences contd.

• Exchange traded – no default risk –clearing houseExchange traded – no default risk –clearing house becomes the opposite party to both buyer and seller.becomes the opposite party to both buyer and seller.

• Most contracts are eventually offset.Only a small Most contracts are eventually offset.Only a small portion results in actual delivery.portion results in actual delivery.

• Profits/ Losses on forward contracts are realized only Profits/ Losses on forward contracts are realized only on the delivery day, the change in the value of a on the delivery day, the change in the value of a futures contract results in cash flow every day- hence futures contract results in cash flow every day- hence less default riskless default risk


OptionOption

Gives the buyers right but no obligation to buy or sell Gives the buyers right but no obligation to buy or sell the underlying at the agreed rate on or before an the underlying at the agreed rate on or before an agreed date,agreed date,

PremiumPremium Call OptionCall Option Put OptionPut Option Seller (Writer)Seller (Writer) American style options – on or before the expiration American style options – on or before the expiration

datedate European Style options – only on the expiration dateEuropean Style options – only on the expiration date


SwapsSwaps

Contractual agreements between two parties to Contractual agreements between two parties to exchange flows -very common and popular product exchange flows -very common and popular product in derivative markets.in derivative markets.

IRS – No exchange of principal but periodic IRS – No exchange of principal but periodic exchange of streams of interest payments in terms of exchange of streams of interest payments in terms of predetermined terms on a notional agreed principal.predetermined terms on a notional agreed principal.

Currency Swap – two parties agree to exchange Currency Swap – two parties agree to exchange specific amounts of two different currencies in the specific amounts of two different currencies in the beginning and make periodic payments over time in beginning and make periodic payments over time in accordance with predetermined terms. accordance with predetermined terms.


IRS – Plain VanillaIRS – Plain Vanilla

FIXEDFIXED FLOATINGFLOATING

COMPANY A 6% LIBOR + 25 bps

COMPANY B 6.75% LIBOR + 50 bps

DIFFERENTIAL 0.75% 25 bps or 0.25 %


COMPANY A COMPANY B

FIXED RATE FUNDING

6%

FLOATING RATEFUNDING

LIBOR + 50 bps

LIBOR

6.15%


PAYSPAYS RECIEVESRECIEVES NETNET

COMPANY COMPANY AA

-6%-6%-LIBORLIBOR

+ 6.15%+ 6.15% 6.15% -6.15% -

(6% + LIBOR)(6% + LIBOR)

=-(LIBOR-0.15%)=-(LIBOR-0.15%)

COMPANY COMPANY

BB

-6.15%-6.15%

-(LIBOR + -(LIBOR + 50bps)50bps)

+LIBOR+LIBOR -6.15% - LIBOR-6.15% - LIBOR

-50BPS + LIBOR-50BPS + LIBOR

=-(6.15 +0.50)=-(6.15 +0.50)

=-6.65%=-6.65%


Documentary L/CDocumentary L/C

LC is an arrangement whereby a bank acting at LC is an arrangement whereby a bank acting at the request of the customer undertakes to pay a the request of the customer undertakes to pay a third party by a given date acording to agreed third party by a given date acording to agreed stipulations and against presentation of stipulations and against presentation of documents the counter-value of goods and documents the counter-value of goods and services suppliedservices supplied

• Banks deal only in documents and not in goods.


IMPORTERBUYER

APPLICANT

CONTRACT

EXPORTERSELLER

BENEFICIARYSHIP

GOODS

TAKEDELIVERY

OFGOODS

APPLYL/C

RELEASEDOCUMENTS

AGAINSTCASH OR

T/R

ISSUINGBANK

NEGOTIATIONOF EXPORT

BILLS

PREPARE& PASS

DOCUMENTS

ADVISE L/C

MAKEPAYMENT

SENDDOCUMENTS

L/C

ADVISING BANK /CONFIRMING BANK

ORNEGOTIATING

BANK

1

5

11

2

107 4

6

8

3

9

DIAGRAMATIC EXPLANATION OF VARIOUS STEPS IN THE OPERATION OF A L/C


FactoringFactoring

An arrangement for financing a company’s An arrangement for financing a company’s Business against the unpaid invoices drawn in Business against the unpaid invoices drawn in favour of the customers and in which the favour of the customers and in which the factor becomes responsible for all credit factor becomes responsible for all credit control, sales ledger administration and debt control, sales ledger administration and debt collection activities.collection activities.

