The Position of Commercial and Investment Banks on the Forex Market
The forex market is the largest one in the world. This has been caused by its decentralized nature, which has been facilitated by the introduction and implementation of technology. In the past only the largest banks used to trade on it. Now, the scope of participants has increased to include many other participants. The participation on the forex has been desired for several reasons:
- The fluctuations in the currency exchange rates have led to getting more short-term profits.
- The forex market provides foreign currency acquisition needed for the trade of foreign goods and services.
- The participation in the forex market is used as an insurance against losses due to changes in exchange rates
- Some seek opportunities to influence the movement of the exchange rates of foreign and domestic currencies.
Different participants become part of the forex for different reasons. No matter what they are, they manage to influence the supply and demand of the trade currencies. As a result, their trades directly reflect on the exchange rates at which currencies are traded.
Since currency exchange rates directly reflect on the prices of goods and services, it is of great importance to be acquainted with the major players on the forex market. They are:
- Central banks
- Investment banks and Commercial banks
- Funds (e.g. mutual funds)
- Individual traders
Of these forex market participants, commercial and investment banks are worth closer examination since they make the biggest portion of the market players in terms of volume.
The interbank market provides the majority of services to commercial and investment banks. It also takes care of the many speculative transactions that are executed each day.
Commercial and investment banks tend to execute trades of currencies between themselves in order to provide for the system of balancing accounts they have.
Generally, the interbank market is structured around a credit-approved system. This means the participating banks trade between themselves on credit based relationships that have been initially established.
A big portion of the foreign exchange market trading is done between banks each day. Since commercial and investment banks represent the middlemen for other participants on the market, meaning that they give them access to the forex market, commercial and investment banks represent the sell side of the forex.
These banks tend to look after their own and their customers’ interests. They execute their transactions and provide their services by means of electronic brokering systems. The established at the banks terminals match sellers and buyers in order to execute the orders for spot deals.
The voice broker system, which was initially used, was gradually replaced by the Electronic Brokering Services Limited (EBS) and Reuters. As a result the interbank trading has been significantly changed by the introduced and implemented electronic brokering. This in turn has led to the elimination of trading within the spread, since a tightening of spreads has occurred.
Electronic brokering is very beneficial to all parties involved thanks to its lower costs of transactions. It also provides higher information transparency, thus significantly increasing the efficiency of the market.
Information transparency has led to the ability of banks to check the rates at which other banks trade. However, in order to benefit from these rates, the bank should establish credit relationship with the one offering these rates.
Trading is not limited only to the benefits of banks. Proprietary desks have been set in order for the banks to make profits for themselves. Their trading activities are further facilitated since they have access to information that other participants don’t have. For example they can see the flow of orders and the entering of other participants in the market.