Thursday, February 2, 2012

5. Foreign Exchange Banking in PK (Guide)


Foreign Remittances

Foreign remittance can be defined as an act of transferring money from one country to an other. Bank issue remittances on behalf of the customers after receiving value of remittance, related charges and Govt taxes. Remittances payable within country are called “inland remittance. Remittances payable outside the country and received from foreign countries are called “foreign remittances.

Foreign remittances are not only source of funds for the banks but also play a very significant role in enhancing foreign exchange reserves of the country.

A discussion of foreign remittances

Foreign inward remittances have been prominent features of the Pakistan’s economy for many decades. It is often argued that remittances have played a stabilizing role, particularly during the Asian crisis when remittance flows have supported household expenditure and offset the sharp reduction in capital inflows.

Pakistan is a major exporter of manpower, possessing the one of the very high rate of out- migration relative to population many countries. The volume of departing Overseas Pakistani Workers have broadly matched the increase in the domestic labor force over the past 40 years. 

This process reflects a range of factors. Creation of employment has generally not kept pace with the increase in the population. Relatively modest economic growth has also contributed to widening wage differentials with advanced economies.

Pakistan is now one of the world’s largest recipients of foreign remittances in absolute terms, behind India, Mexico and Philippine. Aside from exports of goods, remittances are the largest source of foreign exchange for the Pakistan. It is relatively stable source of foreign exchange compared to foreign direct investment and other private capital flows. Traditionally, a large proportion of our overseas labor force comprised workers in the construction and manufacturing sector. According to an estimation, the proportion of income from abroad as a share of total household income is increasing faster than the income generated locally. Labor force migration is largely a lower and middle class phenomenon in the Pakistan. Income 
from abroad is less important for the higher income decides. 

The positive and negative impact of foreign remittances on the economy
There are different views about remittances affect on economic activities:
1. Some of the negative views about remittances & migration of labor 
can be seen as a financial counterpart to migration, which can offset 
some of the output and other losses that may be associated with the
loss of skilled workers, the so-called “brain drain.” The extent and 
economic impact of the brain drain is itself controversial. Some studies 
have challenge the negative view that migration of highly skilled workers 
is detrimental to those left behind. Further in developing countries like 
Pakistan, India and Bangladesh, where rate of unemployment is very 
high, migration of human resource, effects positively on their economy.
2. Some peoples argue that, emigrant can also result into resource 
transfers. Take example of, Chinese population, it has played a 
significant role in the acceleration of foreign direct investment into 
China in recent years. Other side says that, in fact chines economy 
cannot be compared with others. They have a different political and 
social system; there is consistence in their economic policies, and 
strong capital and economic base. 
3. The economic impact of remittances is depending on the proclivity of 
the remittance and its division between consumption and investment. 
If remittances are used primarily to purchase non-tradable goods, this 
could lead to an appreciation of the exchange rate and deterioration 
in competitiveness. But in fact remittances that are consumed will 
generate positive multiplier effects. The size of this multiplier effect 
depends on whether remittances are received by urban or rural areas. 
If remittances are received in ruler areas, these are used in investment 
rather than consumption.
4. A large portion of the funds received as remittance from abroad are 
used in real-estate. Due to investment in real estate, related industries, 
such as cement, steel rerolling, aluminum industries etc. are also 
5. Local labor force also gets job.
6. Remittance Flows results into stability of Income of lower and middle class.
7. A prominent feature of the Pakistan economy over the last four decades 
has been the relative stability in the Forex resources generation, and 
increase in per capita income. 

From the above discussion we came to the conclusion that, there is no doubt that foreign remittances in the Pakistan are an important source of support, especially for the balance of payments. The volume of foreign remittances send by overseas Pakistani has crossed US dollar 3.5 Billions in the year 2008/ 2009. The remittances have contributed lot in improving balance of payment position of Pakistan.

Further analysis of these factors as important determinants of remittance flows are a topic for future research. Similarly, remittances lead to a growth in the Pakistanis case. After migration of labor, unemployed gets opportunities. Due to the enhanced purchasing power of the families of the overseas Pakistanis, local sale is increased, to meet requirement of the consumption goods, production is increased, and as such, it effects very positively on economic conditions of the country. 

