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• Why do banks have to be regulated?
• The competitive context of traditional banking activity.
• Evaluation of the risks.

• Liquidity risk.        • Rate risk.
• Exchange risk.      • Credit risk.

The exchange risk

It is important to remind that the origin of the exchange risk is the holding of claims and debts in currencies, hence the earnings or losses in case of the variation of the legal tender. Like the rate risk, we are going to give some definitions, and then the measure and the management of the exchange risk will be examined.

A- Definitions

It is important to distinguish:

• The global position on exchange that is defined as net sale:

Claims in currencies– Debts in currencies

This global position is not a good indicator of the risk born by the bank for all currencies are mixed-up. It is nevertheless calculated when the regulation of exchanges forbid banks to take a global position on exchange, which means that every night the bank must have a null position.

• The exchange position by currency. For each currency, claims and debts are determined which leads to two situations:

		Currency X
Claims	Debts		claims	Debts

A bank is in a short position when it holds less claims in the currency X than debts. This situation is:
- Favourable if the market price of the currency X depreciates.
- Unfavourable if the market price of the currency apprises.

A bank is in a long position when it holds more claims in the currency X than debts. This situation is:
- Favourable if the market price of the currency apprises.
- Unfavourable if the market price of the currency depreciates.

• The cash exchange position and the forward exchange position. The first step of a forward exchange operation is either a purchase in cash, or a sale in currencies cash. The exchange risk appears from that step. The second step consists in lending or borrowing the purpose currencies of the operation (loans and borrowings in euros and currencies on funds markets). This second step shows a rate risk. So, every forward exchange operation gives birth to an exchange risk and a rate risk.

Thus, a bank receives a forward purchase order in dollars (USD). The operation decomposes like this:
- Purchase in cash with USD => Claim in USD => Exchange risk
- Forward borrowing of FRF => Rate risk
- Forward loan of USD => Rate risk.

B- The exchange risk measure

In such conditions, the exchange risk is measured by the exchange position, currency by currency; euros loans and borrowings are transferred into the calculation schedules of rate risk.

The bank can calculate, for each currency, the loss generated by an opposing variation of the exchange market prices and the amount of these losses is an evaluation of the global expo exposition to the exchange risk that can be compared to the equity total.

C- The management of exchange

Just like rate risk, exchange risk can be managed in two ways:

• The neutralization of the exchange risk: every day, the bank adjustes its exchange position currency after currency in order to remove short and long-term positions.

• The coverage of the exchange risk: If the neutralization is not possible, the bank has to cover the exchange risk thanks to the use of several possible tools that will not be discussed here.

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