Elegant Report

1.0

introduction

There are many activities of banks which involve risk-taking, but there are few in which a bank may so quickly incur large losses as in foreign exchange transactions. The risks inherent in foreign exchange business, particularly in running open foreign exchange positions, have been heightened in recent years by the increased instability of exchange rates. Consequently, the monitoring of these risks has become a matter of increased interest to supervisory authorities.The purpose of this note is to consider the prudential aspects of banks foreign exchange activities. It is not directly concerned with the restrictions that countries may place on their banks foreign exchange business for exchange control, monetary or other macro-economic reasons. In exercising prudential control over this area of banks activities, however, supervisory authorities need to take into account the role of the banks as "market-makers" in foreign exchange. This role has two aspects. Firstly, banks have to quote rates to their customers (including other banks) at which they stand ready to buy and sell currencies.

Secondly, by themselves taking open positions in currencies, banks (as well as non-banks) help to ensure that the foreign exchange markets are balanced at any point of time without excessive and erratic exchange rate fluctuations. In other words, supervisors have to weigh prudential considerations against the need to enable the banks to play their part in the smooth and efficient functioning of the exchange markets. Whatever may be the exact balance struck between these considerations, supervisory authorities must seek to ensure that the risks assumed by banks in their foreign exchange operations are never so large as to constitute a significant threat either to the solvency and liquidity of individual banks, or to the health and stability of the banking system as a whole.

2.0 types of prudential risks

While banks are exposed to a number of different types of risk in the conduct of their foreign exchange business, most of these risks also feature in domestic banking business. In principle, the only risk peculiar to foreign currency business is the exchange rate risk, i.e. the risk that a bank may suffer losses as a result of adverse exchange rate movements during a period in which it has an open position, either spot or forward, or a combination of the two, in an individual foreign currency.

The other risks incurred by banks conducting foreign exchange operations arise more as a result of the international aspects of such business than because foreign currencies are involved. One such risk is the interest rate risk, which arises from the maturity mismatching of foreign currency positions. Even when the spot-plus-forward positions in individual currencies are balanced, the pattern of forward contracts may produce a forward/forward mismatch. In such situations, a bank may suffer losses as a result of changes in interest rate differentials and concomitant changes in the forward exchange premiums, or discounts, of the two currencies concerned.

Another type of risk is the credit risk i.e. that of a defaulting counterparties to a foreign exchange contract, or a loan contract involving foreign exchange. In that case the bank, provided it originally had a balanced book, would find itself inadvertently left with an uncovered exchange position. Although this kind of credit risk potentially encompasses the total of a banks foreign exchange book, the bank would suffer an exchange loss only to the extent that the exchange rate had in the meantime moved in such a way that a cost would be involved in covering the position opened up by an unfulfilled foreign exchange contract.

However, in the case of a loan contract a bank may be exposed for the full amount of the contract.

A further risk is the time-zone risk, which arises because of the twenty-four hour nature of foreign currency markets. With time-lags frequently occurring between settlement in one currency in one centre and settlement in a different currency in another time-zone, banks may be exposed for the full amount of the contract if the counterparty or the payment agent defaults in the interim.

Finally, most foreign exchange contracts involve counterparties who are resident in other countries, with the result that sovereign (or country) risk, e.g. the risk of a ban on the transfer of currency by the nationals of a particular country, will also be present.

3.0 the role of bank management

Primary responsibility for the safety of banks in their foreign exchange operations rests with the managements of banks. In particular, it is managements responsibility to set appropriate limits to the risks taken by a bank in its foreign exchange business and to ensure that there are proper internal control procedures covering this area of a banks activities.

So far as internal controls are concerned, the banks should observe a clear-cut and well-defined division of responsibility between a) foreign exchange dealing, b) accounting, and c) internal supervision. A banks foreign exchange dealers should have clear and binding instructions both as regards general trading principles and as regards limits (by individual currencies and maturities) on open positions, on the size of individual contracts and on exposure (overnight and forward) with individual counterparties. Dealers should be strictly required to record each transaction on a dated and sequentially-numbered form and to pass it promptly to the accounting department. The instructions to the dealers should, moreover, prohibit the conduct of business (including business within the same banking group) at exchange rates which are unrepresentative of the prevailing level in the market and should include a general code of conduct for their relations with exchange brokers. As a matter of general principle, profit targets should not be imposed by a banks management on its dealing department, even though there may well be some presumption that income will be forthcoming from this source.

The accounting department should receive without delay all the information from the dealers that is necessary to ensure that no deal goes unrecorded. All foreign exchange contracts, whether spot or forward, should be promptly confirmed in writing. Furthermore, dealers should never write their own outgoing confirmations; this should be the responsibility of the accounting department alone, which should also be the first to receive the corresponding incoming confirmations. If confirmations are not forthcoming, the counterparties should be contacted promptly and in the absence of satisfactory explanation the bank should inform its supervisory authority.

In addition, foreign exchange accounting should be organized in such a way that the banks management is continuously in possession of a full and up-to-date picture of the banks position in individual currencies and with individual counterparties. This information should not only include the head office but also the positions of affiliates at home or abroad. Moreover, periodic and frequent revaluations at current market rates should permit the monitoring of the development of the banks profits or losses on its outstanding foreign exchange book.

It will be the responsibility of the internal audit function to make sure that dealers observe their instructions and the code of behavior required from them, and that accounting procedures meet the necessary standards of accuracy, promptness and completeness. For that purpose it will be advisable not only that internal audits and inspections take place at regular intervals, but that occasional spot checks are made. As a further safeguard against malpractices, the auditors, in co-operation with the central management, should from time to time seek an exchange of information on outstanding foreign exchange contracts with the counterparties to these contracts. Banks should inform their supervisory authority if there appears to be a lack of control or cooperation on the part of the counterparty.