SBP role in enhancing Foreign Remittances 

SBP being regulator plays very important role in broadening foreign exchange
reserves of Pakistan. With a view to encourage overseas Pakistanis and others to use the normal banking channels for home remittances, and to protect the remitters / beneficiaries from any losses that they may incur due to unwarranted delays in receipts of funds in the beneficiaries accounts, 
SBP  has put in place a mechanism, which ensures that : 

i. In case where the beneficiary is maintaining his account at any branch 
at the district headquarters, the amount of remittance shall be credited 
within 48 hours (two working days) of the receipt of funds b the bank.
ii. In case where the beneficiary is maintaining its account at any branch 
at tehsil or sub-divisional town, the remittance must be credited within 
72 hours (3 working days) of the receipt of funds by the bank.
iii. Where the beneficiary is maintaining the account at any branch in a 
village / rural area, the remittance must be credited in the beneficiary's 
account within 96 hours (four working days) of the receipt of funds by 
the bank.
iv. A Complaint and Monitoring Cell has been set up in the State Bank 
and in banks which received complaints of remitters / beneficiaries, 
who have not been remunerated by the banks on account of delays.
v. Where a tendency is noted by the State Bank on the part of any bank, 
either through inspection or on the basis of the pattern of complaints, 
to delay the credit in the beneficiary's account, penalties shall be 
imposed on such banks under the provisions of the Banking Companies 
Ordinance, 1962.

Role of State bank of Pakistan, Banking Services Corporation

State Bank of Pakistan, Banking Services Corporation (Bank) came into existence after bifurcation of State Bank of Pakistan under SBP Banking Services Corporation Ordinance 2001 promulgated by President of Pakistan. It started operations from the 2nd January 2002. Consequent upon establishment of SBP, BSC (Bank), the Exchange Policy Department of the then State Bank of Pakistan has also been bifurcated into two Departments. The operation side comes under the jurisdiction of the SBP, BSC, Bank; the Policy side was shifted to the State Bank of Pakistan and working as a full-fledged Department. Incidentally, title of both the Departments is Exchange Policy Department. The business process and role of this Department in the SBP BSC (Bank), Head office is as under:
Exchange Policy Department (EPD), SBP, BSC (BANK), is an important department of the State Bank of Pakistan, Banking Services Corporation (Bank), Head Office Karachi.

The work of the Department is operational nature for which Foreign exchange offices are set up at 16 field offices in major cities of Pakistan. Administratively, the Department is divided into four Divisions, out of which one is looked after by a Joint Director and remaining three by Junior Joint Directors. These Divisions are again divided into eight units, which are headed by Assistant Directors.
State Bank of Pakistan, Banking Services Corporation (Bank) came into existence after bifurcation of State Bank of Pakistan under SBP Banking Services Corporation Ordinance 2001 promulgated by President of Pakistan. It started operations from the 2nd January 2002. Consequent upon establishment of SBP, BSC (Bank), the Exchange Policy Department of the then State Bank of Pakistan was bifurcated into two Departments. The operation side come under the jurisdiction of the SBP, BSC, Bank, and H.O. Karachi and is functioning as a full-fledged Department. The Policy side was shifted to the State Bank of Pakistan and working as a full-fledged Department. Incidentally, title of both the Departments is Exchange Policy Department.

The work of the SBP BSC (Banks) is operational nature for which Foreign exchange offices are set up at 16 field offices in major cities of Pakistan. Administratively, the Department is divided into four Divisions. These Divisions are again divided into eight units, which are headed by Assistant Directors.

Exchange Companies with Foreign Entities

The mobilization of home remittances is an important business activity for Exchange Companies (ECs). In this respect, Exchange Companies are expected to exercise utmost prudence in implementation of process involved. However, over a period of time, while reviewing agency arrangements of Exchange Companies, certain structural and operational flows / weaknesses have been identified which could damage Exchange Companies ability to effectively effect and mobilize funds from overseas. In order to facilitate Exchange Companies in their diligence process and bring uniformity & discipline in agency arrangements of exchange companies, following fundamental structure of agency arrangements is designed by SBP but overall responsibility of safeguarding interest of the company and avoidance of all related legal, regulatory and commercial risks would rest with the  exchange company.

Selection of Foreign Entities

I. Only those foreign entities that have effective customer acceptance 
and KYC policies and are effectively supervised by the relevant 
authorities should be selected for agency arrangements.
II. No arrangements should be entered into or continued with a correspondent 
entity incorporated in a jurisdiction in which it has no physical presence 
and which is unaffiliated with a regulated financial group.
III. Particular attention should be paid when continuing relationships with 
entity located in jurisdictions that have poor KYC standards or have 
been identified by Financial Action Task Force as being “non-cooperative” 
in the fight against money laundering.

