It’s not only on spot foreign exchange transactions that banks massively overcharge their smaller customers. New research from the European Central Bank shows that banks charge small businesses up to 25 times more for FX forwards than they charge larger, more sophisticated corporates.
The paper outlining the ECB’s results is yet to be published but the Financial Times understands that researchers, led by Professor Harald Hau of the Geneva Finance Research Institute, have analyzed 500,000 EUR/USD forward agreements offered by 200 banks to a spectrum of business customers, which included multinationals and smaller import-export firms.
With a forward, businesses fix an exchange rate today for a money transfer that will take place many weeks, months or years from now. Forwards are secured with a small deposit and are used for hedging against adverse currency movements and make budgeting easier because of the exchange-rate certainty they offer.
Per the FT, data shows that many businesses are being charged 50 basis points (0.5 percent) for forward contracts that are costing the largest customers amounts nearer 2 basis points. The findings, therefore, paint yet another shocking picture of price discrimination in the foreign exchange industry.
“The elephant in the room is that dealers systematically and consistently overcharge clients who don’t have currency trading expertise,” Professor Hau told the FT.
Hau’s team estimates that, on average, European banks are profiting to the tune of €600 million each year because of discriminatory pricing.
“The price discrimination occurs systematically against the less sophisticated market participants, namely small export and import companies,” Hau said.
Until a regulatory change in 2016, the details of bank charges for currency conversion were unavailable in Europe, and though overcharging had long been suspected, estimates for this have, until now, been inaccurate.
“For the first time we can measure the quality of the market for different participants and what we see looks terrible from a public policy point of view,” Hau said.
Rather than setting prices based on product features, such as the length of an FX forward (i.e., how far into the future would a customer like to fix an exchange rate), data shows that pricing is determined to a great extent by company size, or on the perceived level of a customer’s FX expertise.
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So great is the cost of hedging with these forwards that many SMEs are choosing to take their chances with the markets. Unlike insuring a car, insuring against an FX move that might make a supplier payment in 6 months’ time more expensive isn’t compulsory, and data suggests that customers know that bank-priced forwards offer poor value and are voting with their feet by staying unprotected.
Gambling on the value of future foreign-currency payments isn't necessary, however, because of cheap FX providers like XE Money Transfers and OFX, which sell forwards at far lower rates than the banks do.
Another obvious lesson to be learned from the research is that price comparisons are absolutely essential. More than half of the 10,000 businesses that bought forwards requested quotes from a single dealer, and these businesses paid, on average, 14 times more than those that requested quotes from 5 dealers or more.
For any type of money transfer, a comprehensive comparison calculator is essential to know how much could be saved. Owing to the digital revolution, a number of FX providers now offer currency conversion at a fraction of what’s charged by well-known lenders.
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