It should, moreover, be clear that the internal control procedures should cover not only the parent bank, but its total branch network and, as far as possible, also its subsidiaries. In order to facilitate internal supervision and monitoring of open exchange positions, branches should daily report their dealing positions to head office. While the extent to which individual branches are permitted to run open positions is a matter for a banks management to decide on the basis of geographical factors and the dealing expertise of the branch concerned, head office should strictly enforce the limits it sets in order to keep control of its worldwide exposure.4.0 the role of supervisorsThe role of supervisory authorities in monitoring and controlling banks foreign exchange activity may involve one or more of the following activities:

The surveillance of banks internal control procedures;

The setting of more or less formal guidelines for, or limits on, banks foreign

currency exposure;

The monitoring of banks foreign exchange positions.

As regards the first of these, the supervisors job is to make sure that the banks have internal control systems as discussed in section III above, that these systems function effectively and that both internal and external reporting is as far as possible safeguarded against falsification.

As regards guidelines for, or limits on, banks foreign exchange exposure, it is desirable to distinguish between a banks dealing position in foreign exchange and its infrastructure position in foreign exchange (participations, investment in property, etc.).

Moreover, supervisors should distinguish between a banks total uncovered positions in foreign currencies and its open positions in individual foreign currencies. Thus, it will make quite a difference whether a banks uncovered position results primarily from exposure in just one currency, or whether it is the sum of smaller exposures in several currencies. To take account of these qualitative differences, the authorities might apply a system of dual limits, one on a banks exposure in individual foreign currencies, and one on its overall foreign exchange exposure, i.e. the gross aggregate of its long and short positions in individual foreign currencies. It might also be desirable to restrict a banks net position in domestic currency, but this is more likely to be for monetary or exchange control purposes than for prudential reasons.

A further point which the supervisory authorities have to consider in this context is whether it is desirable to monitor and/or to set limits on banks dealings in gold and precious metals. While in many countries banks dealings for their own account are either negligible or statutorily prohibited, higher prices and greater activity in precious metals markets have increased the possibility that banks may become over-exposed in their operations in these markets. To reduce this risk, banks could be required to include positions taken in gold or precious metals within any limits imposed on their foreign exchange positions, or alternatively separate limits might be imposed on these activities.

In supervising banks foreign exchange business, the authorities will have to base themselves in large measure on bank managements own standards of prudence. They must, therefore, satisfy themselves that management adhere to some rational policies with respect to foreign exchange exposure, such as limiting open exchange positions to a certain proportion of the banks own funds. To avoid the risk of over-trading, it might also be desirable for a bank to keep its total foreign exchange turnover approximately in line with the size of its balance sheet. Those authorities which go further and set guidelines or limits equally need to find some standard by which to judge what degree of flexibility banks should be given. In several major countries, the standard used is the size of the banks capital base.

For the purpose of monitoring the banks foreign exchange business, the authorities need to make use of two types of information flows: statistical reports from the banks about their foreign exchange operations; and information about events and developments in the foreign exchange market.

As regards statistical reports, it will be neither practicable nor necessary for the supervisory authorities to obtain the full range of information about the banks exchange-market activities and exposure that should be available to the banks own management. The periodic reports to the authorities should, however, show, as a minimum and rather frequently, the banks open spot-plus-forward position in individual currencies and preferably also their gross positions. Limits on foreign exchange exposure will shield a bank from risk only when they are adhered to on a permanent basis. Therefore, the authorities will have to make sure, perhaps by means of unannounced on-the-spot examinations, that these periodic reports also provide a realistic picture of a banks foreign exchange activities between reporting dates.

Where formal limits on exposure are applied, the periodic reports supplied by the banks might be required to include statements of each occasion on which the limits were exceeded. The authorities also need to guard against banks "parking" foreign exchange positions with their affiliates in other countries. Although this practice is difficult to detect where multinational groups are involved, supervisors should have access to banks dealing slips and should ensure that these are properly dated and sequentially numbered.

General information about developments in the exchange market is available to the authorities through the contacts which central banks maintain with market participants. In that connection the authorities should encourage banks to keep them informed, for example, about requests by other banks to deal (or to carry over exchange contracts) at rates which are unrepresentative of the level prevailing in the market, confirmations not being forthcoming, an excessive volume of foreign exchange business transacted by another bank, or more generally about market rumours and anomalies. Where the central bank is not responsible for banking supervision, it should pass on information it obtains from its market contacts to the supervisory authorities. Similarly, on an international level the authorities should exchange on a confidential basis any market rumours concerning banks under their respective supervision.

5.0 Bankin regulations for the treasury dept.

5.1 Foreign Exchange Dealingsa) Banks are free to place and otherwise deal in foreign currency and there is no limit on nostro balances. However, the SBP has placed exposure limits on banks to regulate the foreign currency risk faced by these institutions. b) Authorized Dealers are no longer required to surrender the foreign currency received under the incremental foreign currency accounts, scheme notified under the SBPs Circular No.FE-31, to the SBP. The SBP does not provide forward cover on these deposits any more and authorized dealers have to bear the foreign exchange risk themselves.c) The SBP is reported to be currently in dialogue with foreign exchange dealers to frame rules and regulations to initiate derivatives trading in the country. The current focus is on derivative products such as Forward Rate Agreements (FRAs), Interest Rate Swaps (IRSs), Non-Deliverable Forward (Options) etc. In this regard, presentations have reportedly been made to the SBP by the Foreign Markets Associations (FMA) and some foreign and nationalized commercial banks.

