Research On The Foreign Exchange Risk Measurements Of Chinese Commercial Banks

Since July21,2005, China has carried on the managed floating exchange rate system based on market supply and demand with reference to a basket of currencies. On June19,2010, China made a commitment to enhance the flexibility of RMB trades, as the Central Bank of China announced that China would further promote the reform of RMB exchange rate formation mechanism and would increase the RMB exchange rate flexibility. On April14,2012, the Central Bank of China proclaimed the expansion of RMB floating range against the US dollar in foreign exchange market--since April16of the current year, RMB was allowed to trade against the US dollar to1%from original0.5%in the inter-bank spot foreign exchange market and the ratio of the difference between the lowest buying rate and the highest selling rate of the US dollar which were provided by the designated foreign exchange banks to the exchange rate on the paying day was expanded from1%to2%. Under the background that the flexibility of exchange rate has been gradually increasing, it is vital to research foreign exchange risk measurements of Chinese commercial banks.The increase of the flexibility of the RMB exchange rate means that the range of RMB appreciation and depreciation will be increased and thus commercial banks will face higher foreign exchange risk. At present, the common methods measuring foreign exchange risk include foreign exchange exposure analysis, sensitivity analysis, volatility analysis, pressure test, scene test and the VaR method advocated by the Basel Committee. Nowadays, Chinese commercial banks mainly adopt foreign exchange exposure analysis, pressure test and historical-simulation-based VaR method. Compared with other VaR methods, GARCH models can describe the characteristics of financial data with high frequency more accurately and at the same time can deal with the heteroscedasticity of financial data. As the exchange rate data hold the feature of high frequency, this empirical study of foreign exchange risk measurements takes GARCH models on the basis of the historical simulation method.The research emphasis of this paper is on the foreign exchange risk measurements of Chinese commercial banks before and after the second RMB exchange rate reform. Qualitative analysis and quantitative analysis are combined in this paper. This paper uses GARCH models and historical simulation method to calculate the VaR values under a certain confidence interval. The VaR values include US dollar, HK dollar and the Euro. Besides, this paper uses comparative analysis to compare the VaR values difference and foreign exchange exposure income of commercial banks before and after the second RMB exchange rate reform so as to better analyze the foreign exchange risk after the reform. The variables used include return series of US dollar, HK dollar and the Euro before and after the reform. The return series are gained by taking the logarithm and the first difference of the USD/RM、HKD/RMB、EUR/RMB exchange rates. All VaR values of return series are calculated by GARCH models except the euro return series which is calculated by the historical simulation method for it does not meet the conditions of GARCH models. At last, eight representative commercial banks are selected to be analyzed to obtain the specify amount of foreign exchange gain or loss caused by foreign exchange exposure with reference to their balance sheets.This paper gets conclusions through the empirical study:the foreign exchange risk of the US dollar and of the HK dollar after the second RMB exchange rate reform is higher, but the foreign exchange risk of the Euro is lower than before. However, Chinese commercial banks’ main foreign exchange operations concern US dollar and HK dollar, so the foreign exchange risk of Chinese commercial banks becomes higher after the second RMB exchange rate reform. The amount of US dollars which banks hold is large and the exchange mismatch is large, so the US dollar exchange risk is large. But as the VaR value of HK dollar’s return is huge after the reform, the HK dollar exchange gain fluctuates more than the US dollar. Finally, this paper gives suggestions of how to control foreign exchange risk by banks after all the empirical analysis.