Luận văn thạc sĩ UEH risk management of exchange rate in forex trading case study of commercial banking system in ho chi minh city , luận văn thạc sĩ

Rationale of the study

Viet Nam has gradually integrated into the global economy arena after officially becoming a member of the world trade organization (WITCO) at the end of year 2006 Together with the process of economy liberalization, the priority of economic sectors is financial banking industry This opportunity help Viet Nam banks get favorable conditions in banking activities but also face with a lot of pressure on competition The economy liberalization leads to liberalizing capital flows, interest rate and foreign exchange rate… The current financial crisis clearly shows how complex financial market is and that risk management of exchange rate will become more important to protect commercial banks from damages or losses toward their foreign exchange operation Basically, most Viet Nam banks’ profit focus on credit operations accounting for 70 - 75% of total income and not yet concern much about preventing risk of exchange rate Nowadays the fluctuations of exchange rate, interest rate, gold price in international market have effected strongly to domestic market creating many new types of financial derivative instruments and investment funds which forced commercial banks to protect themselves by using more hedging tools in foreign exchange operation; Therefore, Vietnamese banks need to upgrade capacity of risk management, especially risk of exchange rate that will be considered in this research study and contribute some improvements for managing risk of exchange rate of commercial banking system in Ho Chi Minh City (HCMC).

Research problem

Structure of the study

Chapter I reviews the rationale of the study, and presents research problem, research methodology, subjects and scope of the study, significance of the study

Chapter II examines the background information of the foreign exchange market, the characteristics and development of the Viet Nam foreign exchange market Especially, this chapter is also to review some foreign exchange literature and methods of exchange rate risk management used for commercial banks in theory to identify, analyze and measure risk of exchange rate in foreign currency trading operation

Chapter III is to describe, justify, and explain the research methodology used in the study The research process starts from problem definition, which include exploratory research conducted to clarify ambiguous problems After identifying research problem, the research design must be developed A research design is a master plan specifying the methods and procedures for collecting and analyzing the needed information to answer the research questions outlined in chapter I

Survey a real case of commercial Banking System in HCMC is presented in chapter IV This chapter presents descriptive findings of exchange rate risk management practices Objectives of this chapter are (1) to observe the current situation of foreign exchange operation in foreign currency trading operation of commercial Banking System in HCMC from

2007 to 2009 and the real application of derivative instruments for preventing exchange rate of commercial banking system in HCMC, (2) to point out practical issues to be solved in risk management of exchange rate (3) to evaluate outcome performance of risk management of exchange rate risk of commercial banking system in HCMC of which the highlights of achievements, shortcomings as well as main causes effects to risk management of exchange rate risk of commercial banks in HCMC

Finally, chapter V will provide some conclusions and recommendations for improving risk management of exchange rate of commercial banking system in HCMC.

Limitations of the study

The foreign exchange market is one of complex financial market affected by many economic factors in which Vietnamese bank is one of subjects participating in the market and facing with many difficulties Methods of risk management of exchange rate mentioned in this research study mainly focus on risks of exchange rate towards foreign currency trading operation of commercial banking system without doing researching on interest rate risk, liquidity risk, operational risk, country risk, legal risk

To enhance risk management of exchange rate of commercial banking system efficiently, the research study needs to learn more about the risk management of exchange rate in relationship between foreign currency trading operation and credit operation, capital mobilization as well as other investment activities

Due to the restrain of author’s experiences, the research study could not solve all aspects of risk management of exchange rate that will continue to be completed by other research.

Conclusions

The research problem of risk management of exchange rate in foreign currency trading operation of commercial banking system will be explored and clarified to provide some recommendations for improvement of risk management of exchange rate through practical issues pointed out in foreign currency trading operation of commercial Banking System in HCMC

The method of risk management of exchange rate of commercial banks is more complicated than that of company because commercial banks have a lot of forex transactions with many types of foreign currency and different durations which create receivables and payables in foreign currency of balance sheet of commercial bank Therefore, the research study hopes for contributing a part of solutions on risk management of exchange rate in foreign currency trading operation of commercial banking system in HCMC

Introduction to the foreign exchange market

The Viet Nam foreign exchange market (VINAFOREX)

The establishment and development of Vietnam foreign exchange market was in connection with economic revolution in the late 1980s and in the early 1990s, the study focus on some important periods as follows: a Foreign exchange center from 1991:

With decision no 207/NH-QĐ dated 16/08/1991 issued by SBV regarding to establishment of foreign exchange centre operating as official foreign exchange market for following objectives:

- To establish an official foreign exchange market among commercial banks and economic units

- To assess and measure supply and demand of foreign currency in the market

- To issue official exchange rate between USD and VND

- To prepare initial conditions for establishment of financial market in the future

After working three years with two trading sessions per week on Tuesday and Friday at Hanoi Capital and Ho Chi Minh City, Foreign exchange center ended transactions by establishing an interbank foreign exchange market b Interbank foreign exchange market from 1994 – 1998:

The Interbank foreign exchange market was established under decision no 203/NH-QĐ dated 20/09/1994 issued by Governor of SBV in order to set up an organized market for dealing foreign exchange transactions among commercial banks and create foundation for activities of foreign exchange market in the future In addition, through interbank foreign exchange market, the SBV can intervened into market efficiently in order to implement national monetary policy Before 1998, foreign exchange transactions in Vinaforex market primarily are spot transactions In 1998, Forward and Swap transactions have been taken officially c Market for Derivatives from 1998 until now:

Forward and Swap transactions have been conducted formally under decision no 17/QĐ-NHNN7 dated 10/01/1998 guiding regulations of foreign exchange operations According to this foreign exchange regulations, almost commercial banks participating into transactions have to negotiate amount of currency to be paid at the forward rate fixed in the future within the limit of margins stipulated by SBV recently At the beginning, SBV has granted operation licenses for 28 commercial banks to conduct forward and Swap transactions in which there are 21 foreign bank branches, 7 Viet Nam commercial banks (4 state-owned banks and 3 Joint stock commercial banks) From 1998 until now, almost commercial banks including state-owned banks, Joint stock commercial banks, Joint venture banks and foreign bank branches have launched out into forward and swap transactions

In 2002 with the approval by SBV, the Eximbank (EIB) experiments with option transactions of strong currencies like EUR, AUD, SGD against USD

After that, some commercial banks in HCMC like ACB, VAB, and TCB also get permission of option transaction from SBV Option transactions could be expanded its scope of trading between USD and VND instead of trading on EUR/USD or AUD/USD as before Otherwise, it also used in gold option At present, SBV requested commercial banks to stop conducting option USD/VND by issuing decision no 1820/NHNN-QLNH 18/03/2009 d Organization and operation of VINAFOREX market:

VINAFOREX market was established from 1991 when the Vietnamese economy transforms into market economy After 18 years, VINAFOREX market has developed significantly on scope of activities as well as types of transactions and has attracted the participation of enterprises and commercial banks in both international and domestic market

Regarding structure and operation of VINAFOREX could be described as model below:

It show that commercial banks act as intermediary to carry out foreign exchange transactions in order to satisfy the need of clients, enterprises, especially import-export companies Besides, commercial banks also trade in foreign currency each other through interbank foreign exchange market domestic and international to aim at profit target and ensure balance of foreign currency positions and reduce risks to minimize.

Exchange rate and risk management of exchange rate….…

Definition of exchange rate

Exchange rate is the price at which one currency is exchanged for another or one currency to be presented by an amount of other currency

Example: 1 USD = 19.000 VND which mean that the price of 1 USD is displayed by amount of 19.000 VND.

Classification of exchange rate

In reality, we usually see some types of exchange rates as follows: a Bid and Offer exchange rate:

Bid rate is a bank buying rate at which banks use to buy a reference currency

Offer rate is a bank selling rate at which banks use to sell a reference currency Bid rate is often preceded and lower than Offer rate

Ex: Citibank quote EUR/USD = 1.4725 – 1.4735 in which the preceded rate of 1.4725 is bid rate of EUR (selling USD), the post rate of 1.4735 is Offer rate of EUR (buying USD) b Spot and forward exchange rate:

Spot exchange rate is an exchange rate that is negotiated today but exercised on the second working day after signing day of contract Forward exchange rate is an exchange rate that is negotiated today but exercised over three working day after signing day of forward contract c Banknote and transfer exchange rate:

Exchange rate of banknotes are listed for cash & cheque

Transaction exchange rate are used for transaction currency Normally, bank note buying rate is lower than transaction rate and bank note selling rate is often equal or higher than transaction rate d Open and Closing rate:

Open rate is an exchange rate used for the first deal of working day Closing rate is an exchange rate used for the last deal of working day Normally, banks do not list all exchange rates signed in working day but announce closing rate

The closing rate is an essential criterion showing fluctuation of foreign exchange rate within working day Note that closing rate today may be not open rate for tomorrow e Official exchange rate:

Official exchange rate is an exchange rate issued by central bank, reflecting the value of domestic currency against foreign currency Official exchange rate often used in calculating import and export taxation and several foreign exchange activities of government such as short, medium and long term loans

In addition, the Official exchange rate established through Interbank averaged exchange rate market is the basis for commercial banks to define transaction rates within trading band regulated by central bank f Free market exchange rate (free market exchange rate):

Free market exchange rate is set up depending on supply and demand of foreign currency in the free market g Nominal and Real exchange rate:

Nominal exchange rate is expressed as a rate between two currencies after taking inflation into account

Real exchange rate is an actual rate of exchange reflecting correlative purchasing power between two currencies h Crossed exchange rate:

Crossed exchange rate is an exchange rate derived from the third currency (intermediate currency) i Fixed and Floating exchange rate:

Fixed exchange rate is issued by central bank without changing Under the pressure of supply and demand in the market, to maintain Fixed exchange rate central bank must intervene into market permanently

Floating exchange rate is set up basing on supply and demand relation in the foreign exchange market, central bank do not need to interfere into foreign exchange market.

Types of foreign exchange transactions

Spot transaction

rate, the value date is the next 2 working days This kind of transactions are popular in Vinaforex market and being carried out by most commercial banks.

Forward transaction

binding obligation to buy or to sell a certain amount of currency at a pre- agreed rate of exchange on a certain future date

2.3.3 Swap transaction is a transaction between two parties to exchange cash flow of two currencies at periodic intervals over a predetermined period of time (e.g swapping from USD to JPY) In a cross currency swap, there is physical exchanges of principals at maturity The equivalent amount based on the initial spot exchange rate unlike the standard interest rate swap There are two kinds of swap transactions as follows:

- Currency swap including spot and forward transaction: conducted at the same time in buying spot transaction and selling forward transaction or vice versa

This kind of currency swap is very popular in foreign exchange market

- Currency swap including two forward transactions: conducted at the same time in buying and selling two forward transactions at a pre-agreed rate of exchange on two different future dates

2.3.4 Future transaction is a contract for specific quantities of given currencies by which the exchange rate is fixed at the time the contract entered into and the delivery date is set by the exchange Actually, Futures contracts are the standardized forward contracts that trade on organized futures markets for specific delivery only Future contract is standardized on kind of currencies traded; size of contract; delivery date using as a hedging tool as well as speculation to take full advantage of foreign exchange rate in consistence with market trends.

Option transaction

but not obligation, to buy or sell a quantity of underlying asset at a predetermined price for a specific maturity (otherwise, to buy or sell a specific amount of currency at a specific exchange rate on or before a specific future date) For the right, the buyer typically pays a fixed price which is referred to as option premium The seller of the option correspondingly has obligation to meet the financial responsibilities in the event the buyer decides to exercise this right

There are two types of currency options as the following:

- European option can be exercised only on expiry date

- American option can be exercised on or before the expiry date.