5.2 Foreign Exchange RegulationsThe foreign exchange business of banks is administered under the provisions of the Foreign Exchange Regulations Act, (FER) 1947 and the rules and regulations made thereunder. It is mandatory for all Authorized Dealers (which includes banks) to conduct their business under the regulations issued from time to time by the SBP and the Government of Pakistan. Certain principal requirements under FER pertaining to banks are summarized in the ensuing paragraphs.5.3 Forward Exchange Facilities1. Under FER, an Authorized Dealer may enter into contracts for forward purchase or sale of foreign currencies to provide forward cover, in respect of:

Exports and imports of goods, private foreign currency loans obtained from banks / financial institutions from abroad, loan from parent companies of multinationals, suppliers credit including credits under PAYE Scheme, for financing foreign currency cost of the project as per the governments industrial / investment policy and instructions issued by the SBP.

Repatriable foreign currency loan obtained from banks / financial institutions abroad or parent company or other overseas branches / associates by foreign controlled companies in Pakistan to meet their working capital requirements.

Portfolio investment made by non-residents in rupee denominated shares and securities on repatriable basis out of funds remitted from abroad.

Forward foreign currency transactions between Authorized Dealers subject to their exchange exposure prescribed limit.

Foreign currency transactions (other than US Dollar) by Authorized Dealers with their overseas branches and correspondents to cover transaction entered into by them with their customers.

Funds mobilized in foreign currency by issuance of certificate(s) of investment by investment banks, leasing companies and modaraba companies, holding restricted Authorized Dealers license issued by SBP.

Imports under letters of credit / indents for imports on consignment basis registered with an Authorized Dealer against foreign currency account maintained by any person with an Authorized Dealer in Pakistan.

2. Foreign exchange forward cover facility will not be available in respect of the following:

Import of crude oil and POL products.

Import by departments of federal and provincial governments, corporations (other than Trading Corporation of Pakistan) or Industrial undertakings in which government holds majority interest.

Overseas bank branches and correspondents to cover rupee bills established by them in Pakistan.

Dividend/interest/coupon income in respect of a non-resident's investment in Pakistan.

Foreign direct investment in Pakistan by non-resident investors. 5.4 Private Foreign Currency Accounts (PFCA):1. An Authorized Dealer is authorized to open PFCA of the following without approval of SBP and such accounts are free of foreign exchange restrictions:

Pakistan nationals including holder of dual nationality

All foreign nationals

Joint accounts

All diplomatic missions and their diplomatic officers

All international organizations in Pakistan

Firms, branches of foreign firms / companies in Pakistan and also companies established / incorporated and operating in Pakistan.

Charitable trusts, foundations, etc.

Non-resident exchange companies.

All foreign firms / corporations (other than banks and financial institutions owned by banks) incorporated and operating abroad owned by persons who are otherwise eligible to open foreign currency accounts.

2. PFCA cannot be opened by:

Airlines and shipping companies operating in/through Pakistan collecting passage and freight in Pakistan.

Investment banks, leasing companies and modaraba companies.

3. PFCA cannot be fed with:

Foreign exchange borrowed, unless otherwise permitted by SBP.

Foreign exchange proceeds of goods exported.

Proceeds of securities issued or sold to non-residents.

Payment received for services rendered.

Earnings or profits of overseas offices or branches of Pakistani firms and companies including banks and investment of resident Pakistanis abroad.

Foreign exchange purchased from an Authorized Dealer for any purpose.

Foreign exchange generated from kerb market by corporate bodies / legal entities.

4. Special foreign currency accounts may be opened by Authorised Dealers with the specific or general permission of the SBP for receiving funds on account of foreign equity or foreign currency loans for purposes of industrial and other projects and receipts in foreign currency by contractors.

5.5 SBPs Forward Cover Scheme:(a) Authorized Dealers are allowed to fix their own rates of interest for term deposits provided they are within the average bid rates issued by British Bankers Association and other conditions as prescribed.

(b) The maximum rate of interest including the margins is published daily by the Foreign Exchange Rates Committee.

(c) On foreign currency deposits of less than three months, interest shall be paid on the basis of last return allowed on similar rupee PLS saving accounts but shall not exceed interest rate applicable to the relevant foreign currency deposits.

(d) Authorized Dealers shall sell all the deposits in foreign currency accounts to the SBP. The SBP shall cover exchange risk of all such deposits as well as interest accruing thereon subject to payment of forward cover fee to the SBP. In respect of premature withdrawal of such deposits, fee for unexpired period is refundable by the SBP.

As stated in paragraph 6.3.1, SBP does not currently provide forward cover and banks are not required to surrender foreign currency received to SBP.

Authorized dealers may accept foreign currency deposits:

1. From their overseas branches and foreign banks operating abroad on such conditions as may be prescribed by the SBP from time to time with regard to amount and period of maturity.

2. Interest on the above deposits may be payable annually, six monthly or quarterly with the consent in writing of depositors.5.6 Deposits Under FE-25 Scheme:

Foreign currency deposits accepted outside the SBPs Forward Cover Scheme i.e. FE Circular No. 25 of 1998 are not required to be surrendered to the SBP. Such deposits shall not be provided forward cover. FE-25 deposits mobilized may be lent, invested or placed on deposits in Pakistan or abroad by Authorized Dealers subject to applicable regulations in force. Rate of return on such deposits may be determined by Authorized Dealers in their discretion subject to maximum rate not exceeding LIBOR.

5.7 Foreign Currency Accounts of Private Power Projects (the project) In PakistanAuthorized Dealers may open and maintain:

"Special Foreign Currency Accounts" in or outside Pakistan (over and above the exposure limits and reporting requirements under FE-25 scheme) to enable deposit of foreign equity / foreign currency loans to be utilized for the purposes of the Project.

