Currency Swap Arrangements

Recently, the RBI decided to address the liquidity deficit in the banking system by bond purchases & a $10B dollar/rupee buy/sell forex swap. 𝐁𝐮𝐭 𝐰𝐡𝐚𝐭 𝐢𝐬 𝐚 𝐟𝐨𝐫𝐞𝐱 𝐬𝐰𝐚𝐩?   A financial agreement where two parties exchange currencies today & agree to reverse the transaction at a future date at a pre-determined rate   Let's consider the RBI's example:  ✔️ RBI is planning to enter into the dollar/rupee buy/sell forex swap for 3 years ✔️ RBI will buy $10B from banks today, giving them ₹86,950 crore (at 1 USD = 86.95 INR) ✔️ For the sake of this example, let's consider a pre-agreed swap rate for 2027 is set at 1 USD = 88 INR (i.e., banks will return ₹88,000 crore to RBI in exchange for $10B) ✔️ After 3 years, banks must return the rupees, and the RBI will return the $10B   The USD/INR rate will not necessarily be at 1 USD = 88 INR 𝐒𝐜𝐞𝐧𝐚𝐫𝐢𝐨 𝟏: 𝐑𝐮𝐩𝐞𝐞 𝐃𝐞𝐩𝐫𝐞𝐜𝐢𝐚𝐭𝐞𝐬 (𝟏 𝐔𝐒𝐃 = 𝟗𝟎 𝐈𝐍𝐑 𝐢𝐧 𝟐𝟎𝟐𝟕) - Banks need ₹90,000 crore to buy back $10B at market rates - But they only need to return ₹88,000 crore to RBI as per the swap - Banks 𝐠𝐚𝐢𝐧 ₹𝟐,𝟎𝟎𝟎 𝐜𝐫𝐨𝐫𝐞 because they are buying back dollars cheaper than the market price 𝐒𝐜𝐞𝐧𝐚𝐫𝐢𝐨 𝟐: 𝐑𝐮𝐩𝐞𝐞 𝐀𝐩𝐩𝐫𝐞𝐜𝐢𝐚𝐭𝐞𝐬 (𝟏 𝐔𝐒𝐃 = 𝟖𝟓 𝐈𝐍𝐑 𝐢𝐧 𝟐𝟎𝟐𝟕) - Banks need only ₹85,000 crore to buy back $10B at market rates - But they are locked into returning ₹88,000 crore to RBI as per the swap - Banks 𝐥𝐨𝐬𝐞 ₹𝟑,𝟎𝟎𝟎 𝐜𝐫𝐨𝐫𝐞 since they are buying back dollars at a higher-than-market price   𝐖𝐡𝐲 𝐝𝐨 𝐛𝐚𝐧𝐤𝐬 𝐩𝐚𝐫𝐭𝐢𝐜𝐢𝐩𝐚𝐭𝐞? ✔️ Instant Liquidity – Banks get ₹86,950 crore today, which addresses the liquidity deficit issue in our example. They can lend or invest ✔️Potential Forex Gains – If INR weakens beyond the pre-agreed swap rate, they profit ✔️ Interest Rate Arbitrage – If banks invest the rupees in high-yield instruments, they can earn extra returns over 3 years   Banks borrow ₹86,950 crore today, but their final cost depends on where USD/INR stands in 3 years compared to the pre-agreed swap rate (₹88). If INR weakens, they win; if it strengthens, they lose.