Risk management of exchange rate

Definition of risk management of exchange rate

- Risk management is the process consisting in the identification, measurement and control of risks within a level coherent with the risk appetite of the institution

- Risk management of exchange rate in foreign exchange operation includes the contents of the identification, measurement and control of risks caused by fluctuations of exchange rate towards open forex position by using solutions for preventing risk of exchange rate

- Purposes of risk management of exchange rate

+ To protect commercial banks from serious losses without anticipating the worst in foreign exchange operation

+ To prepare for disadvantageous changes of exchange rate towards foreign exchange operations

+ To reduce the sensitive market movements towards foreign exchange operation

+ To strengthen the competitive advantages

+ To regulate the risk of exchange rate and catch the business opportunities

2.4.2 Factors influencing risk management of exchange rate

- International trade comprises of import and export operations and other foreign investments An increase in export activities will get supply of foreign currency raised, in condition that other factors remain unchanged exchange rate will be decreased On the contrary, an increase in import activities will get foreign exchange rate increased due to demand of foreign currency going up Likewise an increasing foreign investment into host country will increase the supply of foreign currency that make exchange rate between foreign currency and local currency going down

- CPI (customer price index) affects the exchange rate between foreign currency and local currency through an increase in price of domestic product higher than price of global product which means that import goods are cheaper and export goods become more expensive relatively so the supply of foreign currency will decreases and demand of foreign currency increases On the contrary if a decrease in price of domestic product lower than price of global product will cause the foreign exchange rate to raise

- Interest rate is the price of a capital used by borrower Thus if there is a different interest rate of currencies among countries it make cash flow transfer In the event that real interest rate of local currency is higher than real interest rate of foreign currency, asset in local currency will be more attractive than asset in foreign currency and the cash flow of asset in foreign currency will transfer into asset in local currency In forex market, those activities cause changes to a decrease in demand of foreign currency and an increase in supply of foreign currency and vice versa

- Growth rate of relative income: If there is an increase in local country’s income higher than foreign country’s income, the import will raise in volume more than volume of export This make demand of foreign currency increase greater than supply of foreign currency in forex market Therefore, the local currency depreciates against foreign currency and exchange rate between foreign currency and local currency goes up

- Government policies: The government has an impact on foreign exchange rate through macro economic policies that changes three key indexes including inflation, interest rate and economic growth rate Furthermore, Government also influence on demand and supply of foreign currency by protectionism like quotas on fixed product, protective tariff and other tax rates which change price of products and return on asset (R.O.A), return on equity (R.O.E) This mean that the flow of merchandise and cash flow have been affected and transferred in and out of the country If the Government strengthen protectionism which make value of import products more expensive and reduce volume of import products; Therefore, demand of foreign currency will be decreased causing foreign currency to be depreciated and local currency raise in price and vice versa

- Market expectation: Activities of speculation have an influence on foreign exchange rate because speculators have great expectation of foreign exchange rate on a certain currency They will buy foreign currency that they expect to raise in price and sell foreign currency that they expect to reduce in price Through this activities, speculators can cause fluctuations of foreign exchange rate in the forex market

- Psychology of investors is an important factor affecting to foreign exchange rate If many investors trusted one foreign currency raising in price, especially USD, the demand of USD will increase Thus, exchange rate between USD and VND will go up

Besides, in the event of political and economic environment changes, affect to supply and demand of foreign currency and cause volatility of foreign exchange rate

2.4.3 Identification of risk of exchange rate

Basically, foreign exchange operation contains high risks Next to normal risks, banks have to face with interest rate risk, credit risk, settlement risk, technical risk, operation risk, legal & regulatory risk and country risk, foreign exchange operation have to stand one more special risk, “exchange rate risk” Due to changing exchange rate frequently and pointlessly, risk of exchange rate is considered as a permanent risk in connection with characteristics of foreign exchange operation of commercial banks

In the foreign exchange operation, there are three basis measures to make profits as follows:

- Profits arising when dealers create foreign exchange position that could be made by buying or selling a certain currency and waiting for exchange rate movements, then dealers trade off foreign exchange position and get profits

- Profits taken by arbitrage that buying one currency with the low price at one place and selling this currency with high price at other place aim at earning profits without risks in short time Due to behaviors’ buying or selling at the same time and same volume, arbitrage do not bear risk of exchange rate because of not creating foreign exchange position

- Profit taken from differences between bank buying rate and bank selling rate because bank buying rate is often lower than bank selling rate so that the differences mentioned above is bank’s profit In fact, commercial banks play the role of service providers on behalf of clients to buy or to sell foreign currency; Therefore, banks do not accept the risk of exchange rate

Through analysis mentioned above, forex dealers only face with exchange rate risk when maintaining open position Open position of a certain currency is difference between asset and liability (in and off balance sheet) of a certain currency at one point of time All transactions that make transferring the ownership of foreign currency (present or future) will create open position in which trading currency is mainly done Thus, in reality banks only manage well foreign exchange position to prevent risk of exchange rate

If total asset is greater than total liability (In and Off balance sheet of one currency), this currency is called long position When this currency has appreciated in value creates forex profits On the contrary, when this currency has depreciated in value causes forex losses

If total asset is smaller than total liability (In and Off balance sheet), this currency is called short position When currency has appreciated in value causes forex losses On the contrary, when currency has depreciated in value creates forex profits

Risk management of exchange rate with Long or short position in

2.4.5 Risk management of exchange rate with Long or short position in net exposure:

- Definition: Net Exposure (NEi) with the same duration for one foreign currency is defined as the gap between asset and liability adding net forex position of that currency at the same duration We have the formula as follows

- Ai and Li are asset and liability in foreign currency i

- CLi and CSi are positions of buying or selling currency i

If NEi > 0 when foreign currency i drop in price, bank gets loss of net exposure

If NE < 0 when foreign currency i raise in price, bank gets loss of net exposure

Example : ABC bank have transactions with same duration of 3 months as follows:

Buying 3.000.000 USD and selling 4.600.000 USD Lending 3.420.000 USD and mobilizing 3.350.000 USD

= -1.500.000 USD So NE USD < 0 and USD raise in price when it become due after three months ABC bank will get loss of net exposure of USD.

Risk management of exchange rate with Long or Short position in

In fact, banking transactions such as activities of mobilizing and lending as well as currency trading have related to many different durations and several types of currency so that defining net total position of foreign currencies with different durations become so complicated

- Definition: Net Total Exposure (NTE) with the different duration for one foreign currency is defined as Net Exposure of every forex transaction after adjusting durations of transaction that can be measured as follows:

- Ri is value of transaction i of term-receivable of foreign currency (such as lending, buying bonds & bill of exchanges, investing in foreign currency and forward buying transactions

- Pj is value of transaction j of term-payable of foreign currency (such as deposits, issuing bonds & bill of exchanges, receiving foreign investments and forward selling transactions

- D is the averaged duration of all currency transactions

- Ni and Nj is correlative duration of receivables i and payables j (i,j 1,2,3,4…)

If NTE > 0 and foreign currency drop in price, bank gets loss of net total exposure

If NTE < 0 and foreign currency raise the price, bank gets loss of net total exposure

Therefore, either NEi or NTE is open (positive or negative) banks have to make decisions : (1) Accepting open position bank may get profit or loss due to fluctuations of exchange rate between foreign currency and local currency; (2) Using solutions to hedge risk of exchange rate Based on needed information, bank can predict trends of exchange rate to set up an expected exchange rate in the future and depend on bank manager’ behaviors toward exchange rate risk to decide

In order to manage risk of exchange rate when forex position is long (NEi or NTE >0) or short (NEi or NTE0 NE i or NTE 0, that means ACB has receivables greater than payables and face with exchange rate risk when USD drop in price In order to avoid this net total exposure, ACB can conduct the following measures:

+ Selling forward contract with the average duration of 3.07 months (92 days) or + Buying put option with the average duration of 3.07 months or (92 days)

Classification of risks associated with foreign exchange operation.33

- Operational risk: risks caused by non financial factors which include systematic risks; human being risks and accidental risks

- Liquidity risk: happens when banks can not conduct their business due to weak liquidity problem of market (no one want to do business or participants joining market have same demands)

- Settlement risk is possibility of loosing money happens when partners do not make payment for sales contract at the delivery date due to certain reasons

- Counterparty risk is possibility of transaction exposure happens prior to the delivery date of contract, partners become creditworthiness (or insolvency)

- Market risk is the essential risk causing transaction exposure When the fluctuation of exchange rate or interest rate in the market happens making banks get losses or damages at the time banks hold a certain currency position

2.5 Legal foundations for spot transactions and derivative transactions:

- Decision no 16/1998/QD-NHNN7 dated 10/01/1998 issued by Governor of SBV, guiding for forward rate and swap rate setting

- Decision no 17/1998/QD-NHNN7 dated 10/01/1998 issued by Governor of SBV promulgating regulation of foreign exchange operation

- Decision no 18/1998/QD-NHNN7 dated 10/01/1998 issued by Governor of SBV promulgating regulation of forex position towards credit institutions permitted for foreign exchange operation

- Decision no 1081/2002/QĐ-NHNN dated 07/10/2002 issued by Governor of SBV guiding banks to report forex position at the end of the day and month

- Decision no 65/1999/QD-NHNN7 dated 26/02/1999 issued by Governor of SBV, stipulating an announcement of Interbank average exchange rate instead of proclaiming official exchange rate (with trading band +/-0.25%)

- Decision no 893/2001/QD-NHNN dated 17/07/2001 issued by Governor of SBV, prescribing swap transaction between SBV and commercial banks

- Decision no 679/2002/QD-NHNN7 dated 01/07/2002 issued by Governor of SBV, stipulating spot exchange rate, forward rate, swap rate and level of increasing percentage of forward rate USD/VND for every durations

- Decision no 648/2004/QD-NHNN7 dated 28/05/2004 issued by Governor of SBV, supplementing decision no 679/2002/QD-NHNN7 guiding banks to setting forward rate and expanding duration of forward transaction

- Decision no 1452/2004/QD-NHNN7 dated 08/12/2004 issued by Governor of SBV, explaining types of transactions, subjects participating, scope of foreign exchange transactions, durations of transaction and abiding regulation of foreign currency position This decision has taken the place of decision no 17/1998/QD-NHNN7 dated 10/01/1998

Through this chapter, we can take a look at main characteristics of international forex market and Vinaforex market in particular Several concepts related to exchange rate and types of forex transaction have made senses The key points of this chapter are to learn how to identify exchange rate risk and gain measures of analysis and measurement in theory to mitigate risk of exchange rate of commercial banks

In reality, commercial banks will base on decision no 1081/QĐ-NHNN issued by Governor of SBV to define forex position at the end of the day As a result of forex position (positive or negative), banks can manage risk of exchange rate towards all foreign currency transactions as deposit, lending, buying and selling foreign currencies (spot and forward transactions) by accepting open position to get profit if fluctuations of exchange rate are consistent with expected exchange rates or using solutions to prevent risk of exchange rate through interbank foreign exchange market with derivative instruments

Chapter II reviewed relevant literature on how to identify, analyze and measure exchange rate risk of commercial banks in theory The research objectives were created based on the literature and the reality of exchange rate risk management of commercial banking system in HCMC

The purpose of this chapter is to describe, justify, and explain the research methodology used in the study The research process starts from problem definition which includes exploratory research and a research design must be developed to set up a master plan specifying the research methods and procedures for collecting and analyzing the needed information to answer the research questions outlined in chapter I

This chapter is structured into five sections Section 3.1 generally introduces the chapter including the main contents, objectives and structure of the chapter Section 3.2 discusses and explains how the research design can be appropriately utilized in this study to answer the research questions Section 3.3 mentions methods of data collection Section 3.4 presents data analysis, which will be conducted in chapter IV of the study Finally, section 3.5 summarizes the conclusions drawn from the chapter

This section examines the types of research in terms of classification, purpose and techniques and then, explains how the research design is selected as the most appropriate for the study