"Special Foreign Currency Insurance Account" for payment of insurance/reinsurance premium and for receiving claims against covers taken in foreign currency outside Pakistan.

Off-shore Foreign Currency Control Account to meet the foreign currency cost for operating the Project.

Off-shore Foreign Currency Operating Account for remittance / deposit periodically to meet O&M expenses.

Off-shore Disputed Payment Escrow Account for remittance of balance therein after the resolution of the dispute, if any.

Off-shore Foreign Currency Debt Payment Account for depositing the amount required for debt services.

Off-shore Debt Services Reserve Account in which maximum balance will not exceed the next 12 months debt services payment and which will be liquidated simultaneously with the retirement of debt.

Off-shore Foreign Currency Maintenance Reserve Account in which a maximum balance of US$ 3 million during the term of Power Purchase Agreement may be hold and which will be liquidated concurrently with the term of the agreement.

Off-shore Foreign Currency Dividend Account will be used for receiving dividends as and when declared and paid by the company.

(b) Any earning or interest earned in balances held in the above accounts is required to be repatriated to Pakistan.

(c) Income tax due on payments made through the above accounts shall be deducted by the Authorized Dealers and deposited into the government treasury.

(d) Authorized Dealers are authorized to open and maintain Special Foreign Currency Accounts of Engineering, Procurement and Construction (EPC) and Operation and Maintenance (O&M) Contractors of the Project operating in Pakistan with the approval of the Government. 5.8 Foreign Currency Accounts of Foreign Oil/Mineral Exploration Companies and Foreign Contractors and their Sub-contractors (The Depositor)

(a) Authorized Dealers are authorized to open foreign currency accounts under FE-25 Scheme or Special Foreign Currency Accounts for the above of class of Depositors to meet all their expenditure in Pakistan including salaries of foreign nationals and non-residents in Pak rupees by converting funds received from abroad in the said accounts in the inter bank market.

(b) Firms and companies belonging to the above class of Depositors, intending to raise foreign equity and foreign currency loans may be also permitted by Authorized Dealers to open "Special Foreign Currency Accounts" for receiving such funds. The funds available in such accounts are to be used only for making such payments as may be permissible under the FER.

5.9 Remittance of Export Commission, Brokerage and Discount:

(a) Authorized Dealers are permitted to make remittance, on behalf of exporters, of commission, brokerage and discounts to foreign importers or agents at rates not exceeding the maximum prescribed.

(b) Authorized Dealers may also remit commission at a higher rate than above subject to prior approval of the SBP.

INTERNET MERCHANT ACCOUNTS In order to promote E-Commerce, Authorized Dealers are permitted to open internet merchant accounts in local currency or in US Dollar on submission of National Tax Number Certificate and subject to the following conditions:

(a) Merchant must be engaged in the said business

(b) Merchant has a registered place of business in Pakistan

(c) Merchant has Export Registration Certificate

IMPORT TRADE CONTROL In the context of import trade, Authorized Dealers:

(a) Should ensure that the registration numbers of importers are mentioned on the import documents.

(b) Should, before establishment of letter of credit / registering contracts, ensure that goods to be imported are classifiable under the Import Control Schedule.

(c) Should ensure that letters of credit are opened only against firm contracts.

(d) May approve application for advance remittance against imports to the extent of 50% of the estimated C&F value of the goods to be imported.

(e) Are not permitted to open clean, revolving, transferable or packing credits except with prior approval of the SBP.

REMITTANCE OF ROYALTY / FRANCHISE AND TECHNICAL FEES ETC. (a) Authorized Dealers are allowed to make remittance of royalty/franchise and technical fee and dividends without approval of the SBP, subject to the conditions and provisions of FER.

(b) Branches of foreign banks operating in Pakistan are allowed to remit their profits to their head office subject to prior approval of the SBP.

PRIVATE REMITTANCES (a) Subject to prior approval of the SBP, Authorized Dealers may make remittance on behalf of foreign nationals on account of certain assets including bank balance, sale proceeds of securities, sale proceeds of real state purchased by the applicant during his / her stay in Pakistan.

(b) Authorized Dealers are permitted to make remittance on behalf of self-employed foreign national(s) on account of family remittance facilities.

LOANS, OVERDRAFTS AND GUARANTEES (a) Authorized Dealers are permitted to grant short terms rupee loans to their overseas branches and correspondents without approval of SBP to finance exports from Pakistan and are liquidated within a period of two weeks.

(b) Authorized Dealers may grant loans to Pakistan nationals resident outside Pakistan against their foreign currency accounts balance.

(c) Authorized Dealers are granted general permission to grant rupee loans to their clients against guarantees of non-residents / guarantees received from banks functioning abroad.

(d) Authorized Dealers subject to prior approval of the SBP, may obtain short term loans and overdrafts (not for purpose of carrying speculative exchange position etc.), from overseas branch and correspondents for period not exceeding 7 days at a time, if such loans or overdrafts are required to be secured by collateral to be lodged in Pakistan or elsewhere.

(e) Authorized Dealers are not permitted to obtain long-term loans in foreign currency without the prior approval of the SBP.

(f) Authorized Dealers are not permitted to grant any loans or overdrafts in foreign currency, whether secured or unsecured, without the prior approval of the SBP.

(g) Without the prior approval of the SBP, Authorized Dealers are not permitted to give guarantees or undertakings in favor of residents in Pakistan either on behalf of non-residents or against overseas guarantees or collaterals lodged outside Pakistan.

(h) Without the prior approval of the SBP, Authorized Dealers are not permitted to give guarantees to overseas bank branches or correspondents or hold collaterals on their behalf in respect of any credit facilities or guarantees.