Essentials of the Agreement 

1. The agreement should be for payment of home remittances in PKR only.
2. All funds against home remittances should be received in advance in 
Exchange Company’s FCY Accounts maintained with banks in Pakistan. 
3. For transactions greater than USD 1,000 the agreement should require 
foreign entity to provide address of senders in addition to his/her name. 
However, address may be substituted with any unique Identification 
Number/ National Identity Number/Customer Identification Number/Date 
& Place of Birth.
4. The agreement should be non exclusive meaning thereby that it should 
not restrict Exchange Company, directly or indirectly,  to offer similar 
competing  services under other arrangements. 
5. The agreement should give ownership rights of all related 
accounting/book-keeping and other record to Exchange Company and 
the same is be maintained for at least five years.
6. The agreement should not contain clauses which give blanket approval 
to foreign entity to assign or transfer their part of the agreement or 
any right or duty thereof, to any third party without prior approval of 
7. The agreement should be in compliance with all the regulations, 
instructions, directives, circulars and other communications issued by 
the State Bank and contains provision of incorporating any amendments 
made therein from time to time.
8. The agreement should ensure compliance of prudent practices and 
standard policies related to Internal Controls, Information Technology, 
Anti Money Laundering and Know Your Customer etc.
9. The agreement should not compromise State Bank right to terminate 
the agreement at any time. 

Post-agreement Follow up 

1. The Exchange Companies should continuously monitor market repute 
and financial condition of the foreign entity to ensure that all the time 
during validity of the agreement, foreign entity is capable to meet its 
financial obligations under the agreement.
2. Foreign entity should be made bound to immediately bring into notice 
of the company any change in laws, rules and regulations which may 
effect business arrangements.
3. For any subsequent amendment in the agreement, prior approval of 
SBP should be ensured.
4. Foreign entity should also be required to keep EC updated about any 
change in its network.

SBP role in controlling inward and outward Foreign Remittances
Chapter X of the SBP foreign Exchange manual deals with Inward and outward Foreign Remittances. The salient features of this chapter are given below:

1. Inward Remittances. 

The term 'inward remittance" means purchase of foreign currencies 
in whatever form and includes not only remittances by M.T., T.T., draft 
etc., but also purchase of travelers cheques, drafts under travelers 
letters of credit, bills of exchange, currency notes and coins etc. Debit
to banks' non-resident Rupee accounts also constitutes an inward 

2. No Restrictions.  

There is no restriction on receipt of remittances from abroad either in 
foreign currency or by debit to non-resident Rupee accounts of banks' 
overseas branches or correspondents. Authorized banks may freely 
purchase T.Ts, M.Ts, drafts, bills etc., expressed and payable in foreign 
currencies or drawn in Rupees on banks' non-resident Rupee accounts. 
There is also no objection to their obtaining reimbursement in foreign 
currency from their overseas branches and correspondents in respect 
of Rupee bills and drafts which are purchased by them under letters 
of credit opened by non-resident banks or under other arrangements.  
3. Outward Remittances. 

The term "outward remittance" means sale of foreign exchange in any 
form and includes not only remittances by T.Ts, M.Ts, drafts etc., but 
also sale of traveler’s cheques, travelers’ letters of credit, foreign 
currency notes and coins etc. Outward remittance can be made either 
by sale of foreign exchange or by credit to non-resident Rupee account 
of banks' overseas branches or correspondents. 

4. Mode of Remittances. 

Authorized Banks should avoid issuing drafts in cover of outward 
remittances whenever remittance can be made by T.Ts, or M.Ts, etc. 
Where, however, the normal means of transfer is likely to result in 
unnecessary hardship or inconvenience to the remitter, drafts may be 
issued in the name of the beneficiaries of the remittance but such 
drafts should be crossed by the issuing bank as "Account Payee only".  
5. Prescribed Application Forms. 

(i) There are three types of application forms for outward remittances:  
(a)  Form 'I' is to cover remittance against imports.
(b)  Form 'T-1' is to cover sale of exchange for travel.
(c)  Form 'M' is to cover all other remittances 
(ii) Any person who wishes to purchase foreign exchange must lodge an 
application with an Authorized banks on the appropriate prescribed 
form duly supported by the requisite documents. On receipt, the 
application should be examined and if the bank is satisfied that the 
application is covered by the regulations and it is empowered to 
approve the remittance on behalf of the State Bank, it may affect the 
sale of foreign exchange. If the transaction requires prior approval of 
the State Bank, the application should be forwarded by the bank to 
the State Bank for consideration with comments under its stamp and 
6. In some cases, applications are made by letters it should be
accompanied by Form 'T-1' or 'M' as the case may be, duly filled in. 
If the remittance is permissible, the State Bank will return the form 
duly approved. In cases where remittance is required to be made in 
installments at periodical intervals (student permits etc), the State Bank 
may issue special permits authorizing remittances in the desired 

7. Applications to be submitted to the State Bank only through an 
Authorized bank. 

All applications for foreign exchange should be forwarded to the State 
Bank through Authorized Banks who should arrange their delivery to 
the State Bank through their own messengers or through post. All 
applicants who present their applications directly to the State Bank 
will be asked to resubmit them through an Authorized bank.  

