F/X Both a Threat and Opportunity for U.S. Banks

markets-8-18-17.pngUncertainty in foreign currency (F/X) markets remains high due to numerous circumstances in the United States and beyond our shores. Geopolitics, worldwide central bank policies, vast economic data, commodity prices and a host of other factors combine to create volatility, and these have been increasingly difficult to forecast of late.

After a significant run up beginning in the fourth quarter of 2016, the dollar continued to weaken into the summer against most foreign currencies, generally falling below the levels seen before the presidential election. This was partly due to continued disappointment at the lack of any progress from the Trump administration on tax reform, health care and infrastructure spending, along with the Federal Reserve’s outlook for interest rates. Coupled with the backdrop noted above, the result has been an increase in volatility for the dollar and its relationship with many currencies worldwide.

Impact on Current Markets
Today, U.S.-based businesses are more global than ever, whether they are importing, exporting or have a physical presence overseas. A dynamic once reserved for large corporations, many smaller businesses are now impacted by direct and/or indirect international exposure. As a result, risks associated with F/X volatility have become a crucial topic for companies to address.

This increased volatility is also relevant to financial institutions for several reasons. Bank borrowers that are not appropriately managing business related international currency risks are potentially exposing themselves to negative pressures on profitability. From the bank’s perspective, this is a concern as it could impact the creditworthiness of the borrower. In addition to profitability and credit, F/X volatility could have significant repercussions for a borrower’s accounting and regulatory disclosures. Ultimately, these circumstances will filter down to the bank itself during due diligence/credit approval processes, ongoing credit reviews and FASB implications (i.e. CECL calculation). Clearly, today’s operating environment is becoming more and more challenging for both borrowers and lenders.

How Middle Market Banks May Capitalize on F/X Volatility
For many forward thinking financial institutions, F/X has become a proactive line of business whereby the bank provides F/X advisory and/or execution services. If implemented properly, this business line can become a key differentiator versus peers in the acquisition of new clients, the retention of current customers and the creation of a source of non-interest income.

To be clear, having the capability to process a foreign currency wire is not the same as having a proactive F/X line of business. Success requires the knowledge to identify F/X risks inherent in certain businesses, the access to risk management tools such as forwards and options, and the expertise to design a proper solution for each customer. All of these items need to be delivered via a dynamic technology infrastructure capable of managing complexity.

Certain large (and some mid-sized) financial institutions have the scale to develop F/X as a line of business in-house. However, many commercial bankers typically don’t have the bandwidth and depth of subject matter expertise required to maximize this opportunity. As a result, along with sizable upfront expenses and time lost in building out an internal platform, many of these institutions are establishing relationships with specialist firms that can deliver the technology and advisory expertise required to be successful.

There are a few questions that every institution needs to ask as they are evaluating their F/X objectives. For example, what is the F/X opportunity for the bank? Is this opportunity large enough to be relevant? Does the bank have adequate internal expertise or should it outsource to a third party? How does the bank want to implement this line of business? Is the bank only looking for a payments solution? Does the bank prefer both an advisory and payments solution provider? Once these answers are identified, a bank can then select a F/X fintech company that will best address these needs.

As there are multiple fintech companies in the F/X sector with distinct areas of expertise, it’s vital for a financial institution to perform their due diligence. F/X fintech companies can assist financial institutions in several different capacities–including pure trade execution, marketing of the F/X platform, assisting in the prospecting of new clients, providing hands on advisory expertise and serving as an educational resource to the financial institution and/or client. An important consideration during this process is the evaluation of the fintech company’s financial standing and internal risk management controls in order to ascertain its long-term viability.

Observations for Financial Institutions and Fintech
No matter the subject, savvy financial institutions are looking to fintech companies as a way to enhance their franchise offerings as well as increase efficiencies and profitability. Be it F/X, electronic loan document processing, cloud-based web services or big data analytics, to name a few, banks and fintech companies are finding ways to collaborate. This is a major change from a few years ago when many fintech companies were perceived as more of an adversary than an ally. Moving forward, successful relationships will be established between banks and fintech companies that understand how each other thinks, behaves–and most importantly, embraces the culture found at each institution.

Michael Griffith