It has now become important to be aware about the foreign exchange aspects of banking. Ever since India got independence, banking has remained highly monitored, controlled and regulated by the Government of India and Reserve Bank of India. Banks were not allowed to fix their own interest rates either of deposits or advances. These were fixed by the Reserve Bank of India. The banking was being done in a highly traditional manner. In the name of international banking, banks were only catering to foreign currency needs of residents and non residents of India and to settle the transactions of exporters and importers. But these transactions are only a miniscule part of international banking. 

Two developments in independent India have brought big changes  in the banking sector. First in 1969 when the government nationalised 14 private banks and the second in 1990, when India adopted the path of economic liberalization. Even with nationalisation,  the regulations of RBI had become more strict, but with economic liberalization, the economy of India and also the banking has become integrated with the world banking system. Getting integrated with overseas banking has got its favourable as well as adverse impact. The 2008, US subprime crisis adversely impacted the banking system world over, but Indian banking system, barring ICICI Bank, was not impacted. But now economic liberalization has travelled a long way. The Indian economy and banking system has become integrated with the world banking system. Indian banking has truly become International banking. Any adverse happening in other corners of the world can impact the Indian banking system. Hence, now it has become more important to understand the functioning of foreign exchange in the banking system.

When we are discussing International Banking, first we should understand the types of transactions in international trade. These are Current Account transactions and Capital Account transactions.

Current and Capital Account Transaction

Capital Account transaction means a transaction which alters assets or liabilities including contingent liabilities outside India of a person resident in India and vice-versa. It’s an economic definition rather than an accounting or legal definition.

Current Account transaction is a transaction other than a capital account transaction.

Current Account transactions are freely permitted unless prohibited - they are regulated by the Central Government.

Capital Account transactions are prohibited unless generally permitted - they are regulated by RBI.

 CURRENT ACCOUNT TRANSACTIONS

• Foreign trade - exports & imports
• Foreign Travel, education, medical expenses
• Living expenses of parents, spouse and children living abroad
• Interest on loans & net income from investments

 Four Categories of Current Account Transactions:-

Schedule 1 - Transactions in foreign currency with nepal and Bhutan & earnings from lottery and racing

Schedule II  - Transactions requiring prior approval of Government of India

Schedule III - Transactions requiring prior approval of RBI

All others - no approval of RBI, viz: Exports & Imports

 CAPITAL  ACCOUNT TRANSACTIONS

• Maintenance of foreign currency accounts in India or abroad
• Investment in foreign securities
• Transfer of immovable property outside India
• Issuing guarantee in favour of resident outside India
• Taking out an insurance policy from an insurance company outside India
• Raising of foreign currency loans in India and abroad
• Sale and purchase of forex derivatives in India and abroad

When we have discussed Current and Capital Account Transactions, let’s understand Balance of Trade and Balance of Payment also. 

 Balance of Payment is a summary of the economic transactions of the residents of a country with the outside world during a year.

Advent of FEMA

Foreign Exchange Management Act, 1999

FEMA came into effect from 1st June 2000

• Pragmatic approach to  the management of forex rather than severely monitor and regulate as under FERA 1973.
• Business friendly- to enable face global competition and speed up the process of liberalisation
• Paradigm shift – mistrust (FERA) to faith (FEMA)- makes for a more simple application of law
• Psychological impact of the word “Management” as opposed to “Regulation” on the foreign investors cannot be underestimated 

 Simple and transparent rules

• Clear indication of  what is permissible and what is not
• Number of application forms brought down
• Powers to ADs adequate to ensure fewer interventions from RBI

Structure of FEMA

• Applies to the whole of India and all branches, offices and agencies outside India which are owned or controlled by a person resident in India. 
• FEMA has 49 sections of which 9 (section 1 to 9) are substantive and the rest are procedural/ administrative
• Section 46 of FEMA grants power to Central Government to make rules to carry out the provision of FEMA
• Section 47 of FEMA grants power to RBI to make regulations to implement its provisions and the rules made there under.
• RBI is entrusted with the administration and implementation of FEMA

Now, let’s have broad overview as how FEMA is different from earlier FERA:-

Overview of International Trade

There are three dimensions to overseas trade:-

• Trade/ Non Trade aspects of Ministry of Commerce
• Exchange control aspect of Reserve bank of India
• Bank specific guidelines.

But while dealing with the international trade, we have to be aware of rules,  regulations and guidelines of the other bodies and authorities. Let’s discuss in brief, the role of other bodies in international trade:-

1. DGFT - Director General of Foreign Trade

The Ministry of Commerce, Government of India, formulates the Foreign Trade Policy of India and this Policy is implemented through DGFT. It ensures what can come to India and which item can go out of India, i.e. Importability and exportability. Hence, DGFT acts as licensing authority for exporters, importers, and export and import business. It can prohibit, restrict and regulate exports and imports.

