Discuss the importance of foreign exchange management for the survival and viability of a treasury function in the banking sector.

Question

Discuss the importance of foreign exchange management for the survival and viability of a treasury function in the banking sector.

Answer

The market for trading foreign currencies (often referred to as the FOREX market) is a highly liquid sector of the global economy (Bernstein, 2011). The daily transaction volume taking place on the FOREX market is the highest in comparison to other markets, estimated to be 5.3 trillion USD (McLeod, 2016). The FOREX market plays an important role in facilitating international capital flows, which is a critical component to ensure a long-term and sustainable economic growth (Lien, 2006). However, because the FOREX market is considered to be an OTC market (over-the-counter, meaning that the market is not overseen by regulatory agencies), the risk associated with FOREX trade could be particularly high (Bernstein, 2011). This means that banks and other financial institutions must devise strategies to mitigate their foreign exchange risk exposure. In banks, it is the treasury function which is responsible to devise hedging strategies against currency risk (Chorafas, 1992). Many commercial banks hold assets in foreign currencies, so any sudden movement in the value of a given currency (such as the quick depreciation of the GBP in the aftermath of the Brexit referendum) can be financially devastating. The factors which ultimately determine the banking sector’s FOREX risk strategy are the materiality of the FOREX exposure, the volatility of the currency and the risk appetite of investors and other stakeholders (Bernstein, 2011). To conclude, due to the high-risk nature of the FOREX market, it is a must both for commercial banks and for the global economy in general to manage their foreign currency risk exposure to ensure their survival during financially volatile times.

References

Bernstein, J. (2011) The complete day trader: Trading systems, strategies, timing indicators, and analytical methods. New York: McGraw-Hill Professional. Chorafas, D. N. (1992) Treasury operations and the foreign exchange challenge: A guide to risk management strategies for the new world markets. New York: Wiley, John & Sons. Lien, K. (2006) Day trading the currency market: Technical and fundamental strategies to profit from market swings. Hoboken: John Wiley. McLeod, G. (2016) Daily FX. Available at: https://www.dailyfx.com/forex/education/trading_tips/daily_trading_lesson/2014/01/24/FX_Market_Size.html (Accessed: 20 October 2016).