In order to explore research problem of risk management of exchange rate in foreign currency trading operation of commercial banking system in HCMC, the qualitative research as a form of exploratory research is most appropriate to clarify the ambiguous research problem mentioned through literature review and the current foreign exchange operation of CBS-HCMC that are investigated and described in the research study

According to Zikmund (1997) classified research methods into four basic types: surveys, experiments, observation, and secondary data studies In this research, survey and secondary data methods were utilized Survey was chosen as a research method in this study to investigate and clarify risk management of exchange rate of commercial banking system in HCMC The argument for choosing survey was based on two major reasons Firstly, survey provides a quick, efficient and accurate means of assessing information about the population Secondly, survey is more appropriate where there is a lack of secondary data In this case, secondary data of risk management of exchange rate of commercial banking system in HCMC is insufficient; thus, conducting a survey to gain information about rate risk management of exchange rate of commercial banking system in HCMC was in mainstream Selection of appropriate methods to communicate with respondents (banking experts) was very important in the surveys This selection may be based on the possibility of communicating with respondents and the budget allocated for the research

Therefore, this study used personal interview as a method to obtain information about risk management of exchange rate from the responses of experts and managers of commercial banking system in HCMC

In addition to using personal interview to obtain primary data relative to risk management of exchange rate of commercial banking system in HCMC, the secondary data method was also used to examine them The financial ratios as forex turnover, forex return ratios, return ratios of spot, gold and derivative, total income before tax ratios… were derived from financial statements These financial statements were available from SBV of HCMC branch for period from 2007 to 2009

Based on introduction of the thesis stated in chapter I, the respondents of research question must satisfy the research objectives to make sure that the information collected is appropriate for solving the research problem This study has the following research questions a Why does the risk management of exchange rate of commercial banks have to be considered and What are the factors affecting to risk management of exchange rate? b What are the current method of risk management of exchange rate and the practical issues to be solved in foreign currency trading of commercial banking system in HCMC? c What are the recommendations for improvement of risk management of exchange rate in foreign currency trading of commercial banking system in HCMC?

In seeking answer to these questions, it is essential to have information as follows:

- The current foreign exchange operation of commercial banking system in HCMC

- Reasons that commercial banking system in HCMC must conduct risk management of exchange rate

- Factors affecting to risk management of exchange rate in forex of commercial banking system in HCMC

- The current method of risk management of exchange rate of commercial banking system in HCMC with types of transactions

- The current application of derivative instruments for hedging risk of exchange rate of commercial banking system in HCMC

- The evaluation of outcome performance of risk management of exchange rate of commercial banking system in HCMC

- Experiences of commercial bank’s risk management of exchange rate

- Evaluations of SBV towards commercial banking system in HCMC’s risk management of exchange rate in FX trading

- Expectations of commercial banking system in HCMC against Forex regulations of SBV

Conclusions

Through this chapter, we can take a look at main characteristics of international forex market and Vinaforex market in particular Several concepts related to exchange rate and types of forex transaction have made senses The key points of this chapter are to learn how to identify exchange rate risk and gain measures of analysis and measurement in theory to mitigate risk of exchange rate of commercial banks

In reality, commercial banks will base on decision no 1081/QĐ-NHNN issued by Governor of SBV to define forex position at the end of the day As a result of forex position (positive or negative), banks can manage risk of exchange rate towards all foreign currency transactions as deposit, lending, buying and selling foreign currencies (spot and forward transactions) by accepting open position to get profit if fluctuations of exchange rate are consistent with expected exchange rates or using solutions to prevent risk of exchange rate through interbank foreign exchange market with derivative instruments

Introduction

Chapter II reviewed relevant literature on how to identify, analyze and measure exchange rate risk of commercial banks in theory The research objectives were created based on the literature and the reality of exchange rate risk management of commercial banking system in HCMC

The purpose of this chapter is to describe, justify, and explain the research methodology used in the study The research process starts from problem definition which includes exploratory research and a research design must be developed to set up a master plan specifying the research methods and procedures for collecting and analyzing the needed information to answer the research questions outlined in chapter I

This chapter is structured into five sections Section 3.1 generally introduces the chapter including the main contents, objectives and structure of the chapter Section 3.2 discusses and explains how the research design can be appropriately utilized in this study to answer the research questions Section 3.3 mentions methods of data collection Section 3.4 presents data analysis, which will be conducted in chapter IV of the study Finally, section 3.5 summarizes the conclusions drawn from the chapter.

Research design

This section examines the types of research in terms of classification, purpose and techniques and then, explains how the research design is selected as the most appropriate for the study

In order to explore research problem of risk management of exchange rate in foreign currency trading operation of commercial banking system in HCMC, the qualitative research as a form of exploratory research is most appropriate to clarify the ambiguous research problem mentioned through literature review and the current foreign exchange operation of CBS-HCMC that are investigated and described in the research study

According to Zikmund (1997) classified research methods into four basic types: surveys, experiments, observation, and secondary data studies In this research, survey and secondary data methods were utilized Survey was chosen as a research method in this study to investigate and clarify risk management of exchange rate of commercial banking system in HCMC The argument for choosing survey was based on two major reasons Firstly, survey provides a quick, efficient and accurate means of assessing information about the population Secondly, survey is more appropriate where there is a lack of secondary data In this case, secondary data of risk management of exchange rate of commercial banking system in HCMC is insufficient; thus, conducting a survey to gain information about rate risk management of exchange rate of commercial banking system in HCMC was in mainstream Selection of appropriate methods to communicate with respondents (banking experts) was very important in the surveys This selection may be based on the possibility of communicating with respondents and the budget allocated for the research

Therefore, this study used personal interview as a method to obtain information about risk management of exchange rate from the responses of experts and managers of commercial banking system in HCMC

In addition to using personal interview to obtain primary data relative to risk management of exchange rate of commercial banking system in HCMC, the secondary data method was also used to examine them The financial ratios as forex turnover, forex return ratios, return ratios of spot, gold and derivative, total income before tax ratios… were derived from financial statements These financial statements were available from SBV of HCMC branch for period from 2007 to 2009

Based on introduction of the thesis stated in chapter I, the respondents of research question must satisfy the research objectives to make sure that the information collected is appropriate for solving the research problem This study has the following research questions a Why does the risk management of exchange rate of commercial banks have to be considered and What are the factors affecting to risk management of exchange rate? b What are the current method of risk management of exchange rate and the practical issues to be solved in foreign currency trading of commercial banking system in HCMC? c What are the recommendations for improvement of risk management of exchange rate in foreign currency trading of commercial banking system in HCMC?

In seeking answer to these questions, it is essential to have information as follows:

- The current foreign exchange operation of commercial banking system in HCMC

- Reasons that commercial banking system in HCMC must conduct risk management of exchange rate

- Factors affecting to risk management of exchange rate in forex of commercial banking system in HCMC

- The current method of risk management of exchange rate of commercial banking system in HCMC with types of transactions

- The current application of derivative instruments for hedging risk of exchange rate of commercial banking system in HCMC

- The evaluation of outcome performance of risk management of exchange rate of commercial banking system in HCMC

- Experiences of commercial bank’s risk management of exchange rate

- Evaluations of SBV towards commercial banking system in HCMC’s risk management of exchange rate in FX trading

- Expectations of commercial banking system in HCMC against Forex regulations of SBV

By discussions of knowledgeable individuals, the researcher can progressively sharpen the concepts and know exactly what data to collect during the project and how the project will be conducted in this research to solve the research problem.

Data collection

Document Collection

According to Yin 2003, for cases studies, the most important use of documents is to corroborate and augment evidence for the thesis Document collection was conducted by retrieving foreign exchange operation data of a number reports of commercial banks in HCMC, outcome performance of derivative instruments for preventing risk management of exchange rate, annual report of SBV-HCMC for a period from 2007 to 2009 and information related to this study from banking magazines This information provided a deeper understanding about the current situation of foreign currency trading operation, the process of risk management of exchange rate and solutions for preventing exchange rate risk of commercial banking system in HCMC.

Personal Interviews

most important sources of case study is the interview A questionnaire was designed and based on what information to be acquired reflecting interviewer’s actual line of inquiry The questionnaire consists of many open- ended questions so as to exploit more explanation and description relative to risk management of exchange rate of commercial banking system in HCMC and suggest solutions for improving exchange rate risk management

Interview questions were generated from the literature and the reality of exchange rate risk management of commercial banking system in HCMC

Therefore the researcher asked interviewees to elaborate on their perception of risk management of exchange rate and their recommendations for improvements So a list of interview participants was established, including two different categories as follows: Experts of SBV of HCMC who manage foreign exchange operations of commercial banking system in HCMC;

Managers of commercial banks in HCMC In this research, the personal interviews were carried out with 05 experts of SBV-HCMC including 01 director of SBV-HCMC, 02 deputy directors of SBV-HCMC, 01 manager of department of foreign exchange control and 01 manager of general department Interviewees of commercial banks in HCMC were 03 Executive directors, 04 Treasury managers who are directly in charge of foreign exchange operation and 01 chief of international business Therefore, it was hoped that through this interview, the researcher would discover practical issues and recommendations that CBS-HCMC can streamline its risk management of exchange rate in the future

Research questions Information needs Questionnaire

1 Why does the risk management of exchange rate of commercial banks have to be considered and what are the factors affecting to risk management of exchange rate?

1.1 The current foreign exchange operation of CBS- HCMC

1.2 Main reasons that CBS- HCMC needs to conduct risk management of exchange rate

1.3 Factors affecting to risk management of exchange rate in foreign currency

1 What do you think about the current situation of foreign exchange operation of CBS-HCMC?

2 Why do commercial banks have to do risk management of foreign exchange rate?

3 What are the factors affecting to risk management of exchange trading of CBS-HCMC? rate in foreign currency trading of CBS-HCMC?

2 What is the current method of risk management of exchange rate and What are the practical issues to be solved for CBS- HCMC from 2007 to 2009?

2.1 The current method of risk management of exchange rate of CBS- HCMC with types of transactions

2.2 The current application of derivative instruments for hedging risk of exchange rate of CBS-HCMC

2.3 The evaluation of outcome performance of risk management of exchange rate of CBS - HCMC

4 How can commercial banks identify, measure and control damages or losses of exchange rate ?

5 What are advantages as well as strong points of the current method of risk management of exchange rate of CBS-HCMC?

6 What are shortcomings as well as weak points of the current method of risk management of exchange rate of CBS-HCMC?

3 What are the recommendations for improvement of risk management of

3.1 Experiences of CBS- HCMC towards risk management of exchange rate

7 What are the main reasons that cause the failure in risk management of exchange rate in foreign exchange rate of CBS-HCMC?

3.2 Evaluation from SBV towards CBS-HCMC in risk managing of exchange rate?

3.3 Expectations of CBS- HCMC against foreign exchange regulations of SBV currency trading operation of CBS-HCMC that you experienced?

8 What are the general and specific solutions for CBS-HCMC to improve risk management of exchange rate?

9 What are the recommendations towards forex regulations of SBV?

In short, during the interview process, all of interviewees were asked to provide their perceptions on risk management of exchange rate that they found useful to share with the researcher A questionnaire was described in Table 01 and the performance was analyzed to draw conclusions and may also provide a basis for recommendations.

