Bank X entered into a spot Forex deal with Bank Y. Bank X agreed to sell US$ 1 million to Bank Y at a particular exchange rate. On the date of delivery, Bank Y settle the equivalent rupee funds to Bank X. However Bank X

Answer 4 Credit Risk and Market Risk involved in the given case. Credit Risk: In today's complicated international financial markets, the credit risk arises on account of non-performance of obligations by counterparty in respect of on Balance Sheet items as well as off-Balance Sheet contracts such as forward contracts, interest rate swaps and currency swaps and counterparty risk in the interbank market. These have necessitated prescribing maximum exposure limits for individual counterparties for fund and non-fund exposures. Market Risk: Market Risk arises on account of the external factors, i.e., market forces of demand and supply factors. Market risk arises from the adverse movements in market price. Market risk can also be defined as the risk of losses on account of on-Balance Sheet and off-Balance Sheet positions due to the movements in market prices. In the given case, Bank Y is facing a Credit Risk, also called Settlement Risk. This would lead to further risks for Bank Y. There would be shortage of funds in the Nostro account of Bank Y. Bank Y needs to fund the account and should (a) either arrange for a fresh deal and/or (b) borrow in US$ at the market interest rate. The non-receipt of US$ has created not only credit risk, but also liquidity as well as mismatch risk in the assets and liabilities of the bank Y. Further on account of approaching the Forex market, to enter into a new forex deal and to borrow funds in the US$, bank Y would also face market risks (viz, exchange rate risk and interest rate risk respectively).