How Banks Make Money on Currency Exchange: A Clear, Practical Guide

Every time you buy a foreign currency, pay for a hotel abroad with your debit card, or send money across borders, a quiet, automatic calculation happens behind the scenes. The exchange rate you see is rarely the same as the rate banks and money-transfer services use between themselves. That difference — plus an array of fees and service charges — is how many banks and financial institutions profit from foreign exchange (FX). This article explains, step by step and in plain language, how banks make money from currency exchange, the mechanics behind spreads and fees, the roles of market making and hedging, the difference between retail and corporate FX pricing, and practical tips to get better rates and avoid unnecessary costs.

What is currency exchange and who sets the rate?

Currency exchange is the process of converting one nation’s money into another’s — for example, converting U.S. dollars (USD) into euros (EUR). There are three rate concepts to understand:

1. Mid-market (or interbank) rate

The mid-market rate is the midpoint between what major banks are willing to buy and sell a currency for in the global wholesale market. It’s the most transparent reflection of supply and demand at a given moment and is the rate you commonly see on financial websites or currency converters.

2. Bid and ask (buy/sell) rates

The bid price is what a buyer is willing to pay for a currency; the ask (or offer) price is what a seller is asking to receive. The difference between ask and bid is the spread. For traders and market makers, the spread is a primary source of revenue on spot transactions.

3. Retail or consumer rate

Banks and consumer-facing services add a markup to the mid-market rate, and they often charge explicit fees on top. The rate a customer receives — whether at the teller, via an ATM abroad, during an online transfer, or when paying with a card — is almost always worse than the mid-market rate. That markup plus any explicit fees is the bank’s profit on that transaction.

How banks earn from currency exchange: the main revenue sources

Banks and financial intermediaries typically generate revenue from FX via four main channels:

1. The spread (rate markup)

When banks quote exchange rates to customers they widen the bid-ask spread compared to the wholesale market. For example, if the interbank EUR/USD mid-market rate is 1.2000, the bank might buy euros at 1.1985 and sell at 1.2015 for retail customers. If a customer wants USD 12,000 for EUR 10,000, the bank’s markup is implicit within that rate difference. The spread is an immediate and automated profit on every conversion.

2. Fixed fees and commissions

Some banks charge a flat fee or a fixed percentage per transaction (e.g., $10 per international wire or 0.5% of the transaction value). These fees can be standalone or layered on top of the spread, especially for cross-border wire transfers and remittances.

3. Service and convenience charges

Certain conveniences — like urgent transfers, same-day processing, branch services, or conversion at an ATM — come with extra fees. Banks often monetize convenience: a customer who values speed or branch assistance pays more than someone who uses an online portal.

4. Strategic FX positioning and hedging profits

Larger banks and their trading desks may take positions in FX, market-making, or arbitrage. They use sophisticated hedging strategies and derivatives (forwards, swaps, options) to manage and sometimes profit from short-term price movements. While retail customers don’t participate in this directly, the bank’s overall FX trading profitability contributes to its bottom line.

Why the spread exists: costs, risks, and profit

The spread is not pure profit in all cases — it compensates for multiple business realities:

Operational costs

Processing a currency conversion involves systems, compliance checks (KYC/AML), payments infrastructure, correspondent banking relationships, and staff. These costs must be covered.

Counterparty and market risk

Between the time a bank accepts your exchange request and when it executes in the wholesale market (or matches with another client), rates can move. The spread helps offset that risk, plus the cost of hedging if the bank chooses to lock in a rate using forwards or swaps.

Liquidity and access

For less-traded currency pairs or for small-amount retail transactions, liquidity is lower and execution is more expensive. Banks widen spreads where liquidity is thin to manage execution risk and costs.

Profit margin

Like any business, banks set pricing to generate returns for shareholders. The markup on FX is a reliable revenue stream with high turnover: even a small margin applied to millions of transactions scales into meaningful profits.

