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With all the modern technology that we have, I am astonished that financial institutions charge such exorbitant prices for currency conversions. My bank, Fifth Third, charges a 3% conversion fee, while Paypal charges about 4%. I know that currency fluctuates - free-floating and managed - but I can't understand why there is such a high conversion fee, let alone a conversion fee at all.

Is there not some central service that tracks current currency rates that banks can use to get currency data? For example, XE has an API (web service) that for $12,000/year gets you live currency data with unlimited requests. But at 3% they would only need $400,000 to recover such an expense; this is purely speculation, but as a major national bank, I would imagine that they have much much more than $400,000 in international transactions per year. This is even more true for Paypal, yet bizarrely their rate is even higher at 4%!

Why do these fees exist? Are there back-end processes and requirements that require financial institutions to pass off the loss to consumers as a fee? Or, is it just to make money on the convenience of international transactions?

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    You start off talking about charges for foreign-currency transactions (not really the same as currency conversion fees), but then you mention the fees for accessing exchange rate data - not really sure what your numerical example is intended to indicate. Banks charge fees for their services and the level of these fees is 'what the market will bear' - is this so surprising? – AakashM Sep 18 '17 at 9:59
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    @AakashM I believe that the questioner has the (wholly erroneous) belief that paying for current exchange rate information is the main cost incurred by banks in providing a currency exchange service. – Mike Scott Sep 18 '17 at 11:32
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    @MikeScott That's exactly why I asked the question in the first place - I don't know the why. – Chris Cirefice Sep 18 '17 at 11:36
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    All else being equal, this is simply another fee that the bank makes money off of. – Grade 'Eh' Bacon Sep 18 '17 at 12:35
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    There is at least one currency exchange company that I can think of, which is founded on the premise that banks charge too much (TransferWise). It's founders have been interviewed many times on the topic - might be worth reading up. – ksiimson Sep 18 '17 at 12:39
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Mainly because they can.

Yes, there is a cost for banks to execute such transactions, and yes, there is a cost to cover the implied risks, but it is far from 3 or 4%.

There are banks that charge a flat rate of less than 30$ (and no percentage), so for larger amounts, it is worth shopping around. Note that for smaller amounts, which are the majority of personal transactions, that is probably about as, if not more expensive, than paying 3% - below 1000$, 3% is less than 30$. So charging a percentage is actually better for people that want to transfer smaller amounts.

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    Currency conversions have explicit and implicit costs. Explicit costs are things like a 1% foreign transaction fee or a fixed $30 fee. Implicit costs are hidden in the exchange rate itself. That is, if they give you a crappy exchange rate, it can be very expensive without being obvious. If you are converting a large amount of money, you should find several ways to convert and look at the "real" conversion rate (how much source currency it costs you vs. how much target currency you get) and decide based on that. – Eric Sep 18 '17 at 16:52
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    When I saw the title I was going to write an answer that was mainly just words 2:4 – ford prefect Sep 18 '17 at 17:09
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    @ford prefect: Me too. Banks, like any other business (e.g. PayPal), are out to make money, so they charge whatever the traffic will bear. – jamesqf Sep 18 '17 at 17:14
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    Upvoted for "Mainly because they can." They re a business after all! – Leon Sep 20 '17 at 8:30
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    Same thing as "Why do delivery places charge a delivery fee nowadays when they were created to make up for exorbitant gas prices?". Because they make money doing so. – Anoplexian Sep 21 '17 at 16:11
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All institutions, financial or otherwise, seek to maximize profits. In a free market, each bank would price its services to be competitive with the current state of the market.

Since the currency conversion fee is generally a small part of the decision as to which bank to choose, banks can be non-competitive in this area. If this is an important consideration for you then you would need to find a bank with a lower conversion fee, but be prepared to have higher fees in other areas.

TL;DR: The market bears it.

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    I'd argue that, at least in the case of the market of frequent travelers, the market doesn't bear it, though your answer is otherwise right. Most U.S. travel-oriented cards (and even some that aren't travel oriented, such as Discover and Capital One) don't have foreign transaction fees these days. – reirab Sep 18 '17 at 19:40
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    While I agree about financial institutions, the blanket statement about "all institutions, financial or otherwise" isn't true. – user62886 Sep 19 '17 at 10:57
  • @reirab there may not be an explicit foreign transaction fees on some credit cards, but the card issuer is still charging the consumer a hidden fee by using a less favorable rate than what the issuer is able to convert currencies at. – Ben Taber Sep 21 '17 at 21:44
  • @BenTaber Looking back at a recent AmEx statement, the exchange rates ranged from about 0.1% in my favor to about 0.5% in the bank's favor. Certainly not anything like what the OP is asking about. – reirab Sep 21 '17 at 22:09
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Why do these fees exist?

From a Banks point of view, they are operating in Currency A; Currency B is a commodity [similar to Oil, Grains, Goods, etc]. So they will only buy if they can sell it at a margin.