Debt AdministrationDebt Administration Credit ProtectionCredit Protection Factor FinancingFactor Financing


Factoring can be defined asFactoring can be defined as

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


ForfaitingForfaiting A mechanism of financing exports by A mechanism of financing exports by

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


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


Flow- ChartFlow- Chart Exporter finalizes contract with overseas buyer and opens LC through his Exporter finalizes contract with overseas buyer and opens LC through his

bank.bank. Exporter ships the goods as per schedule agreed with buyerExporter ships the goods as per schedule agreed with buyer Exporter draws series of bills of exchange and sends them along with the Exporter draws series of bills of exchange and sends them along with the

shipping documents, to his banker for presentation to importer for shipping documents, to his banker for presentation to importer for acceptance through latter’s bank. Bank returns avalised and accepted bills acceptance through latter’s bank. Bank returns avalised and accepted bills of exchange to exporter.of exchange to exporter.

Exporter informs the importer’s bank about assignment of proceeds of Exporter informs the importer’s bank about assignment of proceeds of transaction to the Forfaiting banktransaction to the Forfaiting bank

Exporter endorses avalised Bill of Exchange (BOE) with the words “ Exporter endorses avalised Bill of Exchange (BOE) with the words “ Without Recourse” and forwards them to the Forfaiting Agency (FA) Without Recourse” and forwards them to the Forfaiting Agency (FA) through his bank.through his bank.

The FA effects payment of discounted valueThe FA effects payment of discounted value Exporter’s bank credit exporterExporter’s bank credit exporter On maturity of BOE, the FA presents the instruments to the Aval for On maturity of BOE, the FA presents the instruments to the Aval for

payment payment


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


SWIFT – a private non-profit message transfer SWIFT – a private non-profit message transfer system. Provides an exclusive system. Provides an exclusive telecommunication network throughout the telecommunication network throughout the world for transmission of financial messages world for transmission of financial messages among banks and financial institutions among banks and financial institutions

CHIPS provides a clearinghouse for the CHIPS provides a clearinghouse for the interbank settlement of U S dollar payments interbank settlement of U S dollar payments between international banks. A net payment between international banks. A net payment settlement systemsettlement system


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

CHAPS – In London, similar to CHIPS in New YorkCHAPS – In London, similar to CHIPS in New York


NRE and FCNR AccountsNRE and FCNR Accounts


Reserve Bank Of IndiaReserve Bank Of India

It is empowered under the statute to control It is empowered under the statute to control and regulate and regulate foreign exchange reserves and policies related to foreign exchange reserves and policies related to

international trade,international trade, Inflow/outflow of foreign exchange,Inflow/outflow of foreign exchange,

It also has supervisory powers over the It also has supervisory powers over the persons authorized to deal in foreign persons authorized to deal in foreign exchange.exchange.



An essential function of a central bank is to maintain An essential function of a central bank is to maintain the stability of the external value of the domestic the stability of the external value of the domestic currency corresponding to the economic strength of currency corresponding to the economic strength of the country and the monetary and fiscal policies of the country and the monetary and fiscal policies of the authorities concerned. the authorities concerned.



The guidelines and directions by RBI, so issued relate The guidelines and directions by RBI, so issued relate to foreign exchange transactions relating to exports, to foreign exchange transactions relating to exports, imports, remittances, travel and tourism, investments imports, remittances, travel and tourism, investments in India, repatriation of funds, non-resident Indian in India, repatriation of funds, non-resident Indian segment, as also overseas investment by Indian segment, as also overseas investment by Indian residents.residents.

One important function of RBI is compiling data One important function of RBI is compiling data related to export-import trade, forex markets, non-related to export-import trade, forex markets, non-resident deposits, as also international assets and resident deposits, as also international assets and liabilities.liabilities.


FEMA, 1999FEMA, 1999 All transactions in Foreign exchange are governed by All transactions in Foreign exchange are governed by

FEMA 1999. FEMA 1999. FEMA replaced FERA,1976.FEMA replaced FERA,1976. Important Provisions of FEMA related to exports, Important Provisions of FEMA related to exports,

imports, exchange rates, currency of payments, NRIs, imports, exchange rates, currency of payments, NRIs, etc…etc… Provisions for Foreign Travel.Provisions for Foreign Travel. Other Remittances.Other Remittances.

Foreign Currency A/C in IndiaForeign Currency A/C in India Exchange Earners Foreign Currency (EEFC) A/CsExchange Earners Foreign Currency (EEFC) A/Cs Resident Foreign Currency (RFC) AccountsResident Foreign Currency (RFC) Accounts Resident Foreign Currency (Domestic Resident Foreign Currency (Domestic


EXPORT-IMPORT BANK OF INDIAEXPORT-IMPORT BANK OF INDIA

Established by an Act of Parliament in 1981.Established by an Act of Parliament in 1981. Bank commenced operations on March 1, 1982.Bank commenced operations on March 1, 1982. Exim Bank's mission is to facilitate globalization of Exim Bank's mission is to facilitate globalization of

Indian business.Indian business.