Different models: Retail banking vs corporate/wholesale FX

Not all customers receive the same pricing. Banks segment FX services by customer type and transaction size.

Retail customers

Individuals exchanging cash, using cards abroad, or sending small remittances get standard retail rates. These rates often include wider spreads and fixed fees. Banks justify this with higher per-transaction costs (cash handling, branch service) and lower negotiating power for consumers.

SMEs and corporate customers

Smaller businesses can often negotiate better rates than consumers, especially when they transact frequently or in larger volumes. Banks may offer tiered pricing, lower spreads, and tailored hedging products (forwards, options) to businesses with predictable FX needs.

Institutional and wholesale clients

Large corporate treasuries, hedge funds, and banks themselves trade on the interbank market with near-midmarket rates and tight spreads. These institutions may receive credit lines, netting arrangements, and direct market access that retail customers don’t have.

Hidden mechanics: correspondent banks, SWIFT, and pass-through costs

Cross-border transfers often involve correspondent banks — intermediary institutions that pass the payment along a chain from sender’s bank to recipient’s bank. Each intermediary may take a fee or apply its own FX conversion, further widening the effective cost to the customer. The Society for Worldwide Interbank Financial Telecommunication (SWIFT) transmits messages about payments, but SWIFT itself is not a money mover — it simply provides the secure messaging network. Still, the chain of banks involved increases complexity and cost.

How pass-through fees work

A bank may tell you a transfer is free, but an intermediary bank in the chain might charge $15. That fee can be deducted from the transferred amount or billed separately. Transparent banks disclose correspondent fees up front, but disclosure varies by institution and region.

Spot, forward, and swaps: how banks manage FX exposure

Banks don’t want uncontrolled currency risk on their balance sheets. They use a toolkit of instruments to manage exposure and sometimes to profit:

Spot transactions

These settle quickly (typically two business days) and reflect current rates. Retail card transactions and many consumer conversions are spot-based.

Forwards and swaps

Forwards lock in a rate for a future date; swaps combine spot and forward legs to exchange currencies over multiple dates. Banks use forwards and swaps to hedge customer obligations or to offer businesses predictable FX outcomes.

Options

FX options give the holder the right, but not the obligation, to exchange at a set rate on or before a date. Banks sell options or use them to mitigate tail risk. Options pricing includes implied volatility and time value, creating additional revenue for the selling bank.

An example: How a simple retail FX conversion earns revenue

Let’s walk through a concrete example so you can see the numbers.

Scenario

You’re travelling from the U.S. to France and you want to convert USD 1,000 to euros at your bank before you leave. The mid-market EUR/USD rate displayed online is 1.2000 (meaning EUR 1 = USD 1.2000).

Bank pricing

Your bank offers EUR at 1.1880 on the buy side (bank buys EUR from you at this USD rate) and sells EUR at 1.2120 (bank sells EUR to you at this USD rate). Alternatively, the bank might show a single consumer-facing rate that already includes its markup.

Calculation

If you hand over USD 1,000 to buy euros at the bank’s sell rate of 1.2120, you receive: EUR = 1,000 / 1.2120 ≈ EUR 825. A mid-market conversion at 1.2000 would have delivered EUR = 1,000 / 1.2000 ≈ EUR 833.33. That difference of EUR 8.33 is the implicit cost from the spread. Expressed as a percentage: (833.33 – 825) / 833.33 ≈ 1% effective markup. If the bank also charged a $10 fee, the total cost becomes higher.

Where banks widen margins: common situations that cost you more

Some scenarios tend to generate larger markups and fees:

Cash exchange at airport kiosks and hotel desks

These locations often have the widest spreads and highest fees. Convenience comes at a premium.

Small transfers and micro-payments

Fixed fees matter more when the transfer amount is small. A $15 fee on a $50 transfer is a 30% cost — far more expensive than a 0.5% spread on a $1,000 transfer.