Data analysis

The process of analysis begins after the data have been collected

During the analysis stage, several interrelated procedures are performed to summarize and rearrange the data In the analysis stage, the data are edited and coded, then processed usually by computer

The financial ratios such as ratios of spot returns, gold returns and other returns; forex return ratios; ratios of income before tax; ratios between forex return and income before tax and forex turnovers were derived from financial statements of commercial banking system in HCMC for a period from 2007 to

2009 The process of deriving these ratios required a transformation of raw data into more suitable data for analysis Using computer package (Excel) will help this data to transform easily and quickly

Interview responses were coded using two group discussion (Experts of SBV and Directors or managers of CBS-HCMC) relating to four research questions mentioned above, then each group was analyzed according to different purpose of needed information such as the current foreign exchange operation of commercial banking system in HCMC and main factors affecting to risk management of exchange rate for group of the first research question; the current method of analysis and measurement of exchange rate risk of commercial banking system in HCMC, experiences of commercial bank’s risk management of exchange rate for group of the second research question; practical issues to be solved in risk management of exchange rate of commercial banking system in HCMC for group of the third research question, the qualitative appraisal for improving risk management of exchange rate of commercial banking system in HCMC for group of the fourth research question

In this research, content validity was considered rigorously There are at least three ways to achieve content validity – from the literature, from survey results and secondary data All of three ways were conducted to establish the questionnaire in the present study Chapter IV will present in more details on how these techniques are applied to analyze the data collected.

Conclusions

This chapter examined some aspects of research methodology for this study, including research designs, methods of data collection and data analysis As respectively indicated by sections, this study was an exploratory research in which the case study technique was used for data collection via personal interview and document collection

Personal interview provided information related to risk management of exchange rate and measures to be taken for preventing exchange rate risks of commercial banking system in HCMC In addition, secondary data was used to derive financial ratios based on reports of SBV of HCMC branch as well as a number of commercial banks in HCMC in order to corroborate and augment proofs for the research study All data collected directly and indirectly from balance sheets of commercial banking system in HCMC are transformed into more suitable format for analysis by utilizing Excel software After data transformation, a set of tables and graphs are used to summarize, describe process of risk management of exchange rate of commercial banking system in HCMC

In summary, using many specific research methods, the qualitative research attempts to obtain an in-depth understanding of practical issues in prevent risk of exchange rate in foreign currency operation commercial banking system in HCMC due to fluctuations of exchange rate Then, the research will contribute some new recommendations for improvement of risk management of exchange rate The data findings and survey results of risk management of exchange rate of commercial banking system in HCMC will be presented in chapter IV

THE CURRENT SITUATION OF RISK MANAGEMENT OF EXCHANGE RATE

IN FOREX TRADING OF COMMERCIAL BANKING SYSTEM IN HCMC

Overview of commercial banking system in HCMC

According to annual report of SBV-Ho chi Minh city branch, the network of credit institutions in Ho Chi Minh city updated to June 2010 as follows:

- 01 Head office and 01 Main transaction office of Mekong Data Bank (SOBs) and 03 Branches of themselves and 88 Branches of SOBs without head office in HCMC from Agribank; BIDV; VCB and Vietinbank

- 18 Head office of Join stock commercial Banks (JSCBs), 09 Main transaction offices and 138 Branches of themselves and 51 Branches of JSCBs without head office in HCMC

- 03 Head office of Joint Venture Banks (JVBs): Indovinabank;

Shinhanvinabank; Vinasiambank and 05 Branches of themselves and 03 Branches of JVBs without head office in HCMC

- 03 Fully Foreign-Owned Banks (HSBC; Shinhanbank and HongLeongbank) and 01 main transaction office and 01 Branch of ANZ

- 12 Head office of Finance & Leasing Co and 02 Branches of themselves and 10 Branches without head office in HCMC

The network of credit institution system in HCMC has total of 1.774 units classified as the following criterions:

Table 4.1: Net work of credit institution in HCMC updated to June, 2010

Head-Office operating in of HCMC

Head-Office operating out of HCMC

(Sources from SBV-HCMC Branch)

Graph 4.1: Organization chart of credit institution system in Ho Chi Minh City

ORGANIZATION CHART OF CREDIT INSTITUTION SYSTEM

C dit Institution System in HCMC re

01 HO of State-Owner-Banks (SOCBs)

03 Br & 88 Br of SOBs without HO in HCMC

18 HO of Joint-Stock Commercial Banks

138 Br & 51 JSCBs without HO in HCMC

03 HO of Joint Venture Banks (JVBs)

05 Br &03 JVBs without HO in HCMC

03 Fully Foreign-Owned Banks (FFOBs)

01 Branches without HO in HCMC

Overall assessment of money market and banking operations in HCMC…53

According to annual reports of SBV-HCMC, the situation of money market and banking activities in Ho Chi Minh city has reflected by general data as follow:

Table 4.2: Data of total charter capital, total fund mobilization, total loan outstanding and Profit & Loss statement of CBS-HCMC from 2007-2009

(Sources from SBV-HCMC Branch)

Total charter capital (JSCBs Head Office in HCMC)

In year 2008, credit institution had experienced temporary difficulties of liquidity of VND so that in the context of year 2009, growth rate of loan outstanding by banks reached 36,6% is greater than that of fund mobilization of 30,9%; especially, fund raising that is most short-term capital accounting for 70% of total fund mobilization That actually influences strongly on banking activities in HCMC as well as money market at the end of 2009

Some of commercial banks got liquidity problem of VND but redundancy of USD savings; However, SBV has conducted refinancing or swap between USD and VND with commercial banks, especially for small-size commercial banks By assisting CBS-HCMC with short-term capital, the SBV has brought about positive impacts on stabilization of monetary market The liquidity problems of commercial banks in HCMC has been overcome properly and created favorable conditions for money market continuing stability for year

2009 and first six months of 2010 a Achievements::

- Based on the Profit and Loss statements of commercial banking system in HCMC at the end of year 2009, Income Before Tax (IBT) gained has reached 13.114 billion VND as an increase of +55,5% compared with year 2008 This achievements gained depend on special efforts of developing banking services and credit operation of commercial banking system in HCMC

- Banking services has developed rapidly, especially Core-banking technology that create favorable condition for developing stronger banking services and minimizing administration formality and time for customers In 2009, with regard to ATM operations, there are 1.781.221 Debit cards issued with total turnover of 87.860 billion VND, raising up to 2.862 ATM and 16.570 POS with nearly 6 million debit cards issued This has brought a lot of benefits for residents of HCMC like ATM payment services for salary, electricity and water supply and changes step by step customers’ habit of payment in cash

- In the context of slowdown world economy in combination with inflation and trade deficit of Viet Nam, credit operation of commercial banks in HCMC has still raised 36,6% compared with year 2008, reflecting that the requirement of capital from money market and capital circulation of economy still develop normally without recession like several countries in the world b Causes:

- In 2009, the loan outstanding of CBS-HCMC has increased by 36,6%, greater than that growth of 20,6% in 2008 of which demand of VND capital increased strongly due to reasons (1) effect of capital requirements from interest rate subsidiary program of Government with 4% reduction that supported enterprises to expand their business production; (2) the “warming up” of real estate market; security market; gold domestic market that enhance investors to use more leverage of capital from commercial banks in HCMC

- In year 2009, Joint stock commercial banks in HCMC has raised charter capital with value of 12.299 billion VND, increasing up 32,1% compared with year 2008, reaching to 50.618 billion VND This support for commercial banks to expand credit operation, invest information technology and renovate modern equipments to develop their business operation

- Interest rate management of SBV continued remaining at low level of 7%/year during the first 10 months of year 2009, helping enterprises, individuals to approach capital of CBS-HCMC at negotiated interest rates easily c Difficulties:

- Interest rate of fund mobilization has been increased, especially VND short- terms interest rate as 3 months, 6 months, 9 months and 12 months equivalent to long term interest rate reaching 10,5%/year several commercial banks got liquidity problem of VND so that CBS-HCMC have to raise interest rate to mobilize more capital from public

- The supply and demand of foreign currency is still not stable due to trade deficit The amount of foreign currency bough from exporting companies is not enough to satisfy customers’ needs of importing goods Otherwise, sources of foreign direct investment and indirect investment are going down due to world economic slowdown that put a strong pressure on foreign exchange rate

The gap between banking rate and black market rate is around 1000 VND/USD, even 1.500VND/USD, causing state of holding foreign currency and speculation in the foreign exchange market

- In year 2009, the domestic and international gold price has been raising strongly and continuously Sometimes global gold price has reached to 1.225,5 USD/ounce equivalent to 29 million VND/tael on 03/12/2009 that really effected to sensitive state of holding of investors and residents, especially gold trading operation of CBS-HCMC such as domestic gold trading platforms related to activities of gold lending as well as oversea gold trading account which has effected strongly to outcome of banking activities due to fluctuation of global gold price

- Lack of experiences in risk management on Asset and Liability as well as ability of bank staffs that make credit operation, especially foreign exchange operation, become more risky so that Asset and Liability Management (ALM) have to comply with regulations of SBV and market movements based on focusing more on risk reduction than high return

4.3 Overview of foreign exchange operations of commercial banking system in HCMC

Unlike capital business activities based on interested rate, foreign exchange operation of CBS-HCMC is basically affected by fluctuations of exchange rate, requiring intelligence and special efforts to catch up opportunities, forecasting volatilities of exchange rate and market movements

The nature of foreign exchange operation creates business of 24/24 hours every day Information sources are explored through public media communications or specific software such as Reuters, Money line Telerate, Thombson, Bloomgber Most of forex transactions can be conducted by telephone, fax, Reuters Dealing or Internet Online Normally, Foreign exchange operation of commercial banks in HCMC consists of the following operations:

- Outward and Inward foreign currency remittances

- Offshore and local Interbank trading

- Service intermediary for customers’ investments in term of foreign currency, Gold and valuable papers

However turnover and profit from Foreign exchange operation are still winning about 30% to 35% of income before tax meanwhile Credit operation has still achieved main proportion ranging from 65% to 70% of income before tax of commercial banking system in HCMC

Table 4.3: Profits from foreign exchange operation of CBS-HCMC from 2007 to 2009 as follows: Unit of currency: Billion VND

Credit institution system in HCMC

Ratio of Forex profit on Income Before Tax

Ratio of Forex profit on Income Before Tax

Ratio of Forex profit on Income Before Tax

(Sources from SBV-HCMC Branch)

Graph 4.2 : The forex profit compared with income before tax of commercial banks in HCMC from 2007 to 2009

FOREX PROFIT COMPARED WITH TOTAL INCOME BEFORE TAX YEARS 2007 TO 2009

TOTAL INCOM E BEFORE TAXFOREX PROPIT

Graph 4.3 : The forex profit breakdown by four types of commercial banks in

FOREX PROFIT BREDOWN BY FOUR TYPES OF CBS IN HCMC YEAR 2007-2009

Overview of Forex operations of commercial banking system in HCMC.56

Foreign currency trading operation

- Firstly, foreign exchange operation of commercial banks in HCMC mainly meet the customers’ requirement of international payments in which turnover of spot transactions normally accounted for nearly 90% of total forex turnover and gain an advantage over derivative transactions

- Secondly, Risk management of exchange rate in foreign currency trading mainly base on open forex position and use solutions to prevent risk of exchange rate for both forex deals (spot and forward transactions) and money market transactions due to fluctuations of exchange rate through interbank market

- Thirdly, in the context of the global economic crisis and complex development of domestic and international financial market, forex operation of CBS-HCMC has been affected strongly, resulting in sharp decrease on forex turnover as table of figures below CBS-HCMC have to face with many challenges in assuring that the supply of foreign currency must be sufficient to meet the demand of foreign currency for payment of import companies

Table 4.5: Forex turnover of commercial banks in HCMC from 2007 to 2009

Unit of currency: Billion USD

(Sources from SBV-HCMC Branch)

Buying Selling Buying Selling Buying Selling

Graph 4.6 : Forex turnover breakdown by four types of CBS-HCMC from

FOREX TURNOVER BREAKDOWN BY FOUR TYPES OF CBS-

- Fourthly, a few commercial banks in HCMC have established self-trading in foreign exchange operation and derivative products are still poor to serve for customers for year 2007-2009

- Finally, the exchange rate between USD and VND is always guaranteed by SBV and banks’ customers are not familiar with derivative instruments so that most of import and export companies do not pay much attention to the use of derivative instruments for preventing risk of exchange rate Otherwise, at the Interbank, subjects joining market are limited and primarily deal with spot transactions each other so that foreign exchange operation of commercial bank in general and activities of currency trading in particulars has less developed.