SECURITIES(a) Unless exempted by general or special permission of the SBP, Authorized Dealers are required to seek prior permission of the SBP before purchasing shares or securities registered in Pakistan on behalf of persons resident outside Pakistan. They are required to maintain a complete record of shares held by non-residents.

(b) Authorized Dealers are required to maintain a complete record of non-residents in respect of proof of original investment in shares made in foreign exchange.

(c) Branches of foreign banks in Pakistan and foreign controlled investment banks incorporated in Pakistan are permitted to invest in rupee denominated registered listed corporate debt instruments issued in Pakistan, subject to such conditions as stipulated in FER.

(d) Foreign bank branches in Pakistan have general permission to underwrite the issue of shares to the extent of 30% of the public offering or 30% of its own paid-up capital and reserves, whichever is less.

(e) Foreign banks' branches in Pakistan have general permission to underwrite the issue of participation term certificates, term finance certificates and modaraba certificates, which are convertible into ordinary shares to the extent of 30% of the public offering or 30% of its own paid-up capital and reserves, whichever is less.

5.10 xxxx

6.0 interview for bank foreign exchange dealingsBank deals in foreign exchange only for the exports and imports. Bank does not provide the foreign exchange for speculative purposes but only for the purpose of the international transactions so we can say that the bank operates foreign exchange only in a limited way.

State Bank of Pakistan controls the Forex dealing in banks. At the time of partitioning the state bank controls the forex dealings with full regulations but it is now semi regulated and State Bank provide some regulation and some policies are made by the bank itself.

Problem of underdeveloped country like Pakistan is that their exports are low priced and imports are of high so resulting unfavorable Balance of Trade and Balance of Payment that way the State Bank of Pakistan has to interfere into the forex market. The shortfall of forex is managed by the State Bank of Pakistan through its regulations.

Major exports of Pakistan priced as follows which are of very low price in international market:

Raw material

Unfinished goods

Agriculture

Imports of Pakistan are high priced due to which the Balance of Payment and Balance of Trade are turned to be unfavorable these includes

Technical goods

Capital goods

Exports and imports policy of Pakistan is issued by the commerce division of Pakistan. These policies affect not only the exports and imports of country but also the forex dealings of the banks as these are dependent on the exports and imports of the country.

6.1 Mode of Imports & Exports:There are three basic ways of imports and exports of the products. These are as follows

1. Letter of credit

2. Agreement/ Contract/ Performance Invoice

3. Advance payment

6.2 Letter of Credit (LC):In case of letter of credit following four major partied are involved as follows1. Supplier/ Exporter

2. Beneficiary

3. importers Bank

4. Exporters BankIn case of letter of credit the bank takes the responsibility of payment and takes the documents of import or export as grantee. The importer make payment to the importers bank, importers bank transfer this payment to the exporters bank and this exporters bank give payment to the exporter. In this way we can say that the banks operate as intermediary between exporter and importer and charge for this action.

TYPES OF LC There are two basic types of letter of credit as for as payment is considered

1. At sight

2. DA(documents against acceptance)

TYPES OF CONTRACT1. At sight

2. DA(documents against acceptance)

6.3 Payment of Letter of Credit to Exporter:Payment of letter of credit depend upon the type of letter of credit opened so following modes are adopted for the payment of letter of credits

1. Payment in case of sight

In case of letter of credit at sight the payment is made immediately after the shipment of goods.

2. Payment in case of DA

In this type of letter of credit the payment is made after specific time period and immediately after the shipment of goods if payment is needed immediately then bank charge the nominal cost of payment other wise the full payment is made after the time specified.

EXAMPLE It is like that the exporter export the goods and the payment is to be made after 90 days but the exporter need the payment at the movement then in case of sight letter of credit he can receive full payment from the bank without any problem but if the case is document against acceptance then he cannot receive full payment immediately but after deduction some charges he can receive the payment.

6.4 Forex Dealing Rates used by Banks:

In case of any foreign trade, buying and selling, all the receipt and payment are made through the banks and the banks use ready market rates or spot market rates for issuing the letter of credit for foreign trade.

As the currency is also like a commodity so deals in the market like other commodities for value determination. The rate determined from the market demand and market supply is called spot market rate. It takes a lot of time to complete the process of shipment and documentation of shipment of goods so the currency fluctuation is involved in order to save from this fluctuation bank normally charge some price.

6.5 Exports and Imports In Pakistan:

Exports and imports are made only through the letter of credit in Pakistan so at sight or DA can be opened. In case of DA the payment is to be made after time so bank gives the choice to his customers to enter into forward contract with bank in order to safe from market fluctuations.

Forward Contract offered by the banks is of three types:1. Option

2. Fixed

3. Combination of fixed and optionIn case of option the payment can be made or received at any time when the customer wants so the bank charge higher price for that as the more risk is involved for the bank. If the rate is depreciating then customer can take payment before time and if the rate is appreciating then the customer can wait so the bank charge to cover its risk factor.

In case of fixed forward contract the customer can take payment or made payment only after a fixed time period so the bank charge lower price in this case as lower risk is involved.

In case of combination of two the customer can make the contract fix for some portion of time and option in certain time in order to decrease the overall cost of the future contract lets take an illustration to make it clear lets an importer has to make payment of the letter of credit. He knows that the payment is to be made at least 15 days after and my be at any time between 16 to 30 days so he can take the 1 to 15 a fix future contract and can take an option contract from 16 to 30 days. This will reduce the cost of the customer.

6.6 Common Steps of LC and Documents against accceptance:In case of letter of credit and contract certain process remains same whether these are at sight or these are documents against contract these steps are as follows:

Exporter

Importer

Sell $ to bank

Buy $ from bank

Rs. is received

Rs. is paid

In case of import and export the bank has to be involved and without bank involvement transaction cannot be conducted. In case of importer the importer first buy the dollars from the bank and pay rupee to the bank these dollars bought by the exporter are not physically delivered to the importer but paid by the bank to the exporter on behalf of the importer.

