Banks are at the heart of the foreign exchange market. They trade currencies for their customers, for their own risk-management needs, and in some cases to influence the value of their country’s currency. Understanding their role helps explain why prices move the way they do.
Risk warning: Trading forex and CFDs on margin carries a high level of risk and may not be suitable for all investors. You could lose money rapidly due to leverage. Past performance is not an indication of future results. This article is for education only and is not investment advice.
The interbank market
Much of the world’s currency trading happens between large banks, in what is often called the interbank market. These banks quote buy and sell prices to each other and to large clients electronically, around the clock on weekdays. The prices you see on a retail trading platform are ultimately derived from this wholesale market.
How commercial and investment banks take part
- Serving customers: companies that import or export goods need to exchange currencies, and banks handle these payments.
- Hedging: banks help businesses and investors protect themselves against currency moves, using tools such as forwards and options.
- Market making: large dealing banks continuously quote prices and stand ready to buy or sell, earning the spread.
- Managing their own exposure: banks trade to balance the currency risk on their own books.
Since the global financial crisis, rules in many countries have restricted banks from making large speculative bets with their own money, so much of their activity is now linked to serving clients and managing risk.
Central banks
Central banks, such as the US Federal Reserve, the European Central Bank and the Bank of Japan, play a different role. They do not trade for profit. Their decisions on interest rates and other policies are among the biggest drivers of exchange rates. Some central banks also intervene directly, buying or selling their own currency to slow a sharp move. Read more in How interest rates and central banks move forex markets.
What this means for retail traders
- Major pairs such as EUR/USD are very liquid because so many banks and institutions trade them.
- Big moves often happen around central bank meetings and major economic data, when large players adjust their positions.
- Retail traders usually do not trade directly with the interbank market. They trade through a broker, which sets its own spreads and fees.
- Institutions have far more resources and information than individuals, which is one reason retail trading is challenging.
Summary
Banks trade forex every day: commercial and investment banks serve clients, hedge risk and make markets, while central banks influence currencies through policy and occasional intervention. For individuals, understanding this helps explain liquidity and volatility. If you are thinking about trading, start with What is forex and how does it work?.
Risk warning: Trading forex and CFDs on margin carries a high level of risk and may not be suitable for all investors. You could lose money rapidly due to leverage. Past performance is not an indication of future results. This article is for education only and is not investment advice.