Experience of risk management of exchange rate from Vietnam

- Transaction office of Agribank incurred loss of 499,8 billion VND of which loss of forex operation is the value of 447,6 billion VND, accounting for 98,9% of total losses within the later 9 months of year 2004

- The loss of 447,6 billion VND is approximately 28,3 million Euro including EURO/USD transactions arising primarily on a couple days of December, 2004 as table below:

Table 4.6 : EURO/USD transactions and total losses of 28,3 million EURO at Transaction office II of Agribank

Day of transactions Deals of EURO/USD

December 22th & 23th, 2004 Two buying deals of 30 million Euro December 24th, 2004 Four buying deals of 30 million Euro December 27th, 2004 Four buying deals of 30 million Euro

(Sources from SBV-HCMC Branch)

- Counterparties dealing with Agribank consist of ABN-Amro; Citibank-

Ha Noi branch; Fostis (HongKong), HSH (Singapore)

+ Transaction office II of Agribank exceeded over limits of position regulated by SBV (+/- 30% of total own capital of bank)

+ Not reporting limit of position to SBV at the end of day or submitting incorrect reports related to limit of position to SBV

+ No forecasting fluctuations of exchange rate EUR/USD in the international forex market and continuing dealing with EURO/USD transactions with greater amount of Euro to make up for previous losses after recognizing transaction exposure

+ Weakness in risk management of exchange rate that the process of forex transactions was broken down without any solutions for hedging risk of exchange rate Especially not setting trading limits and stop loss limits for dealer who transacts in the international interbank market, not regulating responsibilities of independent report between dealing room and middle office

4.3.3 Treasury organization and relation ship with other departments

- Basically Treasury organization consist of three sections as follows:

+ Front Office regarded as Dealing room: Dealers carry out transactions of foreign currency on both domestic market and Interbank market For domestic market, dealers directly buy or sell foreign currency with customers (import and export companies and individuals) at trading desks (spot desk, forward desk and option desk); For Interbank market, dealers directly face with competitors including domestic banks and international banks Main function of front office are to observe market movements, reading news-bulletin at different markets, discussing the volatilities of related currencies and market trends Dealers are responsible for profit and lost statement and make sure that his/her forex transactions is belongings to trading limits which are monitored and controlled by middle office

+ Back office is functional room independent with front office, having responsibility to confirm transactions, making payments and remittances, checking balance of customers, listing transactions and back up account

+ Middle office in charge of checking, monitoring and supervising trading limits and loss limits of head office, branches, preventing transactions from exceeding over trading limits and loss limit of dealing room, especially self- trading, and making independence report, revaluation of position compared with that of front office

In fact, most of commercial banks in HCMC often establish treasury organization at head office but at branches do not have the same treasury organization Dealers at branches must hold more than one position and combine explanations with selling derivative products for customers so turnover and expected returns from foreign exchange operation at branches are mainly from spot transactions Specifically, ACB is one of the leading banks with operational treasury model at the head office and provide full range of derivative products Based on strategy of restructure of operational treasury and training qualified forex dealers, ACB has created process for foreign exchange operation of which trading limits, procedure of handling forex transactions and internal operational treasury manual are set up at basis level; so that ACB has expanded scope of forex business and applied many solutions for hedging exchange rate risk for themselves and customers

Derivative instruments used in common are forward, swap and option, especially future contracts still not allowed and wait for approval of SBV

- According to survey result, the Treasury Organization of Bank for foreign trade of Viet Nam (VCB) which provides full range of derivative products including self-trading, the following chart of Treasury Organization of VCB is common in use for most medium commercial banks in HCMC

Graph 4.7 Treasury Organization of VCB (Sources from VCB-HCMC)

Foreign exchange (FX)Trading Dept

Corporate Money Market Trading Desks

- VCB’s Risk management of exchange rate could be identified, measured and controlled by open positions (long or short) and trading limits and loss limits as approved by ALCO (Asset and Liability control organization) of VCB

According to SBV’s forex regulation, the total forex position of +/-30% owned-capital of VCB at the head office controlled by middle office which will be distributed for every branches and VCB also manage forex position of each branches under the form of trading limits and loss limits of which managers or dealers of head office and branches are assigned at different limits and depend on the following criterions:

+ General trading limits for dealing room that are distributed to each dealer

The principal of distribution depend on job title, experiences and ability of each dealer trading in forex market.(Branch manager: 5 mio, Chief desk: 2 mio, dealers: 1 mio.)

+ Specific trading limits of each currency: Besides the general trading limits, each currency has different trading limits Common currencies with less movement have high limits (USD, EUR, JPY) but other currencies with more movements are low limits (AUD, CAD…)

+ Trading limits for each types of transactions : trading limits for spot, forward, swap and option transaction including intraday limit, overnight limit…

+ Loss limits of each dealers will be managed daily, weekly, monthly and yearly to make sure that dealers can not exceed the assigned stop-loss limits

Besides, middle office also monitors trading lines of counterpart bank which have pre-agreement with VCB and branches in order to reduce risks due to adventure forex transactions with strange counterparty banks

- Particularly, FX trading operations of VCB-HCMC branch includes:

+ Individuals: VCB-HCMC can buy types of foreign currency in cash through forex counters or travelers’ cheque such as American Express, Visa, Master card, Thomas cook, Citicorp and Bank of America and from source of oversea remittances but sell foreign currencies for individuals with specific purposes (e.g study abroad, residence, travel abroad, going on a business )

+ Companies and financial institutions: VCB-HCM conducts many types of forex transactions under the form of Spot, Forward and Option contracts in gold trading or foreign currency trading through domestic market and both local and international interbank market in accordance with forex regulations of SBV

+ VCB-HCM carry out structured products which combine between money market products and forex products according to customers’ need Most types of foreign currency are GPB, USD, HKD, CHF, EURO, JPY, THB, AUD, CAD, SGD

- The relationship between FX trading department and other departments at VCB-HCMC branch:

In reality, FX trading department has closed relation with other departments in order to process transactions and introduce derivative products for customers such as Customer relationship department, Credit department, International payment department (transactions of Import & Export), Accounting department and Treasure department

Here is the organization chart describing relationship between operational treasury and other departments of VCB-HCMC:

Graph 4.8 : Relationship between forex trading department and other departments of VCB-HCMC (Sources from VCB-HCMC)

The current application of derivative instruments for preventing exchange

Forward transactions

From year 1999, forward transactions have been launched out into the market with growth rate of forward turnover year by year (minimum ratio of 2.8% and maximum ratio of 8.2% shown in Table 4.9) It proved that forward transactions are very important for banking operation of CBS-HCMC as well as customers Especially, after decision no 648/2004/QD-NHNN dated 28/05/2004 was issued by SBV guiding the new way of setting forward rate, the forward turnover increased fairly good for the following years

Table 4.9 Growth rate of forward turnover of CBS-HCMC from 1998 to 2009:

(Sources from SBV of HCMC)

Most of forward transactions are used having durations of from 7 days,

14 days, 30 days and 60 days in compliance with periods of import and export payments and the foreign currency payments are mainly USD However, the ratio between forward turnover and total forex turnover is still at low level during year 2007 to 2009 shown in table 4.10 below, the maximum level of 10.2% in year 2009 It proved that the turnover of forward transactions of CBS in HCMC is limited, the research study will analyze and figure out practical issues why forward transactions of CBS-HCMC is still constrained

Table 4.10: Turnover of Forward buying and selling in comparison with total forex turnover from 2007 to 2009 as follows: Unit of currency: Billion USD

( Sources of SBV of HCMC branch)

Graph 4.10: Forward turnover compared with Forex turnover of commercial banking system in HCMC during 2007 to 2009

FORWARD TURNOVER TOTAL FOREX TURNOVER

4.4.1.2 The current forward rate setting

- According to previous regulations, forward transactions were based on spot rate plus an increasing percentage of forward rate for every durations as stipulated by SBV As a result, forward rate was usually higher than spot rate at the date forward contract exercised

- At present, based on decision No 648/2004/QD-NHNN dated 28/05/2004 issued by SBV, the new way of setting forward rate permits commercial banks and customers to negotiate forward rate between USD and VND each other but not exceed maximum exchange rate based on three factors: (i) Spot rate at the signing date of forward contract; (ii) difference between basic interest rate issued by SBV and USD target interest rate issued by FED (Federal reserve fund of USA) and (iii) durations of forward contract The formula of setting forward rate setting is as follow:

F = S + S.(Rb - Rt).t (2.1) Forward point as follow:

- F : Forward rate; S : Spot rate; FW : Forward point;

- Rb : Basic interest rate of VND (%year)

- Rt : Target rate of USD (%/year)

- t : Duration of transaction (year) The recent formula of forward rate setting is accuracy and better than the previous regulations because forward rate depends on two basic interest rates of VND and USD as mentioned above In reality, the forward transactions are still not used in common but spot transactions are always playing an important part The first reason is that the official exchange rate issued by SBV is stable around 5%/year so that import and export companies do not pay attention to risk of exchange rate; the second reason is that forward rate is often higher than spot rate on due date of forward contract so that most of import companies prefer using spot transaction to buying forward contracts

4.4.1.3 Factors affecting to forward transactions of commercial banks

According to table 4.11, the performance of forward rate during periods from

2007 to 2009 show that forward rate are often higher than spot rate on due date of forward contract Therefore, the two factors affecting directly to volume of forward transactions are forward rate and spot rate on the due date of forward contract This could be clarified by analyzing figures in table 4.11

The forward rate higher than spot rate on due date of forward contract also explains the reason why the forward buying turnover of commercial banks is always greater than forward selling turnover and achieved approximate 70% of total forward turnover It proved that the difference between forward rate and spot rate on the due date of forward contract stated that the way of forward rate setting is not suitable and spot rate should be considered They are two factors affecting to forward transactions of CBS in HCMC The first factor is the spot rate does not reflect the real value of VND and is still suffered from SBV’s intervention daily The second factor is the way of forward rate setting depends on two basic interest rates of VND issued by SBV and USD issued by FED which are not consistent with the real interest rates of deposit and loan of CBS in HCMC whereas enterprises depend on real interest rates of CBS in HCMC to decide between benefits and expenses when conducting forward transaction

An other reason is revealed, according to decision No 1452/2004/QD-NHNN dated 08/12/2004 issued by SBV, main subjects involved in forward transactions are import and export enterprises and individuals When enterprises sell foreign currency for CBS in HCMC without presenting any documents but when buying foreign currency for spot and forward transactions enterprises have to present many kind of documents to prove for purpose of using foreign currency That contributes to limit the development of forward turnover

Table 4.11 : Forward rate and spot rate at the due date of forward contract from year 2007-2009

Spot rate Basic interest rate of VND by SBV

Target interest rate of USD by FED 01 month 02 months 03 months

(Source: Spot rate and interest rate of VND from SBV of HCMC and interest rate of USD on Federal reserve website at http://www.federalreserve.gov/fomc/fundsrate.htm) Graph 4.11 Forward rate in term of 01 month, 2 months and 3 months compared with spot rate of CBS in HCMC from 2007 to 2009 as follows:

7-Jan 7-Apr 7-Jul 7-Oct 8-Jan 8-Apr 8-Jul 8-Oct 9-Jan 9-Apr 9-Jul 9-Oct

Forward rate of 01 month Forward rate of 2 months Forward rate of 3 months Spot rate

