If you use your bank to change currencies or send money abroad, there’s a good chance that you’re getting ripped-off on the exchange rate. Financial institutions often stick a large margin on foreign exchange (forex) rates when dealing with retail clients, figuring that it’s a way to make extra profits without most clients realising what’s going on.
The size of the mark-up varies, but with some banks it can be a premium of 4% or more – sometimes including a fixed fee on top. Given that the bid/ask spread in the interbank currency market (where big institutions trade) is almost non-existent for major currencies, these kinds of margins are clearly excessive.
The good news is that there is often a way to cut them significantly. Instead of using your bank to change currencies, you can use a currency broker (sometimes known as a foreign exchange transfer specialist) or a peer-to-peer currency transfer website. These firms offer far more competitive exchange rates and can often bring the cost down to 1% or less.
Currency brokers and P2P websites
Currency brokers such as TorFX and HiFX have been growing in popularity in recent years as people become more aware of how much their banks have been overcharging them. These firms work by buying the currency you want in the institutional market and selling it onto you for a commission.
Peer-to-peer (P2P) platforms such as TransferWise and CurrencyFair are a newer development and operate in a different way to the brokers.When you sign up to one, you join a large pool of other individual users who all want to carry out their own currency transfers. The P2P platforms work by matching all those users on opposite sides of the transaction (for example, those that want to sell sterling for dollars with those that want to sell dollars for sterling) and take a commission for doing so.
Which of these approaches is best depends what currencies you want to convert and how much money is involved. In general, the P2P platforms offer very good rates for smaller transactions, but it’s likely you could negotiate better rates for big deals directly with a broker.
How much could you save?
How much margin you save depends on how much you’re transferring – larger amounts will usually save you more. Different money transfer firms use different fee structures and the cheapest for one transaction may not be the cheapest for another. So it’s important to shop around and compare rates.
Below, I’ve compared the costs of a bank, two currency brokers and two peer-to-peer transfer websites for varying sizes of transfer from sterling to Singapore dollar. The rates are tradeable online quotes, taken around 7pm on Friday 13 February 2015. The interbank rate at the time was around S$2.086 per pound.
The firms compared and their charges were:
- A bank, HSBC UK. They quoted a fee of £4 (£0 to transfer to another HSBC account), plus a variable exchange rate depending on transfer size.
- A currency broker, HiFX. They quoted a fee of £9 for the two smallest transfers and nothing for larger ones, plus a variable exchange rate depending on transfer size.
- Another currency broker, WorldFirst. They quoted a variable exchange rate depending on transfer size.
- A peer-to-peer website, TransferWise. They quoted a commission of 0.5% and set the exchange rate at which users’ money is exchanged at the interbank rate.
- A second peer-to-peer website, CurrencyFair. They quoted a flat fee of £3, plus a commission of 0.15% based on the rate at which users’ money is exchanged. Unlike TransferWise, this is not the interbank rate but is set by supply and demand on the platform (so you could get a better or worse rate). If no exchange rate is available for the currency you want (because not enough users are offering it) CurrencyFair offers you the interbank rate plus a commission of 0.4-0.5% – in my comparison, this seems to have been what happened.
I put all these numbers together to calculate the effective interest rate (including flat fees) and the resulting margin over the interbank rate that you’d pay through each of these firms on six transactions from £1,000 to £50,000. The results are in the table below.
CurrencyFair HiFX HSBC TransferWise WorldFirst
£1,000 2.069 2.005 2.01 2.076 2.032
Margin 0.80% 3.90% 3.70% 0.50% 2.50%
£2,000 2.072 2.018 2.013 2.076 2.043
Margin 0.65% 3.30% 3.50% 0.50% 2%
£5,000 2.074 2.045 2.024 2.076 2.057
Margin 0.56% 2% 3% 0.50% 1.30%
£10,000 2.075 2.056 2.026 2.076 2.061
Margin 0.53% 1.40% 2.90% 0.50% 1.10%
£20,000 2.075 2.062 2.036 2.076* 2.064
Margin 0.50% 1.20% 2.40% 0.5%* 1%
£50,000 2.075 2.064 2.047 2.076* 2.068
Margin 0.50% 1.10% 1.90% 0.5%* 0.80%
*For TransferWise, the maximum single transfer for Singapore dollars at the time was S$40,000 – but since they use a fixed commission, it should work out at the same rate
You can see there are some significant savings here. If you want to send £1,000 internationally, then TransferWise’s quote saves you more than 3% compared to what HSBC would charge. As far as I know, HSBC is relatively typical of UK banks on this score and better than some, so the extent to which banks overcharge is obvious.
