Unit:1 Introduction Foreign Exchange

FEM B y,
TY BBA (IB)
Ms.Komal S Dalnar
 Topics :

1.1 Administration of Foreign exchange

1.2 Foreign exchange transactions

FEM
1.3 Purchase and sales transactions
1.4 Authorized dealers
1.5 Foreign currency accounts
1.6 Multinational banking
Introduction:

• Any economics transaction that happens between residents of two countries involves
exchange of one currency into another.

• A resident may import goods or services from abroad or export them from his
country. An investor may find that investing abroad gives him higher returns. A
tourist who visits another country requires the currency of the country he visits to
meet his expenses there.

• A foreigner who visits Kerala to get ayurvedic treatment for his ailments has to spend
in Indian rupees. An IT professional from India earns dollars while on job abroad, but
his parents in India want rupees to buy a house for him in Bangalore.

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 FR

• In all these cases, the source of purchasing power is available in one currency
whereas its use is in another currency.

• Each currency has geographical jurisdiction to function as legal tender in settlement

of debts. Beyond the country of issue, barring few exceptions, a currency cannot
function as legal tender.

• When the above transactions are executed, through the intermediation of banks,
currencies are converted from one form to another.

• The term foreign exchange refers to this process of conversion of currencies. It also
refers to foreign currencies themselves, since they cannot function as legal tender,
but yet serve the purpose of exchange of values.

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• It may be seen that foreign exchange relates to any
monetary transaction involving residents of two
countries. FR
• These transactions can broadly be classified into
1.Trade transactions
2.Non-trade transactions.
• Import and export of goods and services are trade
transactions.
• Going abroad on tour or getting medical treatment
abroad are examples of non-trade transactions.

• International trade refers to trade between the

residents of two different countries.
• Each country functions as a sovereign State with its
own set of regulations and currency.
• The difference in the nationality of the exporter and
the importer presents certain peculiar problems in the
conduct of international trade and settlement of the
transactions arising therefrom.

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 FR
Important among such problems are:

(i) Different countries have different monetary units;

(ii) Restrictions imposed by countries on import and export of goods;

(ii) Restrictions imposed by nations on payments from and into their

countries; and

(iv) Differences in legal practices in different countries.

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 FR

• The existence of national monetary units poses a problem in the settlement of international
transactions.

• The exporter would like to get the payment in the currency of his country. For instance, if Amerex
of New York exports machinery to Indimp, Mumbai, the former would like to get the payment in
US dollars.

• Payment in Indian rupees will not serve their purpose because Indian rupee cannot be used as
currency in the USA. On the other hand, the importers in India have their savings and borrowings
in India in rupees.

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 FR

• The conversion of currencies is done by banks who deal in foreign exchange.

• These banks maintain stocks of foreign currencies in the form of balances with banks
abroad.

• For instance, Indian Bank may maintain an account with Bank of America, New York, in
which dollar balances are held.

• In the earlier example, if Indimp pay the equivalent rupees to Indian Bank, it would arrange
to pay Amerex at New York in dollars from the dollar balances held by it with Bank of
America.
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 FR

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 EXCHANGE RATE FR
• The rate at which one currency is converted into another currency is the rate of exchange
between the currencies concerned.

• In our illustration, if Indian Bank exchanges US dollars for Indian rupees Rs. 73.66 a dollar,
the exchange rate between rupee and dollar can be expressed as;

• USD 1 = 73.66 Rs.

• The rate of exchange for a currency is known from the quotation in the foreign exchange
market. The banks operating at a financial centre, and dealing in foreign exchange,
constitute the foreign exchange market.

• As in any commodity or stock market, the rates in the foreign exchange market are
determined by the interaction of the forces of demand for and supply of the commodity
dealt in, viz., foreign exchange.

• Since the demand and supply are affected by a number of factors, both fundamental and
transitory, the rates keep on changing frequently, and violently too.

