Foreign Exchange Trading and Risk Management Mercantile Bank Ltd.

Foreign Exchange Trading and Risk Management Mercantile Bank Ltd.

1.0

Introduction

Background: This report was done as part of the requirement for successful completion of the internship program. Exposure to the business world and acquiring practical work experience was the primary objective of this assignment. The attached with mercantile bank ltd. For internship. The report focuses on treasury division as i was attached with that division during the tenure of the internship. The topic for this report was decided upon after approval by faculty advisor associate professor of institution of business administration.

Problem Statement Foreign Exchange dealing is a technical job and has a great prospect in our country. Floating Exchange Rate has been introduced very recently and it has put the banking sector into a new era. Bangladesh Bank’s total control is not there but there is some risk factor involved in it.

Mercantile Bank Ltd. wanted to find whether the process of their foreign exchange operation is good enough to avoid any unwanted risk and the prospect in foreign exchange dealing in their present standing.

Objective: The basic objective of the report is to see whether the process of Foreign Exchange Operation in Mercantile Bank Ltd. is complying with the guideline issued by Bangladesh Bank and how Mercantile Bank Ltd. is handling the Foreign Exchange trading.

Broad Objective: The broad objectives of the report are-

•

To find whether the process of Foreign Exchange Operation is complying with the guideline issued by Bangladesh Bank

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To find whether the process is good enough to avoid the foreign exchange risk and how it is working.

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To find the prospect of Mercantile Bank Ltd. in foreign exchange dealing.

Specific Objectives: The Specific objectives are •

To analyze the overall situation of the foreign Exchange Market prevailing in Bangladesh before and after the exchange rate was declared floating.

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To acquire a general idea about the various divisions of a private bank and their functions and operations, in this case Mercantile Bank Ltd.

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To observe and analyze the foreign exchange operation from dealing room to back office.

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To observe whether the foreign exchange operation is complying with the guideline issued by Bangladesh Bank

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To find the standing of Mercantile Bank in Foreign Exchange Dealing.

Sources of data: In this report both Primary and Secondary sources of data have been used. For both the Organization part and Project part, quantitative information from the Annual reports of MBL and qualitative information from other literature regarding the various divisions and their functions, operations were used. So, basically secondary data were utilized. For the project part, primary data were collected by holding informal interviews with the employees to learn about their response/reaction to the change that is occurring in the organization.

Scope of the study:

This report covers the organizational structure, background, basic functions of the various divisions and the performance of the bank. In case of the project part, the study area and observations are limited to Treasury division only.

Methodology: The methodology of the report is given below, •

For the procedure of different banking operations, The observed the operations and worked with the Officers at the same time. The informally interviewed the MBL Officials for getting more information.

•

For the analysis part, data have been collected from different statements and the annual reports of the bank.

Limitations of the Study: The following limitations are apparent in the report— •

For the Organizational part, almost no financial information for the year 2004 were available, in some cases only un-audited information could be collected.

•

As the floating exchange rate is introduced very recently the data of its impact was not that much available.

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The information regarding the dealing profit & loss were not disclosed officially and that’s why it was not possible to judge the performance of the dealing process of Mercantile Bank Ltd. with the help of material yardstick like profit.

Preview of the Report: As it is internship report in the first part after this introduction chapter there is the Organisation Part. In this part how different units of Mercantile Bank Ltd. contributes and works has been described. Also the structure of the organization is shown and the chapter ended with a SWOT Analysis of Mercantile Bank Ltd. After the Organization Part then there is Project Part. In the project part first of all an introduction is given to describe the need for foreign exchange operation and the risk arising from the foreign exchange. Then there is a description of the foreign exchange scenario in Bangladesh. Then we will see how Mercantile Bank Ltd. performs its Foreign Exchange operation and how they minimize the risk. And finally there would be some sorts of observations to see the compliance with the Bangladesh Bank guideline.

2.0 ORGANIZATION PART

2.1 Introduction The territories that now constitute Bangladesh were integral part of Mughal Empire and thereafter British India and then Pakistan. That is why we have the common historical background of banking and banking institutions as that of Pakistan and India. For the beginning of banking in the territory now comprised Bangladesh we must go back to the Calcutta Agency Houses. The important two houses were MS. Alexander and Co. and MS. Fergusson and Co. both the two were the predecessors of the early joint stock banks in the then India. The Bank of Hindustan was the earliest bank started under the direction of the British ruler in British India.

After the partition of British India into Pakistan and India, Bangladesh became integral part of Pakistan. Immediately after independence in 1947 an expert committee was appointed to study the issue of banking in the ten Pakistan. On the recommendation of the expert committee, the Reserve Bank of India continued its functions in Pakistan upto 30 th September 1948 and thereafter the State Bank of Pakistan, having been established on 1 st of July 1948, started functioning and assumed the full control of banking and currency. By the date of Bangladesh proclaimed independence, there were about fourteen scheduled banks with about 3042 branches all over the country. Some foreign banks were also functioning in Pakistan on that date. After the emergence of independent Bangladesh on 16th December 1971, the government of the peoples Republic of Bangladesh formally took over the charge of the administration of the territories now constitutes Bangladesh. In order to rehabilitate the war devastated banking system of Bangladesh, the government promulgated a law called Bangladesh Bank (Temporary) Order, 1971 (Acting President Order No. 2 of 1971). By this order the State Bank of Pakistan was declared as Bangladesh Bank and the offices, branches and the assets of the said State Bank were declared to be deemed as offices, branches and assets of Bangladesh Bank. It was also declared by the aforesaid Order that all currency notes and coins issued by the said State Bank and government of Pakistan and were in circulation in Bangladesh shall be deemed to have issued by the Bangladesh Bank. By the steps stated above, the banking system of Bangladesh started with a legal shape. Private sector banks started functioning during the year 1983-84 with the objective of government policy to make sure effective and meaningful participation of the private sector in the overall national economy. In this background of liberalization of economic policies in Bangladesh, Mercantile Bank emerged as a new commercial bank to provide efficient banking services

with a view to accelerating socio-economic development of the country. The Bank was incorporated on May 20, 1999 in Bangladesh with its Registered Office situated at 61, Dilkusha Commercial Area, Dhaka 1000, Bangladesh and started banking operation on 2 nd June 1999.

2.2 Divisions of MBL: All policy formulations and subsequent executions are done in the Head Office. It comprises of nine major divisions namely Credit Division, International Division, Central Accounts Division, Human Resources Division, Information Technology Division, Marketing Division, Training Division, Research and Development Division, Audit and Compliance Division.

Besides these main divisions, there are twenty braches all over the country to look after the Bank’s day–to-day operations. The structures and functions of each of the divisions of MBL are described below:

CHAIRMAN BOARD OF DIRECTORS

MANAGING DIRECTOR

RESEARC H& DEVELOP MENT

HRD

TRAIN ING

AUDIT & COMPLI ANCE.

CREDIT DIVISION

MARKETTING

Figure 1: Structure of MBL

CENTRAL ACCOUNTS DIVISION

INTL DIVISION

IT

2.2.1. Credit Division: The primary objective of this division is to evaluate the credit worthiness and debt payment capability of present loan customers and loan applicants. It is also responsible for keeping track of the credit portfolio by obtaining regular information from the branches. It sets prices for credits and ensures affecting it at the branches. This department also monitors the various loan accounts of the branches and prepares various statements for Bangladesh Bank.

The Credit Risk Management Department is assisted by the Credit Administration Department, which is mainly concerned with the post-approval functions of the division. The aspects that are critically tracked and monitored by Credit Admin are •

Credit expiry

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Past dues

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Excess over limit

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Document deficiency

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Reporting

Credit Administration is involved in basically 2 broad functions: Loan Monitoring: The important aspects of this part are: •

Follow approval terms

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Proper loan disbursement

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Monitor interest payments and principal repayment

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Balance with general ledger

Documentation: The important functions of this part are: •

Look at sanction terms and Fill up loan documentation checklist

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Ensure Proper loan documentation and Obtain client sign off

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Filing with the Registered Joint Stock Corporation ( RJSC)

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Registered mortgage deed execution

2.2.2 Human Resources Division : The employees are Mercantile Bank’s most valuable resource. Having competent and professional employees is becoming increasingly important in today’s competitive world, and

MBL has a significant competitive advantage in this respect. Many of its employees have worked here since the BCCI area and therefore have vast experience in their respective fields.

Also the new employees are recruited with sound academic background and given proper training after recruitment to groom up for their responsibilities. They plan to inculcate a high performance culture where the employees will work with fun and pride.

2.2.3. Audit and Compliance Division : The main function of this division is to provide legal assistance to the branches and to ensure strict adherence of rules and policies by all concerned officials of the bank through routine and surprise inspection and audit. The functions of this division are as follows: •

Implement rescheduling process of stuck-up loan to the branches for obtaining repayment schedule through strong persuasion and serve final notice etc. as the condition required.

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Monitor the individual cases with respect to their securities, value of securities, and finally review of possibility of recovery of bank’s stuck-up classified loan.

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Investigate suspicious or irregular matters being directed by higher management. Also conduct such inquiry being requested by affected branch-in-charges.

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Time to time follow-up of stuck-up advances of branches and keep the branches under constant pressure.

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Inspect all branches’ operations at least once in a year.

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Carry out surprise audit as felt necessary.

2.2.4. Central Accounts Division : Finance and Accounts division task is to •

Maintain daily liquidity positions, treasury bills, call money, debentures, placement of funds etc.

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Monthly-accrued interest calculation of all interests bearing accounts, inter-branch calculation for Head Office, amortization of all fixed and other assets.

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Preparation of statement of accounts and profit and loss account for the bank.

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Weekly deposit and advance analysis and Cost of fund analysis.

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Maintenance of accounts, preparation of annual report of the bank, maintenance of provident fund accounts, maintenance of income and expenditure posting, maintenance of salaries and wages of the employees etc.

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Fulfilling reporting requirements of Bangladesh Bank.

2.2.5 Information Technology Division :

Previously, Mercantile Bank had a very low level of automation. There was hardly any PC in the whole Bank before 2001. But when the new management took over in 2001, they gave huge emphasis on computerizing the bank’s operations. After 2 years, almost all the operations in the bank are now automated. The Bank is also shifting to a new IT platform, which aims at maintaining, operating and strengthening the technology base of the bank to enable error free production of information that ensures ongoing efficiency and profitability of operation. A world class banking software called Flex Cube has been installed which will centralize operations and provide Online Banking, Internet Banking, Automated Teller Machine, Telephone Banking, Point of sale dispenser, Credit Card facility etc.

At present, the IT department serves the following functions: •

Development of software’s for bank’s operation according to need, their maintenance and purchase of new software.

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Maintenance of computer hardware and upgrading the PCs whenever required.

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Training of the staff so that they can perform properly in the automated environment.

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Preparing training materials.

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Troubleshooting with the new software.

2.2.6. International Division:

International Division is responsible for assisting the authorized branches to deal in foreign trades, that is, import and export businesses on account of the customers of the bank by giving approval for transactions and controlling them at various stages.

It deals with all correspondents of foreign banks having arrangement with the bank. Every year new agents are added. The larger the number of correspondents and the wider the coverage area, the richer will be the international connections of the bank.

The functions performed by this division are as follows: •

Correspondent banking relationship

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Supervision of foreign exchange transaction of other units

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Monitoring on compliance of Bangladesh Bank regulations

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Supervise sale / purchase of foreign currencies

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Reconciliation of Nostro Accounts

2.2.7. Marketing Division The main function of this division is to build relationship with the potential customers and strengthen the relationship with the existing customer. The functions performed by this division are as follows •

To inform and explain the potential customer about the facilities provided by the bank.

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To search for new area of business and collect information about the potential sector.

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To prepare strategy for getting competitive advantage.

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To provide information to other division about the present market scenario.

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To keep close contact with the existing clients.

2.2.8. Training and Development The main function of this division is to prepare the employee of the bank as competent and quality workforce. The function of this division is s follows •

Arrange training and orientation program for the fresh bankers.

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Provide specific training program for the employee to make them more professional.

2.2.9. Research and Development Excellence in banking operation depends largely on a well-equipped and efficient Research and Development Division. Such activities require the investment of substantial money and a set of highly qualified personnel with multidisciplinary background. Although it is not possible at this stage to undertake R&D activities similar to those of the banks in the developed countries, Mercantile Bank has established a core Research and Planning Division comprising skilled persons from the very inception of the Bank

2.3 Performance 2.3.1 Capital The Authorized Capital of the Bank is Tk.1200.00 million and the paid-up Capital of the Bank is Tk.639.53 million as of December 31, 2003.

2.3.2 Deposits The Bank mobilized total deposits of Tk.16,287.46 million as of December 31,2003 as compared to Tk. 15,150.42 million in 2002. Competitive interest rates, deposit mobilization efforts of the Bank and confidence reposed by the customers in the Bank contributed to the notable growth in deposits. The Bank evolved a number of attractive deposit schemes to cater to the requirement of small and medium savers. This improved not only the quantum of deposits; it also imparted qualitative changes in the deposits structure.

2.3.3. Advances The Bank has formulated its policy to give priority to small and medium businessmen while financing large-scale enterprises through consortium of banks. The total loans and advances of the Bank stood at Tk. 10,775.95 million as of December 31,2003 as compared to Tk. 8,896.19 million in 2002.

2.3.4. Consumer Credit Scheme The Bank has introduced Consumer Credit Scheme to cater to the credit needs of the low and middle-income groups for household durables. Consumer Credit Scheme has attracted good response from the customers. An amount of Tk. 169.98 million which is 1.58% of the total credit portfolio was outstanding under the scheme as of December 31, 2003.

2.3.5. Import Business From the very beginning the Bank has embarked on extensive foreign exchange business with a view to facilitating international trade transactions of the country. The Bank has established 10,986 Letters of Credit amounting to Tk. 20,380.80 million as of December 31,2003 as against 10,076 Letters of Credit amounting to Tk. 15,112.50 million in 2002.

Items of imports financed by the Bank included electronic equipments, sports goods, rice, wheat, seeds, soyabean, palmolein, dyes, chemicals, accessories etc.

