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State Bank in talks with foreign exchange dealers on derivatives trading

KARACHI (February 06 2003) : The State Bank of Pakistan has been holding a dialogue with foreign exchange traders to frame rules and regulations to initiate derivatives trading in the country.

SBP has already taken a number of measures to liberalise the forex regime and is gradually introducing reforms, step by step, say the bankers.

Derivative is a financial product. Its value is derived from the value of another financial product.

Types of derivatives include 'Forward Rate Agreements' (FRAs), 'Interest Rate Swaps' (IRS), 'Options', 'Warrants' and 'Futures'. Professionals and retail investors trade in these.

For investors it offers the opportunity to earn extra income, or protect the value of their holdings.

There are many applications available to the investors, depending on the level of risk they are willing to accept.

The derivatives are used as risk management tools. They can expose to more or less risk, depending on how they are being applied.

The current focus of the market is on derivative products such as Forward Rate Agreements (FRAs), Interest Rate Swaps (IRS), Non-deliverable Forwards (NDF), etc.

Pakistan has been slow in undertaking structural reforms, but the one area that it has a good story to tell is the financial sector reforms undertaken since 1993, say international financial institutions.

During the last two years, SBP has attempted to create a market-based environment in the financial sector and do away with regulating and directing the banks in terms of lending policies.

In its effort to bring more healthy change, the SBP is encouraging the interbank market to introduce new products to meet the global standard, and it is said that banking community has willingly accepted the challenge and is exploring all possibilities.

Hence, it is working with SBP on various types of options to introduce new products.

Since Pakistan expatriates' foreign money is flowing regularly into the country and the size of banks' deposit base has expanded substantially, therefore liquidity remains a growing concern for the commercial banks, as the demand continues to remain thin.

The Government is expected to maintain its policy of debt retirement and simultaneously reducing the debt servicing cost on new debts. And the private sector is yet to take advantage of low lending rates and any new ventures are not on the horizon.

Financial Market Association (FMA) and a couple of foreign banks have already made a presentation on derivatives to the SBP, but most recently Habib Bank Ltd (HBL), one of the largest commercial banks, made an impressive presentation of derivatives products to the State Bank of Pakistan, highlighting the risks involved in derivatives business.

FORWARD RATE AGREEMENTS (FRAS): It is a product used as protection against future movements in interest rates. Two parties agree to a rate for a specified future settlement date, based on an agreed principal amount. No commitment is made by either party to lend or borrow the principal amount.

Their exposure is only the interest difference between the agreed and actual rates at settlement.

INTEREST RATE SWAP (IRS): This is transfer, between two parties, of interest rate obligations, one of which has an interest rate fixed to maturities, while the other floats in accordance with changes in benchmark, such as KIBOR, LIBOR prime rate etc.

NON-DELIVERABLE FORWARD (OPTION): Right acquired for a price to buy certain specified currency or instrument known as 'Call Option', or to sell it at an agreed price-Put Option-within a specified time.

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