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 FR
1.2 Foreign exchange transactions
Definition:

• The Foreign Exchange Transactions refers to the sale and purchase of

foreign currencies.
• Simply, the foreign exchange transaction is an agreement of exchange of
currencies of one country for another at an agreed exchange rate on a
definite date.

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 FR

• Foreign Exchange Transaction means a transaction in which one party agrees to deliver
a quantity of a specified money or unit of account in consideration of the other party's
agreement to deliver another quantity of a different money or unit of account either
currently or at a future date, and in which delivery is to be through funds transfer, book
entry accounting, or other form of payment order, or other agreed means to transfer a
credit balance.
• The term includes a transaction of this type involving two or more moneys and spot,
forward, option, or other products derived from underlying moneys and any
combination of these transactions.
• The term does not include a transaction involving two or more moneys in which one or
both of the parties is obligated to make physical delivery, at the time of contracting or in
the future, of banknotes, coins, or other form of legal tender or specie.

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 More Definitions of Foreign Exchange Transaction
FR

Foreign Exchange Transaction means the acts of purchase and sale of foreign exchange or
the acts of borrowing, giving credits, and of accepting or providing foreign exchange in any
manner whatsoever, and the word also includes the act of granting approval for foreign
exchange by the Bank.

Foreign Exchange Transaction means an agreement between the parties providing for the
purchase by one party of an agreed amount in one currency in exchange for the sale by it of
an agreed amount in another currency to the oth- er party for settlement on the same due
date.

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Types of Foreign Exchange Transactions FR

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 1.Spot Transaction: FR
• The spot transaction is when the buyer and
seller of different currencies settle their
payments within the two days of the deal.
• It is the fastest way to exchange the currencies.
• Here, the currencies are exchanged over a two-
day period, which means no contract is signed
between the countries.
• The exchange rate at which the currencies are
exchanged is called the Spot Exchange Rate.
This rate is often the prevailing exchange rate.
• The market in which the spot sale and purchase
of currencies is facilitated is called as a Spot
Market.

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2.Forward Transaction FR

• A forward transaction is a future

transaction where the buyer and seller
enter into an agreement of sale and
purchase of currency after 90 days of the
deal at a fixed exchange rate on a definite
date in the future.
• The rate at which the currency is
exchanged is called a Forward Exchange
Rate.
• The market in which the deals for the sale
and purchase of currency at some future
date is made is called a Forward Market.

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 FR

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 3.Future Transaction: FR
• The future transactions are also the forward transactions and deals with the
contracts in the same manner as that of normal forward transactions.
• But however, the transactions made in a future contract differs from the
transaction made in the forward contract on the following grounds:
• The forward contracts can be customized on the client’s request, while the
future contracts are standardized such as the features, date, and the size of the
contracts is standardized.
• The future contracts can only be traded on the organized exchanges, while the
forward contracts can be traded anywhere depending on the client’s
convenience.
• No margin is required in case of the forward contracts, while the margins are
required of all the participants and an initial margin is kept as collateral so as to
establish the future position.

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4.Swap Transactions FR
• The Swap Transactions involve a simultaneous borrowing
and lending of two different currencies between two
investors.
• Here one investor borrows the currency and lends another
currency to the second investor.
• The obligation to repay the currencies is used as collateral,
and the amount is repaid at a forward rate.
• The swap contracts allow the investors to utilize the funds
in the currency held by him/her to pay off the obligations
denominated in a different currency without suffering a
foreign exchange risk.

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 5.Option Transactions FR

• The foreign exchange option gives an

investor the right, but not the obligation to
exchange the currency in one denomination
to another at an agreed exchange rate on a
pre-defined date.
• An option to buy the currency is called as a
Call Option, while the option to sell the
currency is called as a Put Option.

