Foreign currency operations involve banks. A requirement (asset) and a liability (obligation) are created in one currency when they are purchased or sold. As a result, currency exchange rates have a significant impact on the demands and liabilities of banks, which are held in a variety of currencies.
Currency risk is the chance of losing money or making money because of bad changes in the exchange rate.
The bank’s currency position is determined by the ratio of its foreign currency assets to liabilities. The currency position is closed if a bank’s requirements and obligations in a particular currency are equal; however, if there is a mismatch, the position is open. The banking industry is in a relatively stable closed arrangement state. But this arrangement makes it impossible to profit from the change in the exchange rate. In turn, the open one can be either “long” or “short.” If obligations are greater than requirements, the position is referred to as “long” and “short.” When the bank’s assets in a currency exceed its liabilities, a long position in that currency carries the risk of loss in the event that the currency’s exchange rate falls. When a currency’s liabilities exceed its assets, a short currency position carries the risk of loss in the event that the currency’s exchange rate rises.
The following activities have an effect on banks’ currency positions:
• Obtaining foreign currency interest and other income.
• Operations using derivatives (such as forward and futures transactions, settlement forwards, swap deals, etc.), • Conversion operations that require the immediate delivery of funds which, regardless of the method and form of settlement for such transactions, have foreign currency requirements and liabilities.
A closed position for each currency is the best way to avoid currency risk. The volume of currency bought and sold can make up for the imbalance between assets and liabilities. In this manner, business banks ought to make powerful frameworks of the board of cash gambles. As soon as an authorized bank receives a license from the National Bank to conduct transactions in foreign currency values, it can maintain an open currency position. to avoid losses or risks associated with currency transactions; The guidelines for an open currency position are established by the Central Bank. The Basel Committee’s recommendations on banking supervision and international banking practices serve as the foundation for this strategy for regulating foreign exchange risk. The open currency position is restricted to 10% and 15% of the bank’s capital in the UK, 15% and 40% in France, and 25% in the Netherlands, respectively.
At the end of each day, currency positions are recorded in the account. Changes in the exchange rate result in either profit or loss for the bank if it has an open foreign exchange position. As a result, the Central Bank takes measures to prevent significant exchange rate fluctuations.