When the bank buys foreign exchange from the customer, it sells the same in the inter-bank market at a better rate and thus makes a profit out of the deal. In the inter-bank market, the bank will accept the rate as dictated by the market. It can, therefore, sell at the market buying rate for the foreign currency concerned.
Thus the inter-bank buying rate forms the basis for quotation of buying rate to the customer by the bank. Similarly, when the bank sells foreign exchange to the customer, it meets the commitment by purchasing the required foreign exchange from the inter-bank market. It can acquire foreign exchange from the market at the market selling rate.
Therefore, the inter-bank selling rate forms the basis for quotation of selling rate to the customer by the bank. The inter-bank rate on the basis of which the bank quotes its merchant rate is known as ‘base rate’.
Types of Buying Rates in Foreign Exchange
All purchase transactions of foreign exchange are not similar with respect to the delay in the bank getting the foreign exchange or the work involved. Let us, for example, take the following purchase transactions.
(i) The bank pays a demand draft drawn on it by its correspondent bank.
(ii) The bank purchases a sight bill drawn on London.
In the first case, at the time of issue of the draft, the foreign correspondent bank would have credited the account of the bank with them. Therefore, the bank is already provided with foreign exchange. In the second case, the bill has to be sent to London. The bank’s account with the foreign correspondent bank will be credited only after the bill is presented to the drawee abroad and he makes payment against it. This involves some time, known as the transit period. Depending upon the time of realization of foreign exchange by the bank, two types of buying rates are quoted in India.
1. TT Buying Rate (TT stands for Telegraphic Transfer). This is the rate applied when the transaction does not involve any delay in realization of the foreign exchange by the bank. In other words, the Nostro account of the bank would already have been credited. The rate is calculated by deducting from the inter-bank buying rate the exchange margin. FEDAI has prescribed the exchange margin that could be built into the TT buying rate as between 0.025% and 0.08%. The bank has the discretion to charge any rate of exchange margin within the range prescribed.
Though the name implies telegraphic transfer, it is not necessary that proceeds of the transaction is received by telegram. Any transaction where no delay is involved in the bank acquiring the foreign exchange will be done at the TT rate. Examples of transactions where TT rate is applied are: (i) Payment of demand drafts, mail transfers, telegraphic transfers, etc., drawn on the bank where bank’s nostro account is already credited, and (ii) foreign bills collected.
TT BUYING RATE
Inter-bank spot buying rate for foreign currency = Rs….xxx
Less: Exchange margin = Rs….xxx
= TT Buying Rate = Rs….xxx
Round off to nearest paise and quote to the customer.
2. Bill Buying Rate. This is the rate to be applied when a foreign bill is purchased. When a bill is purchased, the proceeds will be raised by the bank after bill is presented to the drawee at the overseas center. In the case of usance bill the proceeds will be realized on the due date of the bill which includes the transit period and the usance period of the bill.
If a sight bill on London is purchased, the realization will be after a period of about 15 days (transit period). The bank would be able to dispose of the foreign exchange only after this period. Therefore, the rate quoted to the customer would be based not on the spot rate in the inter-bank market, bu. on the inter-bank rate for 15 days forward. Likewise, if the bill purchased is 30 days usance bill, then the bill will realize after about 45 days (15 days transit plus 30 days usance period). Therefore, the bank would be able to dispose of foreign exchange only after 45 days; the rate to the customer would be based on the inter-bank rate for 45 days forward.
In the inter-bank market the forward margin is normally available for periods in multiples of a month and not for 15 days, etc. The bank has the option of rounding off the period of 15 days, etc., either to one month or to zero month, i.e., to the higher or lower month. Thus, in case of the sight bill mentioned above, the period may be rounded off to one month and the rate quoted to the customer based on one month forward rate in inter-bank market or it may be quoted on the basis of the spot rate in inter-bank market. In the case of usance bill involving transit period and usance period totaling 45 days, the rate to the customer may be based on two months forward rate or one month forward for the currency concerned in the inter-bank market. In order to round off the period to the advantage of the bank, if the forward margin is at discount, the transit and usance period is rounded off to the higher month and if the forward margin is at premium, it is rounded off to the lower month.
As noted under TT buying rate, the bank would include exchange margin in the rate quoted to the customer while quoting for purchase of bills also. The FEDAI has allowed the banks to load exchange margin of 0.125% to 0.150% in the rates quoted for purchase of bills. A further margin of 0.125% to 0.150% is allowed for usance bills on DP (Documents against Payment) terms.
It should have been observed that there will be more than one bill rate, each for a different period of usance of the bill.
BILL BUYING RATE (BBR)
Inter-bank spot buying rate for foreign currency (IBBR) = Rs. xxx
Add: Forward premium (FP) (for transit and usance; rounded off to lower month) = Rs. xxx
Less: Forward discount (FD) (for transit and usance; rounded off to higher month) = Rs. xxx
Less: Exchange margin (EM) =Rs. xxx
= Bill buying Rate=BBR
☆ BBR=IBBR+FP-EM (OR)
* Round off the nearest paise and quote to customer.