International Banking & Foreign Exchange Management

The foreign exchange reserves of a country, also known as forex reserves are a combination
of cash and other reserve assets, such as gold, held by the central bank or another monetary
authority; they can be used to manage the country's balance of payments, fluctuate the
foreign exchange rate of the currency, and maintain financial market confidence. The
reserves are held in one or more reserve currencies. A majority of foreign exchange reserves
are held in US dollars, while a smaller amount is held in euros.
Foreign exchange reserves assets can comprise banknotes, deposits, and government
securities of the reserve currency, such as bonds and treasury bills. [2] Some countries also
hold gold as part of their reserves, and special drawing rights are also considered reserves
assets. For convenience, the cash or securities are often retained by the central bank of the
reserve or other currency, and the "holdings" of the foreign country are tagged or otherwise
identified as belonging to the foreign country without actually leaving the vault of the
central bank. Sometimes, they may be physically relocated to their home country or another
country. In general, foreign cash reserves are not paid interest or gold holdings, but the
central bank usually earns interest from government securities. However, the central bank
can benefit from a foreign currency depreciation or suffer a loss from its appreciation. The
central bank also incurs opportunity costs when it holds reserves (especially cash) as well as
from the cost of storing, protecting, and maintaining them.
Central banks may refer to foreign exchange reserves as reserve assets in the capital
account of the balance of payments or as reserve assets in their assets by functional
categories. Among the different types of financial assets, reserve assets include gold bullion,
unallocated gold accounts, special drawing rights, currency, reserve positions in the IMF,
deposits in other banks, debt securities, loans, equity (listed and unlisted), investment fund
shares, and derivative instruments such as forward contracts and options. Foreign exchange
reserves do not have counterparts in liabilities of the International Investment Position.
Usually, when the monetary authority of a country has a liability, this is included in Other
Investments. In the Central Bank's Balance Sheet, foreign exchange reserves and domestic
credit are assets.
RBI is the custodian of foreign exchange reserves in India. As a metric of a Country's health,
Foreign Exchange Reserves or Forex Reserves are assets such as foreign currencies, gold
reserves, treasury bills, etc that are kept by the central bank or another monetary authority
to monitor and influence the exchange rate of the country's currency. They are also meant
to improve financial stability in the country. To support imports, all international
transactions are settled in US dollars. In addition, they are crucial for supporting and
maintaining confidence that central banks will act, whether through monetary policy or
against exchange rates. In terms of the value of this reserve, foreign currency assets are the
biggest contributor, followed by gold, SDRs, and the reserves at the International Monetary
Fund. In 2020, India's forex reserves will cross $500-billion for the first time in history due
to an increase in foreign direct investment and foreign institutional investment. The low
price of oil helped to reduce outflows as well. Consequently, India had adequate cushioning
to deal with external shocks. It shows that foreign exchange is the most important
parameter of India's health in the international market. Therefore, the purpose of the
Foreign Exchange Reserve are as follows:

 The most significant objective of the plan is to ensure that RBI has backup funds if
their national currency rapidly devalues or becomes insolvent.
 The Reserve Bank of India (RBI) sells dollars in the Indian money market if the Rupee
deteriorates due to a spike in demand for foreign currency. This can be done to
prevent the rupee from depreciating even further.
 An economy with a good stock of foreign reserves has a good image at the
international level because trading partners can be confident about payments.
 The presence of a good forex reserve is an important factor in attracting foreign
trade and has positive effects on the reputation of a country.
 Forex reserves alleviate any vulnerability that might result from a sudden disruption
of foreign capital flows, which could occur during a crisis.
 Foreign exchange reserves serve as a buffer against such effects and give the
country a sense of security that its imports will be supported in the event of external
shocks.
 In international trade, currency flows arise, which are handled by private banks
pursuing the transaction motive. Likewise, speculative motives remain the
responsibility of individuals or corporations.
 Reserves, on the other hand, are often thought of as a last resort stock of foreign
currency for unpredictable flows, which is consistent with the precautionary motive
for holding foreign assets.
 The precautionary motive for holding foreign currency, like the demand for money,
can be positively correlated with wealth and the cost of covering unplanned deficits,
and negatively correlated with the return on alternative assets.
Ans. 2 (

Foreign Exchange Reserve is generally referred to the money or other any assets next to money held by Central Bank or similar monetary

authority. The foreign exchange reserve is comprised of various monetary products ranging from foreign banknote, foreign bank

deposits, and foreign treasury bills to short & long-term foreign government securities. 

