General Bank Management CAIIB International Banking Module A

General Bank Management (CAIIB) International Banking (Module A) – PART-I Foreign Exchange R N Hirve Chief Manager International Division Mumbai 29 th November 2008

Contents of Module A n n n n RBI and exchange control in India ICC, FEDAI, ECGC, EXIM Bank# Exchange rates Risk management and basics of derivatives# Documentary letters of credit Facilities for exporters and importers# Correspondent Banking

EXCHANGE CONTROL IN INDIA n n n n FEMA 1999 - W. E. F. 1 ST JUNE 2000 ORIGIN IN DEFENSE OF INDIA RULES (DIR) 1935 CONTROL TO CONSERVE FEX DUE TO SEVERE CONSTRAINTS ON FOREX RESERVES DUE TO II ND WORLD WAR 23 MAR 1947 THESE RULES BECAME FERA 1947 MODIFIED/AMENDED-FERA 1973 W. E. F 1. 1. 1974 FURTHER RALAXATIONS SINCE 1994. FCRA 1976 - [permission from Min. Of Home Affairs to receive FC – HC/DC Judge, Newspaper Editor, Publisher, Columnist, Printer, Political party leader, Office Bearer, Candidate for election, Charitable Trust]

FEMA n n n V/S FEMA (49 Sections) Plays a role of facilitator which regulates & manages of FE transactions Civil Act. - prosecution to prove guilt NRI status Penalty Regulation, Discretion & Permission n n n FERA (81 sections) Acted as controller for Conservation of FE Criminal Act- accused to prove innocence NRI status not compatible with IT Act Penalty & prosecution Only regulation

FOREX TRANSACTIONS n n n n n 4 D – TRADE CONTROL, EXCHANGE CONTROL, BANK’S INTERNAL GUIDELINES, KYC IMPORTANT SOURCE OF OTHER INCOME FOR BANKS – INTEREST/COMMISSION/EXCHANGE IMPORTS EXPORTS INWARD/OUTWARD REMITTANCES FC A/CS: EEFC/RFC/ESCROW/FCNR-B FCLS FOREX DEALING/TRADING OPERATIONS Receipt/Payment/Borrowing/Lending in FX

FEMA 1999 n n How to receive FX : Exports + IRS + Borrowings + Inbound Investments How to remit FX: Imports + ORS + Lending + Outbound Investments

Capital Account Residents Creation of Assets/Liab. Outside INDIA n n Non Residents Creation of Assets/Liab. In INDIA

Capital A/C ( Contd. ) n n Inflow -- Equity Debt &Assistance ECB/ADR/GDR/FDI/FII/NR INV. EXT. . assistance to INDIA n n Out flow Repayment of loans, Repatriation of capital, Foreign investments by Residents. /EXT. Assistance by INDIA

Current A/C ( Full convertible since 19/08/1994 Trade a/c flows, Misc payments, annual accruals- intt, dividend & profit) Inflow Export of goods & services – travel, insurance, investment , transport income, compensation to employees etc n n Outflow n Import of goods & services travel, insurance, investment , transport income, compensation to employees etc

CURRENT A/C TRANSACTIONS n n n SCHDULE I- Prohibited Eg. Remittance of lottery winnings, Racing, purchase of lottery tickets etc. SCHDULE II- Permitted by Ministry/Deptt. Eg. Cultural tours-HRD-Dept of Education & Culture, Remittance of freight of vessel chartered by a PSUMin of Surface Transport etc SCHDULE III - Permitted by RBI Eg. Gift /Donation exceeding USD 5000, release of exchange in excess of USD 10, 000 or eq. in one financial year( April-March) [i/o one calendar year] for one or more visits to any country except Nepal & Bhutan, etc.

