Currency trading was a big piece of the profits Goldman Sachs & Co. reported this week, but the demand for foreign exchange and the liquidity of the currency markets has been benefitting banks much smaller than the investment banking firm.
Improvements in technology for sourcing and settling trades have helped more regional players compete for business in recent years, making foreign exchange an increasingly important market for banks outside of Wall Street's inner circle. A key lesson emerging from the global financial crisis — keep your market risk hedged — may accelerate that trend, as even the tiniest of commercial banking customers dealing with imports or exports seek new currency strategies.
Some lenders are simply acting as middlemen in the foreign exchange market, leaving the sourcing of trades and, in some cases, post-trade services in the hands of large financial institutions that provide "white label" services to smaller banks. But advances in Internet-based technology for the sourcing and settling of trades have allowed a growing number of banks to be their own provider of liquidity.
"The Web is a great thing if it's leveraged correctly — the small guys can act just like the big guys," said Tony White, a managing director at Wall Street Systems, which makes software that helps banks including Fifth Third Bancorp process currency trades.
Away from the heavy trading action on Wall Street, it can be difficult for customers to get the same pricing they would find with a money-center bank. But often they can get close enough to make it worthwhile for them to stick with a bank they already know and trust.
"In this business, it's not just about competing on spreads," said Michael Speranza, vice president of brokerage and capital markets at Fifth Third. "Clients tend to be a little more sticky because they're not just treating us as a one-off bank."
Of course, Wall Street's titans are not expected to relinquish their dominance any time soon in a market where more than $3.2 trillion exchanges hands every day. But smaller banks have taken part in the explosion of volume seen across the market, with average daily transactions as measured by the Bank of International Settlement's 2007 triennial foreign exchange survey more than doubling in a decade's time.
Fifth Third had been dabbling in the spot currency market as far back as 1983, but the Cincinnati company started ramping up its service offering in the early 1990s.
The business has surged since then, with the foreign exchange group's revenue growing by 40% last year, to $100 million, Speranza said.
Most of Fifth Third's foreign exchange business involves balance-sheet hedging for commercial customers, such as the heavy-equipment maker Deere & Co.
Another big application is the facilitation of importing and exporting for multinational clients, many of whom use Fifth Third for other kinds of bank services as well.
Citizens Financial Group Inc. of Providence, R.I., a subsidiary of Royal Bank of Scotland Group PLC, started beefing up its foreign exchange offering about five years ago in response to customer demand, said David Tente, a senior vice president responsible for currency payment solutions at Citizens.
Today it offers hedging strategies for customers with factories in Mexico or with outsourcing contracts in the Philippines, and helps U.S. businesses buy goods from Canada in local currency. It will deposit foreign checks, allow businesses to maintain accounts in euros or other foreign currencies, and help retail customers — including the Indian nationals who populate some of the areas where Citizens has branches — to send remittances back home.
Citizens, which offers identical foreign exchange services through RBS sister bank Charter One, can leverage off its corporate parent in some areas, such as technology and marketing.
But banking regulations mean that some walls between subsidiaries must be maintained, Tente said.
Regardless of how banks choose to offer foreign exchange services — either on their own or through a third-party liquidity provider — they have become increasingly crucial to provide, said Douglas McKibben, a vice president with the research firm Gartner Inc.
"Customers generally don't care what the source of a service is as long as it's available and easily accessible and the front-end institution stands behind it," McKibben said.
"So partnerships are quite necessary for some of these things at times, and generally that is not a problem with customers."
McKibben surmises that commercial customers, who often use as many as three different banks for cash management, will usually give their foreign exchange transactions to their primary institution and trust they are being treated fairly.
And with counterparty credit getting scrutinized like never before, a multipronged relationship can be just as important to the bank as it is to the customer.
"If you're just running foreign exchange and you're not aware of the [customer's] total corporate posture on credit," Speranza said, "you possibly could be putting the company in jeopardy."