In the other case exporter receive the dollar from the importer. These dollars are not physically delivered to the exporter but the exporter sells these dollars to the bank and received the rupee from the bank.

6.7 Banks Forward Buying and Selling:

Bank while dealing the forex of imports and exports buy and sell the forward contracts in order to save the exporter and importer from the additional risk involved in the forex. But here bank buy at lower rate and sell at a higher rate and the difference makes it profit as the bank has to bear risk as well. Banks deal in foreign exchange at both ready as well as forward rate. If the $ is going up then there is no need to get the $ discounted and if the $ is going down then the $ can be discounted but bank charge for that.

6.8 Forex Position of Banks:

Position of every bank is determined in buying and selling of $ if the bank is over selling then its position is termed to be short and if it is over buying then its position is called as long and if the bank is not over selling neither over buying then we call it square position. This position is determined in the head office of every bank and daily report is send to the State Bank of Pakistan.

Every bank is allowed to make its position short up to a maximum limit called open limit which is 15% of their paid-up capital no bank can exceed this limit. In the case the bank fall short more than this limit then the bank is charged a penalty. The over short fall of bank can also be managed by the overnight borrowing from other bank or the State Bank of Pakistan. Treasury department of every bank is responsible for the preparation of the statement of short or long position. Reserves of bank the account of a bank with other bank is called as NOSTRO account and other banks account with a bank is called as VOSTRO net of these two accounts is determined on the daily basis and inform to the SBP. Bank cannot give the foreign exchange to any person except for the following purposes:

1. Traveling check $2100 once a year

2. Going for study abroad then payment to the respected university for dues after admission Control rates of banks are determined on the demand and supply basis. The bank is credited earlier by the clean OD or T-cheque and receives the payment later but if the documents are unclean then the situation is vice versa. If the letter of credit is clean then the opening bank is not credited earlier. Bank is concerned with only the recovery of money and not with the rates fluctuations. All the matters relating to the rates and currency dealing are done at the treasury office at head office and not in the banks separately. Treasury office determine the

1. Liquidity position

2. Net account determination Every bank has a very smart MIS system in order to manage the funds and to obey the rules of SBP. If at any point in time the bank get short of funds then the bank can borrow from other banks or the SBP overnight or temporary lending which is at REPO rate for three days. The exporter needs some qualification without which the bank doesnt provide them foreign exchange in order to deal in the international transactions. Followings are the important ones:

1. Member of respected chamber of commerce

2. NTN/ Provisional tax number

3. Deed of partnership if any Importer need following qualifications to start import of goods:

1. Member of respected chamber of commerce

2. NTN/ Provisional tax number

3. Deed of partnership if any

4. Sale tax number E-form is prepared by the exporter and 4 copies are arranged. 1st copy is kept by the importer, 2nd and 3rd are given to custom office and after verification provided to bank, 4th copy is given to exporter of goods. Following are the three major parts of the E-form

1. Undertaking

2. Particulars of export

3. Bank

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7.0 documents used in foreign tradeIn handling international trade through the mechanism of documentary credits all banks are concerned with the documents relating to or covering the goods but not in the goods itself .according to the export promotion bure in credit operations all parties deal with documents, and not with goods ,services and other performances to which the documents may relate as documentary credits are highly popular and common method for settlement of international trade debts and banks are merely concerned with the documentary credit officers have a thorough understanding of the nature and type of various documents and the requirements about them under the USP.

7.1 Bills of Exchange:i. In law a bill of exchange is an unconditional written order signed by the drawer , addressed to a specified person (called the drawee) , requiring him to pay on demand or at a determinable future time a certain amount of money to or to the order of a specified person , or to bearer.

In international trade such is also refer to as a draft.

ii. The exporter draws the B/E on the importer and gives it with the shipping / other documents and necessary instructions to his banker for collection.

In documentary credit the exporter is required to draw the bill on the issuing bank or on a confirming bank or on a nominated bank. If the credit calls for draft on the applicant like importer, bank will consider such draft as additional document.

iii. The law relating to bill of exchange in Pakistan, India and Bangladesh s enacted in the negotiable instruments act 1981.

iv. The bank officers should be familiar with the legal provisions relating to:

Requisites of valid bill of exchange.

Its presentment.

Rights of concerned parties

Stamping

Acceptance, dishonour and noting.

Determination of maturity date in the case of bill of exchange.

Rules for calculating maturity of usance bills:

a) Where a bill is payable a certain number of months after date /sight the period shall terminate on the date of the month corresponding to the date of the bill or date of sighting.

If however the month in which the period terminates has no corresponding date the period shall be deemed to terminate on the last day of such month.

b) Where a bill is payable a certain number of days after date or after sight then in calculating the maturity date the day of the bill or its presentment/acceptance shall be excluded.

c) Every B/E is at maturity on the third day on which it is payable on the bases a or b above. These three days are known as days of grace. The maturity date is determined after adding the said three days of grace. However the days of grace have been abolished in UK.7.2 Commercial Invoicesi. A commercial invoice distinct from a Performa invoice (which is an invitation to order) evidences clam for payment for goods sold. It is issued by the beneficiary of the credit who is seller of the goods and is made out in the name of the applicant. It records the type and quantity of goods sold however be signed by the issuer unless specifically required by the credit.

ii. A commercial invoice contains

Description/default of goods

Payment/delivery terms

Transportation particulars

Units price

Break down of due amount including expenses.