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 FR

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1.4 Who are Authorised Dealers? FR

• Authorised dealers are the institutions that have the license from the RBI to sell
and buy foreign currencies. Most of the authorised dealers are banks.
• As per the Foreign Exchange Management Act, 1999, the Reserve Bank, on an
application, may authorise any person to be known as an authorised person, to
deal in foreign exchange as an Authorised Dealer.
• Different categories of Authorised Dealers
• There are three types of authorised dealers, depending upon the type of
institutions. These three types are classified under there categories.
• Category I
• Category II
• Category III

Ms.Komal Dalnar https://rbi.org.in/Scripts/BS_CircularIndexDisplay.aspx?Id=2775 22

Who is a Category I Authorised
Dealer? FR
Category I Authorised Dealers are select
banks who can carry out all permissible
current and capital account transactions as
per directions issued from time to time.
There are 106 authorised dealers of
Category -I as per the RBI regulations
Who is a Category III AD?
Category III ADs are select financial
and other institutions (as
Authorised Dealers Category-III) to
Who is a Category II AD? carry out specific foreign exchange
transactions incidental to their
Category II are select entities to carry out
specified non-trade related current account business / activities.
transactions, all the activities permitted to
Full Fledged Money Changers and any other
activity as decided by the Reserve Bank

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Who is Full-Fledged Money Changer? FR
Another category, outside the Authorised Dealers, who can
deal in a lesser way in foreign exchange dealing are the Full
Fledged Money Changers.
They have less functionalities vis a vis ADs.
FFMCs are select registered companies as Full-Fledged
Money Changers (FFMC) to undertake purchase of foreign
exchange and sale of foreign exchange for specified
purposes viz. private and business travel abroad.

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1.5 FOREIGN CURRENCY ACCOUNT FR
What is a foreign currency
account?
A Foreign Currency Account is an
account held or maintained in
currency other than the currency of
India or Nepal or Bhutan.

1. Non-Resident Ordinary Accounts (NRO)

2. Non-Resident External Rupee Accounts (NRE)
3. Foreign Currency Non-Resident Accounts
4.Resident Foreign Currency Accounts
•Resident Foreign Currency (D) Accounts
•Exchange Earners’ Foreign Currency Accounts

https://www.rbi.org.in/scripts/FAQView.aspx?Id=69

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 FR
1. Non-Resident Ordinary Accounts (NRO)
• Non-resident ordinary accounts can be opened either by money received from abroad
in foreign exchange or out of rupees earned in India.
• When an Indian resident goes abroad for job / employment his local account will
automatically be designated into a non resident ordinary account by bank.
• Funds held in the account can normally be utilized only in India.
• NRO accounts can be maintained in any form like savings account, fixed deposit,
recurring deposit account, etc.
• One important point to note is that even pure non residents who are neither Indians nor
Persons of Indian Origin can maintain NRO accounts.

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 FR
2. Non-Resident External Rupee Accounts (NRE)

• The NRE account can be opened only with money received from abroad and not from local rupee
sources. There can be joint holder to the account but not with residents.
• The joint account holder should also be a non resident. The funds held in the account can be
freely repatriated outside India without limit and without any approval from RBI.
• Since the account is maintained in rupee, for repatriation purpose the Rupee will be converted into
the desired foreign currency at the prevailing rate of exchange.
• Interest earned on the account is free from income tax. The account can be maintained as savings
bank account, fixed deposit, recurring deposit, etc.
• The fixed deposit account should be for a minimum period of one year and for a maximum period
of 3 years.

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3. Foreign Currency Non-Resident Accounts
FR

• FCNR Accounts are term deposit accounts. They can be maintained in four currencies: US Dollar, Pound
Sterling, and Japanese Yen.
• Presently it can be maintained in the new European Currency “Euro” also. They can be maintained for period
ranging from one year to 3 years.
• They are paid back in the same currencies and are reparable. The account is maintained in foreign currency
and paid back in the same currency.
• Hence, there is no conversion of currency when balance is repatriated outside India.

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Resident Foreign Currency Accounts FR
Usually residents are required to maintain their bank accounts in Indian rupee only.

However the Reserve Bank has permitted to maintain foreign currency accounts.

The main advantage of resident foreign currency account is that depositor can use the
funds for personal and business purposes without buying foreign currency from banks
at the ongoing market rate.

