Foreign Exchange Dealer

Most commercial banks in the United States customarily have bought and sold foreign exchange for their customers as one of their standard financial services. But beginning at a very early stage in the development of the over-the-counter market, a small number of
large commercial banks operating in New York and other U.S. money centers took on
foreign exchange trading as a major business activity.

They operated for corporate and other customers, serving as intermediaries and market makers. In this capacity, they transacted business as correspondents for many other commercial banks throughout the country, while also buying and selling foreign exchange for their own accounts. These major dealer banks found it useful to trade with each other frequently, as they sought to find buyers and sellers and to manage their positions. This group developed into an
interbank market for foreign exchange.

While these commercial banks continue to play a dominant role, being a major dealer in the foreign exchange market has ceased to be their exclusive domain. During the past 25 years, some investment banking firms and other financial institutions have become emulators and direct competitors of the commercial banks as dealers in the over-the-counter market.

They now also serve as major dealers, executing transactions that previously would have been handled only by the large commercial banks, and providing foreign exchange services to a variety of customers in competition with the dealer banks. They are now part of the network of foreign exchange dealers that constitutes the U.S. segment of the foreign exchange market. Although it is still called the “interbank”market in foreign exchange, it is more accurately an “interdealer”market.

The 1998 foreign exchange market turnover survey by the Federal Reserve Bank of New York
covered the operations of the 93 major foreign exchange dealers in the United States. The total
volume of transactions of the reporting dealers, corrected for double-counting among themselves, at $351 billion per day in traditional products, plus $32 billion in currency options and currency swaps, represents the estimated total turnover in the U.S. over-the-counter market in 1998.

To be included in the reporting dealers group surveyed by the Federal Reserve, an institution must be located in the United States and play an active role as a dealer in the market. There are no formal requirements for inclusion, other than having a high enough level of foreign exchange trading activity.Of course,an institution must have a name that is known and accepted to enable it to obtain from other participants the credit lines essential to active participation.

Of the 93 reporting dealers in 1998, 82 were commercial banks, and 11 were investment banks or insurance firms. All of the large U.S. money center banks are active dealers. Most of the 93 institutions are located in New York, but a number of them are based in Boston, Chicago, San Francisco, and other U.S. financial centers. Many of the dealer institutions have outlets in other countries as well as in the United States.

Included in the group are a substantial number of U.S. branches and subsidiaries of
major foreign banks—banks from Japan, the United Kingdom, Germany, France, Switzerland,
and elsewhere. Many of these branches and agencies specialize in dealing in the home currency of their parent bank. A substantial share of the foreign exchange activity of the dealers in the United States is done by these U.S. branches and subsidiaries of foreign banks.

Some, but not all, of the 93 reporting dealers in the United States act as market makers for
one or a number of currencies.A market maker is a dealer who regularly quotes both bids and
offers for one or more particular currencies and stands ready to make a two-sided market for its
customers.

Thus,during normal hours a market maker will, in principle, be willing to commit
the firm’s capital, within limits, to complete both buying and selling transactions at the prices he quotes, and to seek to make a profit on the spread, or difference, between the two prices. In order to make a profit from this activity, the market maker must manage the firm’s own inventory and position very carefully, and accurately perceive the shortterm trends and prospects of the market.

A market maker is more or less continuously in the market, trading with customers and balancing the flow of these activities with offsetting trades on the firm’s own account. In foreign exchange, as in other markets, market makers are regarded as helpful to the functioning of the market—contributing to liquidity and short-run price stability, providing useful price information, smoothing imbalances in the flow of business,maintaining the continuity of trading, and making it easier to trade promptly.