The currency brokers are less competitive than the P2P sites for smaller amounts, but improve as the amount gets larger. In reality, there is scope for negotiation for larger deals with brokers and they might well be able to beat the P2P sites.
For example, HiFX will do online transfers of up to £300,000. But if you were transferring that much, you’d should ring and haggle, instead of taking what you’re offered online. In fact, I’d say that even with a £20,000 transfer you’d have a good chance of negotiating a better margin than the 1.2% quoted online in the example above.
I’ve listed HiFX and WorldFirst in the example above, but there are plenty of other brokers including TorFX, CaxtonFX, Currencies Direct, Travelex and Moneycorp. Smaller, less well-known firms may also offer good rates: one reader has suggested London-based City Forex and Thomas Exchange as significantly cheaper than some of the big names.
Since rates vary quite a bit, it makes sense to get quotes from more than one firm and choose whichever gives the best rate for the currency and trade size you need. Account opening is usually pretty fast: it can normally be done online and completed in an hour or less. There are typically no account fees or maintenance fees and you only pay a commission when you make a transfer. So if you’re planning to make frequent transfers, it may pay to have several accounts set up and pick the one that offers you the best deal on each transaction.
How safe is your money with a currency broker?
Whichever currency transfer firm you use, make sure you’re dealing with a reputable business and not just the firm offering the best quote. Remember that this firm has custody of your money at some point between leaving your bank account and reaching your broker. If it suddenly collapses, what will happen to your funds?
In fact, this industry is more lightly regulated than you might expect, so it’s important to be careful. Regulations vary in different countries – but even in the UK, where the rules seem to be tougher than most – many firms are effectively unregulated. Small payment institutions are obliged to be registered, but are not closely monitored. In the past, some firms have collapsed and clients have lost the money they had in the firm at that point (Crown Currency Exchange was a high-profile example).
It’s very important that to be aware that funds being held by a currency exchange firm are not covered by the Financial Services Compensation Scheme, unlike the money in your bank account. So there is no compensation available from the regulator if the worst happens.
So what should you do to stay safer? In the UK, any large and reputable transfer firm will be authorised and regulated by the FCA as an Authorised Payments Institution under the Payments Services Regulations 2009. This compels them to hold a certain minimum level of capital and – most importantly – to keep its clients’ money in segregated client accounts at a European Economic Area-regulated bank.
You can check whether a UK-based firm is authorised and regulated by searching the FCA register online. If it is not on the register, you should not use it. (If you’re checking the firms listed above, you’ll find the CurrencyFair is not listed – that’s because it’s an Irish firm and is regulated by the Central Bank of Ireland instead.)
You should be aware that this does not completely remove all risks to you. First, segregated bank accounts reduce the ability of the firm to steal your money and swan off to the Caribbean. But it’s impossible to defend against all possibility of fraud and no FSCS compensation would apply if that did happen.
Second, at the point of settlement of the FX conversion, your funds are briefly non-segregated. They are handed over to the transfer specialist’s counterparty in exchange for the foreign currency that it’s buying for you. If one of the firms failed at this point, your money could theoretically be entangled with the failed firm.
This is not a problem unique to currency brokers. It’s a risk that often applies with FX conversion and it even has its own name – Herstatt risk, after a German bank that collapsed mid-transfer in 1974. But I suspect that if your funds were lost in this way in a transfer using a major high street bank, the bank would be compelled to make good any losses to account holders. A small FX transfer specialist might not be able to stand the losses, even if it wanted to do so.
The risks of either event hitting your transfer are small. But clearly, going with the most reputable and responsible currency specialists can reduce the risk that something bad will happen. Of course, if you’re making a big transfer and you’re still worried, you could consider splitting it into more than one transaction and sending it at different times or via different firms.