𝐈𝐧𝐝𝐮𝐬𝐈𝐧𝐝 𝐁𝐚𝐧𝐤’𝐬 ₹1,500 𝐂𝐫𝐨𝐫𝐞 𝐒𝐰𝐚𝐩 𝐌𝐢𝐬𝐩𝐫𝐢𝐜𝐢𝐧𝐠: Hedging of NRI deposits. -When IndusInd Bank reported a ₹1,500 crore hit due to cross-currency swaps, it wasn’t just a routine accounting error—it was a classic case of hedging misalignment and pricing miscalculations. 🧐 The Context of currency swaps Banks face a common FX risk when handling NRI deposits , for example 🔹 An NRI deposits $1 million, which is converted to ₹8.6 crore (at ₹86/USD) and deployed as loans. 🔹 In 5 years, the bank must repay in USD, exposing it to exchange rate fluctuations. To hedge this, the bank executes a cross-currency swap (CCS).  Banks must disclose the nature and terms of cross-currency swaps, including the notional amounts, currencies involved, and the fair value of the swaps ⚙️ 𝐇𝐨𝐰 𝐂𝐫𝐨𝐬𝐬-𝐂𝐮𝐫𝐫𝐞𝐧𝐜𝐲 𝐒𝐰𝐚𝐩𝐬 𝐖𝐨𝐫𝐤 A cross-currency swap involves two key components: 1️⃣ Principal Exchange: At inception, the bank receives INR and gives an equivalent USD amount. At maturity, it swaps back at a pre-agreed rate. 2️⃣ Interest Payments: The bank pays INR interest (fixed or floating) and receives USD interest (floating, often SOFR-based). 💡 Example: Imagine IndusInd enters a 5-year USD-INR swap: -Pays fixed INR rate (5%) -Receives floating USD SOFR rate (~4.5%) This offsets FX risk but introduces interest rate risk based on SOFR movements. 📉 𝐓𝐡𝐞 𝐏𝐫𝐢𝐜𝐢𝐧𝐠: 𝐖𝐡𝐞𝐫𝐞 𝐈𝐭 𝐖𝐞𝐧𝐭 𝐖𝐫𝐨𝐧𝐠 Cross-currency swaps are priced using: ✅ Zero-Coupon Yield Curves: Discount future cash flows using USD SOFR & INR MIBOR. ✅ Fixed Rate Calculation (Solving for the fair INR fixed rate)  The IndusInd Bank Mismatch 🚨 Internal Hedge: Priced using swap cost accounting (ignoring MTM volatility). 🚨 External Swap: Marked-to-Market (MTM), causing valuation gaps. 🚨 Low-Liquidity Instruments: 8-10 year swaps lacked depth, amplifying basis risk. 📌 Result: Mark-to-market losses on external swaps were not offset internally, leading to a huge P&L hit. 🎯 Lessons for Finance Professionals ✅ Align Hedge Accounting: Internal and external valuations must match to avoid surprises. ✅ Liquidity Matters: Long-tenor swaps can widen spreads, increasing basis risk. ✅ Transparency is Critical: ALM, Trading, and Finance teams must communicate effectively.

💱 What is a Currency Swap? A currency swap is a financial derivative contract in which two parties exchange principal and interest payments in different currencies The swap typically involves: 1️⃣ Initial exchange of principal amounts in different currencies 2️⃣ Periodic exchange of interest payments (which can be fixed or floating) 3️⃣ Final re-exchange of the principal amounts at the end of the swap term 🔁 Purpose of a Currency Swap Currency swaps are used by: 🔅 Corporates: To hedge against foreign currency debt 🔅 Governments: To manage foreign reserves or funding costs 🔅 Investors and banks: To gain access to cheaper foreign funding or exposure Imagine 💡 1️⃣ A Sri Lankan company (Company A) has a loan in USD but earns in LKR 2️⃣ A U.S. company (Company B) has a loan in LKR (perhaps via a local subsidiary) but earns in USD They can enter a currency swap to exchange their obligations and reduce foreign exchange risk 🔄 Step-by-Step: How a Currency Swap Works 👥 Parties: Company A (Sri Lanka): Needs USD Company B (USA): Needs LKR Step 1️⃣ : Initial Principal Exchange 🔹 Company A gives LKR 32 million (at LKR 320/USD) 🔹Company B gives USD 100,000 This allows each party to access the currency they need without going to the forex market Step 2️⃣ : Periodic Interest Payments (e.g., annually) Let’s assume a 3-year swap: 🔹 Company A pays interest on USD 100,000 at 5% annually → USD 5,000 🔹 