Why banks fix limit to their treasury/ forex operations?

(This post elucidates various terminologies used by banks in their dealing rooms for limit fixed to them in their day to day operations  by their management)

The Treasury operations in the forex (foreign exchange) market are between the banks. The inter-bank foreign currency operations are taking place for two purposes namely (i). Buying and selling foreign currency on behalf of their customers as an intermediary. (ii). Proprietary trading (buying and selling currencies on its own account) with an intention to make money on the movement of the exchange rate.    Like regular business of banking treasury operation is confronted with multiple numbers of risks viz. credit risk, liquidity risk, operational risk, reputation risk, legal risk, market risk, strategic risk, country risk, counterparty risk, contractual risk,  and systemic risk and so on. Most of the forex losses arise from transaction risk (exchange risk), open position or exposure, size of the exposure, duration of exposure,  etc. which may not be preventable but can be controlled by taking steps to reduce adverse effects. One of the important strategies adapted by the banks is a systematic reduction in the extent of exposure to a risk and/or the likelihood of its occurrence by limiting or restricting the operational risk on large deals.

The terminologies used by treasury dealing rooms for the limits fixed/restricted by the respective banks are as under.

Daylight limit:  The highest amount of open position or exposure, the bank can expose itself at any time during the day, to meet customers’ needs or for its trading operations, is known as ‘Daylight limit’

Overnight limit:  The highest amount of open position or exposure, a bank can keep overnight when markets in its time zone are closed is known as Overnight limit.

Gap Limit:  Gap limit is the maximum inter period/month exposures which a bank can keep.

Counterparty limit:          The maximum amount that a bank can expose itself to a particular counterparty is known as the Counterparty limit.

Dealer limit:  The highest amount a dealer can keep exposure during the business hours is known as the Dealer limit.

Deal-size limit: The highest amount for which a deal can be entered is known as the Deal size limit

Stop-Loss Limit: The maximum movement of rate against the position held, so as to trigger the limit or around maximum loss limit for adverse movement of rates is known as Stop-Loss Limit.

Settlement loss limit:  The highest amount of exposure to any entity, maturing on a single day is known as the Settlement loss limit.