8. Forwarding Applications to the State Bank. 

When submitting applications to the State Bank, Authorized Banks 
should take all reasonable precautions to satisfy themselves as to the 
bonafides of the applicants. Banks should exercise due diligence 
(KYC/ CDD) while remitting funds. They should verify that:
a. The application form has been duly completed and signed by the 
applicant and then affix their stamp.
b. Signature thereon in token of their having examined the application.
c. The Bank satisfied them that full documentary evidence as required 
has been submitted. 

9. Processing of Approved Form etc.  

After receipt of approved forms or permits etc., from the State Bank, 
Authorized Banks should see that the forms etc. have been approved 
by the authorized officers of the State Bank and that they bear its 
embossing seal.

Authorizations which are signed by officers, whose specimen signatures 
are not available with the Authorized Bank, should be presented to 
the nearest office of the State Bank for authentication. It is also important 
that once a form has been approved by or on behalf of the State Bank, 
the Authorized Bank should affect remittance only on behalf of the 
original applicant for whom the form has been approved and in favor 
of the beneficiary whose name appears in the approval. They must 
in no case accept instructions from third parties. 

In those cases where Authorized Banks are empowered under the 
instructions laid down in F E Manual to approve applications on behalf 
of the State Bank, they should ensure while approving the form that 
the applications are complete in all respects and that all the necessary 
documentary or other evidence as required has been submitted to 
and examined by them and that they have satisfied themselves as to
the genuiness of the transaction.   

10. Permits for Recurring Remittances.  

(i) Permits issued by the State Bank are of three types. In the first type 
of permits, the State Bank authorizes remittances up to a stated amount 
within a stated period which an Authorized Bank may make on behalf 
of the permit holder. Remittances under such permits may be made 
during the period of validity of the permit in amounts as required by 
the applicant provided that the total of such remittances under the 
permit does not exceed the overall limit laid down in the permit.  
(ii) The second type of permits covers remittances on a periodical (monthly) 
basis but the periodical (monthly) limits are not cumulative and 
remittances in all during any one period (month) must not exceed the 
prescribed rate laid down in the permit. If remittances are not made 
up to the full extent of the limit in any period (month), it is not permissible 
to carry forward unutilized balance in order to make larger remittances 
in subsequent periods.  
(iii) The third type of permits allows remittances on a periodical (monthly) 
basis but the periodical (monthly) amount is sanctioned on a cumulative 
basis so that unutilized amounts for earlier periods (months) can be 
remitted in subsequent periods (months). Unutilized amounts may, 
however, be accumulated only within the validity of the permit and the 
entire unutilized balance of such permits will lapse after the last day 
of the validity of the permit. In such cases it is not permissible to make 
remittances in advance of the entitlements of the subsequent periods 
(iv) Requests for utilization of lapsed quotas should be forwarded by 
Authorized Banks to the State Bank giving full reasons for non-utilization 
on due dates supported by suitable documentary evidence, wherever 

11. Effecting Remittances against Permits.  

In all cases where permits are issued by the State Bank, it will be in 
order for the Authorized Banks to effect remittances against the permits 
subject to reporting on form 'M'. Authorized Banks must state on form 
'M' the number of the permit against which the remittance has been 
made and also certify that the remittance has been endorsed on the 

The remittance must be endorsed on the reverse of the permit giving 
the amount and date of remittance under their stamp and signature. 

When the permit is exhausted, it should be returned to the State Bank 
by the Authorized Banks along with the form 'M' on which the last 
remittance is reported. 

In all cases where the purpose for which the permit was granted 
ceases to exist and no further remittances are required or are
permissible, the unutilized permit should be returned to the State Bank 
with an advice that the permit should be cancelled.  

12. Period of validity of approval by the State Bank.

All Authorizations given by the State Bank are valid for a period not 
exceeding 30 days from the date of approval unless they are expressly 
approved as valid for a specified longer period or unless they have 
been revalidated for a further period. Similarly, permits issued by the 
State Bank are also valid for specified periods as stated on the permit. 
Authorized Banks should not effect any remittance against approved 
forms, permits etc., which have been lapsed unless they have been 
duly revalidated.  

13. Release of Foreign Exchange for Travel Abroad. 

Foreign exchange is issued to the travelers against specific or general 
approval given by the State Bank. It may be drawn in any foreign 
currency equivalent to the sanctioned amount.

In cases where a traveler desires to draw foreign exchange partly in 
foreign currency instruments and partly in foreign currency notes, 
Authorized Banks will prepare two separate 'T-1' forms. In the portion 
meant for their certificate, the Authorized Banks will give on both the 
'T-1' forms a suitable indication as to the amounts of foreign exchange 
released in foreign currency instruments and notes. 