Company B pays interest on LKR 32 million at 12% annually → LKR 3.84 million Each party pays interest in the currency it originally received. Step 3️⃣ : Final Re-exchange of Principal At the end of 3 years: 🔹 Company A returns USD 100,000 🔹 Company B returns LKR 32 million This protects both companies from exchange rate volatility during the contract period 🧠Currency swaps are a useful tool for multinational companies to manage foreign currency liabilities, reduce financing costs, and hedge long-term FX risk But they must be entered with clear legal agreements and understanding of counterparties #RiskManagement #CorporateFinance #FinancialStrategy #TreasuryManagement #DerivativeMarkets #CurrencyTrading #HedgingStrategies #ForeignExchangeRisk #OptionsTrading #FinancialMarkets #CFRM #SL02

𝗖𝘂𝗿𝗿𝗲𝗻𝗰𝘆 𝗦𝘄𝗮𝗽𝘀 𝗶𝗻 𝗦𝗶𝗺𝗽𝗹𝗲 𝗧𝗲𝗿𝗺𝘀 Currency swaps are essential derivative instruments for companies and investors operating in international markets. They allow the conversion of payment flows from one currency to another while benefiting from preferential interest rates. When a company borrows in a foreign currency, it is often exposed to exchange rate fluctuations and to potentially higher interest rates compared to borrowing in its local currency. A currency swap can help optimize costs by leveraging comparative advantages in different interest rate environments. Take two companies, A (AAA-rated) and B (BBB-rated), both needing to borrow €10M for five years. A prefers a floating-rate loan but can borrow at 4% fixed or EURIBOR + 30 bps. B prefers a fixed-rate loan but faces 5.2% fixed or EURIBOR + 100 bps. The fixed-rate spread is 1.2% (5.2% - 4.0%), while the floating-rate spread is only 0.7% (EURIBOR + 100 - EURIBOR + 30). This means B has a relative advantage in floating-rate borrowing, while A benefits more in the fixed-rate market, creating an opportunity for a swap to lower costs for both. 𝗘𝘅𝗮𝗺𝗽𝗹𝗲: A European Company Seeking to Borrow in USD A direct loan in USD would cost the company 6% annual interest. However, it can borrow in EUR at a rate of 3%. Using a EUR/USD currency swap, it can convert its EUR-denominated loan into a USD liability, benefiting from the lower EUR interest rate and securing a fixed exchange rate for future USD payments. 𝟮. 𝗛𝗼𝘄 𝗮 𝗖𝘂𝗿𝗿𝗲𝗻𝗰𝘆 𝗦𝘄𝗮𝗽 𝗪𝗼𝗿𝗸𝘀: 𝗖𝗮𝘀𝗵 𝗙𝗹𝗼𝘄s A currency swap is a contract in which two parties exchange interest payments and/or principal amounts in different currencies. 𝗞𝗲𝘆 𝗙𝗲𝗮𝘁𝘂𝗿𝗲𝘀: 𝗘𝘅𝗰𝗵𝗮𝗻𝗴𝗲 𝗼𝗳 𝗻𝗼𝘁𝗶𝗼𝗻𝗮𝗹 𝗮𝗺𝗼𝘂𝗻𝘁𝘀: At the beginning of the swap, the parties exchange a principal amount in their respective currencies. At maturity, they return these notional amounts. 𝗘𝘅𝗰𝗵𝗮𝗻𝗴𝗲 𝗼𝗳 𝗶𝗻𝘁𝗲𝗿𝗲𝘀𝘁 𝗽𝗮𝘆𝗺𝗲𝗻𝘁𝘀: Each party pays an interest rate in the currency they borrow and receives an interest rate in the other currency. 𝗙𝗶𝘅𝗲𝗱 𝗼𝗿 𝗳𝗹𝗼𝗮𝘁𝗶𝗻𝗴 𝗶𝗻𝘁𝗲𝗿𝗲𝘀𝘁 𝗿𝗮𝘁𝗲𝘀: Swaps can be fixed-to-fixed or fixed-to-floating. Suppose a European company needs $100 million for a project. Instead of borrowing directly in USD, it opts for a currency swap. 𝗦𝘁𝗲𝗽𝘀 𝗼𝗳 𝘁𝗵𝗲 𝗦𝘄𝗮𝗽: 1. The company borrows €90 million (equivalent to $100 million at an exchange rate of 1 EUR = 1.11 USD). 2. It immediately exchanges the euros for dollars through a currency swap. 3. The company pays interest in USD at an agreed rate while receiving interest payments in EUR. 4. At maturity, the two parties re-exchange the notional amounts, and the company recovers its euros to repay the original loan. This strategy enables the company to benefit from a lower EUR interest rate while securing its USD payment obligations at a known exchange rate. #CurrencySwaps #FXMarkets #RiskManagement

