Foreign Exchange Comptroller’s Handbook Narrative and Procedures

Other Income Producing Activities Foreign Exchange Comptroller’s Handbook Narrative and Procedures - March 1990 Comptroller of the Currency Administrator of National Banks I (Section 813) Comptroller’s Handbook Foreign Exchange (Section 813) i Foreign Exchange (Section 813) Table of Contents Introduction 1 Risks 1 Policy 6 The Market 12 Examination Procedures 17 Internal Control Questionnaire 25 Verification Procedures 32 Comptroller’s Handbook Foreign Exchange (Section 813)1 Foreign Exchange (Section 813) Introduction This section is intended to provide minimum background and procedural guidelines to examiners responsible for evaluating a bank’s foreign currency activities. Within individual banks, foreign currency money market and exchange trading operations may be combined or completely separate with regard to policies, procedures, reporting, and even dealing. However, they ultimately must

be viewed together to evaluate liquidity and to insure compliance with overall bank objectives and risk management strategy. For the sake of brevity, this section discusses both functions as if they were performed by the same traders, processed by the same bookkeepers and managed by the same officers. Close coordination is required among examiners performing the foreign exchange, due from banks—time, nostro account, and funds management functions. Most importers, exporters, manufacturers, and retailers tend to let banks handle their foreign exchange needs. They rely on banks to make and receive their foreign currency payments, to provide them with foreign currency loans, to fund their foreign currency bank accounts, and to purchase their excess foreign currency balances. They may ask banks to provide such services for immediate delivery, i.e., at spot (short-term contracts, perhaps up to 10 days), or they might contract to buy or sell a specified amount of foreign currency for delivery at a future date. In either instance, the rates for such services may be established prior to the finalization of the commercial transactions, and the related costs may be calculated and often passed on to the buyers. Risks In contracting to meet a customer’s foreign currency needs, by granting loans, accepting deposits, or providing spot or forward exchange, a bank undertakes a risk that exchange rates might change subsequent to the time the contract is made. The bank, therefore, must turn to wholesale markets, principally other banks, to acquire the cover necessary to protect itself against loss on such contracts. The astute banker manages that risk by maintaining constant surveillance over the following: Net Open Positions. A bank has a net position in a foreign currency when its assets, including spot and future contracts to purchase, and its liabilities, Foreign Exchange (Section 813) Comptroller’s Handbook2 including spot and future contracts to sell, in that currency are not equal. An excess of assets over liabilities is called a net “long” position and liabilities in excess of assets, a net “short” position. A long position in a currency which is depreciating will result in an exchange loss relative to book value because, with each day, that position (asset) is convertible into fewer units of local currency. Similarly, a short position in a currency that is appreciating represents an exchange loss relative to book value because, with each day, satisfaction of that position (liability) will cost more units of local...

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