Foreign Exchange Risk Management In Banks Essay

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BANKING GUIDANCE NOTE (BGN 6.0) Foreign Exchange Risk Management 31st March 2006 Contents Part 1 – Banks incorporated in the Isle of Man 1 2 3 4 5 6 Rationale for Foreign Exchange Risk Management Overview of the Commission’s Approach to Foreign Exchange Risk Management Foreign Exchange Risk Management Policy Procedures and Systems Calculation of the Net Open Position Valuation Page No. 2 4 4 5 6 7 Part 2 – Banks operating in or from the Isle of Man which are incorporated outside the Isle of Man (“branches”) 1 2 3 4 Rationale for Foreign Exchange Risk Management Overview of the Commission’s Approach to Foreign Exchange Risk Management Foreign Exchange Risk Management Policy Procedures and Systems 8 10 10 10 Appendix 1- Glossary 1 Part 1 – Banks incorporated in the Isle of Man 1. 1.1 Rationale for Foreign Exchange Risk Management The foreign exchange market is arguably the largest and most liquid of the international markets, and large and rapid movements in exchange rates are commonplace. In order to minimise the possibility of financial loss, it is therefore essential that banks identify, measure and manage their foreign exchange risk effectively. Foreign exchange risk is not confined to proprietary positions taken by a bank and client driven transactions, but can also arise from known profit flows in foreign currency, and provisions for bad debts denominated in foreign currency. It is important that these exposures are identified and, where necessary, hedged, on a timely basis. Banks are exposed to a number of different risks in the conduct of foreign exchange and general business, and these may be categorised as follows. This list is not exhaustive and is for guidance purposes only: a) Exchange rate risk (open position) The risk that the bank may suffer losses as a result of adverse exchange rate movements during a period in which it has

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