Currency trading attracts all kinds of people and entities with the varying financial muscle needed to place trades. When the focus is on large players capable of placing hundreds of millions worth of trades, a new phenomenon crops up, commonly referred to as the interbank market.
Simply put, the interbank market occurs whenever players with massive financial banking take to the currency market. Like retail traders, they engage in trading activities to profit from price movements as opportunities crop up in the trillion-dollar market.
Transactions involve two players, one on the buy-side and the other on the sell-side.
Given the play’s financial muscle, it is uncommon to find trade sizes of less than US$1 million. Similarly, given the sizes of transactions, this segment serves to enhance liquidity.
The interbank network is a network that pools together highly financed entities providing a platform for them to trade against each other and try to squeeze optimum profits as currency prices fluctuate. Given the amount of money in play, it is common for players to trade to a tune of more than$100 million.
Given the transaction sizes involved, this segment of the broader marketplace goes a long way to influence the rates of various currencies in the market. Likewise, the segment acts as a key driver and catalyst of the overall US$6 trillion markets.
Unlike in the stock market, there is no centralized exchange in the interbank market. Decentralization is a key theme in the market as transactions are recorded in exchanges depending on where an entity is. Multiple businesses are key in this case, seen as one of the factors behind enhanced efficiency in trade executions.
Similarly, dealers are required to place and track their traders, given the lack of a clearinghouse. Likewise, it is challenging for one player to have the market at ransom as trades don’t occur in one exchange. Besides, no single dealer can impact currency prices disproportionally.
How it works
The interbank market operates under minimum scrutiny given the limited government oversight or regulation. The lack of any authority regulatory to track trades requires players to only adhere to national banking regulations.
These segments of the traditional forex market account for about 50% of daily turnover given the play’s huge orders. Activities in the unique subset of the overall influence fluctuations experienced in various currency pairs.
The custodians tasked with ensuring players meet their obligations in the unique market include The Electronic Broking Services. Besides, The Thomson Reuters Dealing also provides a network for banks to trade against each other. The two connect thousands of banks worldwide. They process transactions on either side of the trade depending on the currency pair in play. The two enable trading in various currencies while mostly focusing on the most liquid as they tend to attract the most bids given the reduced cost of trading on tightened spreads.
Players execute trades based on the mutual understanding developed over the years. There is usually a gentleman’s agreement on what each player has to do on each side of the trade as there is no regulatory body to oversee everything. Market rates are available to everyone to see, conversely minimizing one party’s chance during the other.
The bigger the participants, the more mutual understanding, highly needed to execute big market-moving trades. The bigger the broker, the better or competitive the prices.
Interbank market players include institutions capable of transacting in millions of dollars. Similarly, it is the precept of commercial banks and trading firms. Central banks also play a key role in the market given that their actions influence currency strength on affecting dealers’ sentiments.
Amid a multitude of players, only a small subset of players largely influence liquidity levels in the market. They include the likes of Citibank, Deutsche Bank, and UBS.
These banks are known to know to operate and maintain trading desks that support their currency trading activities with the sole aim of generating a profit. In this case, they place trades upon carrying out technical and fundamental analysis.
Central banks’ role in the unique marketplace is to ensure sufficient liquidity to complete transactions. Likewise, they provide supply and cash flow by offering loans to market players. Besides, they pass monetary policies that influence sentiments conversely strength of the underlying currency. These actions also go a long way in according to maximum protection to foreign exchange reserves. Unlike other players, they don’t look to profit from their actions.
Pricing in the market
Pricing is the precept of institutions that can place trades capable of swaying the market in a given direction. In this case, the bank dealers are at the forefront of determining different currency pairs’ exchange rates.
Similarly, prices come down to several things. For instance, prices are determined based on the prevailing market rate and liquidity level. Interbank dealers refrain from taking positions whenever the liquidity is thin, one of the causes of the wide spreads experienced at times in the market.
Interbank dealers also take into consideration the overall market view of a given currency before deciding to buy or sell a pair, conversely affecting its fluctuating price. If a dealer feels that currency such as the Swiss franc is poised to strengthen backed by a solid economy, they will offer a competitive rate to other market participants looking to hold the CHF for a few hours or days for a profit.
The interbank market pools together some of the world’s wealthiest institutions and offer a framework for them to trade against each other. Given the trade’ sizes, the market accounts for the most volume in the overall market.
In addition, activities and transactions in the market go a long way in affecting currency pair underlying prices. This is partly because the big boys place trades that go a long way in swaying other traders’ sentiments allowing prices to trend in a given direction.