iii. Unless otherwise stipulated in the credit banks may refuse commercial invoices issued for amounts in excess of the amount permitted by the credit. Never the less if a bank pays or accepts such invoices its decision will be binding upon all parties provided that such banks has not paid or accepted the drafts for an amount in excess of that permitted by the credit.

iv. The description of the goods in the commercial invoices must correspond with the description in the credit. In all other documents however the goods may be described in general terms not inconsistent with the description of the goods in the credits.

v. There are variations of commercial invoices to meet the local requirement of importer country and or the importers own dictates. The varied types of commercial invoices are as under.

a) Certified invoices:

These are ordinary signed invoices specifically certifying that the goods are according to specific contract or Performa invoice that the goods are of a specific country of origin. Any other fact as required by the importer. It could be combined certificates of value and origin as used between common wealth members.

b) Consular invoice:

Some importing countries require consular invoice for custom clearance of goods. Accordingly different countries have designed their own forms of such invoices. It is issued by the embassy of importing country in the exporters country. These invoices serve a number of purposes to monitor inflow of goods.

c) Legalized invoice:

Some instead of embassy own printed form some countries requires that the commercial invoices are legalized by their own embassies. As such the beneficiary completes and presents his own signed invoice for embassy certification against a fee.

d) Combined invoice and C.O.O:

Sometimes an invoice usually I two sheets is combined with a certificate of origin. The former part is signed by the beneficiary and C.O.O part is signed by the local chamber of commerce or any other specified independent agency.

7.3 Transport Document

Transport documents are acknowledgement of receipt of goods by the carrier under the contract of carriage. It provides evidence of payment of shipment of goods. It enables buyers to obtain delivery of goods. Are document of title to goods of gods and are documents of title to goods if negotiable form TDs also enable the sellers to obtain finance there against.

Several modes of transporting the goods from the ware house of the seller to the warehouse of the buyer give rise to severable types of trade documents:

MODE CARRIER T.DBY SEA STEAMPSHIP COMPANY BILL OF LANDING

BY RAIL RAILWAY COMPANY RAILWAY RECIPT

BYE AIR AIRLINE COMPANY AIRWAY BILL

BY ROAD TRUCKING COMPANY TRUCK RECIPT

BY POST POSTAL AUTHORITY POST PARCEL RECEIPT

In transport documents following parties are involved.

CARRIER: The party or carrier company engaged in transporting goods who issue the transport document.

SHIPPER: The shipper is the seller or exporter who consigns the goods and is the one from whom goods are recived by the carrier.

CONSIGNEE: The consignee is the buyer or importer in whom favour the shipper or intermediary bank makes the endorsement to enable him to obtain delivery f goods.7.4 Main Transport Documents

MARINE BILL OF LANDING: Marine bill of landing may be issued in sets of more than one original to facilitates splitting of documents for separate mailing. They should indicate name of the carrier and signed by him or his agent. The bank should be in possession of all stated signed orginals constituting the full set. Bank may accept short form or blank type of bill of landing.

The marine bill of landing must indicate that the goods have been located on board or shipped on a names vessel by pre- printed wording or by notation evidencing date of loading on board a name vessel (which may be the same vessel as was intended).

The marine bill of landing must indicating the port of loading and port of discharge (as stipulated in the credit) by pre printing or by notation where the place of receipt /taking in charge or place of destination is shown differently in charge or place of destination is shown differently in the bill of landing. Banks may accept a bill of landing indicating transshipment, provided that it is not prohibited by the credit and the entire ocean carriage is covered by a through bill of landing. However even if the credit prohibits transshipment. Bank may accept a bill of landing indicating transshipment provided that the cargo is shipped in containers trailers and lash barges and the bill of landing is a thorough bill of landing. Where the applicant wants total prohibition of transshipment.

A bill of landing like other transport documents should be presented within time period specified in the credit. If no such period is specified bank will not accept a transport document presented later then 21 days after the date of shipment.

SEAWAY BILLS: As the processing of marine bill of landing is rather slow since they have to pass through several hands. Shipping companies developed non negotiable seaway bill to avoid delay in handling the goods once they arrive at the destination. They resemble airway bills and the consignment and delivery is made to a nominated consignee upon proof of identity.

7.5 Air Transport Document

An air transport document should indicate the name of the carrier and that good have accepted for carriage and date of issuance and specific notation of the actual date of dispatch and the air ports of dispatch and destination. It should be signed or authenticated by the carrier or his agent. It may contain all or some of the term and conditions of carriage. Banks will accept on atd indicating transshipment despite prohibition in the credit provided the entire carriage is covered by one air transport document. An air transport document is non negotiable document usually made out to a named consignee to whom the goods are delivered on identification.

7.6 Road, Rail or Inland Waterway Bill:

Roadway bill, railway consignment bill and inland waterway bill are made out to named consignee with only one original for the shipper and delivery of goods is made on identification. They are non negotiable and hence not a DOTGs. Railway receipt indicating shipper or a bank as consignee require endorsement in favor of the buyer enabling him to take the delivery of goods, hence it is a quasi negotiable document . the provisions as to the contents of railway bill , roadway bill and inland waterway bill and treatment of transshipment are the same as mentioned in air transport documents.

7.7 Courier and Post Receipt:

Document issued by a courier evidencing receipt of goods name and signature of the courier and date of pick up or of receipt will be accepted by banks provided it conforms to the stipulations in the credit. A post receipt or certificates of posting which is stamped and is dated in the place from which goods are to be dispatched will be accepted by the banks provided it means the stipulations of the credit.

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Freight forwarder document:

The bank will Accept this document issued by a freight forwarding company or by a company member of FIATA etc provided the document indicates that the freight forwarder is himself acting as a carrier or as a multimodal transport operator and is properly signed /authenticated by him as such or if the freight forward is a name agent for the carrier or the multimedia transport document indicate the name of the carrier or the multimedia transport operator and is duly signed by the freight forwarder as the named agent of the carrier .

