a.IB must have a measurement, monitoring and control mechanism for liquidity positions in each currency with a significant exposure. IB must assess, monitor and, where appropriate, limit the size of its cash-flow mismatches over particular time horizons for foreign currencies in aggregate and for each significant individual currency in which it operates, especially with respect to its domestic currency (or, where different, its functional currency).
b.The IB must employ appropriate stress tests and make use of Shari’ah-compliant hedging strategies for limit setting and controlling currency risk. The IB must especially limit its exposures in currencies that are not highly liquid or have low convertibility.
c.As a part of the overall stress testing exercise of the IB, foreign exchange liquidity must also be analysed under normal and stressed market conditions. The IB must adopt hedging techniques, including Shari`ah-compliant derivatives, if any (the swap market, in particular), remains a key feature of managing relevant foreign exchange exposures.
d.Where an IB provides financing facilities in foreign currencies, it can face a number of risks that must be considered as a part of its overall liquidity risk management strategy and policies. IB must consider the impact of changes in foreign currency exchange rates with respect to the domestic currency and the likely convertibility of these currencies in the event of need. In the case of an unexpected currency devaluation, local customers will be unable or will find it difficult to pay back their foreign currency financing, resulting in cash-flow problems for the IB providing such financing. As a part of its foreign currency liquidity strategy, IB must evaluate the profile of its customers in terms of the nature of its business and the sources of earnings which can impact its ability to settle the foreign currency financing.
e.IB must apply suitable limits on mismatches and positions in various foreign currencies on the basis of appropriate stress tests and scenario analysis. These limits must be reviewed on a regular basis. IB must also evaluate the possibility of loss of access to the foreign exchange markets, as well as the inability or difficulty in swapping currencies in the case of market disruption.
f.Foreign exchange settlement risk arises when an IB finds itself in unexpected positions in currencies as the result of a counterparty’s failure to settle its payments on time. In the correspondent settlement of foreign exchange, the full amount of settlement is at risk until the counterparty fulfils its foreign currency obligations. IBs must establish effective control measures and communications channels in order to mitigate any such settlement risk.