Increased competition highlights transactional cost issues for banks

Feb 28, 2019 | Articles, Practice - Data, Practice - Digital

In today’s highly-competitive financial markets the margins on trading are getting thinner and banks are having to increasingly focus on reducing costs in order to maintain profitability. This is especially true for mistaken or accidental costs incurred by banking services, such as broker-related activity. These often exist in error and provide no benefit to the bank or the client.

Brokers operate as an intermediary in the wholesale financial market, enabling their clients to trade multiple products. This includes matching buyers and sellers in the FX market. Broker fees are applied to these transactions and are calculated based on the volume of trades and the nominal value of those trades. They are charged based on an agreed fee structure which normally contains volume discount rates with a stepped pricing structure.


Impacts trading desk profitability

Unfortunately, banks are often overcharged by brokers, which affects the profitability of the trading desk and can be seen in the examples below: –

  • Discounts/stepped pricing structures are not accurately applied
    • Banks don’t always accurately list the full transaction and it is therefore difficult to validate when discount limits have been achieved
  • Traders agree trades via brokers with zero-fee cost for reasons including:
    • Washing trades for a broker. This is where a bank acts as the intermediate counterparty between two other banks normally due to credit limit issues. This creates costs for the trades that provide no profit unless you count some goodwill garnished from the broker
    • Trading a same-day swap to assist a counterparty with intraday liquidity at a cost to yourself, and getting charged brokerage fees for the right to do this
  • Confusion over different spot or forward trade categorisations can lead to a higher brokerage allocation
  • Swap trades being charged as potentially two separate contracts. (A standard swap is a trade where you exchange on one date and then exchange nearly the opposite at a future point in time)
  • Brokerage discounts not being applied to the whole of the product business or, if applicable, to all products
  • Brokerage agreements decided upon at a product level, thereby reducing the benefits of discounts across the organisation.

Understanding the profitability of a trade is critical

The incorrect monitoring and application of these trade-related costs can have a material impact on the business’ bottom line, especially in today’s post MiFID II world. Understanding the actual profitability of a trade is critical to deciding which business is worth chasing and which isn’t and can therefore have a significant impact on margins.

Regulatory reporting requirements for directives such as MiFID II are starting to request broker information which should necessitate the accurate generation of the appropriate data at the time the deal is booked. However, banks need to start addressing the problem themselves in order to clampdown on unnecessary spending.

Here are some things banks can do to help address these issues:

  • Review the entire brokerage process within your organisation
  • Provide detailed management information to the senior team to enable them to strategically review the brokerage process and suggest improvements to increase the profitability of trading and improve customer relationships
  • Review front-office systems to ensure any trades allocated with zero fees are populated and ensure this information is fed to the brokerage system
  • Review the fee schedule and pricing structure agreements, especially where they are not multi-product
  • Improve operational reporting to ensure trades are appropriately monitored and recorded, enabling incidents of misapplied brokerage to be spotted and addressed.

Checks and balances are essential

While many of these solutions may seem obvious and simple, it is easy for banks to get caught up in procedures and transactions without implementing the necessary checks and balances. There has never been more pressure on financial institutions to reduce costs, so now is the time to address these issues and let a series of small changes make a big difference.

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