Exotic or thinly traded currencies

Currencies with low liquidity (less global demand) attract wider spreads because banks take on more execution risk.

Dynamic Currency Conversion (DCC)

When paying with a card abroad, some merchants offer to charge your card in your home currency instead of local currency. This sounds convenient but often uses an unfavorable conversion rate and additional markups. Decline DCC and pay in the local currency for better bank rates or card provider rates (if your card has low foreign transaction fees).

Pricing transparency: what banks disclose and what they don’t

Disclosure practices vary. Some banks show the mid-market rate and then state the markup; others present the final rate only. Key items to watch on statements and transfer confirmations:

• Displayed exchange rate and whether it’s the mid-market rate or the retail rate
• Itemized fees (wire fee, intermediary fee, service fee)
• Exchange rate used for the conversion
• Final amount received by the beneficiary

If these aren’t clear, ask your bank for a breakdown. Competition and regulation in many jurisdictions push banks toward better disclosure, but gaps remain.

How banks price differently: account types, relationships, and negotiation

Your relationship with the bank matters. Banks price better for:

• High-net-worth or VIP customers
• Businesses with regular FX flows
• Clients who maintain large multi-currency balances

If you transact frequently, you can often negotiate lower spreads or bundled fee waivers. Use competitive quotes from FX specialists as leverage when speaking with your bank.

Alternatives to bank FX: when to use specialists and fintechs

If your bank’s rates look poor, consider alternative providers:

Online money transfer services

Companies like Wise (formerly TransferWise), Revolut, and others often offer near-midmarket rates plus a transparent fee. They use local accounts and smart routing to reduce correspondent fees.

Specialist FX brokers

For larger transfers and business needs, FX brokers can offer competitive pricing and hedging products tailored to your risk tolerance.

Prepaid multicurrency cards and accounts

These products allow you to hold balances in multiple currencies and convert when rates are favorable. They work well for travelers and frequent cross-border shoppers.

When to stick with your bank

Banks still make sense when you value integrated services (loans, deposits, local branch support), need complex trade finance, or have regulatory/AML constraints that restrict third-party providers. For urgent cash needs abroad, your bank or ATM network may be the most practical option despite higher costs.

Practical tips to get better rates and avoid unnecessary FX costs

Here are actionable steps to reduce what you pay for currency exchange:

1. Check the mid-market rate first

Always compare the rate you’re offered to a trusted mid-market source (XE, Bloomberg, or Google). Know the difference so you can spot excessive markups.

2. Shop around

For non-urgent transfers, compare banks and specialist providers. Use providers that show both the exchange rate and the fee so you can compare total cost.

3. Avoid airport and convenience kiosks

Plan ahead and avoid high-premium options. Use bank ATMs in central locations instead of hotel desks.

4. Use cards with low foreign transaction fees

Many credit and debit cards waive FX fees. These can be cheaper than cash exchange in many scenarios. Also, decline Dynamic Currency Conversion and choose to be charged in the local currency.

5. Consider a multi-currency account

If you travel or transact cross-border often, multi-currency accounts let you hold and convert when rates are favorable.

6. Bundle transfers

Smaller transfers suffer more from fixed fees. If possible, combine transfers into larger, less frequent payments.

7. Negotiate with your bank

If you’re a regular customer or a business with volume, ask for better spreads, fee waivers, or a tailored FX package.

Special situations: cards, ATMs, and merchant markups

Some FX costs occur without a visible “exchange” taking place. Two common examples:

ATM withdrawals abroad

ATMs may charge cash withdrawal fees, and the ATM operator or your bank might apply an unfavorable exchange rate. Use partner bank ATMs when possible, and choose cards that reimburse ATM fees if you travel frequently.

Card payments and merchant markups

Merchants sometimes add a markup when processing foreign cards, or they offer to charge you in your home currency (DCC) at a poor rate. Decline DCC and let your bank/card provider handle the conversion for typically better pricing.