Authorized Banks will give a suitable indication to this effect, both on 
the original sanction as well as its photocopy which will be attached 
with the relative 'T-1' forms and surrendered to the State Bank along 
with the monthly returns of foreign exchange transactions.  

14. Processing of Approvals given on one Authorized bank’s Form 
by another Authorized bank.  

There may be instances where a traveler or a remitter might approach 
an Authorized Bank for issue/remittance of foreign exchange against 
approved form 'T-1' or 'M' bearing the identifying prefix and serial 
number of another Authorized Bank. While releasing/remitting foreign 
exchange against such form 'T-1' or 'M', Authorized Banks should 
insert their own identifying prefix and serial number borne on one of 
the blank 'T-1' or 'M' forms in their possession, and score out the prefix 
and serial number already appearing on approved form 'T-1' or 'M' 
under proper authentication. The Authorized Banks should, however, 
destroy that blank form 'T-1' or 'M' whose serial number is so inserted 
by them.  

15. Reporting of Remittances.

Authorized Banks should submit to the State Bank along with the
appropriate returns as laid down in  SBP Manual Chapter XXII, forms 
‘M’, ‘T’-1 and 'I' as the case may be, in cover of each remittance 
effected by them. Where remittances are approved by the State Bank, 
the approved forms should be submitted in original. Where approval 
is given by the State Bank by letter or through issue of permit, particulars 
of the letter or of the permit should be given on the appropriate form 
before submitting it to the State Bank with the returns. 

16. Cancellation of Outward Remittances.  

In the event of any outward remittance which has already been reported 
to the State Bank being subsequently cancelled, either in full or in part, 
Authorized Banks must report the cancellation of the outward remittance 
as an inward remittance. The return in which the reversal of the 
transaction is reported should be supported by a letter giving the 
following particulars:  
a) The date of the return in which the outward remittance was reported.
b) The name and address of the applicant.
c) The amount of the sale as effected originally. 
d) The amount cancelled. 
e) Reasons for cancellation. 

17. Cancellation of Inward Remittances.  

In the event of any inward remittance which has already been reported 
to the State Bank, being subsequently cancelled either in full or in part, 
because of non-availability of the beneficiary, Authorized Banks must 
report the cancellation of the inward remittance as an outward remittance 
on form 'M'. The return in which the reversal of the transaction is 
reported should be supported by a letter giving the following particulars: 
I. The date of the return in which the inward remittance was reported.
II. The name and address of the beneficiary. 
III. The amount of the purchase as effected originally. 
IV. The amount cancelled.
V. Reasons for cancellation. 

18. Utilization of Exchange for the purpose it is obtained.  

Where any foreign exchange is acquired by any person other than an 
Authorized Bank for any particular purpose or where any person has 
been permitted conditionally to acquire foreign exchange, the said 
person will not use the foreign exchange so acquired otherwise than 
for that purpose or fail to comply with the prescribed conditions. In 
cases where the foreign exchange so acquired cannot be used in full 
or in part for the purpose for which it was acquired or any of the 
conditions subject to which the foreign exchange was released cannot 
be complied with, the foreign exchange should immediately be 
surrendered to an Authorized Bank.

4. Foreign Exchange Banking in PK (Guide)


Exchange Position

Cash flow position

There is said to be a 'position' if circumstances are such that a change in a rate will create a profit or loss. If cash inflows and cash outflows are unequal or have mismatched value dates, there is a 'net cash flow position'. 
Separate net cash flow positions apply for each value date.

  Net cash flow position = cash Inflow - cash Outflow

A positive net cash flow position reflects an excess of cash inflow, over cash outflow, on the relevant value date. The surplus cash will be available for investment. If interest rates rise the return will be higher. If interest rates 
fall, the return will be lower.

A negative net cash flow position reflects an excess of cash outflow over cash inflow on the relevant value date. Assuming there are no idle balances, the account will become overdrawn. The shortfall of cash will require funding. If interest rates rise it will become more expensive to fund the account. If 
interest rates fall it will become less expensive to fund the account.

A negative net cash flow position also implies a 'liquidity position'. There is a risk that there will be insufficient funds available for borrowing, in which case the account must remain overdrawn. Being overdrawn may involve 
financial and non-financial penalties.

If cash inflow equals cash outflow on a particular value date, then the net cash flow position is zero. This is referred to as a 'square cash flow position'. 
Changes in interest rates will have no net impact on profits or losses.