These are mainly of the following type:-

1. Resident Foreign Currency Accounts

2. Resident Foreign Currency (D) Accounts
3. Exchange Earners’ Foreign Currency Accounts

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1.Resident Foreign Currency Accounts FR

• These are accounts of resident individuals, who had come back to India after being abroad
as NRIs for some time.

• He/she may sell his foreign assets like securities, property etc., at the time of return to
India.

• This foreign exchange can be used to open the RFC accounts.

• These accounts can be maintained in any foreign currency of the choice of depositors.

• No permission from Reserve Bank is necessary for maintaining this account.

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2. Resident Foreign Currency (D) Accounts
FR
• RFC (D) account can be maintained by any resident individual
even when he had not been abroad at any time.

• One can open a foreign currency account with a bank in India

out money received from your relatives living outside India.

3. Exchange Earners’ Foreign Currency Accounts

• These accounts can be maintained by residents who happen
to receive money from abroad in foreign currency.
• This account can be opened by individuals or corporates.
• One important difference between this account and the RFC
account is that the EEFC account can be opened only out of
foreign exchange earned.

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1.6 MULTINATIONAL BANKING FR

• ‘Multinational banking involves the ownership of banking facilities in one country by

the citizens of another’
• The definition of a MNB is subject to an array of interpretations and is also used
interchangeably with terms such as International Bank or Transnational Bank.
• Broadly, a multinational bank can be classified as an institution through correspondent
relationship, foreign direct investment or direct lending to customers from home offices
that engages into cross country banking.
• In many instances, however, multinational bank is used to refer to a bank with
physical presence outside its home country through a branch, an agency, a
wholly or a majority owned subsidiary, or a bank formed by merger of two or
more banks based in different countries and not the ones with a correspondent
relationship or a representative office.
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 FR
• Robinson (1972) defined Multinational banking as ‘operating a bank in, and
conducting banking operations that derive from, many different countries
and national systems’
• A multinational bank has been defined as “a bank that owns and controls banking
activity in two or more countries.”

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 Multinational Banking: A Brief Taxonomy FR

• The provision of financial services across-borders has a long history, with trade
finance going back to the Phoenicians (c.1000 BC).
• Consideration of this early period demonstrates the importance of trading
relationships in creating a demand for trade finance.
• However, there have been two distinct waves of growth of modern
multinational banking.
• The first of these waves occurred before World War I and was particularly
distinguished by the growth of British overseas banks.
• The second wave of multinational banking occurred in the 1960s and was led by
the expansion offshore of American commercial banks.
• This second wave of multinational banking also saw a widening of the range and
scope of products offered by multinational banks.

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 FR
Today these activities include:

(a) Dealing in foreign currencies, derivative securities, gold, and precious metals
(b) Participating in the Euromarket
(c) Borrowing and lending in foreign currencies
(d) Provision of trade finance
(e) Trading in foreign securities markets
(f) Provision of corporate finance across-borders

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 FR
What is multi national Banking?
- MNB’s those that physically operate in more
than one country.
What is International Banking?
- It engage in cross border operations and do
not set up operations in other countries

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Organizational Structures in FR
Multinational and International Banking

When establishing a physical presence in an offshore market, a bank can choose from a
range of possible organizational structures.

Each of these structures offers different combinations of advantages and disadvantages, some
of which will depend on the particular host nation regulations. In some nations certain
organizational structures may be prohibited.

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Organizational Structures in FR
Multinational and International Banking

1. Correspondent Banking
• Correspondent banks act to clear transactions between banks. These relationships enable
banks to meet the requirements of domestic customers’ foreign exchange and trade
dealings.

• The domestic bank appoints a foreign bank to act as its agent for transactions
in that foreign country.

• Correspondent banking has the advantage of being a relatively low cost method of accessing a
market, particularly a market where establishment costs are large or regulatory barriers to entry are
high.

• By engaging in international correspondent banking, the domestic bank has low cost access to the
expertise of the foreign bank’s corporate and international departments, without the cost of
establishing a physical presence offshore.

