By Deb Shaw, MarketsNow.com
As a former Fintech-focused venture capital investment professional, foreign exchange trading executive and current founder of a foreign exchange startup, I’ve had the privilege of witnessing the development of the FX trading industry first hand. Similar to the evolution of other industries brought about by new technology, foreign exchange businesses are being forced to improve at a rapid pace. Historically, the foreign exchange market was seen as an “easy” profit center for banks, given high fees and a limited number of suppliers.
As the internet democratized the flow of real-time information, it didn’t take long for early pioneers such as XE.com to gain significant traction. At that point, many customers realized that banks were earning fat margins from foreign exchange trading. At the same time, many non-bank financial institutions also entered the market seeing a big opportunity. Some startups focused on leveraged foreign exchange (for speculation purposes), while others focused on international payments.
Over time, banks have lost low-end customers to startups
In both the speculation business and the payments business, startups won market share from larger banks over time. They did this by offering a better service at a much lower price point, and initially focused on low-end customers.
At the outset, most startups offered a fairly crude service. Payment startups, for example, could only facilitate international payments in a narrow range of currencies. Due to the reliance on SWIFT payments and manual back office processes (such as anti-money laundering checks), payments also took a long time to be completed. In the event of a lost payment (a surprisingly common occurrence with SWIFT), tracing a payment could take several days. While most startups charged lower fees relative to banks, fees were relatively high versus the service offering. In the UK, for example, payment startups typically charged 1-2% on payment volumes, versus 5-6% charged by major banks. In short, there were few reasons to use a startup international payment provider (beyond price), and only low-end customers made the switch.
Today, the picture has changed entirely. Revolut, for example, has changed the economics of the payment business by moving away from the percentage-fee model entirely. Instead of charging fees based on volumes, Revolut offers international payments with no markup and charges a fixed monthly cost for business accounts. For basic personal accounts, there are no fees unless the user goes above a specific threshold. Beyond bread-and-butter international payments, the company offers a wide range of services such as (1) a multi-currency digital wallet, (2) a Visa debit card that facilitates electronic payments or cash withdrawals from ATMs, and (3) local bank accounts in select countries. Revolut’s product has gone far beyond comparable products offered by banks, proving that even low-end customers (such as retail users) have unmet foreign exchange needs. Unsurprisingly, the company has rapidly gained traction among customers, and recently raised $250m in venture financing as a result.
Looking to the future, banks will look more like utility companies
While banks are already losing retail and small business customers to startups today, they are also likely to lose their larger business customers over time. Ultimately, the idea of a financial supermarket sounds great in theory by fails in practice. Due to a lack of customer focus, banks are simply unable to compete in every area of the broader financial services sector. This is particularly the case for the least profitable areas, such as international payments.
Given the significant scale required to run an institutional foreign exchange trading business, banks are unlikely to exit the game entirely. Most payment startups, for example, are institutional customers of banks, who facilitate trading in various foreign currencies. In the future, expect banks to focus mostly on the wholesale business, while giving up the personal and commercial banking business to new entrants entirely.
From easy profits to loss leader
Looking at the international payments business today, fees for basic international payment services are now so low that even startups are struggling to earn profits. As a result, most startups are now looking to add new products and services, and ultimately plan on using the international payments business as a loss-leader. This is very similar to how banks have evolved – most provide current and savings accounts at a loss, while making profits on additional services (primarily lending). Startups are now moving upscale themselves, offering new services such as securities brokerage and lending services.
Customers have been the clear winner as a result of the evolution in the industry. In the future, expect the foreign exchange business to become even more competitive as non-bank institutions are provided direct access to central bank clearing infrastructure (as is currently happening in the UK). While foreign exchange startups have been limited by their historical reliance on banks for many key services, this looks set to change as regulation catches up with the realities of this changing industry.
Deb Shaw is the Founder & Head of Research at MarketsNow.com, a research tool that provides news, commentary, trending indicators, live charts and an exchange rate calculator focused on the world’s major currencies and commodities. Every trading day, the website publishes daily updates summarizing recent developments for currencies and commodities that we cover.