As a result of table 4.11, the gap between forward rate and spot rate on the due date of forward contract is due to two reasons: first reason is that spot rate does not reflect the real value of VND although spot rate bases on supply and demand of foreign currency in the interbank foreign exchange market but it still under direction of SBV and always goes up; the second reason, the way of forward rate setting is not suitable, specifically the way of choosing interest rates is not yet suitable because the two interest rates of USD and VND is not consistent with the real interest rate of commercial banks When two practical issues are solved the gap between forward rate and spot rate at the due date of forward contract will be narrowed Thus, forward contracts will be used more and more as hedging instruments against fluctuations of exchange rate for both commercial banks and customers

4.4.2 Option transactions 4.4.2.1 Application of option currency at commercial banks in HCMC

Option has been launched in 2004, therefore this kind of transaction is fairly new for both commercial banks and customers Up to now, it still not develop strongly and is not in common use so that option turnover still get low ratio compared with total spot turnover and total forex turnover

Based on decision no 1452/2004/QD-NHNN issued by SBV, the subjects involved in dealing option with commercial bank are economic entities, other organizations and individuals; especially with other commercial banks and SBV through interbank foreign exchange market The current application of option transaction has brought benefits back for commercial banks in HCMC in term of hedging risk of exchange rate Types of option that most companies have used are American options because they can take advantage of favorable fluctuations of exchange rate to get more profit next to the purpose of hedging exchange rate

Basically, commercial banks in HCMC depend on option premium of foreign bank to offer domestic customers That means, commercial banks play the intermediary role to take commission between local customers and foreign banks who sell/buy option deals This commission shall add into option premium of foreign bank to create a higher option premium called option fee

For example: We have an option as follows:

VCB-HCM sell EUR and buy USD with the amount of 100.000 EUR; in term of 01 month, type of American option, strike price of 1,2625 and option premium of 1.200 USD

It starts when customers want to buy a call option of 100.000 EUR and sell USD for VCB-HCM To offer option premium for customer, VCB-HCM will ask foreign bank to sell a call option of 100.000 EUR against payment in USD in term of one month When foreign bank offer an option premium VCB-HCM will inform customer of the option fee which include option premium and commission; However, the problem is why customers do not buy call option with foreign bank directly to reduce option fee that they already committed with VCB-HCM It is that if local customers contact foreign bank directly the cost will be higher and that foreign bank are not willing to transact in retail contracts with local customers; Therefore, VCB-HCM becomes a clue to gather all local customers’ retail contracts to deal with foreign banks meanwhile VCB-HCM can not conduct forex self-trading yet However, the main reason is that foreign bank do not conduct option transaction in VND because they only do business with strong currencies against payment whereas local companies can not afford foreign currency to deal with; therefore, although option premium cost too much, local customers have to accept it

At present, small and medium commercial banks in HCMC can not transact in forex self-trading yet that they carry out option transactions following customers’ requests, mainly reinsure option from foreign banks to sell for local customers Therefore, option transactions are rarely used in their risk management of exchange rate, especially option strategies are so complicated that local banks in HCMC have not enough knowledge and experience to apply

- More than 5 years development, there are not enough instructions from SBV for commercial banks to conduct option transaction while this is a new and complicated type of transaction

Currency option

of foreign banks adding expected return of local bank Majority of commercial banks in HCMC have no self-trading in option so that they mainly reinsure option contracts with foreign banks Therefore, turnover of option transactions have not developed yet.

The evaluation of outcome performance on risk management of exchange

Achievements

- To mitigate the risk of exchange rate in FX trading Most of commercial banks in HCMC comply with SBV’s regulations on limit of position (+/- 30% of bank’s own capital) to reduce risk of exchange rate in

FX trading and contribute to stabilize forex operation of commercial banking system in HCMC

- To create a considerable forex profit for commercial banking system

At present, forex profit of commercial banking system in HCMC from foreign exchange operation gains an average of more than 30% compared with total income before tax in which profit obtained from spot transactions make up more than 70% of forex profit, gold profit 18% and others profit 12% of total forex profit It proved that forex profit has created remarkable forex profits for commercial banks, especially from exchange rate differences, gold price gap between global and domestic market gold prices in their risk management of exchange rate which contributes to enhance banking operation development in combination with restructure of total income of commercial banks in HCMC under forms of retail banking services

- To combine derivative products with other banking products in hedging risk of exchange rate

In FX trading, commercial bank can also reduce risk of exchange rate by coordinating between forex products and other banking products as hedging instruments for both customers and themselves, especially in shortage of USD, the combination forex transactions or derivative instruments and other banking products like credit or deposit products could be used to protect losses made due to fluctuations of foreign exchange rate

- To exchange management experiences between commercial banks on how to identify, measure and control risk of exchange rate

On behalf of customers who already committed forex transactions, commercial banks in HCMC have to cope with risk of exchange rate

Basically they often handle with those forex transactions by taking position or squaring position through interbank market, especially swap and option transactions through international interbank market because local banks have not enough experiences and levels of knowledge to work out swap and option; therefore, local banks can create good connections and learn more experiences of risk management of exchange rate from foreign banks whose baking operations always have advantages of risk management, high information technology, banking products and services whereas local banks only have spread of banking network throughout the country

- To create more channels to buy or sell foreign currency and various solutions to hedge risk of exchange rate for commercial banking system in HCMC

In forex trading, most of commercial banks in HCMC mainly buy foreign currencies from export companies, other sources of foreign currency like FDI, FPI, oversea remittances, other banks under the form of spot transactions to satisfy customers’ demand Besides, derivative instruments are considered as channels for commercial banking system in HCM to buy or sell foreign currency in FX trading and more solutions to protect commercial banks from serious damages or losses

Shortcomings…

Although commercial banks in HCMC have achieved good results of profitability in foreign exchange operation but still have some shortcomings in risk management of exchange rate as follows :

4.5.2.1 Shortcomings from SBV’s forex management policy

- The official exchange rate between USD and VND has not reflected the real value of VND and still suffer from intervention made by SBV

- The Interbank foreign exchange market is working less efficient, commercial banks find it difficult to balance supply and demand of USD through interbank foreign exchange market, especially buying USD from SBV so that they have to seek for USD by themselves in the market at negotiated rate and find it difficulties in risk management of exchange rate due to the gap between bank rate and market rate

- Situation of economic dolarization and activities of USD cash market affecting individuals and enterprises’ state of holding USD:

Activities of trading USD cash in the black market as well as situation of economic dollarization influences fluctuations of exchange rate that create the exchange gap between bank rate and market; Therefore, investors as well as enterprises have sentiment state of holding USD without selling USD for CBS in HCMC

- Unsuitable regulation of forward rate setting due to the choosing basic interest rates of VND and USD that are not consistent with real interest rate of commercial banks; Therefore it doest not stimulate commercial banks to use forward transactions in their risk management of exchange rate

- Not enough legal framework guiding for CBS in HCMC to conduct forward and option transactions Meanwhile those are complicated transactions requiring skills and strategies for hedging risk of exchange rate Therefore, both commercial banks and enterprises use derivative instruments as channels to buy and sell foreign currency more than purpose of hedging risk of exchange rate so that CBS-HCMC find it difficult in risk management of exchange rate by using new types of derivative instruments

4.5.2.2 Shortcomings from risk management of exchange rate of commercial banking system in HCMC

- Lack of experience on risk management of exchange rate as well as qualified banking staffs to compete with foreign banks:

Commercial banking system in HCMC, especially small and medium banks are lack of experiences on risk management of exchange rate in comparison with foreign banks In term of human resource, local banks have not enough qualified banking staffs in FX trading who have sufficient knowledge of analyzing and forecasting fluctuations of exchange rate in the international forex market as well as ability of using derivative instruments for hedging risk of exchange rate whereas foreign bank branches could be assisted with forex operation skills as well as risk management from head office at oversea;

Therefore, most local banks mainly try to square open position at the end of the day without taking open position and branches of local commercial banks basically square position with their head office to protect losses or damages due to fluctuations of exchange rate

- Lack of source of foreign capital and modern equipments and Information technologies supporting for FX trading:

Most of local banks in HCMC are shortage of source of foreign capital in FX trading to compete with foreign bank branches, especially big deals of foreign currency from foreign investment funds, ranging from 5 mio to 10 mio per day that local banks have not enough source of foreign capital to satisfy customers’ demand whereas foreign bank branches have source of foreign capital backed up from head office, so that the profit of local banks gained from forex transactions (mainly spot transactions and derivative transactions) is lower than foreign bank branches Besides, in term of modern equipments and Information technologies supporting for treasury operation are not updated with professional technology of the world and connected to global banking network and global information system to keep with the latest information;

Therefore, local banks have not developed self-forex trading yet and find it difficult to protect themselves from losses and damages in FX trading due to changes of exchange rate, at the same time to catch up the business opportunities to gain maximum profit

- Shortage of USD in payment to satisfy customers’ demand

Basically, originating from situation of trade deficit, most of enterprises try to hold foreign currency, especially USD in their account, which mean that CBS in HCMC are not shortage of source of USD but lack of USD payment because export enterprises do not want to sell USD for commercial banks at the bank rate; therefore, commercial banks must negotiate with them about terms of payment in USD/VND higher than the bank rate from 1000 to 1500 VND/USD; therefore, CBS in HCMC find many various ways to buy and sell again at the negotiated rate so that they have to cope with the forex regulations of SBV in risk management of exchange rate by hiding exchange differences between banking rate and negotiated rate under many different forms

- Forward transactions is limited and considered as a channel to buy or sell USD with import & exports companies

As a survey results, spot transactions make up more than 90% of total forex turnover and primarily meet the requirements of customers’ payment of international trade and the forward transactions are still at limited volume which is considered as a channel for CBS-HCMC to buy and sell foreign currency from import & export companies in order to make up for lack of supply of foreign currency more than for hedging risk of exchange rate

At present, option fee of commercial banks in HCMC consists of three factors: option premium offered by foreign bank; expected return of local bank and 10% value-added tax (VAT) Bank counterparts as well as customers not only pay high option fee but also loose 10% VAT of option fee in Viet Nam meanwhile local banks that repurchase option from foreign banks do not have to be deducted 10% VAT of option premium This way of option fee setting cost too much and reduces demand of using option for risk management of exchange rate by CBS-HCMC as well as customers.

Causes

- No flexibility of exchange rate policy of SBV

At present, SBV only defines the exchange rate between USD and VND without fixing exchange rate between different foreign currencies In fact, the exchange rate of SBV has not reflected the relationship between supply and demand of USD and recounted the real value of VND in the forex market due to the following reasons:

+ SBV’s daily official exchange rate bases on turnover of Interbank foreign exchange market which make up about 20% of total forex turnover of commercial banking system of Viet Nam so that it can not reflect supply and demand of USD accurately

+ Due to trade deficit situation, demand of USD in the Vinaforex market is always greater than supply of that, commercial banks normally utilize maximum of trading band of 3% for trading every day It mean that the average exchange rate of Interbank foreign exchange market every day must increases an amount of 3% of itself But in fact, official exchange rate announced by SBV remains unchanged or is less than 3% every day; therefore, the exchange rate policy of SBV is still suffered from intervention made by SBV and does not reflect the real value of VND

- Objects participating interbank forex market is limited and less efficient intervention made by SBV

The objects participating interbank foreign exchange market is still limited and SBV often play the role as the first buyer or seller but could not be the final one to intervene into the interbank foreign exchange market so that most of commercial banks in HCMC find difficult to balance supply and demand of USD in their FX trading; Therefore, the activities of interbank foreign exchange market working less efficient is one of causes making commercial banks in HCMC difficult in risk management of exchange rate

- Situation of high inflation and trade deficit

Starting from situation of high inflation and trade deficit, CBS in HCMC is always shortage of USD in payment Most of import companies must seek for USD in the market so that demand of USD in the market increases strongly creating exchange gap between bank rate and market rate; therefore, the structure of double exchange rate in the market establishes and influence investors as well as enterprises’ sentiment state of holding USD without selling USD for CBS in HCMC