2.3.6. Export Business The total export business handled by the Bank amounted to Tk. 15,250.60 million as of December 31,2003 as compared to Tk. 11,377.30 million in 2002. Exports items handled by the Bank included jute good, ready made garments, handicrafts etc. The Bank has sizeable exposure to Readymade Garments sector whose contribution in the total exports of the country was 75% in 2002-03. Readymade Garments has not only contributed to generation of employment of semi-skilled men and women folk, it has also led to emergence of forward looking entrprenuers in the country, absence of which was regarded as a constraint to development efforts.

2.3.7. Foreign Remittance Foreign remittances handled by the Bank stood at Tk. 474.00 million as of December 31, 2003 as against Tk. 496.30 million in 2002. Countries from which inward foreign remittances were received included USA, UK, Canada, Denmark etc.

2.3.8. Operational Profit The operational profit of the Bank amounted to Tk. 575.32 million in 2003 as against Tk. 461.24 million in 2002 and after provision against unclassified loans, the net profit stood at Tk. 427.32 million as of December 31,2003 as compared to Tk. 429.04 million in 2002. An amount of Tk. 211.41 million has been set aside for our tax contribution to National Exchequer.

2.3.9. Results of Operation The Bank commenced business on 2nd June 1999. During this year of operation, the Bank made satisfactory progress.

2.3.10. Total Income The total income of the Bank was Tk. 1989.72 million during the year 2003. Interest income accounted for 79.84% of total income, exchange gains 9.78%, commission 7.64% and other income 2.74% of total income as against 80.46%, 9.07%, 7.39% and 3.08% respectively in 2002.

Components of Total Income (Figure in million Tk.) Components

Amount

%

Interest Income Exchange Gains Commission Other Income

1588.67 194.54 151.91 54.60

79.84 9.78 7.64 2.74

Total

1989.72

100.00%

2.3.11. Net Interest Income The Bank posted net interest income of Tk. 472.85 million during 2003 as compared to Tk. 358.08 million in 2002. Gross interest income of the Bank amounted to Tk. 1,588.67 million and interest expenses amounted to Tk. 1,115.82 million during 2003.

Interest Income Interest income amounted to Tk. 1,588.67 million in 2003. Interest on loans and advances accounted for 76.85%, interest on deposits with other banks 14.21%, interest on Treasury Bills 8.85% and other interest income also contributed 0.09% of total interest income as against 79.50%, 15.93%, 4.36% and 0.21% respectively in 2002.

Components of Interest Income (Figure in million Tk.) Components Interest on Loans & Advances Interest on Deposits Interest on Treasury Bills Other Interest Income Total

Amount 1220.92 225.76 140.55 1.44 1588.67

% 76.85 14.21 8.85 0.09 100.00%

Interest Expenses Interest expenses amounted to Tk.1, 115.82 million in 2003. Interest on deposits under schemes became the largest component of interest expenses and accounted 50.74% of total interest expenses in 2003 as compared to 36.30% in 2002. Interest on FDR accounted for

41.79% of Interest expenses, interest on call deposits 2.02%, interest on savings deposits 2.80%, and interest on short-term deposits 1.65% of total interest expenses.

Components of interest Expenses (Figure in million Tk.) Components Interest on Deposits Under Schemes Interest on Fixed Deposits Interest on Savings Deposits Interest on Call Deposits Interest on Short Term Deposits Other Interest Expenses Total

Amount 566.17 466.35 31.24 22.51 18.35 11.20 1115.82

% 50.74 41.79 2.80 2.02 1.65 1.00 100.00%

Net Interest Margin The net interest margin of the Bank is 3.36% in 2003 as compared to 3.16% in 2002. This indicates a reasonable spread between interest income and interest expenses. The management has been able to achieve this position mainly by close supervision of the Bank’s earning assets.

Interest Rate Spread Interest rate spread as the difference between average interest rate on interest-earning assets and average Interest rate on Interest-bearing liabilities is 1.85% in 2003 as compared to 1.99% in 2002. It shows the effectiveness of the Bank’s intermediation in borrowing and lending activities.

2.3.12. Non-Interest Income The Management effectively leads the Bank to increase non-interest income as to mitigate any adverse interest rate movement. Non-interest income amounted to Tk.401.05 million in 2003 as against Tk. 311.11 million in 2002. Non-interest income is 20.16% of the total income in 2003 as compared to 19.54% in 2002. Exchange gains accounted for 48.51%, commission accounted for 37.88% and other non-interest income contributed to 13.61% and other interest income during the year as against 46.42%, 37.80% and 15.78% respectively in 2002.

Components of Non-Interest Income (Figure in Million Tk.) Components Exchange gains Commission Other non-interest income Total

Amount 194.54 151.91 54.60 401.05

% 48.51 37.88 13.61 100.00

2.3.12. Total Expenses The total expenses of the Bank amounted to Tk.1414.40 million during 2003 as compared to Tk. 1131.06 million in 2002. Interest expenses accounted for 78.89% of total expenses, salaries and allowances 10.49%, rent rates, taxes etc. 2.93%, Stationery, Printing & Advertisement 1.31% and other expenses 6.38% of total expenses as against 81.61%, 9.21%, 3.07%, 1.43% and 4.68% respectively in 2002.

Components of Total Expenses (Figure in million Tk.) Components Interest Expenses Salaries & Allowances Rent, Rates, Taxes etc.

Stationery, Printing & Advertisement Other Expenses Total

Amount 1,115.82 148.40 41.45 18.53 90.20 1414.40

% 78.89 10.49 2.93 1.31 6.38 100.00

Non-interest Expenses Non-interest expenses amounted to Tk. 298.58 million, which is 21.11% of the total expenses in 2003 as compared to 18.39% in 2002. Salaries & allowances accounted for 49.70% Rent, Rates, Taxes etc. for 13.88%, Stationery, Printing and Advertisements for 6.21%, Postage, Telegram, Telephone for 4.21% and other expenses for 26.00% of total non-interest expenses as against to 50.09%, 16.70%, 7.79%, 5.50% and 19.92% respectively in 2002 Components on Non-Interest Expenses (Figure in million Tk) Components Salaries & Allowances

Amount 148.40

% 49.70

Rent, Rates, Taxes etc.

Stationery, Printing & Advertisement Postage, Telegram, Telephone Other Expenses

41.45 18.53 12.57 77.63 298.58

Total

13.88 6.21 4.21 26.00 100.00

2.3.13. Asset Utilization Ratio The asset utilization ratio is 10.86% in 2003 as compared to 9.71% in 2002. This measures how the total assets of the Bank are effectively utilized to generate net operating income.

2.3.14. Operating Efficiency Ratio The operating efficiency ratio is 71.09% in 2003 as against 71.06% in 2002. This measures how much operating expenses are incurred to generate operating revenues.

2.3.15. Earnings Base in Assets The Earnings Base in Assets of the Bank is 91.77% in 2003 as compared to 93.42% in 2002.

Despite small reduction in Earnings Base in Assets, the ratio still indicates very efficient utilization of resources to earn revenues.

2.3.16. Net profit The Bank posted net profit of Tk.427.32 million during January 1, 2003- December 31, 2003.

This was possible due to wise guidance of the Board of Directors, prudent management and firm support from our customers.

Net Profit (Figure in million Tk.) Particulars Interest Income Interest Expenses Net interest income Provision against unclassified Loans Provision for Bad Loans & Advances Non-Interest Income Non-Interest Expenses Net Non-Interest Income Net Profit

Amount 1588.67 (1115.82) 472.85 (15.00) (133.00) 401.05 (298.58) 102.47 427.32

The Bank paid out 40% dividend to the shareholders, 35% cash and 5% bonus for the year 2002.

2.3.17. Asset Portfolio The Bank’s total assets outstanding as of December 31, 2003 amounted to Tk. 18324.73 million as compared to Tk. 16383.17 million in 2002. Of the total assets outstanding in 2003, loans & advances constitute 58.80% of total assets, balances with other banks 14.70%, money at call and short notice 6.77%, investments 11.50% and other assets 8.23% as against 54.30%, 23.00%, 7.69%, 8.44% and 6.57% respectively in 2002.

Asset Portfolio (Figure in million Tk.) Components loans & Advance Balances with other banks Investments Other Assets Money at Call & Short Notice Total

Amount 10775.95 2693.12 2107.26 1508.40 1240.00 18324.73

% 58.80 14.70 11.50 8.23 6.77 100.00

2.3.18. Credit Portfolio The Bank’s total credit outstanding as of December 31, 2003 stood at Tk. 10775.95 million as compared to Tk. 8896.19 million in 2002. The Bank mainly extended credit facilities to the private sector for trade as well as for working capital needs, Break-up of advances for the year 2003 is as follows: Credit Portfolio (Figure in million Tk.) Components Trade & Commerce Jute, Cotton & Apparels(Garments) Large & Medium Scale Industries Construction Transport & Communication Consumer Goods Small Scale & Cottage Industries Other Credits Total

Amount 4099.20 1821.60 1719.10 580.40 175.80 168.98 67.70 2142.17 10775.95

% 38.04 16.90 15.95 5.39 1.63 1.58 0.63 19.88 100.00

Non-performing Loans The Bank has Tk. 444.02 million non-performing loans as of December 31, 2003 as against Tk. 37.36 million in 2002.

Provision against unclassified Advances The Bank has made a provision of Tk. 15.00 million during 2003 as 1% unclassified loans as per Loan Classification Guidelines of Bangladesh Bank, the Central Bank of the country.

2.3.19. Investment Portfolio In an effort to secure more stable and predictable earnings from its investments, the Bank focused its attention on investment in Government securities and in call money market other than equity products. This strategy also reflected the Bank’s intention to improve its capital adequacy ratio by securing assets with lower risks.

Investment Portfolio (Figure in million Tk.) Components

Amount 2,693.12 2,020.00 1,240.00 5,953.12

FDR Treasury Bills Money at Call & Short Notice Total

% 45.24 33.93 20.83 100.00

2.3.20. Funding Structure The Bank’s principal source of fund is deposits, which constituted 88.88% of total banking funds in 2003 as compared to 92.48% in 2002. The Bank’s paid-up capital accounted for 3.49% and other sources of fund contributed 7.63% as against 1.86% and 5.66% respectively in 2002.

Funding Structure (Figure in million Tk.) Components Deposits Paid-up Capital

Amount

%

16287.46 639.53

88.88 3.49

Others Total

1397.74 18324.73

7.63 100.00

2.3.20. Deposit Mix Deposit under Scheme surpassed FDR and became the largest component of the deposit resources in this year. Deposits under schemes amounted to Tk. 6306.94 million, which was 38.72% of total deposits as compared to 27.23% in 2002. Fixed deposit amounted to Tk. 5314.27 million, which was 32.63% of the total deposits in 2003 as compared to 42.20% in 2002 and Call deposits amounted to Tk. 800.00 million, which was 4.91% of the total deposit as against 9.97% in 2002. The other deposits which include current deposits, savings deposits, short term deposits, security deposit and bills payable amounted to Tk.3866.25 million which is 23.74% of the total deposit resources.

Deposit Mix (Figure in million Tk.) Category Deposits under Schemes FDR Call Deposits Others Total

Amount 6306.94 5314.27 800.00 3866.25 16287.46

% 38.72 32.63 4.91 23.74 100.00

2.3.21. Capital Adequacy Authorized Capital The Authorized Capital of the Bank is Tk. 1200.00 million of 12,000,000 ordinary shares of Tk. 100 each.

Issued, Subscribed and paid-up Capital The issued, subscribed and paid-up Capital of the Bank is Tk.639.53 million of 6,395,300 ordinary shares of Tk.100 each fully paid-up in cash in 2003. The Bank raised an additional capital of Tk. 319.76 million in 2003 through Initial Public Offerings (IPO). The shares of the Bank have been listed both in Dhaka Stock Exchange and Chittagong Stock Exchange. The shares of the Bank are being traded at prices higher than the book value.

BIS Capital Adequacy Ratios In accordance with the instruction of Bangladesh Bank, Central Bank of the country, the Bank adopted BIS risk adjusted capital standards to measure capital adequacy. Banks in Bangladesh are required to maintain the capital adequacy ratio of minimum 9.00% of total risk weighted assets.

Capital Adequacy (Figure in million Tk.) Particulars

Amount

Core Capital (Tier- I)

1129.77

Paid-up Capital

639.53

Share Premium Account

31.20

Statutory Reserve

281.03

Retained Earnings

132.33

Dividend Equalization Account

45.68

Supplementary Capital (Tier II Capital)

105.46

1% Provision against unclassified loans

103.14

Exchange Equalization Fund

2.32

Total Risk-Adjusted Capital

Total Risk-Weighted Assets

Capital

1235.23

11788.09

Minimum Requirements

Actual

Adequacy Ratio

9.00%

10.48%

Tier I

4.50%

9.58%

Tier II

0.90%

The Bank’s Capital Adequacy Ratio stood at 10.48% at the end of December, 2003 as against 8.11% in 2002.

2.3.22. Branch Expansion The Bank commenced its business on June 02, 1999. The first branch was opened at Dilkusha commercial Area in Dhaka on the inauguration day of the Bank. The number of branches of the Bank stood at 20 (Twenty) at the end of 2003 covering major trade centre of the country.

The Bank intends to open 10 more branches by the end of the year 2004.

2.3.23. Correspondent Relationship The Bank has established correspondent relationship across the world with a number of foreign banks namely Citibank N.A., Bank of Tokyo Mitsubishi Ltd., Standard Chartered Bank, American Express Bank, HSBC, Comers bank, Mashreq Bank, Habid Bank AG Zurich, United Bank of India, ICICI Bank, Union Bank of India etc. The number of foreign correspondents established by the Bank is 240 as of December 31 2003. Efforts are being continued to further expand the correspondent relationship to facilitate Bank’s growing foreign trade transactions.

2.4. Management The Board of Directors consists of eminent personalities from commerce and industry of the country. Mr. Md. Abdul Jalil. M.P., Chairman of the Board of Directors, is a businessman besides being an eminent personality of the country.

The Bank is manned and managed by highly qualified and efficient professionals. The Chief Executive Officer of the Bank is Mr. Shah Mohammad Nurul Alam who is rich in experience of managing private sector banks as Managing Director. Mr Lutfar Rahman Sarkar, Chief Advisor of the Bank, is the former Governor of the Central Bank of Bangladesh, He brings with him a wealth of experience of managing both the public and private sector banks. .2.5. Financial Products and Services The Bank has launched a number of financial products and services since its inception.