Exchange position

Foreign exchange position is the balances of bank foreign exchange assets and liabilities that generate the risk of obtaining additional revenues or expenditures upon the modification of exchange rates. A positive Net position reflects an excess of inflow, over outflow, on the relevant value date. The surplus will be available for investment. If interest rates rise the return will be higher. If interest rates fall, the return will be lower.
A negative Net F C position reflects an excess of outflow over inflow on the relevant value date. If there are no idle balances, the account will become overdrawn. The shortfall will require funding. If interest rates rise it will become more expensive to fund the account. If interest rates fall it will become less expensive to fund the account.

Net Exchange Position

In Pakistani money market it is recommended that banks should keep their
exchange position square, neither over bought nor over sold. If the amount of foreign currency purchased equals the amount of that currency that has been sold, then the net exchange position will be zero. This is called as a 'square exchange position'.

Buying and selling foreign currencies creates exposure to changes in exchange rates. Buying a foreign currency creates an asset. The position is said to be 'long' the foreign currency. If the foreign currency appreciates there will be an exchange gain. If the currency depreciates there will be an exchange loss.

Selling a foreign currency creates a liability. The position is said to be 'short' the foreign currency. If the foreign currency depreciates there will be an exchange gain. If the foreign currency appreciates there will be an exchange loss.

The excess amount of a foreign currency which has been purchased over the amount of the same foreign currency which has been sold is described as the 'net exchange position'. There is a separate net exchange position for each foreign currency. 

Net exchange position = foreign currency purchased - foreign currency sold

Being long a currency implies having a net exchange position which is positive. Provided the exchange rate is quoted with the foreign currency as the base currency, a rise in the exchange rate will yield an exchange gain and a fall in the exchange rate will result in an exchange loss.
Being short a currency implies having a net exchange position which is negative. Provided the foreign currency is the base currency, a rise in the exchange rate will result in an exchange loss, and a fall in the exchange rate will cause an exchange gain. 

If the amount of foreign currency purchased equals the amount of that currency that has been sold, then the net exchange position will be zero. This is referred to as a 'square exchange position'. Changes in exchange rates will have no impact on profit or loss.

A net exchange position is created or removed at the time the purchase or sale of foreign currency is contracted, not at the time when the related cash flows occur. For example, if a spot contract is entered  today to purchase USD 1 million against JPY at a rate of USD 1 = 120.50, the buyer immediately becomes long USD and short JPY regardless of the fact that he or she will not receive the USD or pay away the JPY until two business days hence. Similarly, forward purchases or sales of foreign currency 
immediately create, or remove a net exchange position. 

Distinction between Net Exchange Position and Net Cash Flow Position

It is important to appreciate the distinction between a net exchange position, and a net cash flow position. Money market transactions create net cash
flow positions, but do not create net exchange positions. Only buying or selling a currency can create a net exchange position - merely borrowing or lending a foreign currency does not.

Borrowing CHF for three months will cause a positive cash flow of Swiss Francs now and a negative cash flow of CHF in three months time, but no exposure to the exchange rate. Unless the CHF are sold (which create a net exchange position), they will be available to repay the loan on maturity and so exchange rate changes will have no effect on profit or loss.
Foreign exchange transactions create both net cash flows positions and net exchange positions. Mismatched cash flows may be offset by either money market transactions or foreign exchange transactions. However, 
net exchange positions can only be offset by foreign exchange transactions. 

Open Foreign Exchange position

The foreign exchange position shall be considered open if foreign exchange assets in a certain foreign currency are not equal to foreign exchange liabilities in the respective foreign currency. The value of the open foreign exchange position represents the difference between the amount of foreign exchange assets in a certain foreign currency and the amount of foreign exchange liabilities in that currency. 
The open foreign exchange position is long if the sum of foreign exchange assets in a certain foreign currency exceeds the sum of foreign exchange liabilities in the respective foreign currency. The open foreign exchange position is short if the sum of foreign exchange liabilities in a certain foreign currency exceeds the sum of foreign exchange assets in the respective foreign currency.

Managing Exchange Risk

Banks dealing in foreign exchange transactions are open to risks from movements in competitors' prices, competitors' cost of currency/ capital, foreign and exchange rates and interest rates, all of which need to be perfectly managed. This is called the task of managing exposure to Foreign Exchange movements.

Exchange risk is simple in concept; it is a potential gain or loss that occurs as a result of an exchange rate change. For example, if an individual owns a share in, the British company or deposit in British pound, he or she will lose if the values of the British pound will drops.

Risk is not risk if it is anticipated. In most currencies there are futures or forward exchange contracts whose prices give an indication of where the market expects currencies to go. And these contracts offer the ability to lock in, the anticipated change. So perhaps a better concept of exchange risk is unanticipated exchange rate changes. 

