Thursday, September 3, 2009

The role of banks in the foreign exchange market (3)

As we noted above, the largest U.S. banks with foreign-exchange departments routinely keep working balances of foreign currencies with major banks abroad. These working balances rise when a bank buys currency for itself or its customers, sells dollars to foreign banks, or purchases financial documents (such as bills of exchange, traveler‘s checks, bond coupons, etc.)
That is denominated in foreign currencies. Transactions affecting a bank's working currency balance are carried out by specialized traders with the aid of telephones, video screens, and teletype equipment to keep them in constant touch with other exchange brokers and dealers. The foreign exchange trader must also keep in close contact with bank's money desk and senior management because foreign-exchange trading can have a profound effect on the bank‘s overall financial position.
This last point was brought home dramatically in 1974 when Franklin National Bank of New York, then the nation‘s 14th-largest commercial bank, was forced into bankruptcy. While numerous factors led to Franklin's demise, massive losses from foreign-exchange trading were one of the primary factors in that bank‘s ultimate collapse. In an era of freely floating exchange rates, trading in foreign currencies can be exceedingly risky, requiring considerable skill and experience.

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