Bank of China, the mainland's second-largest lender, last year booked a 5.1 billion yuan net foreign-exchange loss, prompting one of the bookrunners of its public float to call for a reduction in its foreign-exchange position. UBS expects the Beijing-based lender to post further foreign-exchange losses of 4.3 billion yuan this year and three billion yuan next year on the assumptions that the Chinese currency appreciates to 7.80 yuan against the US dollar by the end of this year and 7.50 yuan by the end of next year. Last year's actual loss represented 4 per cent of BOC's revenue and 9.4 per cent of its pretax profit, according to a pre-deal research by the investment bank, which, along with Goldman Sachs and BOC International (BOCI), is a bookrunner of the mainland bank's initial public offering later this month. The forecast losses for this year and next would represent 7 per cent and 4 per cent of projected profits in those years, UBS said. As the mainland's largest foreign-exchange bank with 43.3 per cent market share of the country's foreign-currency loans and 40.9 per cent of its deposits, BOC was more exposed than its domestic peers to the yuan's 2.5 per cent appreciation to 8.07 yuan against the US dollar at the end of last year. 'The surprising thing is that it has an open on-balance-sheet foreign-currency position of US$60 billion and a net foreign-currency position of US$39 billion after factoring in off-balance-sheet hedges, including an US$18 billion hedge through an option with Huijin [its controlling shareholder],' the UBS report said. BOC, which received a US$22.5 billion state capital injection to kick-start its financial restructuring at the end of 2003, is believed to have bought an option to sell back to Huijin - otherwise known as China SAFE Investments - US$18 billion at the pre-appreciation exchange rate. However, it was unable to hedge US$26.2 billion of its foreign-exchange position because of the thin foreign-exchange market and regulatory restrictions, UBS and Goldman said in their reports. The investment banks advised BOC to cut its open foreign-exchange position, representing 124 per cent of equity last year, to 30 per cent to 40 per cent of its total shareholders' equity, estimated at 272.75 billion yuan by the end of this year. BOC would be able to convert US$15 billion to US$20 billion of its foreign-currency exposure into yuan this year, UBS said. It could exchange US$1.5 billion a month into yuan next year as a result of the hedge with Huijin. Improving profitability at its domestic operations is another key challenge. Profit at domestic operations represented 79 per cent of company assets but contributed only 73 per cent of group revenue, 69 per cent of pre-provision operating profit and 55 per cent of pretax profit.