An Exposure can be defined as a Contracted, Projected or Contingent Cash Flow whose size is not certain at the moment. The level depends on
the value of variables such as Foreign Exchange rates and Interest rates. The Risk Management Guidelines should be understood, and slowly implemented so that, the deal results positive benefits to the bank. It is very important for the banks management to be aware of these practices and update their policy. Once it is done, it becomes easier for the Exposure 
Managers at treasury to get along efficiently with their task. 

Determination of risk

The following cash flows/ transactions will be considered for the purpose of exposure management.

It is advisable for the management to decode a limit for branch 
management, such as Cash Flows above $25,000/- in value will be 
brought to the notice of the Exposure Manager, as soon as they are 
It is the responsibility of the Exposure Manager to ensure that he 
receives the requisite information on exposures from various branches 
of the bank in time (daily activity report). 

These exposures should be analyzed and the following aspects must be studied: 

Foreign Currency Cash Flows/ Schedules 
Variability of Cash flows - how certain are the amounts and/ or value 
Inflow-Outflow Mismatches / Gaps 
Time Mismatches / Gaps 
Currency Portfolio Mix 
Floating / Fixed Interest Rate ratio 


Hedging can be defined as “making an investment to reduce the risk of adverse price movements in an asset”. Normally, a hedge consists of taking an offsetting position in a related security, such as a futures contract. An example of a hedge would be if you owned a stock/ currency, then sold a futures contract stating that you will sell your stock/ currency at a set price,
therefore avoiding market fluctuations. 

Perfect hedging 

Investors use this strategy when they are unsure of what the market will do. A perfect hedge reduces your risk to nothing (except for the cost of the hedge). A  on an  is that, which eliminates the  on another investment entirely. Perfect hedges are quite rare as most investments carry at least a little unique risk that cannot be hedged. However, an example of a perfect hedge is a  on  that completely offsets a position in the . While perfect hedges eliminate risk, they also greatly reduce or sometimes eliminate the potential for a good.

Risk hedging

Risk hedging is the taking of an offsetting position in related assets so as to profit from relative price movements. For example, an investor might purchase futures contracts on one currency say US dollar and sell futures contracts on Euro in the belief that Euro will become relatively more valuable compared with US Dollar over the life of the contracts.

Short hedging

It is an investment transaction, which is intended to provide protection against a decline in the value of an asset. For example, an investor who holds shares of Exxon chemical and expects the stock to decline may enter into a short hedge by purchasing a put option on Exxon. If Exxon does subsequently decline, the value of the put option should increase. Same is applicable for currencies and commodities.

3. Foreign Exchange Banking in PK (Guide)


Forward Exchange Facilities

According to the chapter IV of the SBP foreign exchange manual, Banks and DFIs can enter into forward purchase and sale of foreign currencies against genuine and firm transactions of approved nature.

Forward cover can be provided even if letter of credit has been opened through an other bank or export documents have been handled by an other bank. In that case cover shall be provided on the basis of a certificate indicating that no cover has been provided by the concerned bank or DFI against the transaction.

Bank can provide forward cover for export, import, foreign private loan, and repatriable foreign currency loan within the relevant provisions of SBP manual. No forward cover transaction can be made for period of less than one month.  

Forward purchase of foreign exchange against “Export of Goods” Banks can purchase foreign currencies forward for delivery up to six and half months from the last date of shipment as provided in the contract/ letter of credit. Purchase on consignment basis may be made at any time after shipment has taken place but last date of delivery should not fall after six and half months from the date of shipment

Incase of export of goods to be invoiced in any convertible currency other than US Dollar it is permissible to buy forward cover in term of US dollar. On realization of export proceeds, dollar amount at booked rate will not be delivered but equaling rupee at spot rate will be paid to the exporter.

Forward sale of foreign exchange against “import of goods”.
Authorized branches of banks and DFIs may sell foreign currencies forward to cover import to Pakistan on cash basis under letter of credit or registered contract. The sale contract may be booked any time after opening the letter of credit or registration of contract. A forward sale against Usance bill can 
be made but it will be up to the date of maturity of the bill.

Forward sale facility is not available for:
I. Crude oil and POL products.
II. Import by federal / provincial government, corporations. department 
with majority govt holding, other than TCP and those public sector 
companies who export some part of their products
III. Sale of foreign exchange to overseas banks branches and 
correspondents to cover rupees bills negotiated by them under letter 
of credit. 

SBP Forward cover Scheme

Under the SBP forward cover scheme, the banks and DFIs can fix their own rate of interest on F C term deposits ranging from 3 months, to 3 years provided these rates do not exceed to average bid rates provided by the British bankers association (BBA) for different currencies on previous working day plus margin prescribed by SBP.