Among them monthly Saving Scheme, Monthly Benefit Scheme, Double Benefit Deposit Scheme, Special Saving Scheme, Life Long Pension Scheme, Consumer Credit Scheme, Small Loan Scheme and Lease Finance Scheme have achieved wide acceptance among the people.

Monthly Savings Scheme The prime objective of this scheme is to encourage people to build up a habit of saving.

Under this scheme, one can save a fixed amount of money every month and get a lucrative amount of money after five, eight or ten years.

Monthly Benefit Scheme Under this scheme, one has deposit a fixed amount of money for five or more years and in return he will receive benefits on monthly basis. Benefits start right from the first month of opening an account under the scheme and continue upto five more years.

Double Benefit Deposit Scheme Under this scheme, depositor’s money will be doubled in a seven-year period and the scheme is one of the highest yielding deposit schemes in Bangladesh.

Life Long Pension Scheme Life Long Pension Scheme has been evolved especially for later age. Under this scheme one can get life long benefit if he deposits specific amount per month for a period of 10, 15, 20, or 25 years, the scheme can also be opened in the name of minors.

Consumers Credit Scheme Consumers’ Credit is relatively new field of collateral-free finance of the Bank. People with limited income can avail of this credit facility to buy household goods including car, computer and other consumer durables.

Small Loan Scheme This scheme has been evolved especially for small shopkeepers who need credit facility for their business and cannot provide tangible securities.

Lease Finance This scheme has been designed to assist and encourage the genuine and capable entrepreneurs and professionals for acquiring capital machineries, medical equipments, computers and other items which may help them to be economically self-reliant. Terms and conditions of this scheme have been made easier than ever before in order to help the potential entrepreneurs to acquire equipments of production and services and repay the liability gradually from earnings on the basis of “Pay as you earn”.

Doctors’ Credit Scheme Doctors’ Credit Scheme is designed to facilitate financing to new doctors, established doctors, clinics and hospitals.

Rural Development Scheme Rural Development Scheme has been evolved for the rural people of the country to make them self-employed through financing various income generating projects. This scheme is operated on group basis.

Women Entrepreneurs Development Scheme Women Entrepreneurs Development Scheme has been introduced to encourage women in doing business. Under this scheme, the Bank finances the small and cottage industry projects sponsored by women.

SME Financing Scheme Small and Medium Enterprise (SME) Financing Scheme has been introduced to assist new or experienced entrepreneurs to invest in small and medium scale industries.

Funded Facilities The funded credit facilities are those which involve direct cash. In other words any type of credit facility which involves direct outflow of Bank’s fund on account of borrower is termed as funded credit facility. The following funded credit facilities are provided by Mercantile Bank Ltd. Limited: Cash Credit Cash credit is a continuous loan facility usually provided for working capital fund requirements purpose of the customer. Cash credit is generally given to traders, industrialists for meeting up their working capital requirements. Cash credit can be given on Hypothecation or pledge of goods but Mercantile Bank Ltd. only practices Cash Credit on Hypothecation.

Features of Cash Credit •

A certain limit of credit amount is set at the time of initiation of Cash Credit facility.

•

An expiration date is set, which is not more than one year.

•

The drawings are subject to drawing power.

•

A service charge, which in effect an interest charge is normally made as a percentage of the value of purchases.

•

The primary security of Cash Credit facility is stock of goods, which may be hypothecated to Mercantile Bank Ltd. Limited as collateral.

Over draft

Over draft facility is also a continuous loan arrangement on a customer’s current account permitting him/her to overdraw upto a certain approved limit for an agreed period. Here the withdrawal of deposits can be made any number of times at the convenience of the borrower, provided that the total overdrawn amount does not exceed the agreed limit.

Customer can return any amount at any time within the pre-fixed time of the facility. Turn over of an Over Draft facility is the most important phenomenon on which renewal of the facility depends. Over Draft facility is given to the businessmen for financing working capital requirement and high net worth individual to overcome temporary liquidity crisis.

Secured Over Draft This is a type of over draft facility given to the borrowers keeping sufficient collateral from the customer in the most liquid form. This facility provides specific right to a client to overdraw within a pre fixed limit for a certain period of time. Secured Over Draft is normally granted against the security of tangible asset such as Lien of Fixed Deposit Receipt (FDR), Bonds, Sanchaya Patra but currently Secured Over Draft is given only against Fixed Deposit Receipt (FDR) because Bangladesh Bank has recently prohibited Secured Over Draft against Bonds and Sanchaya patra. Interest charged on the Secured Over Draft is calculated on the basis of the security liened.

Term Loan Terms loans are given to finance the acquisition of capital assets. Loan agreements often contain restrictive covenant and loan is repayable in accordance to amortization schedule.

Collateral is must for term loan.

Under term loan there are three categories: •

Short term loan- loans having maturity less than one year falls under this category.

•

Midterm loan- this loan facility is extended for loans having maturity more than one year but less than three years.

•

Long term loan- tenure of long term loans is more than three years.

Personal Credit Mercantile Bank Ltd. Limited also offers personal credit facility to its customers for buying household appliances. No securities are kept for such type of credit facility but a guarantee from third party is required who ought to be a prominent person or government service holder. Anyone with continuous employment for a reasonable length of time in an

organization is entitled to enjoy this facility. A quotation needs to be submitted on the office pad from where the goods will be purchased.

Limit of personal credit ranges from Tk. 50,000 to Tk. 3, 00,000 and interest rate is 14% which is subject to change.

Loan against Trust Receipt (LTR) Loan against trust receipt is given on good faith on the importer. This is a loan facility upto a satisfactory limit to the traders/customers by Mercantile Bank Ltd. against security of the value of the imported goods. Customer holds the goods or their sales proceeds in trust for the bank for certain period of time till the loan allowed against such trust receipt is fully paid.

The duration of LTR ranges from thirty days (30 days) to three hundred and sixty days (360 days).

Non-Funded Facilities Non funded facilities are also known as contingent facilities are those where bank’s fund is not required directly. A non-funded facility can be turned to a funded facility as per situation creates. Bank receives commission rather than interest income by providing non-funded facilities. Following non-funded facilities are provided by Mercantile Bank Ltd. Limited: Letter of Credit (L/C) A letter of credit can be defined as a “Credit Contract whereby the buyer’s bank is committed (on behalf of the buyer) to place an agreed amount of money at the seller’s disposal under some agreed upon conditions. Since the agreed upon conditions include, amongst other things, the presentation of some specified documents, the letter of credit is called Documentary Letter of Credit. The Uniform Customs & Practices for Documentary Credit (UCPDC) published by International Chamber of Commerce (ICC, 1993) Revision, Publication No. 500 defines Documentary Credit: Any arrangement however named or described, whereby a bank (the “issuing bank”), acting at the request and on the instructions of a customer (the “applicant”) or on its own behalf, 1) Is to make a payment or to the order of third party (the Beneficiary), or is to accept and pay bills of exchange (Drafts) drawn by the Beneficiary, or 2) Authorized another bank to effect such payment, or to accept and pay such bills of exchange (Drafts),

3) Authorizes another bank to negotiate, against stipulated document (s), provided that the terms and conditions are complied with.

Mercantile Bank Ltd. provides only irrevocable letter of credit (L/C) facility.

Guarantee Mercantile Bank Ltd. offers guarantee for its reliable and valuable customer as per requirements. This is also a credit facility in contingent liabilities.

Features of Bank Guarantee •

It is a written document on non-judicial stamp.

•

Expiry date is mentioned specifically with other terms and conditions.

•

Mercantile Bank Ltd. receives commission quarterly @ 0.50% of the guaranteed amount.

Syndicate Loan A Bank can lend upto 15% of its paid up capital without any approval by Bangladesh Bank.

If the loan amount exceeds 50% of the paid up capital then Bank goes for Syndicate loan.

Lead Bank makes the arrangement and Head Office makes the facility agreement by the Bank’s lawyer. All terms and conditions such as security sharing, mode of creating charges, mode of repayment, covenants of the loan are written on the facility agreement.

2.6. SWOT AN ALYSIS Every organization is composed of some internal strengths and weaknesses and also has some external opportunities and threats in its whole life cycle. The following will briefly introduce the customers to the Mercantile Bank Ltd.’s internal strengths and weaknesses, and external opportunities and threats as I have explored in the past few weeks.

2.6.1 Strengths •

Superior quality: Mercantile Bank Ltd. provides its customers excellent and consistent quality in every service. It is of priority that customer is totally satisfied.

•

Dynamism: Mercantile Bank Ltd. draws its strength from the adaptability and dynamism it possesses. It has quickly adapted to world class standard in terms of

banking services. Mercantile Bank Ltd. has also adapted state of the art technology to connect with the world for better communication to integrate facilities.

•

Efficient Management: All the levels of the management of Mercantile Bank Ltd. Limited are solely directed to maintain a culture for the betterment of the quality of the service and development of a corporate brand image in the market through organization wide team approach and open communication system.

•

State of the Art Technology: Mercantile Bank Ltd. utilizes state-of-the-art technology to ensure consistent quality and operation. The corporate office is equipped with Reuters screen and SWIFT. All other AD branches are also equipped with SWIFT system.

•

Experts: The key contributing factor behind the success of Mercantile Bank Ltd. is its employees, who are highly trained and most competent in their own field. Mercantile Bank Ltd. provides their employees training both in-house and out side job.

•

In-House Utility: Mercantile Bank Ltd. is free from dependence on ever disruptive power supply of our public sources. The company generates the required power through generator fed on diesel. Water generation is done by deep tube wells on site and in abundance.

2.6.2 Weaknesses •

Limited Workforce: Mercantile Bank Ltd. has limited human resources compared to its financial activities. There are not many people to perform most of the tasks. As a result many of the employees are burdened with extra workloads and work late hours without any overtime facilities. This might cause high employee turnover that will prove to be too costly to avoid.

•

Problem in Delivery: Few of the Mercantile Bank Ltd.’s products offered to its clients like “Personal Credit (PC)” is lying idle due to proper marketing initiative from the management. These products can easily be made available in attractive ways to increase its client base as well as its deposit status.

2.6.3 Opportunities •

Government Support: Government of Bangladesh has rendered its full support to the banking sector for a sound financial status of the country, as it has become one of the

vital sources of employment in the country now. Such government concern will facilitate and support the long-term vision of Mercantile Bank Ltd..

•

Evolution of E-Banking: Emergence of e-banking will open more scope for Mercantile Bank Ltd. to reach the clients not only in Bangladesh but also in the global banking arena. Although the bank has already entered the world of e-banking but yet to provide full electronic banking facilities to its customer.

•

Banking and information technology might give the bank leverage to its competitors.

Nevertheless there are ample opportunities for Mercantile Bank Ltd. to go for product innovation in line with the modern day need. The Bank has yet to develop credit card facility, lease financing and merchant banking.

2.6.4 Threats •

Mergers and Acquisition: The worldwide trend of merging and acquisition in financial institutions is causing concentration. The industry and competitors are increasing in power in their respective areas.

•

Poor Telecommunication Infrastructure: As previously mentioned, the world is advancing e-technology very rapidly. Though Mercantile Bank Ltd. has taken effort to join the stream of information technology, it is not possible to complete the mission due to the poor technological infrastructure of our country.

•

Frequent Currency Devaluation: Frequent devaluation of Taka and exchange rate fluctuations and particularly South-East Asian currency crisis adversely affects the business globally.

•

Emergence of Competitors: Due to high customer demand, more and more financial institutions are being introduced in the country. There are already 52 banks of various types are operating in the country. Many banks are entering the market with new and lucrative products. The market for banking industry is now a buyer dominated market.

Unless Mercantile Bank Ltd. can come up with attractive financial products in the market, it will have to face steep competition in the days to come.

3.0 Foreign Exchange Market

3.1. Introduction On March 24, 1994 the Bangladesh Taka was declared convertible for current account transactions in terms of Article VIII of the IMF Articles of Agreement and the band of the

central bank’s US Dollar buying selling rate were withdrawn. The declaration symbolized a turning point in the country’s exchange management and exchange rate systems. The period preceding this declaration saw an intensification of reforms undertaken by Bangladesh Bank to ease controls on foreign payments and exchange rate arrangements. . The Bangladesh Taka, which is the domestic currency of Bangladesh and the country’s foreign exchange, had been strictly regulated until the early 1990s. At that time, Bangladesh Bank used to regulate the local currency’s parity against the international currencies. The cross border movement of currencies was also regulated. Bangladesh Bank used to publish a daily foreign exchange rate sheet that had two sets of rates; one being the rates for commercial banks to transact with their customers and the other being rates for the commercial banks to transact with Bangladesh Bank.

The year of 1994 saw a significant shift in the country’s foreign exchange regulatory policies and the Bangladesh Taka (BDT) was declared convertible in the current account. Most restrictions related to current account activities were relaxed where commercial banks were given the responsibility to ascertain genuineness of the transactions and the central bank’s prior approval requirements in these regards were withdrawn. The responsibility of exchange rate quotation was left to the commercial banks where Bangladesh Bank only committed support to the commercial banks to plug any net foreign currency gaps in the market at their pre-specified buying and selling rates.

Now Bangladesh Bank is given the freedom to the commercial market to decide their exchange rate. As the Foreign Exchange Rate is now floating total market has changed. To adapt to the changed environment, many banks established dealing rooms and some centralized their foreign exchange and money market activities under a single functional area which is still in its rudimentary stage. This report’s purpose is to see how well prepared Mercantile Bank Limited is to adapt to this changed situation.

3.2. Foreign Exchange Market The foreign exchange market has played a vital role in the last decade or so in guiding the purchase and sale of goods, services and raw materials globally. The market directly affects each country’s bond, equities, private property, manufacturing and all assets that are available to foreign investors.

The market is a stabilizing factor in the world system of monetary exchange and was created not by design but necessity. There is in excess of one trillion dollars of average daily turnover in the global foreign exchange market. Fifty one percent is in spot transactions followed by thirty two percent in currency swaps and forward outright transaction represents another five percent of the daily turnover.

Foreign exchange rates play a major role in the protection of balance of payments. When the balance of payments deficit of any country is sufficiently wide and chronic, a rationing of foreign exchange among various competing demands is one of the measures to correct the imbalances. Flight of the capital from the country can be curbed by foreign exchange control.

