Operational Exchange Rate for Banks and their Application in Banking Transaction

Many of us want to know about the operational exchange rate of banks and their application in day-to-day foreign-exchange-related banking activities. Customers receive different amounts of local currency for the same amount of foreign currencies in separate transactions. They often become confused.

This article will help you understand the rates applied for different transactions in banks. Trade finance professionals, customers, students, and even resource persons may find this piece of writing worthwhile. 

Here we will discuss the definition of the exchange rate, its different types and use, types of quotation, and how different rates are determined. 

What is Exchange Rate

The exchange rate means the rate at which one currency is exchanged or calculated in another currency. In other words, we can say this rate indicates how many units of one currency (for example, local currency)you need to pay to get one unit of another currency(foreign currency). Conversely, it is the rate at which how many units of foreign currency you will get with one unit of local currency. 

A simple example may be US Dollar 1 = RM4.0050. It means you will get 4.0050 units of Malaysian Ringgit with 1 (one) US Dollar.

What is operational exchange rate of banks?

Operational exchange rate of banks is the rate of exchange which banks usually use for their day to day operation relating to foreign exchange and international business. Usual foreign exchange activities include- 

• Buying foreign currency notes and coins

• Selling foreign currency notes and coins

• Inward remittance encashment

• Outward remittance for private and commercial purposes

• Import payments

• Export proceeds realization

• Guarantee settlement

Why is Exchange Rate important

The exchange rate is a significant factor in dealing with foreign currencies. Many people, including some of my experienced banker friends, search for exchange rates used by banks. 

In most cases, their inquiries were about different types of operational exchange rates used in banks. Those inquiries are - what exchange rate to use for inward remittance? What exchange rate to use for outward remittance, the appropriate rate for realizing export proceeds, the rate for purchase or negotiation of export bills, etc. 

In light of those frequent inquiries, we will discuss the operational exchange rates of banks and their application.

Exchange Rate Quotation

The exchange rate is quoted in two ways. Those are-

• Direct quotation and 

• Indirect quotation

What is Direct quotation:

Direct quotation is the system of quoting the price per unit of foreign currency in terms of local currency. Direct quotation is generally used in Bangladesh and some other countries of the world.

For example: USD 1 = BDT 84.9500 or EURO 1 = BDT 95.6750.

What is Indirect quotation: 

Indirect quotation is the system of quoting the price per unit of local currency in terms of foreign currency. 

For example: BDT 1 = USD 0.0120 or BDT 1 = EURO 0.0098.

We will discuss different operational exchange rates used by banks, which is usually a direct quotation.

Operational Exchange Rate of Banks and Their Application

The banks' operational exchange rate means the exchange rate for currencies used by the banks for their day-to-day foreign exchange or foreign currency conversion-related activities.

Exchange rates are mainly of two types. They are - buying rate and selling rate as we can find in the regular exchange rate sheet circulated and offered by different banks and NBFIs or Money changers. 

You will find a sample Exchange Rate sheet of banks in Figure-1. In this rate sheet, we will see different operational exchange rates for selling and buying FCs. Those rates are grouped into two main types: FC selling rates of a bank and FC buying rates.

Foreign Currency Selling Rates of a bank

Foreign currency selling rate indicates the rate at which Bank/NBFIs/Money Changers sell FC to the people (customer). Banks use different selling rates (Figure-1) for selling FCs to people based on their purposes. We will discuss those rates below.

1. Cash selling rate: 

The Cash Selling rate is the rate quoted for the transactions which will be settled in cash on a particular day. It is the selling rate of FC in cash form by banks to the people.

2. TT & OD (Telegraphic Transfer and On Demand) rate: 

TT & OD rate is used for outward remittance from one country to another. This selling rate is used for Mail Transfer or Telegraphic Transfer (TT rate) and issuance of Foreign Currency Demand Drafts & Travelers Cheques (OD rate).

3. BC (Bills for Collection) selling rate: 

BC selling rate (sometimes written as BC Selling rate) is applicable for import payment settlement. It requires some extra work for banks to handle the import documents, including scrutinizing documents and collecting bills. 

So banks quote slightly higher rate over TT & OD rate for sale of foreign currency for imports, regardless of import payment settlement procedures, whether on Open Account, Payment in Advance (advance TT), Documentary Collection, or a Documentary Credit (a letter of credit).

4. Forward selling rate: 

The forward selling rate for a currency is the rate at which FCs are sold for delivery on a specific future date, and the agreement for this is done today/immediately. 

These Exchange rates are available for 30, 60, 90, 120, 180, 360 days forward indicative rate. Usually, these rates vary depending on negotiation depending on the banker customer relationship.

5. Transfer price/ Treasury selling rate to its branch: 

This rate is used to sell FC to the branch from the head office of a bank. The most common practice is the Treasury Division fixes this rate each day in the bank's daily treasury division circular.

Foreign Currency Buying Rates of a bank

Foreign currency buying rate means the rate at which the Bank/NBFIs/Money Changers buy foreign currency (from now on referred to as FC) from people (customer). 

As we have discussed in the earlier segment about different selling rates used by banks, we see some similar foreign currency buying rates of banks (Figure-1) for buying FCs from people depending on the purposes of the transaction. We will discuss them in the following few segments of this article.

1. Cash Buying Rate: 

The Cash Buying rate is quoted for the transaction to be settled today in cash. At this rate, banks buy FCs from people in cash form. You can exchange your cash FC for Local currency at the counter with this rate.

2. TT clean Rate: 

This rate is applicable for the purchase of FC under any clean instruments like TT, DD, or MT. Here no interest or profit factor is involved, i.e., DD, MT, or TT against which fund has already been covered/paid by the instrument issuing bank and received by the paying bank.

