Understanding the interbank

A concern among some traders is the ongoing “fragmentation” of the stock market. Shares of IBM list on the New York Stock Exchange, but if you buy them, the actual purchase might occur on the NYSE, the Nasdaq, an ECN, or a regional exchange, all of whom might be showing a different price.

However, stock market execution is rather simple compared to the way foreign exchange trades occur. There is no central exchange for spot forex; most trading is done via something called the “Interbank” system, which consists of institutions around the globe that trade foreign currencies on a regular basis and thus have a large supply on hand — banks, obviously, but also insurance companies and other large firms that do business internationally. For companies in the Interbank, trading forex is necessary as a way to hedge against fluctuations in foreign currency prices, as well as to speculate on currency values.

Unlike the U.S. stock market, the Interbank is very loosely organized and minimally regulated. Firms from across the world are part of the Interbank, and the system operates virtually 24 hours a day, every weekday (except for the two hours or so each day between the closing of U.S. West coast businesses and the opening of Australian firms).

Large U.S. banks such as Credit Suisse First Boston, Chase Manhattan, and J.P. Morgan are part of the Interbank, as are large foreign institutions such as Dresdner Bank, Lloyds, and the Industrial Bank of Japan.