What Are Foreign Exchange Markups and How Neobanks Avoid Them
Foreign exchange markups are hidden fees banks add to currency conversion. Traditional banks typically mark up exchange rates by 2-5%. Neobanks use interbank rates with minimal margins. This post explains markups and how neobanks avoid them.
Understanding Foreign Exchange Markups
Foreign exchange (FX) markups are the hidden costs that banks and currency exchange services add when converting one currency to another. They are not always obvious because they are built into the exchange rate itself, rather than shown as a separate fee. Understanding how these markups work is essential for anyone sending money abroad, traveling, or doing business internationally.
What Is an FX Markup?
An FX markup is the difference between the real market exchange rate (the mid-market rate) and the rate you're offered. For example, if the real rate for USD to EUR is 1.10, but your bank gives you 1.07, the difference of 0.03 is the markup. This markup is how banks profit from currency conversion. Markups typically range from 1% to 5% of the transaction amount.
How Traditional Banks Charge You
Traditional banks use several methods to apply markups:
- Inflated exchange rates: They add a percentage above the mid-market rate.
- Flat fees: A fixed charge per transaction, often combined with a poor rate.
- Dynamic currency conversion: When using a card abroad, the merchant's bank offers to convert at their rate, which is usually worse.
These charges can add up quickly, especially for large transfers or frequent travel. A 3% markup on a $10,000 transfer costs you $300.
How Neobanks Eliminate or Reduce Markups
Neobanks (digital-only banks) have disrupted traditional banking by offering more transparent and lower-cost currency services. They achieve this through different business models and technology.
Real Exchange Rates vs. Marked Up Rates
Most neobanks use the mid-market rate or a rate very close to it, with only a small, disclosed margin. For example, Wise (formerly TransferWise) uses the mid-market rate and charges a transparent fee. Revolut offers interbank rates up to certain limits on weekdays. This transparency means you know exactly what you're paying.
Fee Structures of Neobanks
Neobanks typically charge:
- A small percentage fee (e.g., 0.3% to 1%) instead of a hidden markup.
- No fee for low amounts or on certain plans.
- Subscription models that include fee-free currency exchange up to a limit.
Some neobanks, like Monzo and N26, offer fee-free spending abroad using the Mastercard or Visa exchange rate, which is near the mid-market rate. Others, like Starling Bank, have no foreign transaction fees.
Tips to Minimize FX Costs When Using Neobanks
To get the best deal on international transactions:
- Always choose to pay in the local currency rather than your home currency (avoid dynamic currency conversion).
- Compare the exchange rate offered by your neobank with the mid-market rate using a site like XE.com.
- Watch out for weekend or out-of-hours markups, some neobanks add a small premium during non-trading hours.
- Consider a dedicated travel card like Wise or Revolut for frequent travelers.
- Use a neobank with a multi-currency account if you deal in multiple currencies regularly.
Conclusion
Foreign exchange markups are an expensive and often hidden cost of traditional banking. Neobanks offer a fairer alternative by using real exchange rates and transparent fees. By choosing a neobank and following the tips above, you can save significant money on currency conversion. Always review the terms and fee schedules, as each neobank has its own policies. With the right choice, you can make your money go further abroad.