Objectives of EXIM BankObjectives of EXIM Bank

To translate national foreign trade policies into concrete action To translate national foreign trade policies into concrete action points. points.

To provide alternate financing solutions to the Indian exporter, To provide alternate financing solutions to the Indian exporter, aiding him in his efforts to be internationally competitive. aiding him in his efforts to be internationally competitive.

To develop mutually beneficial relationships with the To develop mutually beneficial relationships with the international financial community international financial community

To initiate and participate in debates on issues central to India's To initiate and participate in debates on issues central to India's international tradeinternational trade

To forge close working relationships with other export To forge close working relationships with other export development and financing agencies, multilateral development and financing agencies, multilateral funding agencies and national trade and investment promotion funding agencies and national trade and investment promotion agencies. agencies.

To anticipate and absorb new developments in banking, export To anticipate and absorb new developments in banking, export financing and information technology. financing and information technology.

To be responsive to export problems of Indian exporters and To be responsive to export problems of Indian exporters and pursue policy resolutions. pursue policy resolutions.


EXIM BankEXIM Bank

Financing ProgrammesFinancing Programmes For Exporters and ImportersFor Exporters and Importers For Commercial BanksFor Commercial Banks For Foreign Governments, Foreign Importers and For Foreign Governments, Foreign Importers and

other Financial Institutions.other Financial Institutions. Deferred Payment Exports/Project Exports.Deferred Payment Exports/Project Exports. Assistance for Project Exports/Turnkey Assistance for Project Exports/Turnkey

Projects/Construction Projects.Projects/Construction Projects. Other Services and ProgrammesOther Services and Programmes


EXIM Bank


Export Credit Guarantee Corporation of Export Credit Guarantee Corporation of India Ltd. (ECGC)India Ltd. (ECGC)

It was set up for the promotion of exports in the year It was set up for the promotion of exports in the year 1957.1957.

To protect the exporters from any financial loss.To protect the exporters from any financial loss. Primary goal of ECGC :

To support & strengthen the export promotion drive To support & strengthen the export promotion drive in India by providing a range of credit risk insurance in India by providing a range of credit risk insurance covers to exporters against loss in export of goods covers to exporters against loss in export of goods and service also by offering guarantee covers to and service also by offering guarantee covers to banks and financial institutions to enable exporters to banks and financial institutions to enable exporters to obtain better facilities from them.obtain better facilities from them.


Export Credit Guarantee Corporation of Export Credit Guarantee Corporation of India Ltd. (ECGC)India Ltd. (ECGC)

ECGC issues various types of guarantees to banks, ECGC issues various types of guarantees to banks, financing exporters, which protect banks in case of financing exporters, which protect banks in case of loss from their advances to exporters.loss from their advances to exporters.

Guarantees to BanksGuarantees to Banks At pre-shipment stageAt pre-shipment stage At post-shipment stageAt post-shipment stage

ECGC is a backbone of Indian Project Exports.ECGC is a backbone of Indian Project Exports.


ECGC provides cover to various types of risks, ECGC provides cover to various types of risks, namely, namely, Risk of not receiving payment from foreign Risk of not receiving payment from foreign

buyers,buyers, Trading on short term credit,Trading on short term credit, Of not receiving payments in respect of deffered Of not receiving payments in respect of deffered

payment exports, andpayment exports, and In respect of services rendered and construction In respect of services rendered and construction

projects undertaken abroad.projects undertaken abroad.


FEDAIFEDAI

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


Role of FEDAIRole of FEDAI

It's major activities include -It's major activities include - framing of rules governing the conduct of inter-framing of rules governing the conduct of inter-

bank foreign exchange business among banks vis-bank foreign exchange business among banks vis-à-vis public, and à-vis public, and

liaison with RBI for reforms and development of liaison with RBI for reforms and development of forex market. forex market.


Role of FEDAIRole of FEDAI

Functions:Functions: Set guidelines and rules for forex business.Set guidelines and rules for forex business. Training the bank PersonnelTraining the bank Personnel Accreditation of Forex BrokersAccreditation of Forex Brokers Advising/ assisting member banks in settling issues/ Advising/ assisting member banks in settling issues/

matters in their dealings.matters in their dealings. Represent members on govt. / RBI/ other bodies.Represent members on govt. / RBI/ other bodies. Monitor developmentsMonitor developments Identify problems/ difficultiesIdentify problems/ difficulties Ensure proper adherence.Ensure proper adherence.


Thank YouThank You

international banking - module a

Documents

exchange rates value

contract value

exchange of currencies

bills of exchange

exchange of principal

libor company

spot date value date

agreed date