Currency Conversion have inherent risks, on small amount, the Bank generally does not hedge these risks as it is expensive; but balances the position end of day or if the exposure becomes large. The rate they may get then may be different and the margin covers it. Hence on highly traded currency pairs; the spread is less.

Are there back-end processes and requirements that require financial institutions to pass off the loss to consumers as a fee?

The processes are to ensure bank does not make loss.

is it just to make money on the convenience of international transactions?

Banks do make money on such transactions; however they also take some risks. The Forex market is not single market, but is a collective hybrid market place. There are costs a bank incurs to carry and square off positions and some of it is reflected in fees.

If you see some of the remittance corridors, banks have optimized a remittance service; say USD to INR, there is a huge flow often in small amounts. The remittance service aggregates such amounts to make it a large amount to get a better deal for themselves and passes on the benefits to individuals. Such volume of scale is not available for other pairs / corridors.

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    This really cuts to the point - currency foreign to the bank is a commodity and they buy and sell it to make a profit. Everybody sells at a markup - this is how business works. Hummus, stepladders, Spandau Ballet - you can go out right now and buy anything you want, but simply for more than the merchant paid for it. – J... Sep 21 '17 at 11:50
  • This answer explains some of the pricing mechanisms but that doesn't explain the actual height (3-4%) of the transaction fees. Don't get me wrong - still a fine answer. – Trilarion Sep 22 '17 at 7:20
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    @Trilarion I don't know, I think once the mechanism is clear - that we stop thinking about it as a service and rather as a good - then 3-4% margin on a product doesn't look so big anymore. – J... Sep 22 '17 at 11:04
  • @J... Maybe, maybe not. 1-2% sounds equally reasonable to me. The bad thing with fees is that they add up. – Trilarion Sep 22 '17 at 12:16
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    On a "real" currency exchange, the per-transaction costs are typically extremely low and the bid-ask spread is fractions of a percent. Many banks are international now anyway, or at least do business internationally, so they'll actually already be operating in most currencies you care about and probably converting currency for internal use anyway. All in, I'm willing to bet when they charge you 3-4% for currency conversion, they pocket basically all of that. – Ben Millwood Sep 23 '17 at 16:13
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In my experience working at a currency exchange money service business in the US:

Flat fees are the "because we can" fee on average. These can be waived on certain dollar values at some banks or MSBs, and sometimes can even be haggled.

If you Google EURUSD, as an example, you also get something like $1.19 at 4pm, 9/18/2017. If you look at the actual conversion that you got, you may find your bank hit you with $1.30 or something close to convert from USD to Euro (in other words, you payed 10% more USD per Euro). And, if you sell your Euro directly back, you might find you only make $1.07. This spread is the real "fee" and covers a number of things including risk or liquidity. You'll see that currencies with more volatility or less liquidity have a much wider spread. Some businesses even go as far as to artificially widen the spread for speculators (see IQD, VND, INR, etc.).

Typically if you see a 3% surcharge on international ATM or POS transactions, that's the carrier such as Visa or Mastercard taking their cut for processing. Interestingly enough, you also typically get the carrier-set exchange rate overseas when using your card. In other words, your bank has a cash EURUSD of $1.30 but the conversion you get at the ATM is Visa's rate, hence the Visa fee (but it's typically a nicer spread, or it's sometimes the international spot rate depending on the circumstances, due to the overhead of electronic transactions). You also have to consider the ATM charging you a separate fee for it's own operation.

In essence, the fees exist to pad every player involved except you. Some cards do you a solid by advertising $0 foreign exchange fees. Unfortunately these cards only insulate you from the processing/flat fees and you may still fall prey to the fee "hidden" in the spread.

In the grander scheme of things, currency exchange is a retail operation. They try to make money on every step that requires them to expend a resource. If you pay 10% on a money transaction, this differs actually very little from the mark-up you pay on your groceries, which varies from 3-5% on dry food, to 20% on alcohol such as wine.

7

Banks do of course incur costs on currency transactions. But they're not as high as the fee charged to the customer. Most banks in most places lose a lot of money on operating bank accounts for customers, and make the money back by charging more than their costs for services like currency exchange. If you don't choose to pay those fees, use an online service instead. But bear in mind that if everyone does so then banks will be forced to charge higher fees for current accounts.

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    Sounds like you are the PR guy for some bank. You forgot the bit about "A banks policy is to screw their customers if they can." – Contango Sep 18 '17 at 12:41
  • Paying for a current account!? Not in the UK! – James Sep 18 '17 at 13:58
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    I was with you, up until encouraging the user to do their fair share to keep bank profits high, lest we enter some post-capitalist hellscape where consumers try to pay less for goods and services. – djechlin Sep 18 '17 at 16:13
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    "Most banks in most places lose a lot of money on operating bank accounts for customers" [citation needed] – djechlin Sep 18 '17 at 16:14
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    @James Not in the U.S., either. Paying for someone to use your money is insane. If the bank is not paying you to keep your money, something is wrong. This answer seems to miss where banks actually make their money: interest and fees on loans and card processing fees. FWIW, most U.S. travel-oriented cards don't have foreign transaction fees these days. – reirab Sep 18 '17 at 19:38
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Is there not some central service that tracks current currency rates that banks can use to get currency data?

