The central bank is proposing a new limit on banks’ net open foreign exchange (FX) positions or overbought and oversold positions to ensure market liquidity and to discourage speculative activity.
In a draft circular, the Bangko Sentral ng Pilipinas (BSP) changed the allowable open FX position and the basis for the limit, and adjusted the absolute cap to $100 million from the previous $50 million.
The proposal is that bank’s consolidated net open FX position should not exceed 25 percent of its qualifying capital or $100 million, whichever is lower.
The current allowable open FX position is not specified as a net position, and it is the lower of 20 percent of a bank’s unimpaired capital or $50 million.
Any excess of the allowable limit is settled on a daily basis. The current rule imposes a penalty of P30,000 per day, per transaction, whenever a bank is in excess of its oversold or overbought FX limit.
BSP is proposing to use the qualifying capital as of the month-end two months prior to determine the net FX position limit. In the meantime, banks’ consolidated net open FX position is defined as the “higher of the absolute value of the sum of the net long positions or the sum of the net short positions in individual currencies.”
The BSP said it will be closely monitoring banks’ compliance with the overbought and oversold limit and it will “pay particular attention” to authorized agent banks (AABs) that breach the limit five times within a 20-business day period.
Instances of breaches that will be evaluated will be based on frequency and the gravity of the breaches, and the underlying cause or causes of the breaches and the extent to which these are consistent with the AAB’s declared business strategies, said the BSP. Also to be evaluated are the strength of the AAB’s risk management system and actions taken by the AAB, if any, to address the breaches and restore compliance with the limit.
An open FX position refers to the “extent that banks’ FX assets do not match their FX liabilities.” These are either FX assets exceeding FX liabilities which will be in positive/long/overbought position, or FX liabilities exceeding FX assets to indicate negative/short/oversold position.
Basically, an overbought position is when banks’ FX position leads to an extended upside price movement that is consistent and with no significant retreat. The oversold position is the opposite, or downward price movement.
The BSP said these rules still intend to encourage growth and FX market development as well as to make sure that banks can supply “ample liquidity” in the market – “but at the same time (banks will) conduct their business in a sound manner, banks shall manage their open foreign exchange positions in accordance with these guidelines.”
What is absent in the policy declaration anymore is the recognition that banks are the main players in the FX market or the “market-makers.”
The peso at the P48-level has been consistently on the strong side vis-à-vis the US dollar and remains one of the best performing currencies in the region. The BSP expects the peso to be strong for a long time and it is fully supported by healthy buffers. The country’s FX reserves is at a record high past $100 billion.
Any adjustments in the oversold or overbought limit are prudential measures of the BSP to avoid “excessive exposure of banks” to FX-related risks particularly if this will affect its capital health.
The BSP increased the oversold and overbought limit to 20 percent of unimpaired capital in 2007, at the height of the global financial crisis. Before 2007, the overbought position has an absolute limit of 2.5 percent while banks’ oversold position has no ceiling.