- Unsuitable regulation of setting forward rate

Forward rate is established basing on the two basic interest rates of SBV and FED which is not consistent with daily interest rates of commercial banks so that forward rate is often higher than spot rate at the due date of forward contract; Besides, official exchange rate of SBV is still stable and around 5%/year so that CBS in HCMC as well as enterprises do not concern much about using forward transaction as hedging risk of exchange rate but considering forward contracts as an instrument to buy and sell foreign currency, especially USD/VND

- Not enough legal framework guiding for forward and option transactions

According to decision no 1452/2004/QD-NHNN dated 11/10/2004 issued by SBV regarding durations of forward transactions between USD and VND from

3 to 365 days In reality, customers have demands of hedging risk of exchange rate with durations more than 365 days as deferred letter of credit for importing goods or foreign loans over one year that commercial banks have no regulations and find it difficult in hedging risk of exchange rate for types of forward contracts more than one year

Option fee of CBS-HCMC is not regulated by SBV but depends on option premium of foreign banks, normally costing from 3% to 5% of value of option contract whereas fluctuations of exchange rate are approximately the same as option fee so that enterprises do not need to use option instrument for hedging risk of exchange

No regulations for option strategies that are such a complicated skills that commercial bank do not have enough experiences and knowledge to use them for preventing risk of exchange rate

4.5.3.2 From commercial banking system of HCMC

- Most of local commercial banks have not developed self-forex trading yet and rarely use derivative instruments for hedging risk of exchange rate

Basically, most of local banks’ forex transaction are basically USD against

VND so that local banks in HCMC have not developed self-forex trading yet in international fore market and rarely use derivative instruments for hedging risk of exchange rate and to protect themselves from serious damages or losses in FX trading whereas foreign bank branches are often backed up from head office on training forex operation skills, level of risk management, especially using types of derivative instruments for hedging risk of exchange rate which are familiar to foreign banks for years

- Possibility of increasing legal capital of commercial banking system in HCMC is limited

Under pressure of increasing legal capital required by SBV and the unbalance between mobilization and lending of CBS-HCMC arising regularly, at the end of year 2010 there still have 09 local commercial banks in HCMC not satisfying legal capital of 3000 billion VND which contribute making competitive advantages of local banks weaken in comparison with foreign bank branches so that the limitation of increasing legal capital of local commercial banking system in HCMC how to utilize sources of capital efficiently and pay more attentions to other banking operations of which foreign exchange operation is one of banking activities bringing high profit

Therefore, to improve risk management of exchange rate in FX trading, commercial banks need to enhance identification, measurement and control risk of exchange rate to avoid exposure transactions and strengthen using types of derivative instruments for hedge risk of exchange rate in foreign exchange operation

- In charge of combined responsibilities lead to lack of supervising and checking trading limits, loss limit and forex report to SBV

In fact, local banks in HCMC with a large-scale have set up operational treasury at head office including front office, middle office and back office but their branches and branches without head office in HCMC do not have the same treasury organization so that most of related business departments must be in charged of combined responsibilities in the process of operational treasury Specifically, accounting department functions as back office; Internal audit control works as Middle office Therefore, responsibilities for supervising and checking forex transactions within trading limits, stop loss limit as well as reporting independence are not paid attention much which means that adventure transactions can happen to compensate for losses made before and lead to potential loss, violating reporting regulation on forex position to SBV or submitting incorrect forex position reports to SBV are made Like case of Agribank’s exposure transactions of approximate 500 billion VND equivalent to 28,3 million Euro due to exceeding over trading limits without reporting to SBV, especially no setting trading limits and stop loss limits on international interbank market

- Depending on option premium of foreign banks Basically, most of local commercial banks in HCM have no self-trading and mainly play the intermediary role to get commission between local customers and foreign bank so that CBS-HCMC’s option fee offering customers depend on option premium of foreign bank Therefore, it costs too high and is not attractive for customers to use option instrument for hedging risk of exchange rate.

Conclusions…

Chapter four introduces overview of CBS-HCMC and also present the real situation of risk management of exchange rate in FX trading of CBS-HCMC Some practical issues are pointed out through the current risk management of exchange rate on how to identify, measure and control risk of exchange rate of CBS-HCMC as well as the application of forward and option instruments in risk management of exchange rate of CBS-HCMC Otherwise, SBV’s foreign exchange management policy is not following up with signs of market movements; the lack of experiences in risk management of exchange rate of CBS-HCMC as well as non-modern equipments & information technology and non-qualified banking staff for foreign exchange operation are also practical issues affecting to risk management of exchange rate as well as forex profitability of CBS-HCMC

To strengthen ability of risk management of exchange rate of CBS-HCMC, many solutions for both SBV and CBS-HCMC are presented in chapter V in which SBV should revise foreign exchange regulations to help CBS-HCMC to prevent damages or losses in FX trading in combination with strategy of restructure of operational treasury and long-termed plan for training qualified forex dealers to cope with unexpected changes in foreign exchange operation of CBS-HCMC

CHAPTER FIVE RECOMMENDATIONS AND CONCLUSIONS

Introduction

Under pressure of increasing legal capital required by SBV and the unbalance between mobilization and lending of CBS-HCMC arising regularly, commercial banks in HCMC must know how to utilize sources of capital efficiently and pay more attentions to other banking operations of which foreign exchange operation is one of banking activities bringing high profit

Therefore, to improve risk management of exchange rate in FX trading, commercial banks need to enhance identification, measurement and control risk of exchange rate to avoid exposure transactions and strengthen using types of derivative instruments for hedge risk of exchange rate in foreign exchange operation.

Recommendations for improvement of risk management of exchange rate

Suggestions for State bank of Viet Nam

Based on nature of business activities, foreign exchange market consists of many different markets such as spot market, forward market, swap market, future market and option market in which spot transactions are the foundation for Vinaforex market in general A perfect spot market is a free competition market where the supply and demand are matched to create spot rate correlatively In fact, the official exchange rate of SBV bases on Interbank average exchange rate whose turnover account for 20% of total turnover of spot market but does not reflect the real value of VND and relation of supply and demand of USD Therefore, in order to improve spot market, SBV should basically improve interbank foreign exchange market by:

- Expanding more objects participating in Interbank foreign exchange market including commercial banks and non-bank credit institutions which are also permitted to engage in some banking activities; therefore, the spot rate between USD and VND could reflect more exact supply and demand of USD and participants of interbank foreign exchange market are more easily to find partners to diversify risks after committing contracts with customers

- Decreasing step by step administration intervention made by SBV on the daily spot rate by strengthening economic measures affecting supply and demand of USD indirectly

- Improving SBV’ ability of forecasting fluctuations of exchange rate and analyzing market trends to help commercial banks to hedge risk of exchange rate on time and reduce damages or losses due to unexpected movements of forex market At the same time, to release the state of holding foreign currency on customers’ account, especially USD, and decrease pressure on demand of foreign currency of CBS in HCMC

5.2.1.2 Strengthening regulations on forex position

- Regulations of foreign exchange position:

Decision no 1081/2002/QĐ-NHNN dated 07/10/2002 of SBV requires commercial banks to report forex position at the end of the day, however commercial banks can still have adventure forex transactions breaking trading limits within a day; Therefore, SBV should changes recent regulations of forex position at the end of the day into any time of the day on lined with SBV in order to constrain adventure transactions of forex dealers exceeding over permitted trading limits within one day and avoid activities of speculation

- Expanding more recent forex position ratio of +/-30% of bank’s owned legal capital to create favorable condition for CBS in HCMC to satisfy customers’ demand, especially foreign investment funds which often have great demand of foreign currency per day

5.2.1.3 Adjusting regulation to forward rate setting

The current regulation to forward rate setting does not distinguish between buying and selling forward rate so it is necessary for adjusting regulation to forward rate setting as follows:

F = S + FW point F = S + S x (Iv - Ib) x t/360 of which:

Buying FW point = Sb x [Iv (deposit)– Ib (loan)] x t/360 Selling FW point = Sax [Iv (loan) –Ib (deposit)] x t/360

- FW point : forward point; S : Spot rate; Sb : Bid rate; Sa : Ask rate;

- Ib : Deposit/loan interest rate of base currency (%/year)

- Iv : Deposit/loan interest rate of variable currency (%/year)

If Iv < Ib , FW point is positive that is called premium point

If Iv > Ib, FW point is negative that is called discounted point The strong points of forward rate setting as suggested are as follows:

+ Based on interest rates of deposit and loan of commercial banks, forward rate are consistent with real condition of market and narrow the difference between forward rate and spot rate at the same duration

+ Buying and selling forward rate are defined specifically making commercial banks comfortable to deal with customers and check it again

5.2.1.4 Establishment of option interbank market

- To strengthen hedging risk of exchange rate by option instruments for commercial banking system, it is necessary to establish an option interbank market where commercial banks can conduct transactions that are correspondent with transactions already committed to customers in order to hedge exchange rate risk for their own transactions The supply and demand of option interbank market are matched to create option premiums between commercial banks correlatively The activities of option interbank market is similar to spot market operation When option interbank market is established will help commercial banks become less dependent on foreign bank’s option premium Thus, option contracts will be used more and more as hedging instruments against fluctuations of exchange rate

In the future, organizing a listed derivative market of Viet Nam is necessary supporting of risk management of exchange rate including many types of transactions like forward, swap, option, future products with different durations and various kind of foreign currency.

Recommendations for commercial banking system in HCMC

- Establishing long-term development business strategy from 5-10 years for risk management of forex operation At the first stage, CBS-HCMC should focus more on risk reduction than high return in operational treasury, especially in FX trading, enhancing derivative instruments for hedging risk of exchange rate Next step, marketing and expanding scope of providing derivative and structured products by co-ordination with foreign banks to exchange experiences on risk management and help customers to understand the benefit of derivative instruments to prevent risk of exchange rate; therefore, CBS-HCMC can improve quality of risk management of exchange rate in foreign currency trading in particular

- Building customer policy bases on customers’ financial capacity and prestige to clarify and grant for customers’ trading limits and counterparty banks’ trading line which also reduce damages or losses for commercial banks

5.2.2.2 Standardizing structure and process of operational Treasury

- The process of operational treasury needs to be separated the specific tasks of Front office, Middle office and Back office as well as responsibilities of supervising and checking transactions, reporting independence

- Revaluation of positions: All open position belonging to the FX trading are marked-to-market against determined closing rates This revaluation of open position is to ensure that the exact values of all open positions are obtained for risk management, management reporting and better decision making

- Setting Trading limits and Stop loss limits: To ensure that there are no excessive losses made, dealers should not exceed the assigned trading limits as approved by ALCO (Asset & Liability control Organization) Any excess must be pre-approved

- Transacting in authorized products: To counter the risk of any transactions in non-authorized products, forex dealers can only transact in products that have been approved by ALCO and within the parameters stated for their trading limits

5.2.2.3 Improvement of modern equipments and information technologies for treasury operation

Setting up modern facilities for treasury operation is one of conditions necessary for treasury operation in which modern equipments and information technology should be updated with professional technology of the world and connected to global banking network and global information system to keep with the latest information Therefore, information becomes an important factor to solve on time and protect CBS in HCMC from serious damages or losses due to unanticipated exchange rate in the future A good combination between professional dealers and modern equipments and information technology is the best way to manage risk of exchange rate for CBS in HCMC

5.2.2.4 Enhancing for training qualified banking staffs to improve ability of analyzing and forecasting fluctuations of exchange rate in forex operation

- The issue of human resource influences strongly on risk management of exchange rate of CBS-HCMC The current situation of forex staffs are not qualified to satisfy customers’ demand and have not enough experiences on risk management of exchange rate, especially local banks do not catch up with skills of analysis and ability of forecast of fluctuations of exchange rate in comparison with foreign banks that are backed up from head office

Therefore, in the near future, CBS in HCMC should enhance for training bank employees in combination with skilled approaches of technical analysis of market movements to prevent risk of exchange rate in their FX trading such as Fundamental analysis, Technical analysis and Cash flow analysis that are necessary for qualified dealers in foreign exchange operation

5.2.2.5 Diversifying types of foreign currencies in the international trade

Due to shortage of USD in payment of international trade, commercial banks in HCMC can reduce risk of exchange rate by diversifying the types of foreign currency in stead of payment in USD such as EURO, AUD… in order to cut down the pressure of demand of USD in FX trading and contribute to narrow the exchange gap between bank rate and market rate

5.2.2.6 Strengthening the application of derivative instruments

Commercial banks should combine among business departments in order to launch out and broadcast derivative and structured products into the market, strengthen risk management of exchange rate in forex trading by applying derivative instruments for hedging risk of exchange rate and expanding scope of supplying derivative products for enterprises to mitigate risk of exchange rate more than high return.