In a major milestone, BRICS members China and Saudi Arabia have reinforced the de-dollarisation process by signing, last week, a three-year, $7 billion currency swap deal. This allows bilateral trade to be settled in either yuan or rials, with a cap of 50 billion yuan or 26 billion rials. Interestingly, China has also signed a currency swap agreement with Argentina, a country that recently became a BRICS member, earlier this year. Following these recent developments, it's crucial to understand the context. Several countries have indicated their desire to embark on a path towards de-dollarisation, a step particularly advocated by the BRICS countries. Their objective is to develop a diversified and resilient global financial system, which can lead to ppl greater economic self-determination. There is also a strong desire to diminish American hegemony and mitigate the potential impact of U.S. sanctions. This push has gained traction since extensive sanctions have effectively frozen Russia out of the global payment systems. Moscow now, for instance, accepts payments denominated in yuan for oil exports to China, and in rupees for some of its oil exports to India. In March this year, the yuan overtook the dollar for the first time to become the most widely used currency for cross-border transactions in China. The situation in Argentina provides a stark contrast. The newly elected president, Javier Milei, has raised the matter of dollarisation as a potential remedy for the country's disastrous recent economic performance. The Argentine Peso recently plunged to historic lows due to economic mismanagement, multiple defaults, and U.S. dollar scarcity. If this step goes ahead, Argentina would follow the dollarisation route already chosen by Ecuador, El Salvador, and Zimbabwe, amongst others. Countries such as Myanmar, Cambodia, Liberia, and Vietnam have informally dollarised and use the U.S. dollar as a quasi-currency. In contemplating the adoption of the U.S. dollar, nations need to weigh carefully the advantages of economic stability, lower interest rates, and the facilitation of trade against the backdrop of limited monetary policy flexibility, vulnerability to external shocks, and an inherent inability to address trade imbalances. Watch this space. It will be fascinating to see how the two important trends of dollarisation versus de-dollarisation play out in the coming years. #dedollarisation #brics #russia #currencyswap #yuan #rial #argentina #dollarisation

The People's Bank of China (PBOC) and Central Bank of the Republic of Türkiye have extended their bilateral currency swap agreement for another three years, a deal worth up to 35 billion yuan (approximately $4.9 billion) or 189 billion Turkish lira, as reported by Bloomberg News. The agreement enables the direct exchange of yuan and lira between the two central banks and signals a continued push toward strengthening financial ties and promoting local currency use in cross-border transactions. This renewed commitment not only facilitates trade and investment between the two countries, but also reinforces ongoing efforts to reduce dependence on the U.S. dollar in international settlements. Notably, the deal also includes a memorandum of understanding to establish a renminbi clearing arrangement in Türkiye, deepening the financial infrastructure for yuan-based transactions. As more countries explore alternative currency frameworks and seek greater monetary sovereignty, this development is a clear example of how emerging economies are rethinking the structure of global finance. https://lnkd.in/gPJMtaDU