Under this scheme SBP provides foreign currency on future date on a rate agreed today. This provides help to the importers in calculating correct cost of goods to be imported. SBP provides forward cover on deposits and interest in multiple of US $ 1000, GBP 1000, Euro 1000 and Japnani Yen 250, 000. Fee is payable on full amount of forward cover. The maximum rates for payment of interest allowed by SBP are daily published by Foreign Exchange Rates committee.

Other important points

Banks and DFIs can freely enter into forward transactions, with each 
other provided their exposure remains within prescribed limit
To cover transactions of their customers, dealers of the banks can 
enter into forward transaction with their overseas branches/ 
correspondents, in respect of currencies other than US Dollars.
Banks can provide forward cover to the investment banks, leasing 
companies, and Modarba companies holding restricted authorized 
dealers liscence, in respect of the funds mobilized by them from 
abroad, against issuance of certificate of investment and surrendered 
to State Bank.
Forward contract can be extended on roll over basis even for less 
than one month, if export proceeds is not realized on due date or 
import bill could not be paid in accordance to the terms of letter of 
credit / registered contract. Such extension would be made by closing 
the original contract and booking a fresh contract at new rate.

If a Usance export bill against which forward cover is taken is presented 
for negotiation/ discounting during option delivery period, it can be 
treated as delivery against the contract. In all other cases discounting 
will not be treated as delivery and the bill will be discounted at current 
applicable rate and deal will be closed on maturity.
Forward contract which are not taken up will be closed on maturity. 
Difference with prevailing rate will be recovered or paid to the customer 
as the case may be.
If in a particular case SBP is not satisfied with the transaction of which 
forward cover has been booked, it may direct bank to cancel the 
forward contract.

Forward cover against Foreign Currency Accounts

Persons maintaining foreign currency account in Pakistan can sell forward balance held in their foreign currency account, to the importers against letter of credit / order registered with the bank. Following procedure shall be adopted:
I. The account holder (seller) and importer should deal under intimation 
to the bank where account is maintained.
II. For smooth conduct of the transaction it is necessary, that the account 
holder and the importer should be from the same bank.
III. The seller will instruct the bank to mark lien on the F C account up to 
the amount of the deal.
IV. The bank will make separate deal with the arrangement with the 
importer for recovery of rupee equaling amount of deal at the rate 
agreed between seller and importer.
V. When the documents will be arrived within validity of the deal, bank 
will debit FC account of the seller, take delivery of the amount from 
SBP; take F C amount in nostro account for settlement of LC documents, 
same as inward remittance and credit rupee account of the seller.
VI. Bank will lodge LC documents in their books at the rate agreed between 
importer and the seller and will retire documents in usual arrangement.
VII. Transaction shall be reported in monthly returns in normal way i.e. 
“Form I schedule E-2.
VIII. In case importer fails to avail the contract, it will be closed; difference 
of rate if any shall be settled on maturity date as other forward sale 
contracts are closed.

Foreign Currency accounts of the banks and sale of foreign currency
The authorized banks are permitted to open and maintain account in all fully convertible currencies with their branches and correspondent abroad. The details of these accounts must be reported to the Director Exchange policy department SBP.

All foreign currency balances of the authorized banks /DFIs shall be at the disposal of SBP all the times. SBP may direct authorized banks to sell ready or forward delivery of foreign currencies held by them to SBP or to any person/ institution SBP may decide.

Exposure Limit and Nostro Limit  

SBP from time to time fixes foreign exchange exposure limit for each bank authorized to deal in foreign exchange. These limits are intended to cover position of all branches in Pakistan of the banks incorporated abroad and all the branches and overseas branches of the bank incorporated in Pakistan. The head office of the banks should ensure that these limits are not 
exceeded. It is advisable that banks maintain square or near square position. These are no “Nostro limits for the balances held abroad.

Exchange exposure position

All authorized banks are required to report to Exchange & debt management department SBP all foreign exchange transactions that create foreign exchange exposure in any currency using the software installed by SBP on each banks computer. A floppy along with following reports duly signed by authorized officer must be submitted to Exchange & debt management department SBP:
a) Deals 
b) Take-ups
c) Canceled deals
d) Adjusting entries
e) Closing balance

Other important points

There is no restriction on purchase of foreign currency (inward 
remittances) but sale of foreign currencies (outward remittances) can 
be made against SBP approval under powers delegated to authorize 
Authorized banks can freely buy and sale foreign exchange from each 
other within permissible exposure limit.
SBP can buy or sale US dollars with authorized banks in ready and 
forward contract.

Authorized banks can freely purchase foreign currency from each other and from their overseas branches and correspondents both as ready and forward contract.