Is FX automation the key to banks enhancing customer experience and controlling risks more effectively?
As competition continues to increase, banks are offering a growing set of transfer and exchange services to compete with traditional methods of sending money abroad. The market participants have an increasing list of options when they want to execute an FX trade, ranging from traditional high-touch trades through sell-side sales traders to electronic trades done through multi-dealer systems, single bank platforms and algorithmic models. Nonbank liquidity providers have also emerged as serious competitors.
Delivering the products and services at profitable price points is a considerable challenge, and it is made more complex when the need to maintain pricing transparency while offering differential pricing based on the risks involved are factored in. Regulatory developments such as the Dodd-Frank Act are compelling banks to enforce greater transparency in FX pricing and impose tighter risk-monitoring controls. These challenges are driving banks to innovate and keep pace with evolving technology developments.
So how are banks facing these challenges?
- Maintaining pricing transparency through Automation
Pricing transparency has become vitally important over the recent past. Last year, five of the world’s largest banks- JPMorgan, Barclays, Citigroup, RBS and UBS paid fines totalling $5.7bn (£3.6bn) for charges including manipulating the foreign exchange market. This news has fed into customer fears and has made customers wary of cross border payments. So much so, that according to CGI, 56% of the corporate practitioners are unhappy with the FX services provided by their banks and almost 41% of corporate practitioners are assessing their current relationships with their main banking partners related to FX (including hedging). For the same reasons, customers are also looking at non-bank options for FX solutions. These alternatives often offer quick and easy services along with smoother customer experiences, as shown below:
To stop their customers from switching, banks are now accelerating their move to automation in foreign exchange and rates trading. Not only would this help banks to slash costs, it would also reduce the risk of further price manipulation scandals. Senior bankers are aiming to minimise human intervention since traditional trading over the phone is coming under an intense regulatory spotlight.
Banks have also started providing an online exchange platform to their corporate customers which is integrated with real time rates feed like Reuters or Bloomberg. Corporates can obtain automated quotes where the system generates pricing on request for spot, outright forwards and swaps based on real time market rates. Along with allowing them to view their trade and payment histories, these systems are also allowing the corporate to receive real time notification of transaction queries and track payments every step of the way.
2. Tighter risk monitoring controls by capturing differential spreads
When corporate treasuries and banks are working at the same time, banks can be settle on a same-day using the Online/Reuters rates. But when the bank is working and the treasury is closed or vice versa; or payment is done during non-banking hours, the scenario becomes more complicated and riskier for banks as currencies cannot be settled on the same day. Banks therefore need to capture differential spreads in order to manage the risks effectively-
- Spreads applicable for normal business hours of the bank
- Spreads applicable for off-business hours of the bank
- Spreads applicable on holidays
Consider the following situation: A company in the United Arab Emirates wants to transfer funds from his AED currency account to a USD currency account on a Friday. Since Friday is a holiday in the UAE, the AED currency account is closed and hence the bank can’t settle the transaction on the same day. The transaction will be settled on the next working day and therefore the bank is exposed to risk as there is no certainty about what conversion rates will be available then. Hence banks charge higher margins to cover their risk.
With a new online FX mechanism banks simplify their operations based on rules engines and workflow, where margins are automatically applied on the available (Reuters/Card) rates. These margins can be driven by a range of factors such as Currency Pair, Day of Week, Time, Holiday Status, and Value Date.
Let us consider the below margins for a few business scenarios to understand their applications:
Case 1: Working day for both banks and the currency exchange
In a similar scenario where a corporate in UAE is looking to transfer funds from its AED currency account to a USD currency account on a working day for both the bank and the currency exchange, margins will be applied on such cross border payments basis the time of transaction. Smaller margins (M1) will be applied for working hours than non-working hours. During the working hours the margins charged would be linked to Reuters and during the non-working hours, the margins are linked to the slightly higher card rate.
Case 2: Working day for banks and treasury but the currency is closed
In this case since the bank and treasury are working online rates will be available but the currency exchange is closed for AED and so, M3 margins will be applicable since the currency can only be settled on the next working day. Margin M3 will be better than M4 as margins are applied on online rate.
Case 3: Holiday for banks and currency exchange
If transactions have to flow from one currency to another and it is a holiday for both the banks and the currency exchange, then based on the pre-configured system, M4 margins will be applied on the card rate. This margin covers the risk of a possible drop in the value of the funds post exchange when it is netted on the next working day.