BOT & BOP BOT Current a/c inflows – outflows n n BOP Current a/c + Capital a/c

BALANCE OF TRADE $ in BN (Yr/March) 08 07 06 05 04 03 EXPORTS 155. 51 126. 41 100. 61 79. 24 61. 84 52. 74 IMPORTS 235. 91 185. 74 140. 23 107. 06 75. 21 60. 19 Trade deficit -80. 40 -59. 33 -39. 62 -27. 82 -13. 37 - 7. 45 51. 7 47 39 35 22 TD as % of EXP 14

Exchange Rate (Rs/US$) Foreign Exchange Reserves (US$ billion) Growing Foreign Exchange Reserves

RBI - IECD/FED/DBOD n n n n n FEMA 99 Inflow & Outflow of F/C Maintenance of FC reserves Issue of license to A. D. Inspection & Supervision Monitoring – R returns, XOS, BEF etc Master Circulars AP (DIR) Circulars Intt. Rates on Export Credit

n n n n Guidelines & Rules for FX Business (FEDAI Rule book) Training of Bk personnel in areas of FX Business Accreditation of Forex Brokers Code of Ethics & Conduct for Forex Dealers & Brokers Advising/assisting member banks in settling issues/matters in their dealings Code on Bank’s Commitment to Customers (CBCC)- Intt for delay in payment of Inward remittance beyond 10 days @ 2% over Savings rate ( USD 5000/USD 5000 and above) Represent member banks on Govt/RBI/other bodies Accounting standards/Closing Rates/ Revaluation of Mirror a/cs & outstanding cont

CONCERNED MINISTRIES n n Ministry of Commerce Inflow and outflow of goods & Services (DGFT- FT Policy) n Ministry of Finance n Inflow and outflow of F/C (Customs/Excise/ED/RBI/Exim Bank/ECGC/Banks/0 FIs) n n n Ministry of I. T. Accreditation of software units Promotion of software exports/STP/HTP

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

ECGC n n n Credit Guarantee cover WTPCG- in f/o banks WTPSG- in f/o banks POLICIES- in f/o exporters Status Report on overseas buyers

Other market players n n Insurance companies Transporters Chamber of commerce Exporters/Importers

Interest Rates n n n n PCFC: LIBOR + 100 BP PC: BPLR- 2. 5% Upto 270 days ECB: 3 to 5 yrs: LIBOR + 300 bps more than 5 yrs+500 bps FCNR interest ceiling : LIBOR/SWAP rates prevailing on the last working day of the previous month plus 100 basis points** w. e. f. 15 th Nov 2008 FCNR now in 6 currencies- USD/GBP/EUR/JPY/AUD/CAD* Max 5 years* (* Ref DBOD cir 26/07/2005) NRE interest rate ceiling: LIBOR/SWAP RATES FOR USD of corresponding maturities prevailing on the last working day of the previous month plus 175 bps w. e. f 15 th Nov 2008 –** FEDAI would quote/display these rates fm FEB 2006 –Ref DBOD circular dtd 8 Feb 2006 NRE SAVINGS: At the rate applicable to domestic deposit rates w. e. f. 17 Nov 2005

Correspondent Banking n n n Relationship to be established by approval of the Board or delegated by Board headed by Chairman/CEO. To be placed before the Board in next Board meeting for post facto approval To understand details about Bank’s management, Major Business Activity, level of AML compliance, purpose of opening account, regulatory/supervisory frame work in the country of correspondent bank etc.

USA PATRIOT ACT & Correspondent Banking Guidelines n n United and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Prohibition on Correspondent Accounts for Foreign Shell Accounts , for Foreign Shell Banks - Section 313 Requirements – Terminate relationship no later than ten days after receipt of notice that the foreign bank has Failed to comply with a summons or subpoena Initiate proceedings in a US court to contest the summons or subpoena

USA PATRIOT ACT & Correspondent Banking Guidelines 120 hour rule – Not later than 120 hours after receiving a request Related to anti-money laundering compliance at a covered institution or, Regarding a customer at a covered institution - Covered institution shall provide n information and documentation for account opened, maintained, administered, or managed in the US n

PECULARITIES OF FOREX MARKETS n An Over The Counter Market Only market open 24 hour a day n SYD/TOK/TAIPEI-S’PORE-HK/INDIA/EUR/LON/NY n n n n 1. 30 PM/12. 30 PM/11. 30 AM/9. 00 AM/5. 30 AM//4. 30 AM/11. 30 PM-PREVIOUSDAY No single location – no barriers Exchange rates fluctuate almost every four second Other markets- money, capital, & debt – also affect forex market Controls/policies of respective governments also affect forex markets Settlement of forex transactions normally do not take place simultaneously.

