International Review of Economics and Finance 9 2000 267–286
Exchange rate exposure of the key financial institutions in the foreign exchange market
Anna D. Martin
School of Business, Fairfield University, Fairfield, CT 06430, USA Received 16 June 1998; accepted 7 September 1999
Abstract
Exchange rate exposure is assessed for key individual financial institutions, country-specific portfolios, and global portfolios. The results show that the majority of the key individual
institutions are significantly exposed. U.K., Swiss, and Japanese portfolios are found to be significantly exposed, whereas U.S. portfolios are not exposed. There is also some evidence
that exchange rate exposure does not exist on a global level. To the extent that the vast majority of currency trading is conducted among the financial institutions included in the
portfolio, exposure is expected to be insignificant as gains accrued by one institution would be offset by losses incurred by another institution.
2000 Elsevier Science Inc. All rights
reserved.
JEL classification: F31; G2
Keywords: Financial institutions; Exchange rate exposure; Interbank foreign exchange market
1. Introduction
Past studies on the exchange rate exposure of financial institutions have focused primarily on U.S. banks e.g., Choi, Elyasiani, Kopecky, 1992; Wetmore Brick,
1994; Chamberlain, Howe, Popper, 1997; Choi Elyasiani, 1997. Even though U.S. banks dominate the foreign exchange FX interbank market, non-U.S. banks
are also heavily involved in the FX market. A 1996 survey by Euromoney identifies 30 financial institutions from around the world that constitute 75 of the FX market.
Corresponding author. Tel.: 203-254-4000, ext. 2881; fax: 203-254-4105. E-mail address
: amartinfair1.fairfield.edu A.D. Martin 1059-056000 – see front matter
2000 Elsevier Science Inc. All rights reserved.
PII: S1059-05609900059-3
268 A.D. Martin International Review of Economics and Finance 9 2000 267–286
Table 1 Top 30 financial institutions based on 1996 foreign exchange market share
1996 market
share Financial institution
Country Citibank
United States 9.10
Chase Manhattan United States
9.04 HSBCMidland
Hong Kong 6.50
National Westminster Bank United Kingdom
4.90 J.P. Morgan
United States 4.22
Union Bank of Switzerland UBS Switzerland
3.53 Barclay’s Bank
United Kingdom 2.98
BankAmerica United States
2.81 Deutsche Morgan Grenfell
Germany 2.78
Swiss Bank SBC Switzerland
2.59 ABN AMRO
Netherlands 2.28
Credit Suisse Switzerland
2.02 Standard Chartered
United Kingdom 1.83
Goldman Sachs United States
1.79 Indosuez
France 1.74
SE Banken Sweden
1.71 Royal Bank of Canada
Canada 1.66
National Australia Bank Australia
1.58 Tokyo-Mitsubishi Bank
Japan 1.44
Banque Nationale de Paris BNP France
1.37 Bank of Montreal
Canada 1.20
Lloyd’s Bank United Kingdom
1.19 Bankers Trust
United States 1.19
Merrill Lynch United States
1.16 First Chicago
United States 0.91
Societe Generale France
0.88 Fuji Bank
Japan 0.77
Commerzbank Germany
0.76 Royal Bank of Scotland
United Kingdom 0.74
Bank of Scotland United Kingdom
0.72 The figures in this table are taken from the currency trading survey published in Euromoney 1996.
Table 1 displays their estimated 1996 market shares and countries of origin. This list reveals that eight U.S. institutions control 30 of the FX market and twenty-two
non-U.S. institutions control 45 of the FX market. Institutions from the U.K., Switzerland, Hong-Kong, France, Germany, Canada, and Japan control 12, 8, 6.5, 4,
3.5, 3, and 2, respectively. Interestingly, the largest banks in the world do not necessarily dominate the FX market. Using a 1996 ranking by Institutional Investor,
4 of the 10 largest banks in the world are not considered to be key FX participants.
There is evidence that U.S. banks are exposed to exchange rate risk. Choi, Elyasiani, and Kopecky 1992 find approximately 20 of U.S. banks are significantly exposed
A.D. Martin International Review of Economics and Finance 9 2000 267–286 269
over the 1975–1987 time period. Wetmore and Brick 1994 find some U.S. bank portfolios are significantly exposed to exchange rate risk over the 1986–1991 time
period. Chamberlain, Howe, and Popper 1997 report that approximately 30 of U.S. banks and 10 of Japanese banks are significantly exposed over the 1986–1993
time period. Choi and Elyasiani 1997 find 80 of the largest U.S. banks are signifi- cantly exposed over the 1975–1992 time period.
The present research contributes to the literature in the following ways. First, exchange rate exposure is assessed for the key financial institutions that comprise the
interbank FX market. Differences in exchange rate exposure across the institutions in this study may be attributed to differing degrees of risk aversion and levels of
proficiency in managing the exposure. The market should recognize significant expo- sure for those institutions that are less risk averse andor less proficient in managing
their foreign exchange exposure.
1
Second, differences in exposure across countries are analyzed. Eleven different countries are represented by the institutions in the sample. Differences in exposure
across countries may be attributed to differing regulatory and supervisory requirements e.g., Chamberlain, Howe, and Popper, 1997. Even though the Basle Accord of
1988 initiated uniform minimum capital standards for internationally active banks, it provides only guidelines. In reality, it is unlikely that consistent practices are followed
Barth, Nolle, Rice, 1997.
Lastly, this study assesses whether exchange rate exposure exists at a global level. A portfolio comprised of the key financial institutions involved in the FX market may
be viewed as a system in which all FX trading is conducted. Gains by one institution would be offset by losses of another. A simplified example may help clarify this point.
Assume there are two institutions Trader A and Trader B whose only business is trading foreign exchange with each other. The variance of a portfolio that contains
these two companies would be: s
2 p
5 s
2 A
W
2 A
1 s
2 B
W
2 B
1 2s
A
s
B
r
AB
. Since a trade would consist of one trader winning and the other trader losing, r
AB
5 2 1. Furthermore,
there exists a portfolio with proportions W
A
and W
B
that minimizes the variance, where the portfolio variance is zero. Therefore, it can be argued that there is no
foreign exchange exposure from a global portfolio perspective.
2. Data and estimation
