INTERBANK DEPOSIT & SWAP OF FOREIGN CURRENCY

At present, mortgage lending of foreign currency does not prevail in the interbank market.

Limitations of mortgage lending of foreign currency

Interbank mortgage lending did not reach its projected goal in short time because most financial institutions have been used to credit lending, while interbank mortgage lending needs to redesign the clearing pattern, path, and the accounting procedure, which involves many changes in internal operating process.

Forex swap---a means of lower credit risk

For the ongoing mortgage lending, what the borrower of forex gives up for a period of time is the ownership of his RMB assets instead of the possession. There is no definite legal explanation on the lender's disposal of the mortgaged RMB assets. Besides, if the pledge needs to be disposed, other difficult problems such as the convertibility of RMB on capital account will be involved.

Forex swap can solve the problems mentioned above. In this transaction, the demander of foreign currency sells rather than mortgages its RMB assets, and promises to repurchase it at an agreed price sometime in the future (even one day later). During this process, the possession and ownership of foreign currency funds and RMB funds change at the same time, so credit risk is reduced. Moreover, if one party of the transaction defaults, China Foreign Exchange Trade System (CFETS) can suspend its access to the market, while the other party can cover the position immediately to reduce his loss.

Compliance of swap

As long as swap is carried out only in the interbank market, the ongoing regulations on capital account management will not be violated. Financial institutions participating in the interbank forex market all have a position quota of forex ratified by the State Administration of Foreign Exchange. Therefore, so long as they keep their spot balance within the quota, the existing regulations are obeyed.

Though the two parties concerned do not need to pay any interest, the interest cost, in practice, comes up in the form of price spread.

Besides, through its influence on forward RMB interest rate, swap reinforces the transmission mechanism of both exchange rate and interest rate, which helps the central bank's operation on forex market to play a more important role in guiding exchange rate.

Suggestions on the broking service for swap

CFETS should make detailed trading procedures and charge reasonable commission on swap, which is quite different from credit lending. CFETS can also use the commission as a lever to encourage banks to provide two-way quotation so that the liquidity of market can be guaranteed at any moment.

(by Mou Haiyang & Zeng Haihong)