Factors Influencing Currency Value Economic Factors 1. Balance of Payment 2. Interest Rates 3. Inflation 4. Monetary and Fiscal Policy 5. International Competitiveness 6. Monetary Reserves 7. Government Controls and Incentives 8. Importance of Currency in World Political Factors 9. Political Party and Leader Philosophies 10. Proximity of Elections or Change in Leadership Expectation Factors 11. Expectations 12. Forward Exchange Market Prices

FX Rates n n What is Exchange Rate ? Exchange Rate is a rate at which one currency can be exchanged into another currency. Foreign Exchange Deal Involves the sale of one currency and the purchase of another at an agreed exchange rate

How Banks quote spot rates to customers? n n n Ascertain the ongoing market rate Load a margin Quote Cover One of the party to the transaction must be a bank i. e. AD

SPREAD THE DIFFERENCE BETWEEN THE BUYING AND SELLING RATE (BID AND OFFER RATES) IS KNOWN AS SPREAD

Calculating Cross Rates n n n n n India is a market maker for Indian Rupee Dollar/ Rupee trading ( the first quotes) start in the Mumbai Market BUT WHAT ABOUT OTHER CURRENCIES ? WHERE DO RATES FOR CHF, GBP, EUR ETC COME FROM? HOW ARE THEY CALCULATED? A CHF/RUPEE RATE IS A CROSS OF DOLLAR/RUPEE & DOLLAR / CHF. DOLLAR / RUPEE = 45. 35/36 DOLLAR / CHF = 1. 3440 / 45 CHF / RUPEE = 33. 73 / 75 In other words, 45. 36 / 1. 3440 = 33. 75 AND 45. 35 / 1. 3445 = 33. 73

Calculating Cross Rates … 2 n FOR GBP ( EUR , AUD ) / RUPEE RATE CROSS RATE IS ARRIVED AT BY MULTIPLICATION n DOLLAR / RUPEE = 45. 35 / 45. 36 n x n GBP / USD = n GBP/ RUPEE = 81. 45 / 81. 49 x 1. 7960 / 1. 7965

Forward Rates n What is a Forward Rate ? n Rate agreed for settlement on an agreed date in the future n All rates are derived from Spot rates n Forward rate is the spot rate adjusted for the premium / discount n n n Forward Rate = Spot Rate + / - premium or discount Forward calculation ( examples ) Is the forward rate, the market’s expectation of future spot rates ?

FOREX FORWARDS CONTRACT BETWEEN TWO PARTIES TO EXCHANGE CURRENCIES AT AN AGREED RATE ON AN AGREED DATE FOR EXAMPLE : Bank A agrees to buy from RIL USD 1 mio at 43. 73 INR per $ ON 29 th SEP 2005

n n n Determining are determined Forward rates. Forward Rates by adding/subtracting the premium/discount from the spot rates E. g The Dollar is at a PREMIUM to the Rupee Hence, the Dollar is more expensive to buy at a future date If the Spot USD = 43. 70 ADD 3 months fwd Premium = 00. 06 USD/INR 3 MTH FWD = 43. 76 The USD is at a DISOCUNT to the JPY Hence, the Dollar is cheaper to buy at a forward date If the Spot USD/JPY = 108. 80 DEDUCT 3 months fwd discount = 0. 40 USD/JPY 3 month forward = 108. 40

FOREX FORWARDS As per FEMA 1999 one of the parties has to be an AD The contract could then be between an AD & its customer OR between two ADs The former is the RETAIL segment while the later is the WHOLESALE segment

VALUE DATE n n IN FOREIGN EXCHANGE MARKET IT TAKES SOME TIME TO PROCESS THE TRANSACTION AND SEND INSTRUCTION TO THE CORRESPONDENT BANK/BRANCH ABROAD. THEREFORE IT IS CUSTOMARY TO QUOTE A RATE TO DO THE DEAL EVEN THOUGH EXCHANGE OF THE CURRENCIES DOES NOT TAKE PLACE ON THE SAME DAY.

n VALUE DATE IS THE DATE ON WHICH THE EXCHANGE OF CURRENCIES ACTUALLY TAKES PLACE. THIS IS IRRESPECTIVE OF THE DATE OF DEAL.

