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Foreign Exchange

Regional banks need not blow the budget to stay competitive in FX

Smaller budgets need not constrain smaller banks from using technology to improve the profitability of their FX franchise. A modest investment via the growing plurality of vendors, and reliable measurement techniques to establish the mark-to-market value of all client trades, means smaller-scale banks can often enhance revenues by up to 20% and remain competitive with their rivals, writes Justyn Trenner, chief executive officer of the ClientKnowledge.

As margins tighten and credit becomes scarcer, a tight, efficient FX business model is essential to ensure solid and consistent returns. With the huge budgets that big banks dedicate to obtaining the best technologies, regional banks are often left intimidated. However, we now see a plurality of vendors reducing the cost of key technologies and a wide range of electronic liquidity making tight pricing accessible to all. Regional banks can differentiate on relationship and credit, and retain margin if they are efficient – but only if they are. However, one of the main challenges is getting the business to understand the implications of technology, and the technology arm to understand the practical business priorities for solutions to be built. Through gaining a better understanding of a bank’s business workflow and existing technology, by applying a solid benchmarking approach, the true value of client flow can be determined, and then similarly optimal client pricing and risk-management strategies, whether manual or systematic.

Regional banks are often surprised to find that the technical facelift needed to improve their systems requires relatively modest investment. It can be largely based on smarter and more extensive exploitation of existing systems, plugging gaps with competitively priced technology and avoiding sizeable capital costs by buying software, hosting and quantitative input as a service – monthly offset by improved revenues and lowered costs.

A reliable measurement technique establishes the mark-to-market value of all client trades in real-time, eliminating unintended loss or lower-than-needed pricing and improving spread retention. Analysis will also reveal where less-traded pairs should be auto-hedged and frequent smaller tickets – or larger tickets in liquid pairs – can be internalized and naturally offset. Good benchmarking should, therefore, drive immediate revenue pick-up – by elimination of losses – with the prospect of more, supported by the business case and numbers that will drive acceptance from business, technology and management alike.

Our work with other banks has shown that uplift of revenue is between 10 -20% of captured revenue and a proportion of trades, usually between 5-15%, turn out to carry unintentional mark-to-market losses. Up to one quarter of the leakage comes from eliminating loss-making behaviours, whether it is on pricing or on trading. In addition to this, we often see half of the pick-up coming from identifying opportunities to reduce risk and internalize.

The incremental benefits of these processes, such as better pricing to all client types and venues, reduced transaction costs, reduced risk and consistent profitability, are a much needed boon to the ultimate outcome of improved FX revenues. Armed with this, traditionally smaller players are able to price their key clients competitively, stay in the game and increase shareholder value.

It is this process that has seen a widening of the circle of banks servicing the corporate space, especially, but also the local real-money firms, even if many such banks deliberately leave the most challenging high frequency and high volume but ultra-low margin space to the so-called flow monsters.

 

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