How Is a Foreign Currency Exchange Processed?

Foreign currency exchange is a complicated process that involves multiple global financial institutions and banks.

Retail Foreign Exchange

Individuals typically exchange foreign currency at local banks, foreign exchange counters at airports or prominent international tourist centers. Individuals typically pay cash and receive equivalent foreign currency at the prevailing exchange rate.

Business Foreign Exchange

Global businesses process million-dollar foreign currency transactions each day through commercial banks. Typically, funds are transferred electronically, or by check or demand draft.

Exchange Rates

Exchange rates are set by banks, government bodies and private institutions that trade currencies with each other. Supply, demand and economic factors determine foreign currency exchange rates. Rates vary by small amounts every day.

Consolidation

Foreign exchange trades from retail and business customers are routed to designated settlement agents within each country, every day. The settlement agent consolidates all transactions and processes them.

Settlement Processing

Processing typically involves electronic fund transfers between designated settlement agents. For example, electronic settlements are handled by the Federal Reserve's Fedwire in the U.S. and by the German Central Bank's EAF system. Similarly, transactions are settled with designated settlement agents in other countries.

Exchange

Settlement agents exchange outstanding balances from buy and sell transactions. For example, Fedwire may send dollars to EAF in Germany and receive euros in return, at the exchange rate for the day.

References

• Federal Reserve Bank of New York: All About Foreign Exchange