The Role Of The Commercial Banks In World Currency Trading

World currency trading is no longer just a matter of banks exchanging currencies amongst themselves and now involves a variety of different players, including specialist Forex brokerage firms, with very diverse reasons for trading in currencies.

For example, some players will have to exchange currencies to buy goods and services overseas, while others will simply wish to earn short term profits from exchange rate movements or to influence currency exchange rates for one reason or another.

Whatever reason a player has for being in the market, this diverse group of traders influences supply and demand within the market and so alters the exchange rates at any given moment in time. It is important therefore to understand who the key players are and here we are going to look at one of the most important players - the commercial and investment banks.

Commercial and investment banks operate within what is known as the InterBank market which accounts for by far the greatest proportion of all trading, whether commercial or speculative in nature.

The InterBank market is composed solely of commercial and investment banks buying and selling currencies between themselves. Strict trading relationships are established between the InterBank member banks and lines of credit are established between individual banks before they are permitted to trade.

How Do Banks Trade The Forex?

The commercial and investment banks form the cornerstone of the foreign exchange market because, in addition to trading on behalf of their customers, they also provide the channel through which all other participants have to trade. In effect they are the main sellers within the foreign currency exchange market.

Another important point to remember is that the commercial and investment banks do not simply trade on behalf of their customers, but also trade in their own right through proprietary desks with the objective of realizing a profit for the bank. Commercial and investment banks possess a unique knowledge of the marketplace and have the ability to monitor the activities of other participants such as the central banks and investment funds.

The commercial banks have been at the very hub of the Forex market for many years and their role has remained basically the same throughout this time. However, the introduction of electronic brokering systems such as Reuter's 'Monitor Dealing Service' during the early 1980s and Reuter's 'Dealing 2000-1' in 1989 market the beginning of far reaching changes in the foreign exchange market. However the introduction of Reuter's 'Dealing 2000-3' system in 1992, followed a year later by the launch of 'Electronic Brokering Services (EBS)', brought the ability to automatically match buy and sell quotes from dealers and this changed the very nature of the market.

Electronic trading systems allow dealers today to conduct several trades simultaneously and to trade with far greater efficiency, tighter spreads, lower costs and, most importantly, much greater transparency than was seen previously in telephone dealing systems.

Perhaps the major advantage of electronic dealing however is that the accessibility of the system allows many more players to join the market alongside the commercial and investment banks.

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