Banks face new foreign exchange rules

BANKS trading foreign exchange in London come under a new set of rules in December that will allow them to reduce credit risk by as much as 65 per cent overnight.

The British Bankers Association, after consultation with the Bank of England, yesterday announced a new legal contract governing foreign exchange deals.

It allows banks to net their foreign exchange exposures with any one counterparty before payment is exchanged. Along with reducing credit risk, netting bilateral deals down to a single sum will slash banks' capital requirements and free their balance sheets for increased trading, said Bob Blower, BBA assistant director.

UK banks are particularly keen to focus more on trading than lending, after their bad experiences in the recession.

The forex markets in London and New York have a combined estimated turnover of dollars 420bn per day. The netting measures are expected to be extended eventually to global off-exchange derivatives trading. The agreement was worked out with New York and Tokyo market authorities and is being adopted there simultaneously. But London stands to gain more than the other centres, because of their domestic rules.

At present, banks in forex deals with defaulting companies have ended up out-of-pocket because insolvency specialists take charge of all the profitable trades and leave the banks with the remainder. But the new rules protect banks by netting all the profitable and unprofitable forex deals with the defaulter into a single obligation. This significantly reduces the strain on banks' balance sheets and cuts capital requirements.