Basic Terms used n n n Nostro a/c Vostro a/c Mirror a/c- reflection of Nostro a/c – maintained in FC and eq. rupees of the same- reconciliation of nostro a/c Card Rates/ Notional Rate/ Indicative Rate Opening/ Closing/High/Low Rates Interbank Rate/ Screen Rate Revaluation Rate/ Closing Rate ( FEDAI ) LIBOR Pipeline Transactions Overdue contracts Nostro/Vostro Reconcilaition

Basic Terms Used n n Exchange Position: The difference between the amount of a currency bought and the amount of the same currency sold is known as “position” in that currency. Overbought Position: If the amount of FC bought by a bank is more than the amount sold, the difference between the two is “Overbought/Long/Plus” position Oversold Position: If the amount of FC sold by a bank is more than the amount bought, the difference between the two is “Oversold/Short/Minus” position. Square Position: If the amount of FC bought by a bank equals the amount sold, then the bank is said to have “square” position. If there is a small difference, it is known as “Near Square position” n Open Position: Exchange position at given point of time n O/N Position : Open Exchange position at the end of the

ORGANISATION OF DEALING ROOM n n FX dealing – a highly specialised function Need to have well trained personnel for front office to deal with branches, customers & other banks Back office responsible for the follow-up of the deals made by the dealers Effective control over the dealing operations is of great importance as possibilities exists for manipulation of exchange rates, dealing positions, mismatches etc.

RBI’S ICG – FX BUSINESS SEGREGATION OF DUTIES n n n Front Office- Dealing Room Mid- Office- Risk Management, Accounting Policies & MIS Back Office- Settlement, Reconciliation, Accounting

Exchange traded currency futures n n n n n U S $ - INR currency futures contract Contract to be quoted in rupee terms. Outstanding position in dollar terms Minimum contract size $1000 Maximum maturity of 12 months Available contracts maturities from 1 to 12 months Settlement in cash in Indian rupee at Reserve Bank reference rate Settlement date: last working day (excluding Saturdays) of the month Trading time 9 to 5 p. m. Convenient lot size and standardized contracts

Currency futures segment – in a recognized exchange n n n Eligible Net worth Rs. 100 crore for exchange. At least 50 members for currency derivatives segment Operations, structure and capability n n n Trading membership n n A distinct company as independent clearing corporation Nationwide trading terminal Online screen based trading system with disaster recovery site Separate trading and order driven platform from other segments Separate governing council Net worth Rs. 1 crore for trading member, Rs. 10 crore for clearing member Trading members and sales persons to be accredited by certification FIIs and NRIs would not be permitted to trade Ø Three exchanges in the initial stage Ø NSE, MCX, BSE.

INTERNATIONAL TRADE SETTLEMENT AND PAYMENT SYSTEM n n Advance Payment Open Account / On Account Sales – Consignment Basis Collection Method - Documentary Collection * Demand Bills * Usance Bills - Clean collection Documentary Credit / Letters of Credit 44

Factoring V/s Forfaiting u. On going arrangement Single transaction based u. Open account sale LC or bank acceptance required u. Provides other than financing Primarily a financing services u. Used for offering short term credit to regular buyers (up to 180 days) For medium / long term transaction which could be “one-off” (90 days to 7 years) u. Both with and without recourse Is without recourse u. For domestic and export receivables Usually for export receivables u. No minimum size Transaction should be minimum USD 100, 000

DOCUMENTARY CREDITS n n An arrangement at the request and on instructions of a customer To make payment / authorise other bank to pay or negotiate Against stipulated documents Provided terms and conditions are complied with 46

ART 4: TRIANGULAR CONTRACTUAL ARRANGEMENT SALE CONTRACT DEFINING TERMS EXPORTER IMPORTER L/C APPLICATION ADVICE OF OPENING LETTER OF CREDIT ISSUING BANK ADVISING BANK ISSUANCE OF THE LETTER OF CREDIT 47

PARTIES TO DOCUMENTARY CREDIT n n n n Applicant (Opener / Importer) Issuing Bank Beneficiary (Exporter) Advising Bank Confirming Bank Negotiating Bank Reimbursing Bank 48