 An Authorised Dealer (AD) is any person specifically authorized by the Reserve Bank under Section 10(1) of FEMA, 1999, to deal in

foreign exchange or foreign securities and normally includes banks. It  refers to any type of financial institutions who has received

authorization from the RBI as a dealer to involve in trading of foreign currencies. The transaction of the authorized dealer should have

been conducted in pursuance of a legal mode and under the framework established by law. Authorized dealers are nothing else but the

market pronounced name of AMC i.e., Authorized Money Changer. As per master circular no. 10/2013-14 of RBI dated 01st July 2013 it

describes that the AMC/ADs are entities, authorized by the Reserve Bank under section 10of the Foreign exchange Management Act

1999. In addition to Authorized Dealers category-I Banks (AD Category –I Banks) and Authorized Dealer Category – II (Ads category- II),

Full Fledged Money Changers (FFMCs) are authorized by Reserve Bank to deal in Foreign exchange for specified purposes, to widen the

access of foreign exchange facilities to residents and tourists while ensuring efficient customer service through competition. Foreign

exchange can be purchased from any authorised person, such as an AD Category-I bank and AD Category II. Full-Fledged Money

Changers (FFMCs) are also permitted to release exchange for business and private visits. 

Authorised Dealers shall allow users to freely cancel and rebook derivative contracts. However, net gains (gains over and above losses

if any) on contracts booked to hedge an anticipated exposure shall be passed on to the eligible user only at the time of the cash flow

of the anticipated transaction. In case of part delivery, net gains will be transferred on a pro-rata basis.

iv. Authorised Dealers may, in exceptional cases, pass on the net gains on contracts booked to hedge an anticipated exposure whose

underlying cash flow has not materialised, provided it is satisfied that the absence of cash flow is on account of factors which are

beyond the control of the user. Such instances along with specific justification, shall be kept on record by the Authorised Dealer.

Brief Explanation Of Different Category of Investor’s

   Authorized Dealers Category – I (ADs – I)

1.

As per the latest circular Issued by the RBI, there are around 110 entities who are qualified under the segment of Authorized Dealers

category – I. It includes all type of Commercial Banks irrespective of Nationalized Banks, Scheduled Banks, Private Banks and Foreign

Commercial Banks operating in India. These segments of banks allowed to deals in all type of foreign exchange transaction related to

current and capital account transaction according to the norms and procedure laid down by RBI.

    Authorized Dealers Category – II (ADs –II)

2.

The second category of authorized dealer operates under the restrictive environment for the implementation of some specified

purposes prescribed by RBI. It includes the Upgraded Full Fledged Money Changer and another new inclusion like Department Of Post

and various types of NBFCs who are operated in open markets. As per RBI the detailed of dealers classified under this category are

considered as per region basis. At present, there are 11 region in India which under this category.

   Authorized Dealers Category -III (ADs –II)

3.
The third category of authorized dealer operates with the purpose to boost the international trade by proving them adequate availability

foreign currency for promotion of international trade as per the norms lay down in section 10 of the FEMA Act 1999. It includes the

major player of financial institutions like IFCI, SIDBI EXIM Bank and various Factor Agencies.

   Full-Fledged money Change (FFMCs)

4.

It is the new aspect of regulation of Indian Foreign Exchange markets. It may be any financial entity other than Commercial Banks who

qualified the norms and criteria laid down by RBI. FFMCs are authorized to purchase foreign exchange from resident and non-resident

visiting India and to sell Foreign Exchange for certain approved purposes. The main objective of the enactment of FFMCs is to provide

easy access to foreign exchange transaction to common masses.