37.Market risk can be influenced by changes in foreign exchange rates, that is, foreign exchange risk.

38.Foreign exchange risk is the risk that the value of foreign exchange positions may be adversely affected by movements in currency exchange rates. Foreign exchange positions or exposures incur only general market risk. The capital charge for foreign exchange risk also include a charge for positions in gold. For purposes of market risk capital requirements, the Central Bank takes into account the stable relationship between the AED and the US dollar, with the result that no capital is charged for open positions in USD. Foreign currency is any currency other than the bank's reporting currency.

39.Two steps are required to calculate the overall net open position:

Step 1: Determine the Exposure in Each Currency

The first step is to calculate the bank's open position, long or short in each currency.

The open position in each currency is the sum of:

1. ▪ the net spot FX position (Includes also all asset items less all liability items, including accrued interest, denominated in the currency)
2. ▪ the net forward FX position (Because forward FX rates reflect interest rate differentials, forward positions are normally valued at current spot exchange rates. The net forward position in an exposure should consist of all amounts to be received less all amounts to be paid under forward FX transactions, including currency futures and the principal on currency swaps not included in the spot position. For banks that base their management accounting on the net present values (NPVs), the NPV of each position should be used; discounted using current interest rates and valued at current spot rates)
3. ▪ guarantees and similar instruments that are certain to be called and are likely to be irrecoverable.
4. ▪ net future income and expenses not yet accrued but already fully hedged
5. ▪ any other item representing a profit or loss in foreign currencies
6. ▪ the net delta-based equivalent of the total book of foreign currency options

Step 2: Determine the Overall Net Open Position across FX Exposures

The second step in calculating the capital requirement for FX risk is to measure the risk in the bank's portfolio of foreign currency and gold positions.

You can determine the overall net open position of the portfolio by first converting the exposure in each foreign currency into the reporting currency at the spot rates. Then, calculate the overall net position by summing the following:

1. ▪ the greater of the sum of the net short positions or the sum of the net long positions (excluding the net open position in the US dollar
2. ▪ Take the larger of the two sums, from the step above, and add the absolute value of the net position (short or long) in gold.

The capital charge for foreign exchange market risk is 8% of the position resulting from the calculation above.

Foreign Exchange (FX) Exceptions

40.The Central Bank of UAE may allow banks to exclude certain FX positions from the capital charges calculation. Banks have to comply with both the requirement of para 70 of the Market Risk section of the standards.

41.Items that are deducted from a bank’s capital when calculating its capital base, such as investments in non-consolidated subsidiaries, or other long-term participations denominated in foreign currencies, which are reported in the published accounts at historic cost, do not need to be included as foreign currency exposures for the foreign exchange risk calculation.

42.Banks with negligible business in foreign currencies and with no FX positions taken for their own account may exclude their FX positions if they meet both of the following requirements:

1. ▪ their FX business (the greater of the sum of their gross long positions and the sum of their gross short positions) does not exceed 100% of total capital (Tier 1 + Tier 2)
2. ▪ their overall net open position does not exceed 2% of its total capital