TYPES OF CREDIT n n n n n Revocable / Irrevocable Confirmed Restricted / Unrestricted Transferable Back-to-back Revolving Deferred Red Clause / Green Clause Standby 49

INTERNATIONAL TRADE – ICC’S PUBLICATIONS n n International Standard Banking Practice (ISBP) – for the examination of documents under Documentary Credits – Publication No. 681 International Standby Practices (ISP 98) – Publication No. 590 50

INTERNATIONAL TRADE – ICC’S PUBLICATIONS n n Uniform Customs and Practice for Documentary Credits – UCP 600 and Supplement to UCP 600 for electronic presentation (e. UCP 1. 1 version) Uniform Rules for Bank-to-Bank Reimbursement (URR 525/725) 51

INTERNATIONAL TRADE – ICC’S PUBLICATIONS n n n Uniform Rules for Collection (URC 522) INCOTERMS 2000 Uniform Rules for Demand Guarantees (URDG) – Publication No. 458 52

THE STRUCTURE OF INCOTERMS 2000 4 Groups of terms Group E : Departure EXW EX Works (…. named place) n Group F : Main Carriage Unpaid FCA Free Carrier (…named place) FAS Free Alongside Ship (…named place) FOB Free On Board (…named port of shipment) Group C : Main Carriage Paid CFR Cost and Freight (…named port of destination) CIF Cost Insurance and Freight (…named port of destination) CPT Carriage Paid To (…named place of destination) CIP Carriage Insurance Paid To (…named place of destination) Group D : DAF Delivered at Frontier (…named place) DES Delivered Ex Ship (…named port of destination) DEQ Delivered Ex Quay (…named port of destination) DDU Delivered Duty Unpaid (…named place of destination) DDP (Delivered Duty Paid (…named place of destination) 53

UCPDC – UNIFORM CUSTOMS AND PRACTICE FOR DOCUMENTARY CREDITS n n n n Universally recognised set of guidelines governing Letters of Credit Brochure framed by ICC, HQ at Paris. ICC – World Business Organisation of non-govt. nature working towards Trade Liberalisation, Free & Fair competition 1933 – revised in 1951, 1962, 1974, 1983, 1993 Latest Publication No. 600, 2007 revision adopted w. e. f. 01/07/2007 L/C being one of the safe methods of settlements is commonly used in trade, hence UCPDC has become indispensable. Constructive delivery of goods since matching physical delivery with payment is not possible. By handing over documents or transferring title or to control over the goods is possible under L/C mechanism. UCPDC balances the interests of all parties to L/C and gives maximum possible guidance and assistance. 54

The UCP 600 Revision Some Highlights: n n Fewer articles. UCP 600 contains 39 articles. The UCP 500 has 49. A replacement of the term "reasonable time" with a definite number of days (5) for examining and determining compliance of documents; n A new provision concerning addresses of the beneficiary and the applicant; n An expanded discussion of "original documents"; and n Re-drafted transport articles aimed at resolving confusion over the identification of carriers and agents

The UCP 600 Revision Some Highlights (continued): n n n A new section of "definitions", containing terms such as "honour" and "negotiation“. Honor means, i) to pay at sight if the credit is available by sight payment, ii) to incur a deferred payment undertaking and pay at maturity if the credit is available by deferred payment, (iii) to accept a bill of exchange (“draft”) drawn by the beneficiary and pay at maturity if the credit is available by acceptance. Negotiation means the purchase by the nominated bank of drafts (drawn on a bank other than the nominated bank) and/or documents under a complying presentation, by advancing or agreeing to advance funds to the beneficiary on or before the banking day on which reimbursement is due to the nominated bank.

Summary of Changes n n n The phrase "reasonable time" for acceptance or refusal of documents has been replaced by a firm period of five banking days. The number of articles reduced to 39. New provisions allow for the discounting of deferred payment credits. Banks can now accept an insurance document that contains reference to any exclusion clause. New sections on "definitions" and "interpretations" have been added to clarify the meaning of ambiguous terms. Credit must state if reimbursement is subject to the ICC rules for bank to bank reimbursements.

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