When the bank buys foreign exchange form the customer, it expects to sell the same in the interbank market at a better rate and thus make a profit out of the deal. In the inter bank market, the bank will accept the rate as dictated by the market. It can therefore sell foreign exchange in the market at the market-buying rate for the currency concerned. Thus the inter bank buying rate forms the basis for quotation of buying rate by the bank to its customer.
Similarly, when the bank sells foreign exchange to the customer, it meets the commitment by purchasing the required foreign exchange from the inter bank market. It can acquire foreign exchange from the market at the marketing selling rate. Therefore, the inter bank selling rate forms the basis for quotation of selling rate to the customer by the bank.
The inter bank rate on the basis of which the bank quotes its merchant rate is known as the base rate.
If the bank quotes the base rate to the customer, it makes no profit. On the other hand, there are administrative costs involved. Further, the deal with the customer takes place first. Only after acquiring or selling the foreign exchange from/to the customer, the bank goes to the inter bank market to sell or acquire the foreign exchange required to cover the deal with the customer. An hour or two might have lapsed by this time. The exchange rates are fluctuating constantly and by the time the deal with the market is concluded, the exchange rate might have turned adverse to the bank. Therefore, sufficient margin should be built into the rate to cover the administrative cost, cover the exchange fluctuation and provide some profit on the transaction to the bank. Loading exchange margin to the base rate does this. The bank concerned determines the quantum of margin that is built into the rate, keeping with the market trend.
[Up to 1995, the exchange margin included in the merchant rates were prescribed by FEDAI. For the sake of information, the FEDAI prescribed margins are given below:
1 TT Buying rate 0.025% to 0.080%
2 Bills Buying rate 0.125% to 0.150%
3 TT Selling rate 0.125% to 0.150%
4 Bills Selling rate (over TT Selling Rate) 0.175% to 0.200% ]
The exchange rates listed above are discussed in the next section.
Fitness of Quotation
The exchange rate is quoted up to 4 decimals in multiples of 0.0025. The quotation is for one unit of foreign currency except in the case of Japanese Yen, Belgian Franc, Italian Lira, Indonesian Rupiah, Kenyan Shilling, Spanish Peseta and currencies of Asian Clearing Union countries (Bangladesh Taka, Myanmar Kyat, Iranian Riyal, Pakistani Rupee and Sri Lankan Rupee) where the quotation is per 100 units of the foreign currency concerned. Examples of valid quotation are:
USD 1 = Rs. 62.2350
GBP 1 = Rs. 73.3525
EUR 1 = Rs. 48.5000
JPY 100 = Rs. 39.6075
While computing the merchant rates, the calculations can be made up to five places of decimal and finally rounded off to the nearest multiple of 0.0025. For example, if rate for US dollar works out to Rs. 49.12446 per dollar, it can be rounded off to Rs. 49.1250.
The rupee amount paid to or received from a customer on account of exchange transaction should be rounded off to the nearest rupee, i.e., up to 49 paise should be ignored and 50 to 99 paise should be rounded off to higher rupee (Rupee 7 of FEDAI).
Next: Exchange Quotation