3. TT (Doc) Rate: 

TT (Doc) rate is applicable for executing the instruction to pay a sum of money to a specific person on the presentation of some documents. Those documents can be a commercial invoice, bill of lading, bill of exchange, etc., which indicates a documentary transaction. 

As the banks need to handle some documents, they recover handling charges by offering a lower exchange rate.

4. OD Sight Export Rate: 

OD Sight Export Rate is applied to purchase or negotiate sight export bills. There is a time gap between the payment to the exporter and receipt of foreign currency in the NOSTRO account. So, banks deduct this transit margin from TT (Doc) rates. So, this rate is lower than TT (doc) rate.

The central bank of Bangladesh instructed banks to calculate export proceeds amount at OD sight Export rate in their different circulars for cash assistance. For example – FEPD circular no. 09 dated 05.03.2001, FEPD Circular 14 dated 11.04.2016, FEPD Circular 35 dated Sep 18, 2017, etc.

5. OD Transfer (Cash & TC) Rate: 

Banks quote OD transfer rate to purchase instruments other than export bills and TTs. Banks use this exchange rate to buy cash currency, personal cheques, drafts, TC (Travelers Cheque), etc.

6. Usance Rate or Usance Export Bill Buying Rate: 

Banks use the Usance rate to purchase or discounting usance export bills (sometimes called long bills). The transactions usually involve the purchase or discounting of Export Bills payable at 30, 60, 90, 120, 150, and 180 days after sight.

7. Forward Buy Rate:

The forward buy rate for a currency is the price at which FCs are bought from people for delivery on a future date, and the agreement is done today. This rate is often indicative and a negotiated exchange rate.

8. Transfer Price or Treasury Buying Rate from its branch: 

This rate is used to buy Foreign Currencies from the branch by its head office.

Sample Exchange Rate Circular (Figure 1)

Other types of Exchange rate used by banks:

What is Cross Rate?

A cross rate is an exchange rate expressed as the price of one Foreign Currency (FC) expressed in terms of another Foreign Currency. It is sometimes called a cross-currency offer rate.

For example, the USD to Pound exchange rate can be calculated based on the cross rate between USD/EURO and EURO/Pound.

What does Spot Rate mean?

The usual exchange rate quoted in the foreign exchange market for on-spot deals is called the spot rate. The Spot Rate is the basic rate of exchange.

What is Telquel Rate?

Usance/Long bills presented for discounting, of which a part of usance has already run. In this case, banks take premium or discount into account only for the remaining period of maturity of the Bill. So, the rate quoted for the Bill with a broken period of usance is called the Telquel rate.

For example, a 90 days sight export Bill is presented for discounting 50 days after acceptance. In this case, a bank quotes a rate based on the TT buying rate after loading a margin equivalent to the amount of interest or profit for the broken period (90-50) = 40 days plus grace period, if any.

Determination of Operational Exchange Rates by Authorized Dealers

Now we will discuss a usual process flow (Figure – 2) which will help us understand how Authorized Dealer Banks determines operational exchange rates (both buying and selling). 

This figure shows a basic model. In practice, sometimes, it involves a more complex procedure. However, it will help you understand the primary process.

Determination of Different Operational Exchange Rates (Figure 2)

IB FEX Rate or Inter-Bank Foreign Exchange Rate: 

It indicates an Inter-bank foreign exchange offer rate. With the exchange rate, banks exchange currencies with other banks. It involves price in local currency to purchase FCs, or we can say the cost of foreign currency.

What is Spot or Cash Rate?

Banks adjust the cost of administration (COA) and cost of capital (COC) with the IB FEX Rate to derive the Spot or Cash Rate for both buying and selling.

What is TT Clean Rate?

This rate is derived by adjusting Telex charges with the Spot or Cash rate of FCs. When determining the TT clean rate, only Telex or Swift maintenance charges are deducted from the Spot or Cash rate.

Cross Rates: 

The spot or Cash rate of one FC is adjusted with the Spot or Cash rate for another FC to arrive at a Cross Rate. The usual formula which each dealer follows is, buy at less and sell at high.

What is Forward Rate?

Spot Rate for an FC is adjusted with interest differential or swap rate, for the period until the forward date to derive a Forward Rate.

TT (Doc) Rate: 

TT Clean Rate of an FC is adjusted for documentation charges to reach the TT (Doc) Rate of the FC. The formula for this rate is-

TT (Doc) Rate = TT Clean Rate – Charges for Documentation.

OD Sight Export Rate: 

Trade Charges are deducted from the TT (Doc) Rate of an FC to arrive at the OD Sight Export rate of that FC. The formula for this rate is-

OD Sight Export Rate = TT (Doc) Rate – Trade Charges.

BC Selling Rate:

Trade charges are added to TT (Doc) Rate to arrive at the BC (Bills for collection) Selling Rate of that FC. The formula for this rate is-

BC Selling Rate = TT (Doc) Rate + Trade Charges.

OD Transfer Rate: 

Interest and collection charges are adjusted with the TT (Doc) Rate of an FC to determine the OD Transfer Rate of that FC. Usually, it calculated as-

OD Transfer Rate = TT (Doc) Rate – Collection charge & Interest.

Usance Rate: 

Banks usually use Usance Rate for 30, 60, 90, 120, 150, 180 days determined by deducting or adjusting interest for the tied-up periods from the OD (Sight) / BC (Selling) Rate.

Conclusion: 

Procedures of determining operational exchange rates may vary from bank to bank and from one country and economic system to another country and financial system. However, the above discussion will provide a general idea about the determination and application of those operational exchange rates. 

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Disclaimer: This article was first published in my publication on Medium (Nov 30, 2018) and now it is serving the enthusiasts through the Google Search. Previously it was also published in this blog and in my LinkedIn profile .

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