Conclusions related to research questions

In the recent years, Vinaforex market has established and grown rapidly Policies supporting for commercial banks adjusted in compliance with open market trends and played the decisive role in a foreign exchange operation of CBS-HCMC Although the CBS-HCMC has to face with many difficulties caused by trade deficit, high inflation and unfavorable changes in the world economy, CBS-HCMC has made special efforts to manage risk of exchange rate in FX trading that contributes to create a favorable forex trading environment for many kinds of economic entities

As we know that foreign exchange operation of commercial banks contains a lot of risks of exchange rate more than enterprises due to many kinds of foreign currencies and different durations so if risks have been managed methodically, forex operation of CBS-HCMC will brings more forex earnings and contribute to increasing total income for commercial banks In the trend of WTO integration, improving risk management of exchange rate of commercial banks is an essential needs

Although there are still shortcomings in this thesis, the research study has answered the research questions why commercial banks have to manage risk of exchange rate, how to identify, measure and control risk of exchange rate, especially the current methods of risk management of exchange rate of CBS-HCMC are used in comparison with theory Through the current risk management of exchange rate of CBS-HCM, the research also evaluate achievements, shortcomings and causes to helps CBS-HCMC find out practical issues to be solved for improvement of risk management of exchange rate in FX trading in particular and foreign exchange operation in general

Although this research study provided some recommendations for risk management of exchange rate of CBS in HCMC but should also be expanded for hedging risks of exchange rate on other banking activities, especially in gold trading operation considered as a kind of goods like foreign currency, securities, real-estate that are actually suffered from fluctuation of exchange rate and need a market to exchange

In view of development, risk management of exchange rate in complex financial market international and domestic like Viet Nam will be more strictly regulated and more cautions in term of investment and operations, using types of derivative instrument for hedging risk of exchange rate commercial banking system in HCMC are likely to focus more on risk reduction than high return

- Website of Ministry of Finance: http://www.mof.gov.vn

- Website of State bank of Viet Nam: http://www.sbv.gov.vn

- Website of Asia Joint stock commercial bank: http//www.acb.com.vn

- General reports of SBV-HCMC branch for year 2007, 2008 and 2009

- Reports of forex management of SBV-HCMC branch for year 2007,

- Forex reports of ACB, VCB-HCMC, Sacombank, Viet A bank, Southernbank, HDB, UOB and VID Public bank

- Annual reports of SBV for year 2007, 2008 and 2009

- Programs-Targets and itinerary of banking service development for periods from 2006 to 2010

- Strategy of Banking service development for periods from 2010 to 2020

- Balance sheets of commercial banking system for year 2007 - 2009

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- The use of Option – Master Dao Gia Hung – Banking review of August,

- Some of renovation of exchange rate management in Viet Nam – Dr Le Phan Dieu Thao – Banking & Technology review of October, 2009

- Options, Futures and other Derivatives – John C.Hull & Maple Financial Group Professor of Derivatives and Risk Managers; Director, Bonham Center for Finance; Joseph L Rotman School of Management University of Toronto – Sixth edition by Perrson Prentice hall

- Yin R K (2003) Case study research Sage Publications, Third Edition

Zikmund, W G (1997) Business Research Methodology Fort Worth,

Some issues of risk management of exchange rate in fore trading of commercial banking system in Ho Chi Minh City

- To collect specific contents to confirm that the analysis and evaluations of the study are objective and reality

- To survey recommendations to convince whether the research study base on both literature review and reality to apply or not

Survey contents referring ideas from those people:

- Leaders of State bank of Viet Nam-HCMC branch

- CEO, Managers of Treasury of commercial banks in HCMC

- Lecturers of banking university and economic university of HCMC

- To bring out an overall assessment of the current situations of risk management of exchange rate as well as several specific issues to be solved for improving risk management of exchange rate based on characteristics and types of commercial banks in HCMC

- In each survey questionnaires, interviewees can choose one or multiple choices based on his/her appreciation or raise personal opinions related to concerned problems

1 What do you think about the current situation of foreign exchange operation of CBS- HCMC?

Content Result (%) ratio compared with profit of credit operation

3 Spot transactions accounts for more than 90% of total fore turnover to primarily meet the requirements of customers’ international payment

4 Derivative transactions are less in use but mainly arise in foreign bank branches

5 Most of local banks have not developed self-fore trading yet

2 Why do commercial banks have to conduct risk management of exchange rate?

1 To protect commercial banks from serious losses or unexpected damages in foreign exchange operation

2 To prepare for disadvantageous changes of exchange rate towards foreign exchange operations of CBS-HCMC

3 To regulate the sensitive market movements towards foreign exchange operation

4 To reduce the risk of exchange rate and catch the business opportunities

5 To strengthen the competitive advantage 5%

7 Other issues trading of CBS-HCMC?

1 Supply and demand of foreign currency, especially USD in the foreign exchange market

2 Market sentiment (activities of USD cash market, speculation, sentimental state of investors)

3 Macro and micro economic (CPI, GDP, interest rate) 11%

4 How can commercial banks identify, measure and control damages or losses of exchange rate ?

4.1 How to measure risk of exchange rate on FX trading of CBS in HCMC

1 Account balance of buying and selling spot and forward turnover in balance sheet at the ending day of the month from both enterprises and interbank market

2 Account balance of buying and selling from other sources of foreign currency in balance sheet (FDI, FII and oversea remittances)

3 Account balance of commitment of buying and selling spot and forward transactions off balance sheet at the ending day of the month

1 All open positions are marked-to-market against determined closing rate by supporting system to realize profit or loss at the end of day

2 Long or short positions are exceeded over +/-30% of bank’s own legal capital

3 Dealers’ trading limits should not exceed the assigned trading desk limits as approved by ALCO

4 There are excesses of stop loss limit and V.A.R monitored by treasury settlement belonging to back office

5 Dealers can only transact in products that have been approved by ALCO and within the parameters stated for their trading limits

4.3 How to hedge risk of exchange rate on FX trading of CBS in HCMC

1 Basically squaring open position by buying or selling spot transactions through interbank market or enterprises

2 Buying or selling forward or option transactions for preventing risk of exchange rate

3 Keeping open position to caught opportunities 10%

4 Other issues: Bank managers’ behaviors towards risk of exchange rate (Who are risk averse, neutral or risk prefer)

4 All of them 30% risk management of exchange rate of CBS-HCMC?

1 To mitigate the risk of exchange rate in FX trading 13%

2 To create a considerable forex profit for banking activities

3 To combine between forex products and other banking products in hedging risk of exchange rate

4 To exchange more management experiences between commercial banks on identification, measurement and control of exchange rate risk

5 Using derivative instruments for hedging risk of exchange rate creates more channels for CBS in HCM to buy or sell foreign currency in FX trading and more solutions to protect commercial banks from serious damages or losses

6 What are shortcomings as well as weak points of risk management of exchange rate of CBS-HCMC?

1 The official exchange rate between USD and VND has not reflected the real value of VND and under direction of SBV daily

5% and demand of foreign currency for their FX trading

3 Activities of USD cash market and situation of economic Dollarization affecting sentiment state of holding USD

4 Unsuitable regulation of setting forward rate due to the choosing basic interest rates of VND and USD that are not consistent with real interest rate of commercial banks

5 Not enough legal framework guiding for forward and option transactions

1 Not enough qualified banking staffs and experiences of risk management on treasury operation

2 Lack of source of foreign capital in FX trading and improving modern equipments and Information technologies for treasury operation

3 Unbalanced supply and demand of foreign currency 7%

4 Forward transactions are considered as a channel for CBS-HCMC to buy foreign currency from export companies to make up for the lack of supply of foreign currency more than for hedging risk of exchange rate

5 Most of commercial banks have no self-trading as speculation

2% exchange rate in foreign currency trading operation of CBS-HCMC that you experienced?

7.1 Causes from forex management policy of SBV

1 SBV’s daily official exchange rate bases on turnover of Interbank foreign exchange market which only make up about 20% of total forex turnover

2 The exchange rate policy of SBV is still suffered from intervention made by SBV and does not reflect the real value of VND

2 The Interbank foreign exchange market is working less efficient

3 Activities of trading USD cash in the black market 7%

4 Unsuitable regulation of forward rate setting based on the basic interest rate of VND issued by SBV and USD issued by FED which are not consistent with real interest rate of commercial banks

5 Not enough legal framework guiding for forward and option transactions

7.2 Causes from commercial banks in HCMC

1 Not enough qualified banking staffs and experiences on 8% technologies for analyzing and estimating market movements

3 Weakness in risk management of exchange rate

- Not separating management responsibilities between supervising and checking transactions as well as specific task between treasury manager and chief of forex trading and fund management

- Exceeding the regulation of forex position (30%/total own capital of commercial bank)

- Violating reporting regulation on forex position to SBV

- Not stipulated specific trading limits and stop loss limits on international interbank market

- Less using derivative instruments for hedging risk of exchange rate

8 What are general and specific solutions for CBS-HCMC for improving risk management of exchange rate?

1 Building business strategies and customer targets 5%

2 Standardizing structure of operational Treasury:

- Separating the specific tasks from Front office, Middle office and Back office

- Setting Trading limits and Stop loss limits

3 Modern equipments and information technologies for analyzing and estimating market movements

4 Training banking staffs qualified for foreign exchange operation

9 What are the recommendations for improving forex regulations of SBV

1 Improvement of interbank foreign exchange market by:

- Expanding object participating in interbank forex market including commercial banks and non bank credit institution

- Decreasing step by step administration intervention made by SBV

- Improving SBV’ ability of forecasting fluctuations of exchange rate and analyzing market trends

2 Strengthening regulation on forex position and expanding forex position ratio more than +/-30%

3 Adjusting regulation to forward rate setting based on interest rate of deposit and loan of commercial banks

4 Establishment of option interbank market 5%

1- Every different opinions chosen have represented specific contents in conformity with foreign exchange operation of each commercial banks in HCMC

2- Most ideas of banking experts agreed 100% about questionnaires arising from the current situation of risk management of exchange rate in FX trading, advantages or disadvantages of recent methods of risk management of exchange rate, how to identify, measure and control risk of exchange rate Last but not least, recommendations suggested for SBV and CBS in HCMC for improving risk management of exchange rate However, a number of specific contents is most unanimous as follows:

+ Forex management policy of SBV still have a lot of shortcomings such as interventions made by SBV to daily spot rate, method of setting forward rate, legal frame work guiding CBS in HCMC to conduct derivative instruments for hedging risk of exchange rate, the Interbank foreign exchange market working less efficient so that commercial bank find difficult to balance supply and demand of foreign currency for their FX trading: 75% - 85%

+ Main factors like supply and demand of USD, Marco and micro economy (CPI, Interest rate, GDP), Market sentiment (activities of USD cash market, sentimental state of investors) influence risk management of exchange rate of CBS in HCMC : 70%

+ Problems involved in non-qualified staffs, modern equipments and information technology: 50%

+ Treasury operational process are not standardized and separated tasks and responsibilities between front office, middle office and back office : 40% - 50%