Currency swaps rule forex mkt, cushion reserve

Interbank currency swaps under agreements to exchange cash flows at later dates dominate the country's foreign exchange market shielding the forex reserve to a great extent from any pressure.

Bangladesh Bank, the central bank of the country, recently prepared a note on it elaborating the nature of the forex market.

It said currency swaps, a kind of derivatives, accounted for around 86 per cent of the forex market. The spot market derivatives accounted for 11 per cent with the forward derivatives grabbing the remaining 3.0 per cent.

People at different commercial banks familiar with the matter have told the FE that this dominance helps fend off pressure from the country's foreign exchange reserve to a great extent.

Otherwise, the banks in need of dollars could turn to the central bank to meet their requirements putting pressure on the foreign currency reserve.

The people mostly acting as treasury heads at the commercial banks have said the state-owned banks usually face dollar shortfalls and they meet the demand through such currency swaps.

A currency swap, sometimes referred to as cross-currency swap, involves the exchange of fixed interest along with the principal amount in one currency for the same in another currency.

Interest payments are made at fixed dates and rates throughout the life of the contract, usually for a short period-overnight to five banking days.

The cost of the swap or the interest rate varies depending on the demand and supplies. It usually ranges between 2.0 per cent (annualised) and 3.0 (annualised) per cent.

But it climbs as high as 8.0 per cent (annualised) at a time when the supply of dollars against any other currency remains low.

Asim Kumar Saha, treasury head and senior executive vice present at the privately-owned Mercantile Bank, has told the FE that the central bank encourages this mechanism as it helps cushion the foreign currency reserve.

He has said the state-owned banks usually have lower dollar funds as they handle a large number of LCs (letters of credit) mostly accounting for large corporations.

"So they need such quick arrangements, without intervention of the central bank."

Motiur Rahman, another treasury head at the Prime Bank Limited, has told the FE that the problem, however, is that there is no benchmark rate here to quote in the forex market perfectly.

There is a Dhaka Inter-bank Offered Rate (DIBOR) but it is yet to be widely used by banks as a reference rate.

He has said the commercial banks now usually depend on the market rates of different kinds of short term deposits while fixing the costs of swaps.

For not having the benchmark rate, the costs of swaps in many cases do not match perfectly, he has added.

The swap is typically used for liquidity support and as a hedging tool against the market risks.

But, Md Shaheen Iqbal, head of treasury at the BRAC Bank, told the FE that there were many more risks involving such a type of currency swap.

If a bank takes a foreign currency like the US dollar for a short period, it may land in trouble later when the exchange rate will fluctuate.

"If there is an upward adjustment, then the bank will be a loser," he said.

Besides, he said, if the bank becomes "insolvent" at the time of maturity of the contract, there will arise another risk.

However, there are authorised dealers dealing in some major foreign currencies, mainly US dollar, euro, Japanese yen and Rupee.

But more than 95 per cent of currency transactions occur in the US dollar.

The central bank note has said that in order to avoid any exchange rate volatility, BB actively participates in the foreign exchange market.

The BB updates foreign exchange transaction guidelines on a regular basis to align the foreign exchange market with the economic fundamentals.

In the fiscal year (FY) 2017-18 the BB sold USD 2.31 billion (net) in the market against a net amount of USD 1.77 billion bought in FY '17.

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