The mid-market exchange rate: A definition

What is the mid-market exchange rate and why does it matter? The fact that you’ve arrived here suggests to me that it’s important that you know. If you are making cross-border payments, the mid-market rate is an essential reference point to ensure that you are using a competitively priced money transfer service.

Despite their looks, exchange rates don’t have to be complicated. If you can get your head around the mid-market rate, and understand how the prices offered by money transfer services relate to this benchmark, you will be placed in good stead. It really is the first step in determining that you’re getting a good deal.

Now, let’s take a look at the mid-market rate definition.

What is the mid-market rate?

The mid-market rate is essentially an exchange rate in its simplest form. Every day in the world’s foreign exchange markets, traders buy and sell currencies with each other on behalf of large banks and other financial institutions. Through this, they establish the supply and demand of each currency, which is represented by two prices; the price to buy a particular currency, and the price to sell it.

These two prices are not the same. The buy price will always be slightly lower than the sell price. This is to encourage traders to enter the market and begin trading – to provide “liquidity” to the market and make a small profit in the process. The mid-market rate is the middle point of these two prices and is the clearest representation of the true exchange rate at any one time.

The mid-market rate is also known by other names, such as the “interbank rate” and “real exchange rate”. It effectively represents the price at which banks and other financial institutions (including money transfer services) can acquire currency at. The mid-market rate moves up and down as it is affected by market forces for a particular currency, and by understanding what it is and what it represents is useful when acquiring currency yourself.

Why does it matter?

Knowing that the mid-market rate is the true exchange rate of a particular currency pairing at any one time, we can set it as a benchmark for comparing money transfer services against. If we assume that a service can acquire a currency at or close to the mid-market rate, we can reverse engineer their offer to see how far away it is from the mid-market rate; and thereby understand the total “cost” of us using their service.

Practically speaking, it is unlikely that a service will ever offer the equivalent of the mid-market rate, as most will add a profit margin or “spread” to a currency before selling it to you. However, by comparing the cost of each service relative to the mid-market rate, we are able to make a fair apples with apples comparison, without getting drawn into marketing and pricing games.

Speaking of pricing games, many services will charge a fee and/or a spread to differentiate themselves from their competitors. Because this can confuse matters somewhat, you should try not to focus on either in isolation. Instead, try to consider the overall cost of each service when compared to our benchmark; the mid-market rate. To find out the mid-market rate of any currency pairing, visit XE or Yahoo Finance.

An example

To understand how we can use the mid-market rate to find out the effective cost of a service, let’s go through an example together. Say that I’d like to send £1,000 from the United Kingdom to Australia and that I’d like to compare the money transfer services available.

Here, the mid-market rate of 1.7398 results in a direct exchange of $1,739. As this is only a theoretical rate, there is no “cost” as such. Of the services available to us, Service 1 is the most competitive of the bunch. It offers the mid-market rate but charges a slightly higher transfer fee than Service 2. We receive $1,729 in Australia, therefore $10 has been lost in charges – which translates into an overall cost of 0.57%. A pretty good result, all things considered.

If you’d like to know more about what to look for, read our guide on how to compare money transfer services.

What is a fair cost for money transfer?

So what is a fair cost for using a money transfer service? In my experience, a cost of less than 1% of the overall transaction value is considered competitive. Some market leaders, such as TransferWise (review), are trying to get this down even further, to around 0.5% of the overall transfer value. Over time, this should have an effect of pushing down average prices across the market, as services continue to compete for your business.

It is important to note, however, that the overall cost of money transfer will vary between currency corridors. For some currency pairings, such as between the United Kingdom and Australia, there is significant competition amongst services, leading to a lower cost on average. However, if you are transferring money between two lesser used corridors, you may find that the cost is generally higher. To find out more, the World Bank regularly publishes average remittance costs for popular currency pairings.

Conclusion

Before you make any international payment, take a minute to find out the mid-market exchange rate, and compare this to the prices offered by money transfer services. The mid-market rate shows you what the true exchange rate is at any one time, and will help you understand what the overall cost of using a service is. This will allow you to compare the options available in an orderly and meaningful way.

As I mentioned earlier, many money transfer services employ tricky practices to hide the true cost of using their service. From a customer’s perspective, I think that transparency goes a long way to establish and maintain trust. Everyone wants to know they are getting a fair deal, and by knowing about the mid-market rate, you’ll be in a much better position to do so.