The Hidden Costs of Currency Exchange: Market Rate vs. Bank Rate Explained

Buying currency to travel abroad, conduct business, pay for tuition or make an international purchase involves exchanging money. When exchanging money, many consumers only consider the advertised rate displayed by their bank or other financial provider. By knowing the difference between market and bank rates, consumers and businesses can save money and avoid common financial pitfalls.

Exchange Rate Basics

An exchange rate is the value of one currency when compared to another currency. Currency rates change constantly based on market transactions, global economic events, and financial market changes. Rates move up and down throughout the day as buyers and sellers make purchases on the global marketplace.

Market Rate Defined

The market rate is defined as the real-time exchange rate quoted on global currencies markets where all foreign exchange transactions occur. Brokers, large banks, and businesses will track market rates closely to determine the true value of a currency when the markets are open.

How Banks Calculate Exchange Rates for Customers

Banks typically will not provide their customers with the market rate. Most banks utilize their own exchange rate and then mark up that price to cover business expenses and turn a profit. There is often a hidden spread between what the bank pays for currency and the rate provided to the customer.

Why Are Bank Rates Different?

When a bank buys and sells currency, they take on risk. Between the time they buy and sell that currency, the market could move against them. To compensate for this risk, banks and other providers add a spread between the price they pay for a currency and the price they sell that currency to you.

Definition of Spread in Currency Exchange

A spread is the difference between the buy price and sell price of currency. The spread that your bank adds will fluctuate based on market conditions and the size of your transaction. The spread is how your bank covers their costs.

• If market conditions are unstable, you may see a wider spread
• The less commonly traded the currency is, the wider the spread
• Small transactions may not qualify for the best exchange rate

Are There Any Hidden Fees?

Some people assume that once they have identified the exchange rate, that is the only factor that determines how much of their currency they will lose during an exchange. There can be additional fees which lower the amount of currency you receive. These fees can be masked as service fees, processing fees, transaction fees, third party bank fees or they can be included in the overall exchange rate.

Costs Added to International Transfers

Sending money internationally will typically require at least two financial institutions to complete the transaction. During this process, each bank collects their fees before handing the funds off to the next party. The cumulative effect of these fees can leave you with less money than you expected to receive.

Where Do You Encounter Exchange Fees?

Many people who exchange currency every day are unknowingly losing money to hidden exchange fees. It's easy to take on these fees when they happen during common transactions:

• Spending money while traveling internationally
• Making purchases from international websites
• Paying tuition to international universities
• Bill payments to international vendors
• Sending money to family members in another country

Does Timing Affect Exchange Rate?

Political events, economic announcements, or market sentiment can cause wild fluctuations in currency exchange rates. Even a small change in the exchange rate can have a large impact on your transaction. If you are trading large sums of money, you should take the time to monitor the markets and identify ideal times to make your transaction.

Shop Around at Different Currency Exchange Providers

Not all banks and currency exchange providers are the same. You would be surprised at the difference in exchange rates and fees among providers.

• Specialist providers tend to offer better exchange rates
• Online providers aim to provide more transparency than brick-and-mortar banks
• B2B services offer advantages when you trade in large volumes

Currency Exchange Rates Affect Businesses Too

Companies which buy and sell on the international market can be affected by even the smallest difference in exchange rates. When thousands of transactions occur, these exchanges can add up. If your business imports goods from another country, pays international vendors or receives payments in foreign currency, you will likely track exchange rates and take action to minimize exchange costs.

Save Money by Reducing Your Exchange Costs

There are many ways to save money and reduce your currency exchange costs. By making small changes, you can slowly cut down on the fees you pay:

• Compare exchange rates before you make a transaction
• Take the time to read what fees you will be charged for the money transfer
• Watch the market if you have the time
• Try to avoid changing from one currency to another
• Look into currency specialist providers

The Market Rate vs. Your Bank's Exchange Rate

The exchange rate your bank quotes you is only one part of the cost to exchange currency. When you convert money from one currency to another, it will typically cost you extra in spreads, fees, or both. By being aware of the market rate when exchanging currency, you can better assess if a transaction is worth it or if you're being taken advantage of when transferring funds internationally.