Foreign exchange rates can also be used to protect home industry. If certain industries are facing stiff competition from similar industries abroad, the government may desire to protect the home industry. Imports of the commodities produced by foreign industries may be restricted so that the local industries are allowed to grow. This paves the way for better utilization of the country and also conserves its foreign exchange reserves.

Foreign exchange rates also play a major role in determining who finances government deficits, which buys equities in companies and literally effects and influences the economic scenario of every nation to cope with the foreign exchange risk in an open market economy.

The market has its own momentum and therefore it is crucial to follow a universal time tested policy to tackle the forces behind the free market system with minimal risk involvement.

3.3. Foreign Exchange Risk With the demise of the foreign currency exchange rates during the 1970’s and after the collapse of the Bretton Woods Agreement, the world economy has undergone drastic changes. This has signaled an increase in currency market volatility and trading opportunity.

In simple words, the risk of suffering losses because of changes in exchange rates are known as Foreign Exchange Risk. More precisely, the risk that a long or short position in a foreign currency might have to be closed out at a loss due to an adverse movement in exchange rates is known as Foreign Exchange Risk.

Another type of definition saysThe risk that the amount of a commitment in a foreign exchange currency will vary between the time the commitment was entered into and the date at which the commitment is to be settled or brought to account in the local currency is the foreign exchange risk. The foreign

exchange market has witnessed frequent bouts of excessive volatility. At times it has seemed too many businesses that they have been helpless in the fight to control the associated risks which arise when exporting or importing goods and services. Future cash flow projections, profitability, competitiveness and the ability to service debt can all be impacted by foreign exchange volatility when paying or receiving foreign currency.

Exchange rates movements generate business risks of many types, often complex and sometimes hidden. All businesses trading overseas and increasingly in domestic markets will have some exposure to exchange rate movements either directly or indirectly. Whilst exposure to exchange rate movements may be an inevitable part of everyday activity, the risk arising from such exposure can be controlled.

3.4. Risk Involved in Foreign Exchange Operation: All financial activities involve a certain degree of risk and particularly, the financial institutions of the modern era are engaged in various complex financial activities requiring them to put proper attention to every detail.

The success of the trading business depends on the ability to manage effectively the various risks encountered in the trading environment, and the organization’s policies and processes require development over time to ensure that this is done in a controlled way.

The key risk areas of a financial institution can be broadly categorized into: -

Credit risk

-

Market risk and

-

Operational risk

In view of the significance of the market risk and in order to aggregate all such risks at a single department and to bring expertise in such functions, the concept of TREASURY has evolved. Today’s financial institutions engage in activities starting from import, export and remittance to complex derivatives involving basic foreign exchange and money market to complex structured products. All these require high degree of expertise that is difficult to achieve in the transaction originating departments and as such the expertise is housed in a separate department i.e. treasury.

The main risks treasuries have to manage in the financial markets are credit risk i.e. the settlement of transactions and market risk, which includes liquidity risk and price risk.

Some of the risks that are to be monitored and managed by a treasury can be defined as follows:

3.4.1. Credit risk Credit Risk arises from an obligor’s failure to perform as agreed.

Interest rate risk - Arises from movements in interest rates in the market. The interest rate exposure is created from the mismatches in the interest re-pricing tenors of assets and liabilities of an organization. This risk is generally measured through Earnings at Risk Measures (EAR) i.e. the potential earning impact on the balance sheet due to interest rate shifts in the market (detailed in annexure – I).

Liquidity risk - Arises from an organization’s inability to meet its obligations when due. The liquidity exposure is created by the maturity mismatches of the assets and liabilities of the organization. This risk is measured through tenor wise cumulative gaps.

Price risk - Arises from changes in the value of trading positions in the interest rate, foreign exchange, equity and commodities markets. This arises due to changes in the various market rates and/ or market factors.

Compliance risk - Arises from violations of or non-conformance with laws, rules, regulations, prescribed practices, or ethical standards.

Strategic risk - Arises from adverse business decisions or improper implementation of them.

Reputation risk or franchise risk - Arises from negative public opinion.

3.4.2. Market Risk Market risk is defined as the potential change in the current economic value of a position (i.e., its market value) due to changes in the associated underlying market risk factors.

Trading positions are subject to mark-to-market accounting, i.e., positions are revalued based on current market values and, for on-balance sheet positions, reflected as such on the balance sheet; the impact of realized and unrealized gains and losses is included in the income statement.

Market Factors: A market factor is defined as a variable (i.e., a market price or rate, such as a spot FX rate or an interest rate) that can impact the economic valuation of a contractual position. All relevant market factors must be identified and taken into consideration in the establishment of the independent market risk limit frameworks. They also must be specified

at a sufficient level of detail so that distinct types of market risks to which a risk-taking unit is exposed are separately identified.

It is a part of the market risk management activity to identify and specify all relevant market factors for each risk-taking unit and to take them into consideration in the establishment of the independent market risk limit frameworks.

It is the responsibility of the trading units to notify the market risk management of any new activities that may give rise to market factors not previously identified or defined.

3.4.3. Operational Risk: Operational Risk arises from the day to day operations.

The foreign exchange market directly affects each country’s bond, equities, private property, manufacturing and all assets that are available to foreign investors. Foreign exchange risk is the risk that the amount of a commitment in a foreign exchange currency will vary between the time the commitment was entered into and the date at which the commitment is to be settled or brought to account in the local currency.

The success of the trading business depends on the ability to manage effectively the various risks encountered in the trading environment, and the organization’s policies and processes require development over time to ensure that this is done in a controlled way.

The key risk areas of a financial institution can be broadly categorized into: Credit risk, Market risk and Operational risk. In view of the significance of the market risk and in order to aggregate all such risks at a single department and to bring expertise in such functions, the concept of Treasury has evolved. In the following Chapter we will about the Bangladesh scenario and factors affecting the foreign exchange market in Bangladesh.

4.0 Foreign Exchange: Scenario of Bangladesh

4.1. Foreign Exchange Rate The need for foreign exchange is high in Bangladesh. ‘Cause we had to import a lot more than we export. Other than export, the remittance by non-resident Bangladeshi’s and foreign aid is another source of foreign currency. In previous years we have seen frequent bouts of devaluation of our currency i.e. taka. This is mainly done to keep our exporters in business, although there are other reasons also. This is the past.

Previously, the foreign exchange rate used to be fixed by Bangladesh Bank – the central bank of Bangladesh. They used to give the Tk/US$ rate. It was usually done on the basis of Purchasing Power Parity Theory and keeping the Balance of Payment in mind. And as a matter of fact we have seen that Tk value has gone down from 1 US$ = 35.68 Tk in 1990-91 to 1US$ = 57.90Tk in 2002-03 before the exchange rate was declared floating. Tk was highly devalued before exchange rate was floating. The following table will show that. In 2000-01 Tk was devalued by 10.53Tk. In the floating exchange period the Tk maintained its price quite well. Presently Taka is stable at above 60 per US$. We will see that in another table.

In the following table exchange rate of Taka against US$ and its devaluation are given.

Table 7: Exchange Rate and Devaluation before and after Floating PERIOD 1990-91 1991-92 1992-93 1993-94 1994-95 1995-96 1996-97

Tk/US$ 35.68 38.15 39.14 40.00 40.20 40.84 42.60

Devaluation % -2.49 -8.23 -2.01 -1.12 0.37 -3.95 -4.35

PERIOD 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04

Tk/US$ 45.46 48.06 50.31 53.96 57.43 57.90 58.94

Devaluation % -5.72 -4.54 -4.90 -10.53 -1.55 0.00 -4.37

Now as the exchange rate has been declared floating, central bank has taken away its full control from the market. The market is now allowed to decide the exchange rate. The market force i.e. the demand and supply will now decide the price. The demand and supply of foreign currency, in our case mostly the demand and supply of US$ will fix the exchange rate. In this system exchange rate cannot be fixed to give benefit to some quarters. Before Bangladesh Bank would give a band in which the transaction has to be completed and that most of the time was fixed to help the exporters. But that was a bit injustice to the importers.

Though it is argued that if export increases it will boost the economy but in real case it is not as the devaluation means that one has to pay more for the imported goods but consume same as before. Now as the rate is floating then only the demand and supply will determine the rate as such the price of foreign exchange.

On March 24, 1994, the Bangladesh Taka exchange rate was declared floating and the band of the central bank’s US Dollar buying selling rate were withdrawn. In the floating regime the foreign exchange rate was pretty stable in the second part of the year 2003 and the first part of 2004. But now i.e. from the ending days of May ’04 the price shoot up a little.

Table 8: Comparison of Exchange Rate Before and After Floating PERIOD 1990-91 1991-92 1992-93 1993-94 1994-95 1995-96 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 July'03

Tk/US$ 35.68 38.15 39.14 40.00 40.20 40.84 45.46 48.06 50.31 53.96 57.43 57.90 58.40

PERIOD August'03 September'03 October'03 November'03 December'03 January'04 March'04 April'04 May'04 June'04 July,04 August,04 September,04

Tk/US$ 58.42 58.43 58.42 58.45 58.55 58.91 59.01 59.04 59.63 60.07 59.72 59.39 59.46

The above table will show the exchange rate fluctuations in controlled regime, when Bangladesh Bank was giving the band in which the exchange would take place and in floating rate regime, when the market force is deciding the exchange rate. We will see that Tk was highly devalued in between 1995 and 2000.

We have already seen the high degree of devaluation during the controlled period of Bangladesh Bank. But the devaluation was not as high after the exchange rate was declared floating. It can be observed from the data of following table which shows devaluation in different months after exchange rate was declared floating.

Table 9: Devaluation in Floating Rate Regime Period 2003-04 July'03 August'03 September'03 October'03 November'03

Devalued Amount -0.99 0.11 -0.01 -0.03 -0.01

Period 2003-04 December'03 January'04 February'04 March'04 April'04

Devalued Amount -0.81 0.10 -0.12 -0.08 -0.40

In the following diagram we will show the comparison of devaluation in two systems, which will show the degree of devaluation during the period of central bank’s control and during the floating rate period.

19 90 19 -91 91 19 92 92 19 -93 93 19 -94 94 19 95 95 19 -96 96 19 97 97 19 -98 98 19 99 99 20 -00 00 20 -01 01 20 02 02 -0 Ju 3 l y A '0 Se ugu 3 pt s t em ' 03 b O er' 0 c N to b 3 ov er ' 0 e D mb 3 ec er em '0 b 3 Ja er' nu 03 Fe ary br '04 ua r M y'0 ar 4 ch ' A 04 pr i l' 0 M 4 ay '0 Ju 4 ne '0 4

Tk/US$

19 9 19 0-9 91 1 19 - 9 9 2 19 2-9 93 3 19 -9 9 4 19 4-9 95 5 19 - 9 9 6 19 6-9 97 7 19 -9 8 9 19 8-99 99 2 0 -0 0 0 20 0-0 1 01 20 - 0 2 02 Ju 03 A l Se ug y'03 pt us em t'0 O ber 3 N ctob '03 ov e r D emb '0 3 ec e e m r' 0 3 Ja be r nu '03 Fe ary br '0 ua 4 M ry'0 ar 4 ch A '04 pr i l' 04

Tk Amount

Comparison of Devaluation

2.00 0.00

-2.00

-4.00

-6.00

-8.00

-10.00

-12.00

Period

Fig 1: Comparison of Devaluation in Two Exchange Rate Regime

Before exchange rate was declared floating Tk value went down from 1 US$ = 40.20 Tk in

1994-95 to 1US$ = 57.43 Tk in 2001-02. And when the rate was declared floating it became

much steadier.

Comparison of Exchange Rate Before and After Floating

70.00

60.00

50.00

40.00

30.00

20.00

10.00

0.00

Time

Fig 2: Comparison of Exchange Rate Before and After Floating

Now, a much closer look to the Foreign Exchange Market of Bangladesh after the period of March 24,2004 when the exchange rate was declared floating. The following graph will show the month wise change of exchange rate against US$.

Monthwise Change in FX Rate 60.5

Tk/US$

60 59.5 59 58.5 58

e'0 4 Ju n

M ay '0 4

ua ry '04 Fe br ua ry ' 04 M ar ch ' 04 A pr il' 04

r'0 3

Ja n

m be

'03 ec e

D

em be r

'03 N

ov

cto be r

r'0 3

O

Se p

te m be

ug us t'0 3

A

Ju l

y '0

3

57.5

Month's after Floating Rate

Fig 3: Month wise Change in Foreign Exchange Rate It is pretty obvious from the above figure that, in the initial month the market was pretty stable and the exchange rate was pretty much around 1 US$ = 58.50 Tk. It devalued slightly in January’04 and the market became a bit volatile when the Tk value went down pretty sharply in May’04. It is carrying its trend in the early part of June’04 also. Now we will take a look at another figure which will show the day wise exchange rate and depict how volatile the market was in recent days.

Date

Taka/Us dollar rate (weighted average)

Date

Taka/Us dollar rate (weighted average)

Date

Taka/Us dollar rate (weighted average)

December 11,

60.1377

December 06,

60.1726

December 01,

59.9423

2004 December 09,

59.9069

2004 December 05,

60.4105

2004 November 30,

59.8596

2004 December 08,

60.2732

2004 December 04,

60.1664

2004 November 29,

59.8684

2004 December 07,

60.1915

2004 December 02,

60.0045

2004 November 28

59.9481

2004

2004

The market was volatile in these days. If we want to go behind the scene of why market suddenly became too volatile we have to take a look at certain macroeconomic issues

ec 11 -D

ec 8D

ec 5D

ec 2D

ov 29 -N

26 -N

23 -N

ov

70 65 60 55 50 45 40 35 30 25 20 15 10 5 0 ov

Tk/US$

FX Volatality in Recent Days

Days Fig 4: Day wise Change in Foreign Exchange Rate The market was volatile in these days. If we want to go behind the scene of why market suddenly became too volatile we have to take a look at certain macroeconomic issues.

4.2 Import IF import is more than export then a lot of foreign exchange goes out from our country. We are losing more foreign currency then we are getting. Import payments in July 2004 stood higher at US$976.60 million compared to US$820.60 million in July 2003. Of the total import payment during the month imports under cash and for EPZ stood at 890.00 million , under loans/grants US$72.00 million, import under direct investment US$5.60 million and short term loan by BPC US$9.00 million. Detailed information are shown in the following table,

Import payments and import LCs opened (In million US$) Import payments (c.&.f.)

