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Central Banks Role in the Forex system

Each country has its own central bank that is responsible for formulating monetary policies that affects the value of its currency. The central bank of Nepal is Nepal Rastra Bank established in 2013 B.S. In the US, it is the Federal Reserve System popularly known as the Fed that is a system of 12 regional banks. The central bank in India is the Reserve bank of india, which is also responsible for the forex related policies. Central bank reserve assets are usually kept in three major forms: 1. Gold 2. Foreign exchange 3. IMF-related assets

General Role of the Central Bank in Forex system


Central banks are concerned primarily with liquidity to ensure they have the cash and flexibility needed to protect their countries currencies. The mix of currencies in a countrys reserves is based on its major intervention currencies. Intervention currencies mean the currencies in which the country trades the most. In countries that intervene in the foreign exchange markets, central banks are the key institutions to influence foreign currency values. So their role in the forex system of these countries is dominant. A central bank intervenes in money markets by increasing a supply of its countrys currency when it wants to push down the currency value, and by stimulating demand for the currency when it wants its value to rise.

Specific role of the central bank in forex system:


The central bank role is highly important in intervening in currency markets, which they do by buying and selling currency to affect its price. Central banks role may be enumerated as follows: 1. To coordinate the central banks action with other central banks, or go it alone. 2. To enter the market aggressively to change attitudes about its views and policies 3. To call for reassuring action to calm markets. 4. To intervene to reserves, resist, or support a market trend. 5. To announce or not announcing its operations, being very visible or very discreet. 6. To operate opening or indirectly through brokers. The central banks perform (discharge) these roles depending on the market conditions and the national priorities of their respective countries.

Commercial banks role in the forex system:


These banks are the major agencies that materialises the foreign exchange system, or translates it into action. The facilitate the movement of goods and services involved in the trade, or all forms of investments abroad, through their banking and other agency functions. All over the world, most foreign exchange transactions come from foreign exchange or international business development of commercial banks. The basic functions or role of commercial banks in the forex system are: 1. They buy and sell foreign exchange.

2. They collect and pay money in transactions with foreign buyers and sellers. 3. They lend money in foreign currency, and 4. They also provide counseling services and information to international business clients (customers), and relevant information event to the central bank. 1. Forex Buying and Selling: Commercial banks buy and sell foreign currency for many purposes: a. To serve those travelers going abroad or returning from a foreign country who want to purchase or sell back its foreign currency. b. To serve the residents of one country wanting to invest abroad who need to purchase foreign currency from a commercial bank. c. To facilitate the trade involving further material imports, as a forex collector and dealer: for example, a thai exporter receives payments from a Nepali importer in US dollars and wants to use the precious dollars to buy raw materials from USA. In this instance, the bank has to collect the proceeds of the foreign exchange transaction, and also deal with the forex on behalf of its clients. In other words, the bank serves the client or company as a collector and acts as dealer in a forex transaction. 2. Collection and payment in forex: The bank also serves as a vehicle for payments between its domestic and foreign customers. This function is highly important in collecting foreign currency in the international transactions. It is usually the most common transaction as countries or their firms get involved in international trade. When firms in one country, Nepal, open documentary letters of credit (L/Cs) with their local commercial banks to import goods from another country (Singapore), the banks manage the payment of money in foreign currency to the foreign party. This requires that either the commercial bank has subsidiaries or allies in that foreign country, or it has formal arrangement with some corresponding banks. In Nepalese case,

commercial banks here have arrangements with two major banks Amercian Express (Amex) Bank and Citi Bank that have international banking networks so that any collection and payment in foreign currency at any corner of the world can be arranged through their networks. 3. Lending in Forex: The common practice is that only the central office or headquarters of the commercial bank provides lending in foreign currency when it comes to international business. But when the bank has its subsidiary branchy in a foreign country (say, Malaysia), it can extend such loans in foreign currency in that foreign country. 4. providing counseling and information: Today, with the complexities being added to the foreign exchange deals with all over the world, the client companies seek technical information from their commercial banks. Therefore, the banks also provide counseling services to their client firms. As they keep themselves abreast with international foreign exchange transaction, they have up-to-date and relevant information on the forex system and transactions. So, they can also provide information not only to customers but, at times, also to the central bank. When a company sells goods and services to a foreign customer, an receive foreign currency, it needs to convert the forex into its domestic currency. When importing, the company needs to convert the forex into its domestic currency. When importing, the company needs to convert domestic to foreign currency to pay the foreign supplier. This transactions take place in the OTC market. It is originally the commercial banks that provided the forex services for their customers. Today, some of these commercial banks have eventually begun to take the forex trading as their major business, for eg, the banks in New York, Chicago and San Francisco, the major US money centres.

Most of the forex activity takes place in the traditional instruments of spot, outright forward and FX swaps, and commercial banks and even investment banks or other financial institutions basically trade these instruments.

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