An exporter's forward cover that the underlying exposure cannot support
A mid-corporate branch customer has exported for three years, with average annual export realisation of USD 1.1 million, and its declared turnover supports forward booking within a modest eligible limit. It now asks the treasury desk to book forward cover for USD 3.2 million for nine months, citing “expected orders” for which no purchase order or letter of credit has been produced. Two forward contracts totalling USD 0.6 million were cancelled last quarter through the same branch, and one earlier booking was made without any supporting document on file. The relationship manager notes that the customer is fee-sensitive and that the branch is behind on its forex income target for the quarter. The customer's group exposure is already at 85% of its sanctioned non-fund-based limit. The currency pair has moved 2.4% in the customer's favour since the rupee weakened last month.
1. How do you respond to the request for USD 3.2 million of forward cover?
Read the worked answer
Reasoning. A forward contract must rest on a genuine underlying exposure. The customer's average realisation of USD 1.1 million cannot support USD 3.2 million, and the two cancellations plus the undocumented booking point to use of the forward market for direction-taking rather than hedging.
Action plan.
- Decline the full amount today, in writing, with the reason stated as insufficient documented exposure - not as a limit issue or a pricing issue.
- Invite a booking against documentary evidence: the letter of credit, confirmed purchase order, or shipment documents, in tranches matched to expected receipt dates.
- Where the customer's past performance supports part of the requirement under the applicable framework, book only that portion, and record the basis of eligibility on the file.
- Refer any requirement beyond the eligible limit to the competent authority with the full history attached; do not split the booking across branches to stay within delegated authority.
- Note the group exposure at 85% of the non-fund-based limit as a second, independent constraint in the same note.
2. The customer asks to extend one of the earlier contracts instead of cancelling it. How do you deal with cancellation and extension requests?
Read the worked answer
Reasoning. Cancellation and extension are not loopholes; they are permitted only within the same framework that governs booking. Repeated cancellations are the clearest available signal of speculative intent, and they are visible to the bank's own dealing records.
Action plan.
- Process the extension or cancellation only against documented evidence that the underlying exposure has genuinely shifted or lapsed, and recover the applicable charges and exchange loss or retain the gain in line with the bank's board-approved policy.
- For this customer, require the original booking file to be reconstructed first - the undocumented booking is an unresolved exception and must be regularised with a dated note before any new transaction is entertained.
- Put the customer's booking and cancellation history before the treasury and credit review forum, with a considered recommendation on whether any discretionary facility should continue.
- Do not allow a cancellation to be used as a cover for re-booking at a better rate on the same non-existent exposure.
3. What controls would you propose so that this does not recur?
Read the worked answer
Reasoning. The failure here is procedural, not a one-off. Three separate weaknesses allowed it: no document-on-file check at booking, no consolidated view of the customer's cancellation history, and target pressure sitting directly in front of the dealer.
Controls.
- A mandatory pre-booking checklist - underlying document reference, eligible limit, utilisation, outstanding contracts and cancellations - signed by the dealer before the ticket is punched.
- A customer-level exposure register showing all forward contracts, cancellations and extensions, reviewed at the monthly branch and treasury meeting.
- Segregation of the relationship and dealing functions for high-turnover forex clients, with the RM not able to authorise a booking independently.
- Cancellation history as a formal risk flag, with escalation above a defined number of cancellations in a rolling twelve months.
- Target review: forex income targets must be met through genuine client hedging; a quarterly review of income sources should distinguish hedged income from cancellation gains.
- Document all of it in the branch control register, so the next incumbent inherits the rule, not the memory.