Import LCs opened 2003-2004P 2002 - 2003R 2003-2004 2002 - 2003 10866.70 9657.60 12397.75 10208.78 (+12.52) (+13.09) (+21.44) (+19.15) Import payments Import LCs opened 2004 2003 P P P Month 2005 2003 - 2004 2004 - 2005 2004R July 976.60 820.60 1065.99 898.27 (+19.01) (+14.87) (+18.67) (+39.85) Aug. N.A. 734.80 1063.94 863.23 July-Aug. N.A. 1555.40 2129.93 1761.50 (+25.62) (+20.92) (+31.44)

Fresh opening of import LCs during July-August, 2004 increased by US$368.43 million or 20.92 percent to US$ 2129.93 million compared to US$1761.50 million during the same period of the preceding year.

Fig 5: Growth of Import Fresh opening of import LC in august 2004, increased by US$200.71 million or 23.25 percent to US$106394 million compared to US$ 863.23 million in the same month of the previous year. This year however US$2.05 million or 0 .19 percent lower than US$1065.99 in July 2004.

4.3 Export According to EPB merchandise export during July-August, 2004 stood higher by US$346.76 million or 26.37 percent to US$1661.84 million compared to US$1315.08 million during the same period of the preceding year.

Annual and Monthly Trends in Export Annual Export Monthly Export

2001-2002 $5986.09 (-7.44) Month July August July-August

2002-2003 $6548.44 (+9.39) 2004-2005p 868.13 793.71 1661.84 (+26.37)

2003-2004 $7602.99 (+16.10) 2003-2004 678.17 636.91 1315.08 (+7.72)

In the recent month the growth rate of export remains steady. It is in the band of 15% to 17% from Mid-March to August. This kind of stability comes from the failure in the readymade garments industry to manage new market.

Fig 6: Month wise Export Growth From the above chart it is clear that in the recent period the country manages the drastic fall of export during February, 2004. But even now it is well below the target.

4.4Remittance Then there is also the impact of foreign exchange remittances from Bangladeshi nationals working abroad. Remittances in September 2004, stood higher at US$278.13 million compared to US$271.68 million in August 2004 and US$248.30 in the same month of the last year.

Annual and Monthly Trend in Remittances (In million US$) 2001-2002 2002-2003 2003-2004 A. Annual 2501.13 3061.97 3371.97 remittances (+32.89) (+22.42) (+10.12) P B. Monthly Month 2004-05 2003-2004

remittances

July August September July-September

286.67 271.68R 278.13 863.48 (+13.84)

258.80 227.68 248.30 734.78 (+0.88)

Total remittances during July-September, 2004 stood higher by US$101.70 million or 13.84% to US$836.48 million compared to US$734.78 million during the same period of the preceding year.

Fig 7: Periodical Trend in Remittance From the above chart it is evident that the contribution of remittance in our foreign exchange market is suffering from a downward movement. This contribution was on its peak during the beginning of this year.

4.5. Foreign Exchange Reserve Gross foreign exchange reserves of the BB stood marginally lower at US$3074.97 million at the end of September, 2004 compared to US$3132.28 million at the end of August, 2004 due to ACU payment of US$258.29 million as on 9 September, 2004.

Gross Foreign Exchange Reserve Of Bangladesh Bank Year ended A. Outstanding June, 2002 June, 2003 June, 2004P stock at the end of 1582.9 2469.57 2705.02 the year (+21.13) (+56.02) (+9.53) B. Outstanding Month / Year 2004-2005 2003-2004

stock at the end of the month

July August September

2563.05 3132.28 3074.97 (+23.12)

2361.32 2547.93 2497.63 (+44.02)

This was, however, significantly higher than US$2497.63 million at the end of September, 2003. For the year of 2004 foreign exchange reserve was highest on August.

In July this reserve was lowest due to the import payment of petroleum. Foreign exchange reserves of Bangladesh bank and other bank is given below

Fig 8:

Foreign Exchange Reserve (Month Wise)

Gross foreign exchange balances held abroad by commercial banks stood lower at US$297.25 million at the end of September, 2004 compared to US$319.84 million at the end of August, 2004 and US$376.25 million at the end of September, 2003.

The thing needs to be remembered that this export or import procedures are having an impact in the foreign exchange market as the payments usually comes or goes a few months later then the actual export or import. As an after affect of devaluation growth in export will be observed - as it will allow the exporter more margins. The other that needs to be said that Bangladesh being a developing country and growing stage it needs some degree of devaluation to keep up its export. There is also the fact that we are in a region where India, China and Myanmar is the neighboring country – all these country are growing and has a huge population and export potential. And to keep competing with them in international market we need a slightly weaker currency. This is what we have seen during the floating exchange rate regime.

These are the reasons of volatility in the foreign exchange market from macroeconomic perspective.

The main thing that with this volatile market and most of the banks dealers not being accustomed with the floating exchange market did some mistake and that’s why has incurred a lot of loss through dealing. Even the largest bank in Bangladesh – Sonali Bank incurred about 81 Crore of loss. Not being expert enough in dealing they tried to the Cross-currency trading to profit but in effect they were not in any position to do that. That is the reason of the banks incurring losses. Then Bangladesh Bank took some initiative to stop this loss. It issued a lot of guidelines and regulations to stop the bank from incurring that much loss and to stop the foreign currency going out of the country.

5.0 Dealing and Risk Management

5.1 Introduction March 24, 2004, the Bangladesh Taka exchange rate was declared floating and the band of the central bank’s US Dollar buying selling rate were withdrawn. To adapt to the changed environment, many banks established dealing rooms and some centralized their foreign exchange and money market activities under a single functional area which is still in its rudimentary stage. But it needs to be said that Mercantile Bank Limited showed its maturity in dealing with the matters of exchange rate and that’s why they haven’t incurred any loss through dealing. Whereas big names like Sonali Bank, AB Bank etc incurred a lot of loss.

5.2 Observations in Brief The following observations are made during the stay of twelve week internship period in the Dealing Room of Mercantile Bank Limited: •

MBL has a well equipped dealing room with Internet, Fax, Phone and all other necessary thing. It is access restricted area only the dealers and other related personnel enter into the room.

•

Bangladesh Bank has advised the bank do tap the conversation of dealing – as it will prevent any mistake of rates, amount etc and it may provide hard evidence if necessary. But the conversations during

dealing are not tapped. So the bank needs to take this matter into consideration.

•

Most of the time the deals are recorded immediately after they are completed. They are recorded both in the position blotter and deal slip.

•

All deals done by dealers are required to be processed by the treasury back-office for which they need to be informed of the details of the deals within a certain time. In this process dealers verbally inform to the treasury back-office within shortest possible time. Here the prescribed Time Stamp is not used. In Most of the time the timeline guided by Bangladesh Bank is not followed.

•

Bank has set counter party limit as asked by the Bangladesh Bank.

This limit has set in the meeting of ALCO.

•

A stop loss limit for a product is generally a certain percentage of the organization’s prior year profit from that product. For mercantile Bank the limit is fifty percent, which is subject to rapid change.

•

Dealing room prepares the rate sheet. The current information is collected from the Reuter. Mercantile Bank is a subscriber of Reuter.

In the Reuter’s website they get the information of current rates of different currency in different banks of the world. With this context the rate committee matches the demand supply situation of the bank.

Shortly this is the process of rate determination in MBL.

•

Judging of Rate Appropriateness is extensively done by the back office. Dealing Room prepares the rate sheet but they can only implement it after it is checked and passed by the back office. Even when any dealing is done back office sees whether the price is appropriate or not. And before giving any special price to any specific dealers’ proper permission is taken from authorized person.

•

In Mercantile Bank trigger is set at 90 percent of Stop Loss limit. In case of profit trigger the limit is decided on the market situation.

•

Appropriateness of dealing is judged by both the back and mid office.

Front office of dealing room conducts the dealing. Mid-office checks whether the deal is within the limit (daily dealing limit, counter party

limit and stop loss order limit).Back office of dealing room usually makes the settlement.

•

Dealing room of mercantile bank Ltd. has specific limit for different currency. For example Two million is the daily limit for US dollar.

This limit is judged by ALCO.

•

Dealing room tries to maintain a null outstanding limit everyday to avoid the risk of loss. If the outstanding limit stands in the profit side then the related dealer is advised to make a watch order to a counter party. The policy is to maintain a square position.

•

Treasury back office values all outstanding positions at the current rate to determine the current market values of these. In MBL the treasury back office gathers the market rates from independent source i.e. than dealers of the same organization, especially over telephone or internet.

•

After hours dealing is that which the dealers own trading room is closed. In our market the business hour is still 5 PM, any deals done by dealers after that time is considered as after hour’s deals. MBL does not trade after the banking hours.

•

A dealing transaction done by a dealer who is not physically located in the dealing premises, irrespective of the time of day is an off-premises deal. Of premises dealing is not practiced in Mercantile Bank Ltd.

Now we will describe the observation made in Mercantile Bank Ltd elaborately with critical evaluation of the matter,

5.3. Observations and Evaluation Dealing Room: Since the dealers have access to global live prices of various products through their various communication tools, their desks are access restricted. As a result, dealers are housed inside a covered room known as the “dealing room” where the access is generally restricted only to the dealers and the related personnel. In Mercantile Bank Ltd. there is a separate unit in the sixth floor of the office is used as the dealing room where entry is restricted for other than

related personnel. The dealing room is distinctively separated from the back office so that the dealer can do his job independently, without unnecessary intervention of back office.

Taped Conversations: In MBL, the dealers conclude deals over the phone. This is because deals are done on the local market where dealers are mostly known to each other and they feel comfortable dealing by talking to other dealers over phone. In MBL the conversion with the dealers of other organization is not taped. So such deals over the phone do not have any hard evidence and in a fast dealing environment, there is risk of mistakes (of rates, amounts or value dates etc.).

All telephonic conversations taking place in the dealing room are required to be taped. Taped conversations can assist in resolution of any disputes that may arise. Dealing over the mobile phones is restricted in MBL.

Deal Recording: The job nature of a dealer is highly demanding and the environment of a dealing room is very active. In such an environment when a dealer continues to deal, his/ her focus remains on the market. As such there is a risk of a dealer completely forgetting about a deal or part of a deal or making mistake in recording that deal.

To eliminate this risk, in Mercantile bank Ltd. every dealer must record the deal immediately after it is concluded with the counterparty. The deal recording is done in two ways: Position Blotter: Immediately after a deal is done, the dealer records the deal on the position blotter and updates his position. It is of utmost importance to a dealer to remain aware of his/ her position at all times. This is required to capture any immediate opportunity or to be in a position to immediately react to any adverse situation. A sample blotter has been shown on annexure..

Deal Slip:, Record is also done on a slip or memo which is known as the deal slip or deal ticket. In MBL, the deal slips are electronic and are through inputs into their automated systems. Deal slip contains details such as, payment instruction, value date, currencies, amounts, deal rate etc. The deal slip is passed on to the treasury back-office at the earliest for their further processing of the deal. Ideally, all deal slips are pre-numbered for control reasons and the treasury back-office monitor for any breakage in sequence. Where prenumbered deal slips are in place, any cancelled deal slips must also be forwarded to treasury back-office for appropriate record keeping/ filling.

Deal Delay:

All deals done by dealers are processed by the treasury back-office for which they need to be informed of the details of the deals within a certain time. In this process dealers occasionally raise deal tickets that need to be sent across to the treasury back-office within shortest possible time. This is not the right way to minimize he risk associated with deal delay. The timeliness of raising deal slips/ inputting into the automated system as well as passing them on to the back-office is not only sound business practice but also critical for monitoring of credit risk, price risk and regulatory compliance.

The following table provides guidelines of deal capture standards: Product

Deal-slip raising/ System Input Time

Deal-slip to reach back-office

Spot FX

Within 10 minutes

Within 25 minutes

Forward FX

Within 10 minutes

Within 25 minutes

FX Swaps

Within 15 minutes

Within 30 Minutes

Call/ Notice Money

Within 10 minutes

Within 25 minutes

Money Market Term

Within 10 minutes

Within 25 minutes

Foreign Currency Deposits

Within 10 minutes

Within 25 minutes

Treasury Bills Purchase

By 10:30 a.m. on payment day

Within 30 minutes

Repo

By 12:30 p.m.

Within 30 minutes

Reverse Repo

By 12:00 p.m.

Within 30 minutes

The guidelines as per the above table cannot be maintained properly because the deal ticket is not used regularly. So the back office of the dealing house finds it difficult to judge the proper time.

Counterparty Limits: The issue of counterparty limits arises from the risk that a customer with whom an organization had a reciprocal agreement defaults. Credit risk is the risk that the counterparty to a financial transaction - here a foreign exchange contract, may become unable to perform as per its obligation. The extent of risk depends on whether the other party's inability to pay is established before the value date or is on the same value date of the foreign exchange contract. In Mercantile Bank counter party limit is determined by the board of directors. In

determining the limit board considers the creditworthiness and relationship of counter party.

If the limit can not judge properly bank will have to face following risks, Settlement risk: The risk on the settlement day that one counterparty pays funds or delivers a security to fulfill its side of the contractual agreement, but the other counterparty fails on its side to pay or deliver. This occurs when items of agreed upon original equal values are not simultaneously exchanged between counterparties; and/or when an organization’s funds are released without knowledge that the counter value items have been received. Typically the duration is overnight/ over weekend, or in some cases even longer i.e., until the organization receives the confirmation of receipt of funds. The risk is that the organization delivers but does not receive delivery. In this situation 100% of the principal amount is at risk. The risk may be greater than 100% if in addition there was an adverse price fluctuation between the contract price and the market price.

Pre-settlement risk: The risk that a client defaults on its agreement with the organization before the settlement day. Whilst the organization has not paid away any funds, it still has to replace the contract at the current market rates, which might have moved against it. In this case the organization is exposed to possible adverse price fluctuations between the contract price and the market price on the date of default or final liquidation. The organization’s loss would then be the difference between the original contract price and the current market price on the date of default.

All banking organizations must have appropriate counterparty limits in place for their treasuries. The limit structure will depend on each organization’s credit risk appetite based on their credit risk policies as well as target market criteria. All such credit risk limits should be set by the organization’s credit risk approving unit, which is independent of the treasury dealing function.

