Published: 08:04 AM, 01 May 2025
Interbank Foreign Exchange Market: A Much Needed Issue
Mehdi Rahman
Market is segmented in different categories. It may be by sector, by product, by existence, by virtual, etc. A product goes to ultimate users or consumers through exchange of different hands from production units. In general term, market is of two categories - wholesale market and retail market. Where there is no wholesale market, retail market cannot sustain. Retail market works a catalyst between products and consumers or users.
Foreign exchange is a market where currencies are traded. Cross border settlement is executed in foreign currencies. As such, it is the global marketplace for buying and selling currencies, and it operates as the largest and most liquid financial market in the world. The market involves various participants, including governments, central banks, financial institutions, corporates, and individuals.
Currency pairs are traded, with one currency being exchanged for another, for example, Euro against US dollar, in a system that allows the international flow of trade and finance. The foreign exchange market is decentralized, meaning it does not have a centralized exchange like the stock market but instead operates over the counter (OTC) through a network of banks, dealers, financial institutions, and relevant other participants.
In global foreign exchange market, there is a dominant factor of particular currencies used globally for trade, investment, reserves, and financial transactions. A dominant currency tends to have widespread acceptance in international markets, is commonly held by central banks as foreign exchange reserves, and is often used as a benchmark for pricing commodities.
Currently, the US dollar is the most dominant global currency, as it is widely used in international trade, as a reserve currency, and in financial markets. Other significant currencies in terms of dominance include Euro, British Pound, Japanese Yen, Chinese Yuan but none matches the US dollar's global influence. There are many factors contributing to currency dominance. These include economic size and stability. It means that large and stable economy typically supports a strong currency. Financial infrastructure is a factor which facilitates access to financial systems, including markets for government bonds. It is not easy to use a currency in international trade contracts, investments, and cross-border transactions. The currency needs to be useable. How much of the currency held in global reserves by central banks is an indicator for currency to be dominant.
The dominance of a currency impacts global trade, geopolitical power, and can influence global economic conditions.
Bangladesh is a small economy but it is growing. Cross border transaction constitutes a significant part of the national income. As the economy is growing, its investment is higher compared to savings. This results in negative position of its current account transactions with the globe. Hence, foreign currency management faces challenges.
In this context, a manipulation leads the situation worse. Banks play key roles in foreign currency transactions. There need interbank transactions to keep retail market afloat. But interbank - wholesale market - is reported to be inoperative.
As per business insiders, a bank buys inward remittances, wage remittances in particular, of customers who do not have banking relation with the particular bank. The foreign currency buying bank sends equivalent amount in local currency through payment system network. This deprives foreign currency of banks with which customers maintain accounts. Transactions to buy foreign currency from customers of other banks could lead to an environment where regulatory oversight is diluted, making it harder for authorities to monitor and manage currency flows. In case, banks engage in this practice without proper transparency, it could lead to market manipulation. For example, a bank might artificially influence the demand or supply of foreign currency, impacting the exchange rate.
This practice could lead to unfair competition between banks. If a bank buys foreign currency from customers of another bank, it could bypass the established market rates or pricing structures, leading to confusion and distrust among customers. This leads exchange rate to be depreciated.
As a result of deprivation of foreign currency, banks cannot accommodate foreign currency needs of their customers. But buying banks are not trading the foreign currency in interbank market. Rather they are found using the funds as supply at higher rates. This could make the country vulnerable to external shocks or reduce the central bank’s ability to control its monetary policy effectively.
It is crucial for banks to follow proper channels and guidelines of central bank to maintain transparency and stability in the currency market. If this practice is prevalent, there may be a need for regulatory updates or enforcement to protect the financial system.
In practice, banks buying foreign currency in bulk are not found selling them in interbank market. Rather, foreign currency is sold to remitters such as importers of other banks under the name of 'corporate sales'. This can be seen as problematic for several reasons. This practice may lead to a lack of transparency, potential manipulation of the exchange rate, and unfair competition between banks. Additionally, it can result in a negative impact on the foreign exchange market, as it may bypass established regulations designed to ensure a fair and stable currency market.
Banks are supposed to follow strict guidelines when dealing with foreign currency transactions, especially in the context of importers and exporters, to ensure proper documentation, compliance with regulations, and avoid illegal or unethical practices. When such transactions happen without proper scrutiny, it can lead to money laundering, tax evasion, or create artificial demand, which can disrupt the economy.
There is a mismatch between inflows and outflows. Negative gap in current account transactions needs to be supported by external borrowing. Unless inflows become equal to outflows, dependency on external is to continue. As such, credit lines with global banks are in need. Due to non-payment behavior erupted at the beginning of Russia-Ukraine war; credit line with foreign banks became disrupted. The restoration is yet to be found in full swing. As a result, unhealthy competition is observed in foreign exchange market, particularly in buying foreign currency on account of wage remittances. This results in local currency to face depreciation. Theory does not work in export trade of the country. Depreciation of local currency cannot increase exports; rather export price is reportedly adjusted up to its extent. As such, exchange rate needs to be stable for the greater interest of the economy. As such, competition in purchases of wage remittances in bulk needs to be stopped. There is a way out for which an instruction should be issued from central bank to the effect that payments to beneficiaries' banks need to be made in foreign currency. This can discourage buying banks and facilitate other banks. At the same time, this can stop corporate sales of foreign currency at higher rates by conduit way.
Banks need to show professional behavior in case of settlement of payables. This is a vital issue for restoration of credit lines. Credit lines are a cost, but inevitable for which adherence to commitment is a must. Banks should be self regulated in this context. At the same time, central bank is expected to ask banks to transfer funds, in case of bulk purchases, to respective banks. Instructions should also be given to banks to arrange funds for their customers if they are commit-bound to execute particular transactions. In no way, customers should be allowed to arrange fund
It is important for banks to adhere to regulatory norms to foster trust, stability, and growth in interbank foreign exchange transactions.
Mehdi Rahman works in the
development sector. He also
writes on business phenomena
and monetary issues.