Sure. But this doesn't matter. All the central service can tell you is how much the rate was historically. But the banks/PayPal don't care about the historical value. They want to know the price that they'll pay when they get around to switching, not the last price before the switch. Beyond that, there is a transaction cost to switching. They have to pay the clearinghouse for managing the transaction.

The banks can choose to act as a clearinghouse, but that increases their risk. If the bank has a large balance of US dollars but dollars are falling, then they end up eating that cost. They'll only take that risk if they think that they'll make more money that way. And in the end, they may have to go on the currency market anyway. If a European bank runs out of US dollars, they have to buy them on the open market. Or a US bank might run out of Euros. Or Yen. Etc.

Another problem is that many of the currency transactions are small, but the overhead is fixed. If the bank has to pay $5 for every currency transaction, they won't even break even charging 3% on a $100 transaction. So they delay the actual transaction so that they can make more than one at a time. But then they have the risk that the currency value might change in the meantime. If they credit you with $97 in your account ($100 minus the 3% fee) but the price actually drops from $100 to $99, they're out the $1.

They could do it the other way as well. You ask for a $100 transaction. They perform a $1000 transaction, of which they give you $97. Now they have $898 ($1000 minus the $5 they paid for the transaction plus the $3 they charged you for the transaction). If there's a 1% drop, they're out $10.98 ($8.98 in currency loss plus a net $2 in fees).

This is why banks have money market accounts. So they have someone to manage these problems working twenty-four hours a day. But then they have to pay interest on those accounts, further eating into their profits. Along with paying a staff to monitor the currency markets and things that may affect them.

  • That's fine, but anyone could still have a nearly-zero-spread exchange for a flat fee via Norbert's gambit. So, the banks are overcharging customers who make large transactions. – Neil G Sep 20 '17 at 9:47
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Perhaps it's the terminology "fee" that makes it a little confusing. I'm not sure whether it's due legislation or if it's tradition but banks and money changers in my country don't charge "fees". Instead they advertise separate prices for buying and selling money.

For example they'd normally advertise: USD, we buy: 4.50, we sell: 4.65.

It's a business. Just like selling cars or lemonade selling money only makes sense if you sell it at a higher price than what you bought it for.

Regardless of what you call it it's the profit margin for the seller.

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    This also underscores the fact that there really is no such thing as currency "conversion" - what you are doing is buying one currency using another. The exchange rate is literally nothing more than a reflection of supply and demand. If you buy a lot of Euros you are contributing in increasing the price of Euros. If you sell a lot of Euros you are contributing to the drop of Euros. – slebetman Sep 20 '17 at 9:37
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Echoing that bank fees are mostly "because they can", although partly this is because simply holding onto the money doesn't really pay enough for the physical infrastructure of branches, ATMs and staff. So like a budget airline they make it up on additional fees.

But that document doesn't actually say they charge 3% for currency conversion! It's "0.20% of transaction amount" for currency conversion, which is not bad (although watch out for the "spread" between buying and selling rates).

I see "International POS/ATM Transaction Fee 3% of transaction amount", which is very different. That's a card fee. The big issue with these is fraud - your card number suddenly being used in a different country will nearly always trigger extra fraud checks. It also involves a much more complicated settlement process.

I'm more unimpressed with the monthly service charges and the huge $85 fee for international wire transfers.

3

As mentioned in several other answers, the main reason for high rates is to maximize profit. However, here is another, smaller effect:

Additional answer: It prevents abuse

The typical flow of getting money from an ATM:

  1. You mention that you want 10 Euro
  2. The bank offers to give you 10 Euro at a cost of 11 Dollars
  3. You evaluate the offer for a period of time and accept or decline

Suppose you have a minute to consider the offer, then in that time the currency may drop or rise (which you can see from an external source of information). Therefore this opens a window for abuse.

For real major currencies these huge switches are rare, but they do happen. And when 1 or 2 minor currencies are involved these switches are more common.

Just looking at a random pair for today (Botswana Pula to Haitian Gourde) I immediately spotted a moment where the exchange rate jumped by more than 2 %. This may not be the best example, but it shows why a large margin is desirable.


Note that this argument only holds for when the customer knows in advance what the exchange rate would be, for cases where it is calculated afterwards I have not found any valid excuse for such large margins (except that it allows them to offer other services at a lower price because these transaction).

  • Not just short term things -- it also makes it difficult to win money off of the bank if you are able to predict longer-term fluctuations in relative value. – Hurkyl Sep 23 '17 at 23:21

protected by Chris W. Rea Oct 17 '17 at 20:20

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