In judging the credit worthiness of the counterparty MBL uses the credit reports of D&B and other authentic sources. Sometimes the rating of the counterparty from the Bankers almanac is also used.

Stop Loss Orders: A stop loss limit for a product is generally a certain percentage of the organization’s prior year profit from that product. For example if an organization’s FX trading revenue for the year 2002 was USD A, the management/ market risk management unit may decide to accept

a maximum of 10% loss of that during the current year. In that case the stop loss limit for that organization for 2003 would be A X 10%.

In managing the business within the stop loss limit, treasuries running overnight positions (within their overnight limits) must leave appropriate overnight watch orders. In Mercantile Bank Ltd. the limit is fifteen percent. So this year whenever the amount of loss reaches to 15% of the profit of the year 2003, the stop loss order will come. So Mercantile Bank is conservative in the trading. As a representative of third generation bank MBL did not get the chance to take part in big deals in the previous years. So the amount of the profit is not significant for the foreign exchange market. Fifteen percent of this profit is very much insignificant in the market. This conservatism in stop loss order limit prevents MBL to operate in the foreign exchange market with its full capacity.

Triggers: A trigger is a level of a position at which an organization decides that the management should be made aware of. This may be in terms of a market value of a position or an unusual trading volume etc. This is a predetermined level given by the management. In MBL ALCO determines the trigger. When a trigger is hit, the management needs to be informed of the same. Upon advised of a trigger, the management usually decides on closer monitoring of the particular situation. In cases of a loss trigger, the amount is generally set at a lower level than the stop loss limit (at which the position has to be unwinded). In Mercantile Bank trigger is set at 90 percent of Stop Loss limit. When the loss becomes 90 percent of stop loss limit then the management is informed to take decision. In case of profit trigger the limit is decided on the market situation.

Appropriateness of Dealing: While transacting with a client, a dealer of MBL generally aware of the counterparty’s dealing style & product mix and assess (prior to concluding a deal) whether the customer is dealing in an “appropriate” manner. A dealer has the responsibility to ensure that the volumes of activity and types of products transacted by a client are appropriate for that particular client and the risks of these transactions are clearly understood by them. Prior to conclusion of a deal, a dealer needs to assure that the counterparty is authorized to enter into such transaction (both from counterparty’s internal and regulatory perspective). Here dealer is working as the front office of the dealing room. Appropriateness of dealing is judged by both

the back and mid office. Front office of dealing room conducts the dealing. Mid-office checks whether the deal is within the limit (daily dealing limit, counter party limit and stop loss order limit).Back office of dealing room usually makes the settlement.

Rate Sheet Production: Every day MBL Dealing Room has to produces rate sheet with the following features: a.

Rate for Import bill payment.

b.

Rate for export bill negotiation for sight/usance.

c.

Rate for inward and outward remittance.

d.

Rate for TC and Cash note.

e.

Indicative rate for internal transaction

This rate sheet is produced in those currencies for which MBL maintains Nostro a/c. i.e.

USD, EURO, GBP, JPY, SGD. USD/BDT rate is to calculate on the basis of prevailing free floating rate in the inter-bank. On the other hand cross rate of other 4 (four) currencies is to obtained from Reuters Money 2000 and published in the rate sheet after maintaining sufficient margin. Through this rate sheet treasury maintains daily profitability with our branches and subsequent customers there on. For Corporate Customers treasury may customize this rate but keeping in view the profitability of the bank. Apart from exchange rates the following foreign currency interest rate is to be incorporated. a.

LIBOR for US Dollar in different tenor.

b.

NFCD/ RFCD rates for USD deposit.

Rate Appropriateness: This exercise is carried out by the treasury back-office to check for whether all deals have been dealt at market rates. Any deals done at off-market rates must be raised to the respective dealer for a satisfactory explanation bringing this to the notice of the chief dealer. In case of a non-acceptable justification provided by the dealer, the organization may decide to engage in further investigation.

This monitoring process is placed to guard against application of any inappropriate rates.

Treasury front office primarily uses Reuters for pricing of its products and treasury operations also collect most of the data for their independent verification process from the

same source. Following is a guide that is followed in the process of independent verification of prices for various products/ instruments: Instrument Spot FX

Source Reuters / National Newspapers

Frequency of Update

Note

Once Daily Pages: AFX=, FXXZ, BD(F9)

Forward FX/ Reuters Swaps

Once Daily Pages: AFX=, FXXZ, BD(F9), LIBOR01, GBPF=, EURF=, JPYF=, CHFF= etc.

In absence of an interbank USD/BDT forward market, banks should use spreadsheets to determine tenor-wise forward premiums that should be used for the verification of USD/BDT forward rates.

Cross Currency

Reuters

Once Daily Pages: FX=

Foreign Currency Deposits

Reuters

At Booking Pages: DEPO, GBPF=, EURF=, JPYF=, CHFF= etc.

Money

National Newspapers

Page: BD (F9)

Treasury Bills Purchase

Repo

Independent price verification can not be performed for this since the same is purchased from Central Bank only on primary auctions. On bids from different banks, central bank decides the cut-off point yield. There is no secondary market, at the moment and when a secondary market develops, this should be reviewed.

Reuters/ National

Once Daily on days transactions take place

repo

Newspapers Reverse Repo Reuters/ National Newspapers LCY Term MM

Page: BD (F9) Once Daily on days transactions take place Page: BD (F9)

repo In absence of an interbank term money market, this can not be judged against a market information. However, for clarity, all term borrowings/ placements should have sign-off from one level higher authority from the dealer doing the transaction.

For the information to determine the rate related with foreign exchange dealing Reuter is the main source. MBL is a subscriber of Reuter; the dealing room has the opportunity to visit the pay site of Reuter The rate band for each instrument is fixed depending on the market liquidity and volatility for each of them. An indication of the rate bands that is used by Treasury Operations of MBL for their independent price verification process is shown in the following table. Here we see that for spot rate both in Inter-bank and customer the band is wider than in the case of forward rate and FCY borrowing. In forward rate there is more risk associated because bank has to judge future trend for this rate determination. For call money bank has to consider the present situation, so bank has the opportunity to make the band little wider i.e. 1% of the mid-rate of the market.

Instrument Spot Inter-bank

Rate Band For currencies other than BDT, for contracts with USD FX on one side, a 1% on each sides of the mid market rate can be taken as guidance. For BDT it can be within 5 paisa on either side of the base rate.

Spot Customer

For Spot Customer FX, the band can be 2%

on either FX side.

Forward

25 pips on either side of the base swap rate for currencies inter-bank FXagainst USD other than JPY. 25 bps on either side of the Swaps base swap rate for JPY.

FCY Borrowing

25 bps on either side of the base rate (quoted on Reuters Lending for the particular tenor) for on and off-shore deals 1% on either side of mid rate of range reported on Reuters BD page/ newspaper

Call/Notice Money

Treasury of MBL always tries to maintain the rate according to the above table. But in operation some deviation is occurred for unavoidable market forces.

MBL treasuries publish a rate sheet for retail FX transactions for various types of customer related transactions in various currencies. Buy and sell rates for all currencies for all types of transactions that are covered in the rate sheet is based on sufficient spreads taken from the bid/ offer of central bank's quote on USD/BDT for the day as well as spreads on cross currencies available from Reuters. It is primarily designed to cover retail and small corporate FX transactions. Correctness in preparation of rates for these transactions must be covered through maker-checker control (as well as the automated banking system through defined bands in the system). However, for certain customers, transaction rates might differ from the published rates. In these instances there should either be standing instruction issued by the head of treasury or the relevant rate exception signed by treasury personnel.

On customer FX, the rate bands are higher to accommodate higher spreads. However, since all customer transactions are based on a principle of a positive spread, negative spreads for such transactions must be highlighted as exceptions for explanations and approvals.

Deals Outstanding Limit: In MBL Dealing room tries to maintain a null outstanding limit everyday to avoid the risk of loss. If the outstanding limit stands in the profit side then the related dealer is advised to make a watch order to a counter party. Here the watch order is given to that counter party who is in his banking hour. So the party can affect the deal within the operating time. This policy minimizes the risk of the open position.

It is a good practice to monitor the total deals outstanding of the treasury. This exercise is carried out by the treasury back office to check against any unusual volumes of activity. For example, in a fast dealing environment, a dealer may make a mistake and execute a deal with an additional zero that would make the dealt amount much higher than intended. If a “deal outstanding” monitoring (by an independent unit) process is in place, this would be highlighted and brought to the attention of the senior management for any appropriate action.

Daily Treasury Risk Report: The treasury back-office summarizes all daily positions particularly the end-of-day positions on a report format for the information of the senior management. Such report is ideally contain information about outstanding open position against limit, different currency-wise outstanding exchange position (against limits if applicable), outstanding foreign exchange forward gaps in different tenors, tenor-wise MCO report, interest rate exposures of the balance sheet, counterparty credit limits usage, day’s P&L against trigger & stop loss limit etc.

Code of Conduct: Due to the special nature of job that dealers engage in, they are expected to act in a professional and ethical manner.]

Conversation Language: All dealing related conversations taking place in the treasury is in an acceptable language for operational clarity. To elaborate, all conversations on the Reuters Dealing System is in English and all conversions over telephone is restricted to either in Bengali or in English.

Mandatory Leave: The dealing functions are extremely sensitive involving wholesale and large amounts with exposures to adverse market movements. There is also risk of mistakes not being unearthed.

As a result, for a particular dealer’s functions to be run by a different dealer, all dealers are required to be away from their desks for a certain period of time at one stretch during a year.

During this period, dealers are not expected to be in contact with their colleagues in the treasury area. Typically, this period is defined as a continuous two weeks period. In Mercantile Bank Ltd. the provision of mandatory leave has started from this year.

Position Reconciliation: All dealers’ positions are reconciled with the positions provided by the treasury back-office.

This must be done daily prior to commencement of the day’s business. Unreconciled positions may lead to real differences in actual positions exposing the organization to adverse market changes and real losses. In Mercantile bank treasury back office reconciled position daily.

NOSTRO Account Reconciliation: Banks maintain various nostro accounts in order to conduct operations in different currencies including BDT. The in charge of the international Division

set limits for handling nostro

account transactions that include time limits for the settlements of transactions over the various nostro accounts and the time and amount limits for items that require immediate investigation after receipt of the account statements. In defining these limits, consideration is given to the transit and processing times of the various types of transactions.

The time and amounts limits, if exceeded, require referral to the in charge of International Division for appropriate action. Persons reconciling nostro accounts is independent of originating, responding to, authorizing or booking transactions and must not reconcile the same accounts for a continuous period of more than twelve months. However, after the lapse of at least the next monthly reconcilement process immediately following the twelve month period, these persons can be reassigned the same duties.

The process of matching open items must be performed each time statements are received and must ensure a true match (e.g. dates, amounts and transaction identity). All matches must be cross-referenced between “our accounts” and the statement. Entries that make up a partial or incomplete match are suitably cross-recorded so that a clear audit trail is provided.

The current “our account” records and statements are to be maintained under control and custody of persons in charge of reconcilements.

As frequently as deemed necessary but not less than once a month, a “reconcilement balancing report” is prepared for each “our account” which must include the “our account” balance, the related statement balance and a listing of all open items (all differences and unprocessed items). Tracers are sent if the open item exceeds the established time or amount limits. The operations manager review all reconcilement balancing reports to evaluate the status and progress of eliminating open items and to ensure that investigation and follow-up efforts are satisfactory and tracers are sent on a timely basis.

The operations manager establishes limits for monthly accrual of interests on overdrafts in “our accounts” maintained with other branches and correspondents. Overdraft interest for “our accounts” must be calculated for each day the branch is in overdraft in accordance with its records.

The operations manager sets the time and amount limits for liquidation of open items or differences found unreconcilable. These items are investigated as far as is practicable and if they are found unreconcilable, the operations manager may authorize liquidation through appropriate entries as established as per their accounting policies. However, the items in question must be amply identified and corrective steps taken to prevent recurring differences.

Quarterly, a comprehensive review of all “our accounts” is made by an officer independent of transaction processing and authorization functions to ensure that each account continues to be operated with a valid business purpose and that reconciliation and other controls continue to be in place and are effective.

The following table shows the maximum time limit after which unmatched items is referred to the operations manager.

Type of Transaction

Transit Time 3 days, ACU - 7 days Nil. Immediately notify

L/C payments Foreign exchange settlements

respective

department if settlement does not occur TC encashments Outward remittances Draft payments ACU cover funds

sent

on value date 21 days 3 days 30 days through 7 days

Bangladesh Bank Credits to our accounts with insufficient 20 days details Correspondent

bank

charges 30 days

recoverable from our customers or otherwise Any other credits to our accounts, 7 days where

we

have

not

passed

corresponding debit entry Any other transactions where we have 7 days debited, but they do not credit Any other transactions where they have 7 days debited, but we do not credit Any other transactions where we have 4 7 days credited, but they do not debit

After-hours Dealing: After-hours dealing is that which initiated when the dealer’s own trading room is closed. For specific business reasons, an organization may decide to allow its treasury to engage in afterhours dealing. In such cases the organization must have properly laid down procedures detailing the extent to which they want to take risk during after-hours and which dealers to have dealing authority and upto what limits they can deal during after-hours. For example, if in our market the business hour is till 5 PM, any deals done by dealers after that time would be considered as after-hour deals.

An organization must also have detailed laid down procedures for the accounting of the afterhour deals bearing in mind that during these times there would not be any treasury backoffice staff available. Mercantile Bank Ltd. does not trade after the banking hours. It is because MBL does not have adequate work force and logistic support to continue the business after the office hours. As we are few hours ahead of USA or any other developed western country the bank missed the opportunity to trade with the large and famous dealer of the world.

Off-premises Dealing: A dealing transaction done by a dealer who is not physically located in the dealing premises (irrespective of the time of day) is an off-premises deal. An off-premises deal needs to be treated separately from a deal done from within the dealing room due to it being done using communication tools that are not as special as those of the dealing room. For example, an offpremises deal done on the phone is generally not recorded and thus there is no record in case of any future dispute. Also, deals done from within the dealing room get recorded immediately updating positions and allowing the treasury back-office to take immediate actions (confirmation, settlement etc.), which is not the case for off premises deals.