How regulation and competition shape bank FX pricing

Regulators in many countries require clearer disclosure on FX conversion and remittance fees, and competition from fintechs pushes banks to offer better digital FX experiences. Still, banks enjoy trust and established infrastructure — a tradeoff many customers accept for convenience and security.

Risk, compliance, and why some transfers are expensive or blocked

Anti-money laundering (AML) and sanctions screening add cost to cross-border payments. Banks must verify identities, monitor transactions for suspicious patterns, and sometimes freeze or block transfers if red flags appear. That compliance overhead is another reason small-value or high-risk transfers can be more expensive.

How large banks trade FX: market making and algorithmic pricing

Large banks operate trading desks that provide liquidity in currency markets. They quote two-way prices to clients and other banks, dynamically adjusting spreads based on volatility, time of day, and inventory. Algorithmic pricing and electronic communication networks (ECNs) allow banks to automate execution and manage many micro-transactions at scale.

Inventory management and risk limits

When a bank accumulates positions in a currency, it must decide whether to hedge in the wholesale market or hold the position, both of which carry costs. Pricing strategies incorporate these inventory and capital costs.

Examples of where banks can earn unexpectedly high margins

Be aware of these cost traps:

• International payroll or vendor payments billed with poor rates and hidden intermediary fees
• Card refunds: some banks recalculate refund amounts using a different rate, producing losses
• Cross-border merchant acquirers pricing in ways that favor the merchant over the cardholder

How technology is changing FX pricing

Digital platforms, APIs, and automated FX marketplaces have reduced costs and increased transparency. Fintechs use local clearing and smart routing to bypass some correspondent fees, and open FX APIs let businesses automate rate-checking and execution to lock better prices instantly.

When currency exchange is more than just price: service, speed, and risk management

Sometimes the lowest price isn’t the right choice. Consider other factors:

• Speed: urgent payments cost more
• Reliability: banks with strong compliance and established correspondent relationships may be worth a premium
• Risk management: hedging tools and tailored advice are valuable for businesses exposed to FX volatility

How to evaluate total cost: a checklist

Before you execute an FX transaction, ask or check:

• What exchange rate will be used, and how does it compare to the mid-market rate?
• What explicit fees apply (sending bank, intermediary banks, receiving bank)?
• What are expected settlement times and the risk of rate slippage?
• Are there cheaper alternatives (fintechs, brokers, multi-currency accounts)?
• Is there a way to lock rates or hedge the exposure if needed?

Practical case studies: real-world comparisons

Case A: A traveler withdrawing cash from an airport exchange booth pays a 10% markup via rate and fees. Case B: The same traveler uses a no-foreign-transaction-fee card and an ATM from the bank’s partner network, incurring a 1–2% effective cost. Case C: A small business sending payroll overseas via its high-street bank pays a fixed $35 wire fee plus a 1% spread. A specialized FX broker quotes a 0.2% spread and charges a $10 platform fee — substantially cheaper for regular payroll runs. These examples show how customer needs determine the best provider.

Takeaways: smart habits when dealing with FX

Summary points that matter every time you face a currency conversion decision:

• Always compare the offered rate to the mid-market rate and calculate the effective markup.
• Consider total cost (rate + fees), not just the headline rate.
• Shop larger or regular transfers to specialist providers for better pricing.
• Avoid DCC and be mindful of ATM and airport exchange costs.
• Negotiate with your bank if you transact frequently.

Understanding how banks make money from currency exchange empowers you to shop smarter and avoid hidden costs. Whether you’re a traveler, a small business owner, or someone sending money to family overseas, the combination of spreads, explicit fees, correspondent charges, and convenience markups largely determines what you pay. Use mid-market rates as a reference, compare providers, and consider alternatives like multi-currency accounts or specialist brokers for better outcomes. With a little preparation and awareness, you can keep more of your money where it belongs — in your pocket or your business — instead of paying unnecessarily high exchange premiums.