Credit relationships are now a crucial factor for clients deciding on a bank to which to award their interest rate and foreign exchange business. US-based consultancy firm Greenwich Associates says that almost two-thirds of FX users and three-quarters of those using interest rate derivatives do business only with banks that lend money.
The Greenwich survey indicates that 23% of companies using FX and 20% using interest-rate derivatives say they require a minimum lending commitment from banks that want to be among the top three dealers in these products. Of the companies that stipulate a credit requirement, they demand that dealers must provide between 12% and 15% of their total credit needs to qualify for one of these top dealer spots.
“For dealers, credit demands dictate that foreign exchange and interest-rate derivatives trading will remain a two-tiered game,” says Robert Statius-Muller, a consultant specializing in FX and derivatives at Greenwich Associates. “For universal banks outside the biggest four or five, it is extremely difficult to achieve more than 20% or 25% market penetration in interest rate derivatives or 30% to 35% penetration in foreign exchange, no matter the quality of the service they provide, due to the strength of the lending relationships of top-tier banks.”
The growing importance corporates attach to credit could adversely affect investment banks that don’t offer lending relationships. Statius-Muller believes it will be virtually impossible for non-creditor investment banks to achieve the same levels of market penetration in either market as some of the large global lending banks such as UBS, Deutsche Bank and Citigroup. This could be problematic for institutions that are more purely investment banks, such as Morgan Stanley, Goldman Sachs or Lehman Brothers.
Quality counts – eventually
Such findings raise the question whether credit takes precedence over quality. “All the banks we use have a lending relationship with us,” says one survey respondent. “Otherwise we wouldn’t do business with them.” The report goes on to conclude that even universal banks that don’t make too much of an effort or investment in service quality can probably reach 20% penetration in either market if they are prepared to do enough lending – but at some level, service quality counts.
Tight spreads on major currencies have meant that volume and market share in FX are crucial for banks that want to make healthy profits. Some banks have been able to substantially grow their market share through heavy investment in their electronic FX trading platforms. But credit relationships can also influence whether or not a client trades electronically and this could be limiting the growth of electronic trading in FX.
“Nearly twice as many users of foreign exchange believe that lending relationships are becoming more important in their allocation of business than believe the contrary,” says Tim Sangston, consultant at Greenwich Associates. “Among interest-rate derivatives users, three times as many think that the influence of credit in these decisions is growing.”