As such, an organization must have detailed laid down procedures for the off-premises deals describing how these deals would be accounted for with least possible delay. Typically, organizations would designate particular dealer(s) with the authority for off-premises dealings in case they decide to carry out such activity for some specific business reason/ justification. Mercantile Bank Ltd. does not trade after the banking hours. It is because MBL does not have adequate work force and logistic support to continue the business after the office hours.

.

Mark-to-Market: This is a process through which the treasury back-office values all outstanding positions at the current market rate to determine the current market value of these. This exercise also provides the profitability of the outstanding contracts. In MBL the treasury back office gathers the market rates from an independent source i.e. other than dealers of the same organization which is required to avoid any conflict of interest.

Valuations: The process of revaluing all positions at a pre-specified interval is known as valuation.

Though this exercise, an organization determines that if they are to liquidate all the positions at a given time, at what profit or loss they would be able to do so.

This function is carried out by the treasury back-office of MBL by gathering revaluation rates. Ideally, the treasury back-office should gather such rates from sources other than from the dealers of the same organization to avoid any conflict of interest.

Dealers’ are required to have their own P&L estimate which must be tallied with the ones provided by the treasury back-office. Any unacceptable difference between these two must be reconciled to an acceptable level.

Internal Audit: Considering the complexities of the foreign exchange business, a process for an internal audit has widely been accepted as a check point to review the adequacy of the key control issues.

This function can include checking for adherence to various limits, compliance requirements, statutory management etc.

In addition to regular audits at specified intervals, a concurrent audit process put in place to ensure the treasury’s functioning in an appropriate manner on a day-to-day basis in MBL.

5.4 SWOT ANALYSIS Mercantile Bank Ltd. is operating in foreign exchange market from the very beginning of its inception. In operating the bank has developed individual policy based on its strength and weakness. The try to point out Mercantile Bank Ltd.’s internal strengths and weaknesses, and external opportunities and threats as I have explored in foreign exchange trading,

Strength •

Mercantile Bank has a strong foreign exchange reserve with compare to other private bank. This strength comes from the export business of the bank. In 2003, total export made through MBL is TK.15, 250.60 million which is 75% of the total import. In that time the total export is only 67% of the total import. So from its sound export business MBL generates a well developed foreign exchange reserve, which is crucial in dealing foreign exchange.

•

The Bank mobilized total deposits of Tk.16, 287.46 million as of December 31, 2003 as compared to Tk. 15,150.42 million in 2002.

Competitive interest rates, deposit mobilization efforts of the Bank and confidence reposed by the customers in the Bank contributed to the notable growth in deposits. So the bank has the liquidity which is important in trading both in money market and foreign exchange market.

•

The bank has a well equipped dealing house which is operated by some well groomed talented and trained officers and executives. They have excellent academic and professional experience and fine tuned by the directions of the management.

•

Beside Bangladesh Bank manual the Bank has developed its own guideline for foreign exchange risk management. So the treasury department is always prepared for any kind of situation.

•

Bank has a sound relationship with other financial institution both in the inside and outside the country. The credit worthiness of the bank is quite good. In the bank almanac MBL has the rating of 2160 which is quite good. This sound image contributes in getting favorable limit from other bank.

Weakness •

In operation in the foreign exchange market bank is conservative. So the bank cannot increase its business with its full capacity. As a representative of third generation bank MBL did not get the chance to

take part in big deals in the previous years. So the amount of the profit is not significant for the foreign exchange market. Fifteen percent of this profit is very much insignificant in the market.

•

In operation bank has some flaws. For example Dealers do not use time stamp or deal ticket , so the back office find it difficult to settle the deal in proper time.

Opportunity •

Government Support: Government of Bangladesh has rendered its full support to the banking sector for a sound financial status of the country, as it has become one of the vital sources of employment in the country now. Such government concern will facilitate and support the long-term vision of Mercantile Bank Ltd.

•

For its extensive foreign trade the bank able to make a special relationship with many foreign bank. Sound relationship with the foreign bank will open new area of the dealing business.

Threats •

Poor Telecommunication Infrastructure of the country is a threat in the business of foreign exchange. The world is advancing e-technology very rapidly. Though Mercantile Bank Ltd. has taken effort to join the stream of information technology, it is not possible to complete the mission due to the poor technological infrastructure of our country.

•

Frequent Currency Devaluation is another threat. Frequent devaluation of Taka and exchange rate fluctuations and particularly South-East Asian currency crisis adversely affects the business globally.

From the observation we see that the bank follow the guide line of Bangladesh bank in trading in the foreign exchange market. Besides MBL has its own guide line formulated by the Asset Liability Committee (ALCO). Any dispute arise in the deal time is settled by the guidelines of Bangladesh Bank and ALCO. Board of Directors determine the daily deal limit, stop-loss order limit and counter party limit with the help of the management. Treasury department can be divided in three parts, front office, mid office and back office. Front make the deal and determine the rate. Back office makes the settlement and mid office supervise

the job of both front and back office. In observation we see that Mercantile Bank has a suitable position for its foreign exchange reserve, liquidity position and relationship with financial institution. But the bank can not operate with its full capacity for its conservative nature.

Appendix 1. Guideline of Bangladesh Bank Responsibilities of Treasury Department: The activities of a treasury can be categorized into four major functions as follows: •

Foreign exchange

•

Money market

•

Asset Liability Management

•

Fixed Income

Some of the typical products that would fall under treasury’s functions can be listed as follows: •

Spot foreign exchange

•

Forward foreign exchange

•

Currency swap

•

Interest rate swap

•

Forward rate agreement

•

Non-deliverable forward exchange

•

FX options

•

Overnight deposits

•

Term deposits

•

Coupon securities

•

Discounted securities

Following is a list of some of the common functions that today’s treasuries perform: •

Statutory management

•

Limits monitoring and management

•

Adherence to various internal as well as regulatory policies

•

Minimization of risk

•

Optimization of risk return through specialization

•

Monitoring & management of various Balance Sheet gaps

•

Monitoring & management of various foreign exchange and money market positions

•

Monitoring & management of various cash flows and cash positions

•

Funding of the Balance Sheet at optimum prices

•

The head of the treasury department is the main driver of the ALCO activities/ discussions

•

Propose interest rate matrix to the ALCO

•

Propose various investment options to the ALCO

•

Analyze various economic trends and propose Balance Sheet Strategy to the ALCO

•

Quotation of various foreign exchange rates to customers

•

Dealing in foreign exchange for position covering as well as for own account trading

•

Various funding activities through currency swaps

•

Close liaise with regulators

•

Provide structured treasury solutions to customer

•

Remain vigilant for any arbitrage opportunities

•

Marketing activities for future business growth

•

Proposals/ renewals for various internal limits

•

Estimate daily P&L and work with reporting unit in resolving any difference

•

Record/ maintain all foreign exchange and money market positions and check for differences with system generated/ back-office reports

To support the activities of treasury, an independent treasury back-office is required to function reporting through a different organizational chain. Some of the major functions of a treasury support unit are as follows: •

Input, verification and settlement of deals

•

Preparation of currency positions (of previous day-end) and report to dealers prior to commencement of day’s dealings

•

Reconciliation of currency positions

•

Rate appropriateness function for all deals done

•

Revaluation of all foreign exchange positions at a pre-determined frequency

•

Managing discrepancies and disputes

•

Daily calculation for adherence to statutory maintenance

•

Reconciliation of nostro accounts

•

Claim/ pay good value date effect of late settlements

•

Monitor for dealer’s adherence to various internal and regulatory limits

•

Monitor for dealer’s adherence to various counterparty limits

•

Prepare and monitor all balance sheet gaps

•

Report any limit excesses

•

Various internal and regulatory reporting.

Policy Statement for Dealing Room Operation Currency pair for position taking:

Currency positions may only be held in USD/ BDT currency pair to facilitate handling of normal commercial and financial transactions, which includes minimum working balances in Nostro Accounts in foreign currencies.

Limit and Sub-Limit in USD: All foreign Exchange exposure limits and also currency –wise sub-limits are to be expressed in terms of US$.

Restriction on Forward Positioning: Only spot positions may be held, no mismatch and /or un-matched forward positions are allowed to be held. It follows, therefore, that while forward deals may be undertaken for customers such deals, are immediately covered by matching deals in the market, with no gaps in amounts and periods.

Restriction on Proprietary Position Taking: Dealing Room is not authorized to enter into Foreign Exchange open position on their own account.

Separation of Dealing Room and Back Office: Foreign Exchange operation should be so organized that there will be clear and distinct separation of the Dealing Room and Back office.

Restriction on Un-Matched Forward Exchange: Un-matched/mis-matched forward exchange deals which would cause open position are not permitted. The only forward exchange deals permitted are those for customers.

Daily Revaluation of FCY Asset & Liability: Revaluation of Foreign Currency Assets and liabilities will be on daily basis. Forward positions will be revalued only at the time of liquidation.

Forward and Swap as per Guideline of Central Bank: All forward deals and swaps must follow the guidelines and restrictions given by the central bank.

Counter Party Limit Books: Dealing Room will maintain counter party limit books which will include records of all day to day customer transactions and inter-bank transactions.

Dealing Room Staffing: There should be adequate number of officers with technical skills and knowledge.

Standard Logistic Support: Following standard logistic support to be maintained: a) A separate dealing room with authorized entry only. b) Reuter connectivity with real time information availability. c) Standard communication tools such as e-mail with internet and intranet facilities, fax, telephone, mobile, adequate computer logistics etc.

Liaison with Foreign Exchange and Money Market: Effective FCY transactions involving BDT should be instantly and effectively communicated to Money Market segment of dealing room.

Guideline for Foreign Exchange Dealing Room Guideline for Dealings Room operation covers Sale-Purchase/ Merchant transaction of Mercantile Bank Ltd i.e. for any Dealing Room operation an underlying customer transaction has to be there. In case of proprietary trading only USD/BDT currency pair is allowed. Apart

from that no Foreign Currency trading should be in speculative nature. All dealing transactions must be supported by approval of the competent authority.

Sale Transaction to Customers: Sale Transaction can be of following nature: Foreign Currency sale against BDT - Retail Foreign Currency sale to retail customer for FTT, FDD and TC should be guided by TT & OD rate of rate sheet. Point of Sales may be allowed to take BC rate and the difference between BC and TT OD rate may be refurnished from treasury a/c to particular branch’s account.

Foreign Currency sale against Foreign Currency- Retail Foreign Currency sale to retail customer for FTT, FDD and TC should be guided by mid rate of the respective currency. In case of conversion of foreign currency to another foreign currency the prevailing rate in international market is to be applied.

Foreign currency sale against BDT-Import Foreign Currency sale to Importer should be guided by BC rate of Rate Sheet. In addition to that rate can be negotiable for corporate customers. Any higher rate of selling applied to customers other than the dealt rate by the corporate units the difference may be credited to the respective corporate units from treasury. In case of

application of lower rate to customers

the difference should be credited to treasury’s account from the respective corporate branch unit.

Foreign currency sale against Foreign Currency-Import Import payment made out of FC margin a/c / retention Quota a/c and special payment facility (Import payment out of export proceeds within 1 month) can be made in respective currency’s mid rate. In case of conversion of foreign currency to another foreign currency the prevailing rate in international market is to be applied.

Forward Foreign Currency sale against BDT: Forward Foreign Currency can be sold to importers. In that case the quoted currency should be against BDT and the rates incorporated in the rate sheet for the structured time frame (1Month, 3Month & 6 Month) can be applied. Other than structured time frame Dealing Room can enter into transaction with different tenors. Apart from that forward rates can be of

customized nature for corporate customers Forward Foreign Currency can be sold to any importer making payment out of their FC margin and Retention Quota a/c for the desired Currency pair other than BDT. Forward transaction must follow the guidelines issued by the Central Bank.

Forward Foreign Currency sale against Foreign Currency Forward Foreign Currency can be sold to any importer making payment out of their FC margin and Retention Quota a/c for the desired Currency pair other than BDT. In case of conversion of foreign currency to another foreign currency the prevailing rate in international market is to be applied. Forward transaction must follow the guidelines issued by the Central Bank.

Purchase Transaction from Customers: Purchase Transaction can be of following nature: Foreign Currency purchase against BDT - Retail Foreign Currency purchase from retail customer for inward FTT should be guided by TT Clean rate of rate sheet. Foreign Currency purchase from retail customer for FDD should be guided by TT Doc rate of rate sheet. In case of corporate customers customize rate can be applied.

Foreign Currency purchase against Foreign Currency-Retail Foreign Currency purchase from retail customer for FTT, FDD should be guided by mid rate of the respective currency. In case of conversion of foreign currency to another foreign currency the prevailing rate in international market is to be applied.

Foreign currency Purchase against BDT-Export Foreign Currency purchase from exporters should be guided by TT Clean rate of Rate Sheet for payment against clean bills for collection. In addition to that TT Doc rate is to be applied for export bills negotiation. Usage rate for different tenors are similarly applicable for time export bills. Apart from that rate can be negotiable for corporate customers. Any lower rate of buying applied to customers other than the dealt rate by the corporate units: the difference may be credited to the respective corporate units from treasury. In case of

application of

higher rate to customers the difference should be credited to treasury’s account from the respective corporate/ branch unit.

Foreign currency Purchase against Foreign Currency-Export

For crediting export proceeds into FC margin a/c / retention Quota a/c; respective currency’s mid rate is to be applied. In case of conversion of foreign currency to another foreign currency the prevailing rate in international market is to be applied.

Forward Foreign Currency purchase against BDT: Forward Foreign Currency can be purchased from exporters. In that case the quoted currency should be against BDT and the rates incorporated in the rate sheet for the structured time frame (1Month, 3Month & 6 Month) can be applied. Other than structured time frame Dealing Room can enter into transaction with different tenors. Apart from that forward rates can be of customized nature for corporate customers. Forward transaction must follow the guidelines issued by the Central Bank.

Forward Foreign Currency purchase against Foreign Currency Forward Foreign Currency can be purchased from any exporter for conversion out of their FC margin and Retention Quota a/c for the desired Currency pair other than BDT. In case of conversion of foreign currency to another foreign currency the prevailing rate in international market is to be applied. Forward transaction must follow the guidelines issued by the Central Bank.

Encashment/ Purchase of Foreign Currency Any encashment of Foreign Currency into BDT can be done from Customers FC A/c by applying TT Clean/ TT doc rate by examining the nature of transaction.