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Organizational Structures in FR
Multinational and International Banking

• 2. Representative Offices

A representative office is a small office in the host nation that coordinates a bank's correspondent banking
relationships and renders assistance to the bank’s existing customers.

• The office often has a secondary role of disseminating information about the parent bank and collecting
information about the host country. Representative offices cannot raise liabilities or create assets; instead,
they seek out information about the host environment to determine if profitable business opportunities.

• Representative offices are often used to coordinate matters relating to correspondent relationships such
as check clearance, trade transactions, and foreign exchange matters.

• Representative offices can be run on relatively low budgets and as a result can be easily opened and
closed.

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Organizational Structures in FR
Multinational and International Banking

• 3. Agencies

It provides advantages over representative offices in that they can conduct

transactions.
• The activities permitted to agencies vary according to host country laws, with some
nations prohibiting agency activity by multinational banks.
• The usual limitation on an agency is that it cannot raise or solicit deposits.
• Exceptions do exist in that some countries allow agencies to accept credit balances from
residents that are linked to a specified purpose.
• Such credit balances usually have other limitations as to length of time and terms of
access.

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• 4. Consortium Banks FR
A consortium bank can be considered as a joint venture bank separately incorporated
and owned by two or more shareholders who are themselves banks, usually of different
nationalities.
• Consortium banking is often the only possible method for small and
medium sized banks to access the Euromarkets.
• The consortium bank enables capital and expertise to be pooled to the mutual advantage
of the participants. Some consortium banks are formed to service a particular market
segment, such as cross-border mergers and acquisitions or project finance.
• Another reason for the establishment of a consortium bank may be to access a particular
geographic market. Some nations have banking regulations that require host country
participation and as a result a consortium structure may be appropriate.

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 FR

5. Merchant Bank Subsidiaries

A merchant bank subsidiary is a merchant (investment) bank that is wholly owned by a

bank located in another country. It offers a method of entering a host country without
the constraints that may be imposed on a full banking entry. Such a subsidiary would
offer the full range of wholesale services but would be disadvantaged by lower credit
ratings than would be the case with a full banking license. This lower credit is due to the
perception that merchant bank subsidiaries are not subject to the same level of
prudential supervision

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 FR
• 6.Bank Branches

A foreign bank branch is a branch located in a different country from the country of
incorporation of the parent bank, without the branch itself having separate
incorporation.
• As such, the branch is integral to the parent and is not separately capitalized. The branch
will carry on banking business, subject to the laws of the host
nation.
• The restrictions imposed on foreign branches are such that they usually have the
ability to offer a nearly comprehensive range of banking services, with restrictions on
access to the retail market being usual.
• As the branch is not legally separate from the parent, it has access to the full support, credit
rating, and capital base of the parent.

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 FR

• 7.Bank Subsidiaries

A bank subsidiary is a separately incorporated bank that is controlled by a parent

located in another country. Such subsidiaries are generally wholly owned, as this
reduces potential problems associated with dissenting minority shareholders.
• The host nation regulations imposed on foreign bank subsidiaries often determine
whether this organizational structure is chosen.
• Generally, as discussed above, multinational banks prefer the bank branch structure
to the bank subsidiary structure. However, in some cases, the host nation regulator
will not permit foreign bank branches to be established, mainly due to concerns
regarding prudential regulation.

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Types of Services Offered FR
1) To arrange trade finance
An international bank arranges the finance for the traders who want o deal with the
foreign country.

2) To arrange foreign exchange

The core services provided by the international bank are to arrange a foreign exchange for
the import-export purpose.

3) To hedge the funds

The international bank hedge the funds by buying the securities at the lower price level
and sell it when the price level rising.

4) Offer investment banking services

It also offers an investment banking services by signing underwriting of shares, financial
decisions for investment.

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 FR

•Examples of international banking

City group
•HSBC Holdings
•Bank of America
•JP Morgan Chase
•Royal Bank of Scotland Group.

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 Thank You.
FEM
Ms. Komal Dalnar
9156803369
Komal.Dalnar@iccs.ac.in