Insurance document:

Marine or transit insurance is a contract where an insurance company undertakes ,against premium to indemnify the carrier or cargo owner against a loss arising from sea perils or transit risks.

Where insurance is covered locally by the buyer the insurer initially issues an insurance cover note representing an agreement to insure the specified goods against paid premium which binds the company to issue an insurance policy in due course on receipt of declaration of shipment.

Insurance documents must be issued and signed by the insurance company underwriters or their agents. It must be presented in full set if issued in more than one original.

The insurance document should be effective at the latest from the date of loading on board or taking in charge otherwise banks should not accept if it bears a date of issuance later than the date of loading on board in charge.

Insurance document must be expressed in the same currency as the credit.

Insurance documents must be for a minimum amount equal to 110% of the amount of the credit or 110% of the gross amount of the invoice whichever is grater.

The insurance document should in all other respects conform to the term and conditions of the credit.

Certificate of origin

Certain countries require imported goods to be accompaimed by a certificate in prescribed form indicating the country in which they were produced or manufactured. Certificates of origin customarily accompany goods entitled to the benefits of a preferential tariff or subject to restrictions placed upon imjports from specified countries.

Bill of sight:

It may happen that the importer has insufficient information to enable him to enter a consignment of imported goods. In such a case he can pass a bill of sight at the custom house. In it furnishes all the information that he can regarding the goods and declares that he has received no documents form which he can ascertain full details of the shipment. After signing by H.M customs the bill of sight become the authority to land goods for examinations by customs officiers in the presence of the importer or his agent .the importer is required within three days endorsing on the bill of sight the additional particular required.

Bonds:

Circumstances frequently arise which necessitate an importer entering in to bond with the customs authorities for thw due performance of his obligation in respect of the importation transshipment or re exportation of the dutiable goods. A bond covering a single transaction is termed an ordinary bond but where transactions are recurrent the importer enters into a general bond .owners of approved where houses for storage of bonded goods enter into a storage bond and bonded Carmen and lighter men enter into general bonds for the carriage of dutiable goods by land and water water respectively. The surety in the case of general or storage bond is commonly a bank or guarantee company

Trust receipt or letter of trust;

Under a documentary credit since the banker hold the bill of landing he is constructive possession of the goods.where however a customers of goods standing has accepted a tenor bill and the documents are to be handed to him against payments the banker may be prepared to release the bill of landing to his customer immidiatly on the letter signing a trust receipt. By signing this receipt the customers undertake to hold the the goods and proceeds of any sale of them as a trustee for the banks to pay over the proceeds to the banks as and when received to keep the goods fully insured against fire and to hand to the banks all amounts paid to him by the insurers.

Inconterms:

Inconterms are a standard set of 13 terms developed by ICC to overcome the problems of national laws and their local interpretation. This term explain the apportioning of responsibility, cost and risks concerning movement of goods from the seller to buyer. The brief explanations of these are as under .

EXW(Ex worker name place)

It means that the sellers only responsibility is to make the goods available at this premises and buer bears the full cost and risk of transportations to his desired destination.

FSA(free carrier name place)

It is same as the old fob terms but takes into account multi modal transport. The sellers cost and responsibility is up to the delivery of the goods into the custody of the carrier( who may be a carrier or a multi modal transport operator)

FAS(free alongside ship name port of shipment)

In this case the seller obligations is fulfilled when he places the goods alongside the ship on the quay or in lighters. The buyer has to bear all costs from all that moment and also the clear goods for export.

FOB(free of board named port of shipment)

It means that the seller will bear the cost of transport unto the port and charges for loading onto the vessel. The buyer who will bear the risk of loss the moment the goods passed the shipment rail will pay freight.

CFR(cost & freight named port of destination)

Here the seller must paid the cost and freight to transport the goods to named destination but the risk of loss passes on to the buyer when the goods pass the ship rail at the port.

CIF(cost, insurance &freight name port of destination)

This is same as CFR plus the seller has to procure insurance and pay the premium. The document tendered should therefore include an insurance policy with risk classes as agreed upon. It is mostly used for sea and waterway transport.

CPT (carriage paid to name place to destination)

It is used in any mode of transportation including multi modal transport. The exporter bear the fright upto the place of named destination. The risk of loss is transfer to the buyer when the goods are deliver into the custody of the first carrier. Transport documents should be marked fright paid

CIP (carriage & insurance paid to named place of destination) It is the same as CPT plus the seller has to procure insurance against loss the carriage and bears the risk only up to the point of delivery in to the custody of the first carrier.

Transport documents marked freight paid and an insurance policy coverage the risk as agreed upon should be tendered. This term may be used for any mode of transport including multimode transport.

DAF(delivered at frontier named place)

The seller fulfill his obligation to deliver the goods cleared for export at the named place at the frontier but before the customs border of the adjoining country.

DES(delivered Ex ship named port of destinations)

Here the seller shall make the goods available to the buyer on board the ship uncleared for import at the named port and bears full cost and risk in bringing the goods to the named.

DEQ(delivered Ex quay duty paid named port of destination)

It means the seller must make the goods available to the buyer on the quay at the named port clear for importation. The seller has to bear all risks and cost including duties etc.

DDU (deliver duty update name place o0f destination)

Here the seller is responsible to deliver the goods at the named place in the country of import and bear the cost risk unto that point. Duties, taxes etc and customs formalities are the buyers responsibility.

DDP(deliver duty paid)

This represents the maximum obligations for the seller who will make the goods available at the named place in the country of import and bear the risks costs and duties up to the named place.

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