Dealing in Inter Bank Market: Dealing in Interbank Spot market for USD/BDT currency pair is allowed subject to Overbought/ Oversold limit of Exchange Position approved by Bangladesh Bank. The applicable rate for interbank transaction should be on market. Off market rate transaction is not allowed. In this connection arbitrage function for other currency pair is allowed. In case of any position taking/ speculation in any currency pair is not allowed. For any Forward and Swap transaction rates should within the market dynamics (Interest rate/ exchange rate/ annualization of tenor). Interbank Spot, Forward and Swap transaction must follow the Central Bank’s guidelines issued from time to time.

3.6.4. Special Fund Arrangement in Foreign Currency :

Dealing Room should facilitate for procurement and management for any foreign currency special funding arrangement with Bangladesh Bank. In this connection JDRG

( Japanese

Grant) and EDF ( Exporters Development Fund) can be cited as example.

Fund Management and Liquidity Management: For Liquidity of the foreign currency, our Exchange Position has permitted up to USD 2.0 million in both short/long position. In this connection the following method is applied for liquidity measurement.

Supply of Foreign Currency Closing Balance of All Nostro a/c.

Plus

Export bills realization

Plus

Inward Remittance

Plus

Encashment of FC

Total Supply of FC Demand of Foreign Currency Import bills payment Plus

Outward remittance

Total Demand of FC (Total Supply of FC - Total Demand of FC)= Net liquid position of Foreign Currency After deciding bank’s liquidity either in short/ long position the Dealers may square up by participating in inter-bank dealing market.

NOSTRO Management: After liquidity is maintained Dealing room should maintain the Nostro Position according to the movement of Nostro.

Model Control Policy: Any banking organization and particularly the treasuries use models for the following reasons: •

To generate valuations used in the various financial statements

•

To produce market risk measurements used by independent risk management to monitor risk exposures

All financial models that are used for updating the organization’s independent risk monitoring, must be validated and periodically reviewed by qualified personnel independent of the area that creates such models. The models include valuation and risk measurement systems that are developed in-house, certain models on spreadsheets, and models within vendor systems.

Model Validation is the process through which models are independently and comprehensively evaluated by reviewing underlying assumptions, verifying mathematical formulae, testing the models to verify proper implementation and assessing any weaknesses and ensuring appropriate application. The validation process of a model reduces the risk associated with using a model that has flaws in the underlying assumptions, errors in its implementation and/or is used inappropriately.

Model Validation is generally performed only once on a model – subsequent revalidations on previously validated models are required only if analytic changes are made to the model that affect valuation and/or risk measurement calculations. Model Assumption Reviews must be conducted at least annually, or more frequently as warranted by business and market conditions.

The originator of a model must ensure that it is documented, resides in a control environment and any change to an existing model is reported. The Treasuries using the financial models, in conjunction with their systems support group, are ultimately responsible for ensuring that all models reside in control environments.

A model validation process is not applicable to financial models which only perform simple arithmetic operations. These may include, but are not limited to, value-at-close calculations, earnings-at-risk calculations, interest accrual calculations, and aggregation or consolidation of risk exposures to compare against risk limits.

Exchange Position Management: Dealing Room must ensure to prepare at daily basis the Foreign Currency Exchange Position: the regulatory requirement of Bangladesh Bank and to maintain the limit of the same set by them.

Record Keeping: Dealers must maintain proper records of all deals on daily basis duly authenticated.

Maintaining Blotter: Dealers will maintain the blotter properly. Once a deal is done, the dealer will record the deal immediately on the blotter and update the position.

Guideline for Back Office & General Control Procedure Front Office and Back Office duties and reporting lines are segregated for Foreign Exchange dealing. Following are the general guidelines for back office and system control procedure: General Guidelines for Back Office: Deal Confirmation: As per the deal slip, confirmation letter is prepared and forwarded to the counter party.

Counter party’s confirmation is also checked with the confirmation letter of Mercantile Bank Limited.

Deal Settlement: Deals to be settled as per the deals and as per value date. Settlement to be done to the agreed account. Deal settlement to be checked on regular basis.

NOSTRO Account Reconciliation: Mercantile Bank Limited maintains various nostro accounts in order to conduct operations in different currencies. Nostro account reconciliation will be done by the back office. System will automatically reconcile the entries as per the rules set in the system. After every closure of business day the statement of reconciliation status is reported by the system which is verified by the back office on regular basis.

Compliance of Front Office Operation and Settlement of Disputes: For each and every transaction the following areas have to be complied with the guideline, central bank’s regulations and market practices: a) All rate applied for customer transaction(s) must be guided by rate sheet and for inter-bank transaction(s) the rate should be as per the market. For cross checking purpose, regularly the consolidated rate sheet of BAFEDA should be consulted. b) Counter Party Limit should be monitored on transaction basis. c) For settlement(s) of inter-bank market SSI should be up-dated on regular basis.

d) For any delay / non-settlement of deal by counter-party should be taken into consideration immediately for necessary settlement within reasonable time. e) Any claim regarding delay/ non-settlement of deal from the part of the bank should be checked and settled within reasonable time.

Reports Generation: The management usually gets the transaction detailed and other positions by the reports generated by the system. The reports are known as BO reports.

In addition to this

Management can see the position at any time by logging into the system.

Record Keeping and Reviewing: Back office will maintain the records properly for reporting and reviewing purpose. Records and reports should be provided to the competent authority as and when needed.

General Control Procedure by the System: 

Back office operation will be under an automated platform.



Controlled access to the system to be ensured through a User Profile defining activities containing user ID and password.



Dual access control through maker and checker roles to be ensured.



Maker should save the contract of the transaction in the system to be checked with source document and duly authorized by the authorizer.



Authorizer must be a designated person who is different than the maker.



Accounting entries has to be system controlled and parameterized as per Mercantile Bank Limited’s GL concept.



The unique User ID and a secret password will be duly selected and approved by the competent authority.



For any activity involving movement of funds and/or addition or modification of information, MIS tracing or any other activities, users (maker and checker) shall be accountable. There should be user level responsibility to make sure that the activity has been done properly.



Source documents should also be maintained properly.



Performed jobs should be re-checked again by a different officer (third party) on daily basis as per access authority and role profile.



End of Day (EOD) transactions to be rechecked by the user before leaving the office.



Every user should keep her/his password secret for safety and security of the Bank as well as that of own self. User also should keep in mind that unique User ID and secret password is as good as signature.



Under no circumstances any password should be disclosed. Any user, ownself, will be able to change own password as and when needed and a system driven reminder will be available for this purpose.



There should be end of cycle approach in the system to trace out any unauthorized entry.



The EOD will be carried out by a separate department/users posted in Information Technology (IT) Department.

Management Reporting & Reviewing Reporting to Senior Management: All deals the dealers make will be verified by the treasury back-office on daily basis. If there is any exception/anomaly found by the back office will be reported to the senior management immediately as “Exception Report”.

In addition to the above the treasury front-office will summarize daily, weekly and monthly transaction position and submit the following reports to the senior management.

-

Statement of Exchange Position (currency-wise)

-

Transaction Summary

-

Fund Management Report

Reviewing of Rates (FX & FC Interest) By ALCO : Asset Liability Committee (ALCO) will periodically review Foreign Exchange Rates and Foreign Currency Interest Rates after having market analysis and review by the treasury department. For any contingency situation ALCO members should be communicated immediately by the treasury and ALCO meeting should be arranged accordingly for ultimate decision.

Now that we have known about the policy and guideline for dealing room, guideline for Back Office and general control procedure, and how reports are generated and managed; we will

now take a look at the process of dealing and the related risk associated with this and also compare it with that of standard set by Bangladesh Bank.

Process of Transaction In a proper treasury setup, a dealer strikes a deal in the market and maintains his/ her own record for monitoring the exchange position. Within a reasonable time, s/he passes on the detailed information of the deal to the treasury back office. The back office arranges for the deal confirmation with the counterparty, arranges settlement, reconciles exchange positions and advises to treasury and runs the valuation on a periodic basis. A detailed flowchart of this function is shown below

ANNEXURE V

The Process Flowchart

Dealer strikes a deal

Enters deal into blotter, raises deal ticket, sends ticket to treasury back office

Treasury back office exchanges deal confirmations with counterparty Passes all necessary entries

Advises treasury of accurate position

Reconciles exchange position

Settles the deal

Fig 11: Process Flowchart of Dealing The dealing function requires the dealers to make very quick decisions either for taking advantages of any market movements or for unwinding an unfavorable position. Also, the treasury dealing is a wholesale function that involves large lots. These together make the job of a dealer requiring: -

Proper information sources e.g. Reuters Money 2000, Bloomberg, financial TV channels etc.

-

Adequate and dedicated communication tools e.g. Reuters Dealing System, telephone, fax, telex etc.

-

Specially designed dealing desks to appropriately accommodate the various information and communication tools

-

High level of dealing skills

-

Quick decision making authority

-

Independent decision making authority

-

Specific task allocations

In order to achieve the optimum level of efficiency, returns and most importantly controls, there are certain processes that the organization’s management must put in place. The next chapter will discuss whether Mercantile Bank Limited is complying with the guidelines provided by Bangladesh Bank Terminology: Following are the explanation of some terminologies used in this manual: 

Counter-party Limit Books: Books containing the limits approved for different counter-party.



Exchange Position: Exchange position refers to the position of FCY to be reported as per prescribed format of Bangladesh Bank.



Inter-bank Transactions: Inter-bank Transactions indicates the transactions which involves the banks and financial institutions in the inter-bank market.



Limit and Sub-Limit: Limit and Sub-Limit expresses the approved aggregate value for particular currency (currency limit) either booked as asset or as liability.



Merchant Transaction: Merchant Transaction indicates those transactions which involves in-house customers i.e. exporter, importer and remitter of the bank.



Open Position Limit:

Open Position Limit indicates the limit approved by

Bangladesh Bank for maximum long and short aggregate currency position in equivalent USD. 

Position Taking: Position Taking refers to the transactions for which dealers enter into buy / sell in a particular currency with profit motive through speculation.



Proprietory Position Taking: Same as position taking.



Revaluation: Revaluation of both FCY asset and liability as per standard mid rate of day’s rate sheet.



Un-matched Forward Exchange: Un-matched Forward Exchange indicates that the legs of forward contract are un-matched in terms of amount and tenor.

Instrument

Rate Band

Spot Inter-bank For currencies other than BDT, for contracts with USD FX on one side, a 1% on each sides of the mid market rate can be taken as a guidance. For BDT it can be within 5 paisa either side of the base rate.

on

Spot CustomerFor Spot Customer FX, the band can be 2% on either FX side.

Non BDT side.

For CHF, EUR, GBP, JPY this can be 50 pips on either crosses

Forward 25 pips on either side of the base swap rate for currencies inter-bank FX against USD other than JPY. 25 bps on either side of the Swaps base swap rate for JPY. FCY Borrowing/ 25 bps on either side of the base rate (quoted on Reuters Lending for the particular tenor) for on and off-shore deals.

Call/ Notice Money

1% on either side of mid rate of range reported on Reuters BD page/ newspaper.

Instrument Spot Inter-bank

Rate Band For currencies other than BDT, for contracts with USD FX on one side, a 1% on each sides of the mid market rate can be taken as guidance. For BDT it can be within 5 paisa on either side of the base rate.

Spot CustomerFor Spot Customer FX

For Spot Customer FX, the band can be 2% on either FX side.

Forward

25 pips on either side of the base swap rate for currencies inter-bank FX against USD other than JPY. 25 bps on either side of the Swaps base swap rate for JPY.

FCY Borrowing

25 bps on either side of the base rate (quoted on Reuters Lending for the particular tenor) for on and off-shore deals 1% on either side of mid rate of range reported on Reuters BD page/ newspaper

Call/Notice Money

Terminology: Following are the explanation of some terminologies used in this manual: 

Counter-party Limit Books: Books containing the limits approved for different counter-party.



Exchange Position: Exchange position refers to the position of FCY to be reported as per prescribed format of Bangladesh Bank.



Inter-bank Transactions: Inter-bank Transactions indicates the transactions which involves the banks and financial institutions in the inter-bank market.



Limit and Sub-Limit: Limit and Sub-Limit expresses the approved aggregate value for particular currency (currency limit) either booked as asset or as liability.



Merchant Transaction: Merchant Transaction indicates those transactions which involves in-house customers i.e. exporter, importer and remitter of the bank.



Open Position Limit:

Open Position Limit indicates the limit approved by

Bangladesh Bank for maximum long and short aggregate currency position in equivalent USD. 

Position Taking: Position Taking refers to the transactions for which dealers enter into buy / sell in a particular currency with profit motive through speculation.



Proprietory Position Taking: Same as position taking.



Revaluation: Revaluation of both FCY asset and liability as per standard mid rate of day’s rate sheet.



Un-matched Forward Exchange: Un-matched Forward Exchange indicates that the legs of forward contract are un-matched in terms of amount and tenor.

Instrument

Rate Band

Spot Inter-bank For currencies other than BDT, for contracts with USD FX on one side, a 1% on each sides of the mid market rate can be taken as a guidance. For BDT it can be within 5 paisa either side of the base rate.

on

Spot CustomerFor Spot Customer FX, the band can be 2% on either FX side.

Non BDT side.

For CHF, EUR, GBP, JPY this can be 50 pips on either crosses

Forward 25 pips on either side of the base swap rate for currencies inter-bank FX against USD other than JPY. 25 bps on either side of the Swaps base swap rate for JPY. FCY Borrowing/ 25 bps on either side of the base rate (quoted on Reuters Lending for the particular tenor) for on and off-shore deals.

Call/ Notice Money

1% on either side of mid rate of range reported on Reuters BD page/ newspaper.

Instrument Spot Inter-bank

Rate Band For currencies other than BDT, for contracts with USD FX on one side, a 1% on each sides of the mid market rate can be taken as guidance. For BDT it can be within 5 paisa on either side of the base rate.

Spot CustomerFor Spot Customer FX

For Spot Customer FX, the band can be 2% on either FX side.

Forward

25 pips on either side of the base swap rate for currencies inter-bank FX against USD other than JPY. 25 bps on either side of the Swaps base swap rate for JPY.

FCY Borrowing

25 bps on either side of the base rate (quoted on Reuters Lending for the particular tenor) for on and off-shore deals 1% on either side of mid rate of range reported on Reuters BD page/ newspaper

Call/Notice Money