Financial institutions are prone to using complicated terminology such as "interbank rate" and "FX exchange rate".
The good news is that entrepreneurs do not have to possess the technical experience of Warren Buffett to appreciate how these rates work and how they can impact business operations.
Let's address some common questions in order to clarify things a bit.
Check out our 1-minute definition video below.
1. What is an interbank exchange rate?
This is simply the rate at which banks charge each other when swapping currencies. Each transaction is associated with some type of nominal fee.
It is easiest to view this in the very same way as a normal interest rate on a short-term loan. The main takeaway point here is that interbank rates are much lower than the rates that they will charge the average customer.
This arises from the simple fact that banks need to make a small profit off of each transaction (surprise, surprise). This is actually one of the ways in which they are able to remain in business. These rates are continuously calculated by Tier-1 banks which is why they fluctuate throughout the business day.
2. How do banks determine these rates?
Interbank rates are calculated based on the supply and demand for a specific currency. Still, the chances are high that these rates have little effect upon your day-to-day business operations.
This is why it is important to take a look at how the banks make money off of your transactions and what can be done to minimise the effect.
3. What is the difference between these rates and "real" rates?
The real question is how interbank fees differ from the typical rates that an entrepreneur would be charged. "Real" or spot rates are constantly fluctuating and based upon the current value of one currency in comparison to another. You might still be surprised to learn that these "real" rates are normally not what you will normally be charged.
Yes...we are talking about another markup.
4. How can start-ups lower the transfer rates that they are subjected to?
Even if you are exchanging millions of Hong Kong Dollars (or another currency), you will never be able to enjoy the internal rates shared between financial institutions.
After all, the middleman (the bank) still needs to make a profit whether we like it or not. This is when it could be a good idea to try and obtain what is known as a wholesale rate.
5. And what exactly is a wholesale rate?
Think of a wholesale rate as a happy medium between the interbank fees mentioned above and the normal rates that Mr. Smith would be charged if he wishes to send money from two different bank accounts. Wholesale rates are essentially interbank values with a mark-up fee attached.
To put it simply, you will be getting a better deal by transferring more money at any given time. If you wish to test this theory, speak with a representative from your current bank and ask how their transfer fees would differ if you chose to exchange HKD 100,000 as opposed to HKD 1,000.
Those who are able to exchange larger sums of money will approach closer to the wholesale rate, so it pays to think big (assuming that you can afford to).
6. Are there any alternative transfer options for entrepreneurs and SMEs?
This is the "golden ticket" question. Most traditional banks will inflate their rates in order to accrue a small profit on every transfer.
Of course, such figures will add up over time. One of the ways in which this can be partially avoided is to use a third-party transfer service which is associated with rock-bottom rates.
While fees of zero percent might not be possible, the chances are high that you will still save a fair amount of money.