Warning as NZ banks "return to old forex tricks"

Friday 9th March 2012 1 Comment

Exporters need to be wary of banks dropping premiums on foreign currency hedges in exchange for leveraged exposure to the risk of markets turning against them, says corporate treasury adviser Asia-Pacific Risk Management.

In its latest monthly bulletin, APRM asks whether banks are “up to their old forex tricks” as conditions in foreign exchange markets start mirroring the late 1990’s, when exporters expecting the New Zealand dollar to keep rising were caught by a collapse in its value following the Asian financial crisis.

Such arrangements had got some New Zealand companies into “a power of strife” in 1998, because they had struck “collar” arrangements in which they were able to avoid premiums for buying protection from a rising kiwi dollar as long as they were prepared to take between two and four times as much risk if it fell sharply.

“Leveraged option products are generally hard to risk manage,” says APRM, “especially when currency markets rise or fall suddenly.

“They can also get companies into serious trouble if the currency markets reflect regional economic crises.”

The impact on companies affected by loss of markets in Asia was not only that their forward orders dried up, but their leveraged exposure to an unexpectedly low exchange rate caused a double whammy.

In 1998, that left companies “significantly over-hedged with seriously out-of-the-money foreign exchange positions that needed to be closed out. The hits went straight to the bottom line,” the APRM commentary says.

The firm does not blame banks for offering such products, saying they were often a response to the “restrictive needs” of clients who wanted to avoid premiums on forward cover, particularly in circumstances where the company held a firm view about the future track for the New Zealand dollar exchange rate.

Such arrangements were also not transparent enough to unwind easily in crisis situations.

BusinessDesk.co.nz

Comments from our readers

On 9 March 2012 at 6:34 pm concerned said:

I am really at a loss as to why there is not a law that says that all the money that NZ banks lend must be sourced from NZ. It is the ultimate in safety as it matches local supply and demand without the distortions that foreign country borrowing can cause.