DGFT issues Importer - Exporter Code (IE Code) to persons dealing in foreign trade. It publishes a handbook of Rules and Procedures for foreign trade. It releases HS-ITC classification of items based upon - Freely traded items, Restricted items & Prohibited items for exports and imports.

2. RBI - Reserve Bank of India

RBI controls all inward and outward foreign exchange remittances on account of exports, imports or otherwise. 

It carries out all borrowings and lending activities in overseas market,

RBI monitors all inbound and outbound investments like Foreign Direct Investments (FDI), Foreign Institutional Investments (FII) etc.

It maintains parity of rupee with foreign currencies

It keeps records of foreign reserves in India

3. FEDAI - Foreign Exchange Dealers’ Association of India

• FEDAI -  was formed with approval of RBI during August 1958. 
• A non-profit making association and a self regulatory body under the Section 25 of the Indian Company Act (1956).
• All Public sector banks, foreign banks, private sector and co-operative banks and certain Financial institutions are the members of FEDAI. 
• FEDAI acts as a facilitating body and in consultation with RBI, frames rules / regulations for ADs in India for conduct of the foreign exchange business related transactions. 
• The present revised rules are effective 1st April, 2019 updated as on Nov 15, 2020

 Functions of FEDAI

• It frames Guidelines and rules for Forex business.
• Gives Training to bank personnel in areas of Foreign Exchange Business.
• Provides Accreditation to Forex Brokers.
• Advising/Assisting  banks in settling issues in their dealings.
• Represent banks on Government/RBI and other bodies.
• Announcement of daily and periodical rates to  banks.

 Rules covered in FEDAI

4. ECGC (Export Credit and Guarantee Corporation)

 ECGC is a statutory body under the jurisdiction of Ministry of Commerce and Industry , GOI, based in Mumbai, Maharashtra. 

• GOI had initially set up Export Risks Insurance Corporation (ERIC) in July 1957. 
• It was transformed into Export Credit and Guarantee Corporation Limited (ECGC) in 1964 and to Export Credit Guarantee Corporation of India in 1983.
• ECGC  is the seventh largest credit insurer of the world in terms of coverage of national exports. 

 Facilities provided by ECGC

• Offers insurance protection to exporters against payment risks
• Provides guidance in export-related activities
• Makes available information on different countries with its own credit ratings
• Makes it easy to obtain export finance from banks/financial institutions
• Assists exporters in recovering bad debt
• Provides information on credit-worthiness of overseas buyers

 ECGC - Important Points

• It is a credit insurance company for export promotion.
• Provides policy to Exporters and guarantees to Banks.
• Policy protects Exporter for his risk overseas & guarantee protects bank for its finance to exporters.
• Policy is a shipment level transaction & guarantee can be both pre-shipment as well as post-shipment.
• Policy is en-cashable upon importer’s default to exporter & guarantee is en-cashable upon exporter’s   default to bank in repayment of loan. 

5. Customs Department

• Controls import entry & export exit of goods and services.
• Does valuation of consignment.

 6. Enforcement Directorate

ED is a caretaker of Law

It deals with miscreants

 7. ICC - International Chamber of Commerce

• ICC was Founded in 1919 in Paris to serve world business by promoting trade and investment, open markets for goods and services, and the free flow of capital. 
• ICC provides business with essential resources in three broad categories: ICC rules and guidelines, practical commentaries, and reference works. 
• The best known publications, Uniform Customs and Practice for Documentary Credits and Incoterms, have been translated into more than 30 languages

Publications of ICC

8. OFAC - Office of the Foreign Assets Control

• The Office of Foreign Assets Control (OFAC) is a financial intelligence and enforcement agency of the U.S. government.
• The agency is empowered to levy significant penalties ; freeze assets etc.
• Publishes Specially Designated Nationals (SDN) List

9. FATF - Financial Action Task Force

FATF  is an independent intergovernmental organization and was founded in 1989 on the initiative of the G7 to develop policies to 

• combat money laundering;
• terrorist financing and 
• Proliferation financing.

As on date, FATF has 39 members; one country observer member, 9 FSRBs and some observer organisations.

India is a member of FATF from June 2010.

10. PMLA - Prevention of Money Laundering Act - 2002

 The Prevention of Money-laundering Act, 2002 (PMLA) aimed at combating money laundering in India with three main objectives – 

• to prevent and control money laundering, 
• to confiscate and seize the property obtained from laundered money, and 
• to deal with any other issue connected with money laundering in India,
• To combat Trade Based Money Laundering in International Trade.

 The act was amended in the year 2005, 2009 and 2012.

 11. BANKS

 The role of banks in international trade is very crucial. A banker dealing in forex transactions has to be aware of the rules and guidelines of all the institutions mentioned above. Not only the guidelines of these institutions, the banker has also to be aware of the internal guidelines of his own bank while handling any foreign exchange transaction. Any lapse in compliance on his part may land him into deep trouble.  

The article is based upon the lecture delivered by Mr Tilak Gulati in a training program conducted by Canara Bank, Centre of Excellence, Gurugram for their newly inducted officers.