Forecourts and Foreign Exchange: Why businesses want FX providers that are less like petrol stations and more like discount supermarkets

Posted on the 18th September 2015 by Hamish Anderson in Founders' blog

Forecourts and Foreign Exchange: Why businesses want FX providers that are less like petrol stations and more like discount supermarkets

We all like to get the best possible price when we make a purchase. If we feel that we’re being overcharged or ripped off then, as consumers, we tend to vote with our feet.

The supermarket sector in the UK is a perfect example. For years, a handful of giants such as Tesco and Asda dominated the space. Now the new kids on the block - Lidl and Aldi – are rapidly gaining market share at the expense of the incumbents.

At the heart of the new kids’ strategy is their pursuit of the best price for their customers. They offer the same goods, or the equivalent, at a better price than their rivals. The result is consumers know they will get value if they shop at these stores. Critically - prices are consistently lower. Not just for a day or a week, but all year round.

And if consumers are in doubt they can easily compare prices for products using websites such as Money Supermarket or retailers’ own comparison tools.

Forecourt price comparison

In contrast, consider how to get the best price for another commodity – petrol.

Historically getting the best price for petrol has been difficult. The only way to determine if, for example, Esso’s price for unleaded petrol is better than Shell’s is to drive to the forecourt and taking a look at the display board. This is because petrol pricing fluctuates enormously based on a number of factors – wholesale costs, location, competition and others.

As consumers, this lack of consistency and transparency frustrates us. We want to find out quickly and easily where we can get the best price.

And this is the problem with international payments and foreign exchange, especially for small and medium-sized enterprises (SMEs).

The vagaries and variances of bank foreign exchange practices

There are two important factors at play here – the fluctuations in pricing based on interbank trading, and the impact of the spread.

What most people don’t realise is that, while major multi-national companies are exchanging currencies at the spot rate during trading hours, banks trade billions of dollars on the FX markets outside of these times. The largest financial institutions trade currencies by netting off their exposures, placing orders between them so that they’re not exposed to any changes in the spot rate. This is to ensure they’re not left with large excess currency balances, which could leaed to losses in the event of adverse currency movements.

Whether a bank is looking to buy or sell a particular currency its position can in turn impact the price offered to its customers.

The pricing of foreign exchange consists both of fees and the spread it adds. The spread refers to the difference between the rates that a bank can buy a currency compared with the rate that at which they sell that currency to a customer.

Unfortunately the SME is never shown the rate at which the bank can obtain the currency – they will only be told the rate that the bank is prepared to offer them. This is why banks may be the most expensive places to convert currencies and send money internationally – their spreads are significantly greater than the interbank rates that they charge (and in some cases collude on) with each other.

As a result of these vagaries and variances, not only do the bank rates change daily based on their ‘position’ (as opposed to the interbank rate), but the price that small business customers receive is based on an opaque spread. In fact, the only thing that is predictable about SME currency payments and transfers is that they will be expensive – in many cases total costs can represent between 2% and 4% of the payment value.

While banks offer their very largest corporate clients access to pricing close to interbank rates, smaller businesses are, in effect, forced to operate blindfolded.

Impossible to get the best price with banks

In this sense banks are like petrol stations. It’s difficult to determine the best rate without visiting a multitude of banks (on the phone, in person or via their websites), in the same way as you need to drive onto various forecourts.

In fact, banks are worse than petrol stations.

At least when you see the price on the board at a petrol station you know that’s what you will pay at the pump. Most banks will only guarantee an exchange rate after the transfer has been made.

It’s how the banks, with their less than clear practices and pricing structures, can take large percentages, often without the SME ever knowing. It’s this opacity that makes it really difficult for SMEs to make informed comparisons and decisions about foreign exchange.

Dedicated providers

AT Kearney estimates Aldi and Lidl stock between 1,000 and 3,000 lines, compared with more than 50,000 at other supermarkets. It’s this focus on particular products and services that gives them their competitive edge.

In the same way, exclusive providers to SMEs are more competitive because they can focus on being really good at a particular service. They’re not burdened by an unwieldy infrastructure, the requirements of big corporates, or banks’ wider trading strategies.

In most markets – energy, telecoms, insurance - regulators agree that consumers have a right to be able to compare different providers easily in order to make an informed decision. Like consumers, small businesses deserve to be able to get the best price for international payments and currency exchange.

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