Banks engage in foreign exchange operations. When they are bought/sold, an asset (claim) is formed in that currency and there is a liability (liability) that is formed in another currency. Therefore, banks have demands and liabilities in several different currencies that are highly affected by currency exchange rates.
The possibility of losing or gaining as a result of adverse changes in the exchange rate is called currency risk.
The ratio of the bank’s assets and liabilities in foreign currency determines the currency position. If the requirements and liabilities of the bank in a particular currency are equal, the currency position is closed but if there is a mismatch – it is called open. A closed arrangement is a relatively stable condition for the banking sector. But getting a profit from the change in the exchange rate with this arrangement is impossible. The slot, in turn, can be either “long” or “short”. The position is called “long” (if requirements exceed commitments) and “short” (obligations exceed requirements). A long position in a particular currency (when the bank’s assets in that currency exceed the liabilities in it) bears the risk of loss if the exchange rate of that currency decreases, and the short currency position (when liabilities in that currency exceed its assets) bears the risk of loss if the exchange rate of that currency rises.
The following processes affect currency positions in banks:
• Receive interest and other income in foreign currency.
• Transfers with immediate delivery of funds
• Operations with derivatives (forward and future transactions, forward settlement, swap deals, etc.), for which there are requirements and obligations in foreign currency, regardless of the method and form of settlements for such transactions.
To avoid currency risk, one should strive to have a closed position for each currency. It is possible to compensate for the imbalance of assets and liabilities by the amount of currency bought and sold. Therefore, commercial banks must establish effective currency risk management systems. A licensed bank can have an open currency position from the date of receiving a license from the National Bank to conduct operations in foreign currency values. In order to avoid risks or losses in currency transactions; The central bank sets the standards for an open currency position. This approach to regulating foreign exchange risk is based on international banking practices as well as recommendations of the Basel Committee on Banking Supervision. In the UK, the criteria for an open currency position are limited to 10% and 15% of the bank’s capital, in France 15% and 40%, and the Netherlands – 25%, respectively.
Currency positions are recorded in the account at the end of the day. If a bank has an open foreign exchange position, changes in the exchange rate result in either profit or loss. Therefore, the Central Bank takes measures to exclude sharp fluctuations in the exchange rate