Unhedged Foreign Currency Exposure (UFCE)

Posted under case studies on March 30 , 2020 by Ravi Pandey

Introduction:

Hedging is the activity of entering into financial transactions to reduce the exposure (risk) of financial loss. If no measures (investments) are taken to negate the risk of price movement, then it is called "Unhedged Currency Exposure". Foreign Currency Exposure (FCE) refers to the risk associated with the foreign exchange rates that change frequently and can have an adverse effect on the financial transactions due to exchange rate fluctuations.


Problem Scope:

The UFCE losses may reduce a bank’s capacity to lend and thereby affect the health of the banking system. Various guidelines are issued by RBI, advising banks to closely monitor the UFCE of their borrowing clients and factor this risk into the pricing. (https://www.rbi.org.in/scripts/NotificationUser.aspx?Id=8694&Mode=0#) It has, been decided by the RBI (Reserve Bank of India) to introduce incremental provisioning and capital requirements for bank exposures to entities with UFCE.


Before Sheetkraft:

The complexity of the process is very high since the data required to calculate the exposures is sourced from various departments. Since the files are prepared manually, there is no standard structure across files & the values may not be accurate. To eliminate this error, the user must validate the files gathered from all sources and perform the checks & calculations on their end as well to cross check the values. This being a manual activity, again is time consuming & error prone. The client used to segregate the data into multiple files & send it across various departments via email. Then the departments had to fill in relevant information in the files & send it back to the maker. Since this activity was manual, some errors were reported in the filled data. Our client was performing this process on a daily incremental basis & it approximately took 2-3 hours per day to generate the files for the provision calculation. The provision was calculated at the end of each financial quarter. One of the major difficulties for the client was to calculate the provision for those common borrowers across various departments resulted in cross provisioning.

Let’s see how provision for UFCE are calculated?

  • The provision is to be calculated for all the accounts except for those which belong to NPA (Non-performing Asset) and PWO (Provisional write-off) category. If the Customer belongs to IBPC (Interbank Participation Certificate) or BRDS category (Bill Rediscounting Scheme) then provision will be not calculated & the account will be declared IBPC, BRDS, NPA or PWO depending on the criteria.
  • After performing various checks & calculations (FB_oustanding, Net amount), the data is segregated into multiple files for various departments
  • These files are then sent to the respective departments via mail. The departments fill in the required details such as UFCE AMOUNT, EBID AMOUNT, EBID DATE, etc. which is required to calculate provision. A unique remark is filled to calculate Provision Bracket with the reference of UFCE amount, EBID amount & EBID date.
  • Based on Customer ID, derivative data is mapped with the respective department data.

RBI guidelines for various buckets of likely loss/EBID% (https://www.rbi.org.in/scripts/NotificationUser.aspx?Id=8694&Mode=0#)

  • Likely Loss is calculated using UFCE amount, EBID amount. Volatility rate is calculated using historical data of exchange rate fluctuations. Provision Bracket is calculated as per the RBI Guidelines.
  • After calculating provision, a summary report is generated for all the departments and reports are sent via mail to their respective authorities.

After Sheetkraft:

Our team reviewed the UFCE process flow & various calculation logic, using which the client used to calculate provision. After assessing all the inputs & required outputs, our team finalized a structured design for various input files being used & a proper approach to automate the business process to calculate provision.

After Automating with SheetKraft

  • SheetKraft team automated the process of segregating the data & sending it over email, and added validation in the output files generated. Any redundant data or errors in data format is automatically eliminated due to these validations.
  • The calculated data is put in place in a structured tabular format adhering to the RBI guidelines and is sent via email to relevant stakeholders.

Impact:

Earlier, the data was filled manually so the chances of error were quite high as well as it was time consuming. To perform this activity, they were having maker and checker, but after automating with the Sheetkraft they do not required any checker, it is automatically system generated output which is sent via mail to their respective authorities. Daily, the user had to validate the data, segregate it and send emails to the respective department to fill data required to calculate provision. Even after receiving revised data from departments, the user had to cross validate for any missing data, calculate provision, generate various reports and send emails to higher authorities. They required total effort of approximately 6-7 hours to do the same. But after automating with SheetKraft, it only takes 1-2 minutes to do the same.


Tagged:BankingHedgingForeign Currency Exposure

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