The Reserve Bank of India recently announced the scheduled rollout of a foreign exchange trading platform for retail customers. Indians looking to avoid paying hefty commissions while buying or selling foreign currencies will likely make use of this upcoming platform instead of being forced to approach foreign exchange dealers.
The platform, FX-Retail, is expected to pave the way for better pricing for forex transactions, although a few issues need to be ironed out.
The current framework
The Reserve Bank of India (RBI) allows any person to act as an authorised dealer (AD) for the purpose of dealing in foreign exchange, under Section 10(1) of the Foreign Exchange Management Act, 1999. Currently, retail customers in India are required to purchase or sell foreign exchange from an AD bank (those branches that offer the facility) or foreign exchange dealers. AD banks have the freedom to determine their own charges for various types of forex transactions by virtue of the provisions of the Foreign Exchange Dealers’ Association of India Rules – 10th edition.
However, the same rules stipulate that the AD banks must comply with the RBI’s directions, as well as ensure that consumers with fewer forex transactions are not adversely impacted.
A ‘charged’ issue
Retail users currently do not have direct access to foreign exchange markets. Purchase and sale of foreign exchange is routed through AD banks and/or forex dealers. Both charge a fee for each transaction. The magnitude of these charges has been a major source of concern for retail users.
For instance, retail users typically pay a premium of almost 2 per cent while buying a foreign currency, and are charged 2 per cent of the amount as discount while selling the foreign currency to AD banks. The AD banks enjoy a wide latitude in fixing the rates for transactions. Such rates can widely differ from market rates, putting retail users at a disadvantage. Typically, customers who deal in foreign exchange frequently and in large volumes enjoy greater negotiating powers with the AD banks. This gives rise to questions about transparency in fixing of rates and the need to maintain a level-playing field among market participants.
RBI’s push for trading platform
The RBI released a ‘discussion paper’ in October 2017 that proposed the creation of a foreign exchange trading platform for retail participants. The paper categorised the foreign exchange market into two segments: inter-bank and retail. Two possible options were identified to encourage transparent pricing in foreign exchange markets. First, by “mandating a cap on spreads charged over the inter-bank rates by banks to their retail customers”. Second, “facilitat(ing) price determination of retail customer transactions in the market by providing them direct access to the foreign exchange market.”
The RBI paper preferred the second option as it provided a ‘market-based solution’ to determine pricing in foreign exchange markets. An inter-bank electronic trading platform was proposed to be created by the Clearing Corporation of India Limited (CCIL). This mechanism is expected to improve transparency in pricing by fostering competition while reducing the cost of transactions and risks for AD banks.
Last week, the RBI issued a circular announcing that the trading platform, FX-Retail, was ready to be rolled out. Retail customers can register on the portal from 1 July and start forex transactions from 5 August with following options for the delivery of their foreign currencies: ‘cash basis’ (same day); ‘tom basis’ (next day); or ‘spot basis’ (two days after the date of transaction).
Similar to the RBI’s discussion paper, the RBI circular too provided AD banks the freedom to levy fees to meet their administrative expenses, while mandating that such fees be publicly declared on a trading platform, which is now FX-Retail.
FX-Retail in, but issues remain
While the initiative for creation of an electronic foreign exchange trading platform for retail participants is a welcome move, a few concerns remain.
(i) The RBI decision to allow AD banks to charge retail users a ‘pre-agreed flat fee’ vests significant discretionary powers with them to determine the quantum of fee. The RBI circular does not provide any guidance on how such flat fees may be determined. Consequently, there is a possibility that there won’t be any significant cost reduction for retail users, which was the RBI’s intention. Also, AD banks may collude in determining a ‘pre-agreed flat fee’. It may be noted that the European Commission recently fined five multinational banks for participating in a foreign exchange spot trading cartel, which included coordinated trading activities.
(ii) The RBI circular allows AD banks to put a cap on the total amount of transactions that can be undertaken by a customer on the FX-Retail portal in one day. This restriction can be imposed either across the three segments of cash, tom and spot, or separate limits can be prescribed for each segment. (As per the circular, a single transaction cannot exceed US $5 million. In the event that transactions exceed the limit, a charge of 0.0004 per cent would be levied by the CCIL.)
The circular also does not prescribe any guidance on how such limits on transactional amounts by the AD banks will be determined. Typically, retail users’ negotiation powers are weaker as compared to larger firms, and the FX-Retail platform has been envisaged as one of the means to redress this imbalance. But this discretionary power given to the AD banks could potentially hamper the creation of a level-playing field in terms of the cost of accessing the foreign exchange market.
(iii) The RBI’s discussion paper and the circular have made a distinction between retail and inter-bank segments – both have their own trading platforms. As one of the authors of this article had earlier argued, this bifurcation weakens the principles underlying an exchange platform, which is aggregation, buying and selling orders of foreign exchange irrespective of the type of participants. An integrated exchange would benefit retail users by providing for greater liquidity and more efficient price discovery compared to a standalone retail trading platform.
(iv) The discussion paper and the circular specify that the CCIL will operate the spot foreign exchange trading platform. While the paper proposed that other vendors would be allowed to offer similar platforms in due course, the circular is silent on this issue. However, this first-mover advantage given to the CCIL may be problematic. Financial market exchanges typically enjoy positive network effects. In this case, the CCIL may benefit from this positive externality by virtue of providing the sole platform for spot foreign exchange trading.
A similar scenario had previously unfolded when the CCIL had obtained the sole mandate to settle all trades in the government securities (G-secs) market. Though other players were allowed to participate in trading later, they could not compete against the NDS-OM exchange (operated by the RBI), which remains the largest repository of volumes and trades in G-sec trading due to the ability to provide seamless trading, settlement and clearance functions.
v) The framework envisaged in the circular is antithetical to the gains arising from a unified market infrastructure. In other jurisdictions, the same platform offers a variety of services such as foreign exchange trading, bond market trading, trading of money market instruments. The regulatory oversight required is akin to that of any trading platform.
While the decision to start a retail trading platform is a laudable move, it can be improved by avoiding segmentation of market infrastructure and doing better on transparency.
Radhika Pandey is a Fellow at the National Institute of Public Finance and Policy (NIPFP).
Nelson Chaudhuri is a Research Fellow at the National Institute of Public Finance and Policy (NIPFP).
Raghunath Seshadri is a Research Fellow at the National Institute of Public Finance and Policy (NIPFP).
The views and opinions expressed in this article are those of the authors and not of their institution.