What is the "interbank foreign exchange market"?

The foreign exchange market can be divided into two parts, namely the interbank foreign exchange market and the retail foreign exchange market.



The inter-bank foreign exchange market can also be called the inter-bank foreign exchange wholesale market. This is the top market in foreign exchange transactions, and it is a market for foreign exchange transactions among banks, forming a relatively concentrated foreign exchange market. In the interbank market, there is no such thing as margin trading.



The retail foreign exchange market refers to the market between foreign exchange trading institutions and customers. The most basic class in this market is individual traders, which is characterized by extensive and scattered.



Comparing these two markets, the interbank foreign exchange market is larger. Taking China as an example, according to the data released by the State Administration of Foreign Exchange on January 25, 2017, in 2016, the trading volume of RMB and foreign exchange in China's inter-bank foreign exchange market reached about 112 trillion yuan, which is about the same as the trading volume of the bank-to-customer market (230,000 yuan). 5 times that of RMB billion).



China's foreign exchange market is currently a market system centered on the interbank market.



"Players" in the interbank foreign exchange market The

"players" in the interbank foreign exchange market mainly include: commercial banks, investment banks, central banks, hedge funds and trading companies. Except for the central bank, which is not for profit, all other participants are for profit and information resources. Most of the capital flow of foreign exchange transactions is controlled by 10 to 15 large commercial banks, such as: Citibank, Deutsche Bank, UBS, HSBC. These large commercial banks are engaged in foreign exchange transactions to ensure the normal operation of inter-bank foreign exchange business.



The central bank is the currency management authority of a country, which is mainly responsible for managing the money supply of the society and formulating and implementing monetary policies. The central bank is considered the "lender of last resort" and lends money to commercial banks, which in turn lend currency to primary dealers.



Central banks also use foreign exchange reserves to keep their currencies stable. Foreign exchange reserves are part of the central bank's balance sheet and are recorded on the "liability" side. Although the central bank generally does not intervene in the exchange rate, there have been several examples of the central bank intervening in the exchange rate in history. For example: when a certain currency is severely overvalued or undervalued, the central bank of the country will intervene in the exchange rate of the domestic currency until it returns to a reasonable valuation level. When the central bank thinks it should intervene in the exchange rate, it conducts foreign exchange transactions with a few large primary dealers (mainly large commercial banks), thereby maximizing the impact of its intervention. Generally speaking, once the news of the central bank's intervention in the exchange rate spreads, there will be a lot of buying or selling of the corresponding currency.



Commercial banks, investment banks, trading companies and hedge funds generally participate in the interbank foreign exchange market in the form of market makers. Market makers have pricing power in the market, provide two-way quotations for other traders, and maintain market liquidity through continuous buying and selling. Market makers can take a certain amount of risk on their positions by waiting for market news to turn favorable in order to profit from it.



Under normal circumstances, in the interbank foreign exchange market transactions, each currency pair will be responsible for one or two corresponding market makers. These market makers are usually a large commercial bank or a secondary broker. In each region of the world, each region has a market maker responsible for the transaction of the region's currency. For example, a large commercial bank can be responsible for the euro/dollar transactions in Japan, London and New York. The foreign exchange market is a 24-hour non-stop trading market. Receive the next session to trade. By 3pm London time, EUR/USD trading has carried over to the New York session. A few large financial institutions are exclusively responsible for a certain currency pair. Therefore, instead of four or five market makers being responsible for more than 20 currency pairs, each currency pair is in charge of one or two corresponding market makers.



For transactions in emerging market currencies, transactions are generally concentrated in a certain period of time. For example, for the Chilean peso or the Brazilian real, there may be one or two market makers who process trades during North American hours.



Interbank foreign exchange market trading products



China's inter-bank foreign exchange market was formally established in 1994. In the early days, it could only conduct spot transactions. In 2005, it began to introduce various foreign exchange derivatives transactions. So far, my country's inter-bank foreign exchange market has formed a system of spot and basic over-the-counter derivative products including forwards, swaps, currency swaps, and options, which is relatively consistent with the structure of the international over-the-counter foreign exchange market. Mainly swap products. The combined proportion of spot and swap transactions in my country's interbank foreign exchange market exceeds 90%, and the combined proportion of the above two varieties in the international foreign exchange market also reaches 80%. However, relatively speaking, the transaction share of forward, currency swap and option varieties in my country's inter-bank foreign exchange market obviously lags behind that of the international foreign exchange market.



Interbank foreign exchange market transaction methods



The interbank foreign exchange market provides two transaction methods: bidding and inquiry. Auction trading is also known as centralized matching trading mechanism, which means that members submit their own buying and selling quotations through the electronic trading system, and the trading system will match each transaction according to the principle of "price priority, time priority", and automatically match the transaction. Inquiry transaction refers to the transaction method in which the two parties negotiate and agree on the currency, amount, exchange rate, value date and other elements of the transaction. At present, my country's inter-bank foreign exchange spot transactions can adopt bidding transactions and price inquiry transactions, and foreign exchange derivatives transactions can all adopt price inquiry transactions.



Clearing methods in the inter-bank foreign exchange market



The clearing of foreign exchange transactions in the inter-bank market is divided into centralized and bilateral clearing modes according to different counterparties, and divided into gross clearing and netting clearing modes according to different delivery methods. Centralized clearing means that after the foreign exchange transaction is completed, the transaction center will intervene and act as an intermediary, as the central counterparty to conduct fund delivery with both parties to the transaction. Bilateral settlement means that after the transaction is completed, the two parties carry out fund delivery according to the agreed elements. Gross clearing is to carry out fund delivery for foreign exchange transactions one by one, and net settlement is to net the foreign exchange transactions of clearing members on the same settlement day by currency and then handle fund delivery.



Most countries in the world have canceled the foreign exchange control system, capital can flow freely, and there are basically no restrictions on transactions in the foreign exchange market. Since the financial crisis, many countries have strengthened the supervision of the foreign exchange market, but mainly focused on improving market transparency, centralized trading platforms, and central counterparty clearing, etc., but there are fewer restrictions overall. However, my country's control over the foreign exchange market is relatively strict. Retail market transactions must comply with the principle of actual needs, that is, there must be a real trade background, while institutional transactions in the inter-bank market are restricted by the management of comprehensive positions in foreign exchange settlement and sales, which limits the domestic foreign exchange market. breadth. Corresponding to this is the rapid development of the offshore RMB foreign exchange market. Due to less regulation, the offshore market has developed rapidly in the past two years and has surpassed the domestic market.



The main task of market makers in the interbank foreign exchange market is to provide liquidity support to market customers. Most of the foreign exchange transactions between banks are controlled by 10 to 15 large commercial banks. Market makers mainly profit from spreads and obtain valuable information. Market makers can obtain in-depth market transaction data, which reflect the flow of market funds. Market makers can use these data to understand the future trend of the market, and conduct transactions by themselves to obtain additional income.



Market makers cannot always make a profit by doing transactions themselves, so they often use reverse transactions to hedge risks.

Market makers in the inter-bank foreign exchange market enter into transactions with each other through electronic trading platforms and maintain communication with each other. Many times, the trading system cannot complete the transaction due to the transaction size being too large. At the same time, market makers often don't want other market makers to know their positions, so they will avoid trading in the trading system.



To enter the inter-bank foreign exchange market, banks must have credit guarantees and strong financial strength. The basis for the formation of the inter-bank foreign exchange market is the inter-bank credit relationship, which is established by the "International Market Maker Swap Agreement" (ISDA).