What is a Cross Rate in Digital Banking?10 min read

What is a Cross Rate in Digital Banking?10 min read

This guide will explain what a cross rate is, how it’s calculated, why it’s important in digital banking, and how you can ensure you’re getting the best possible rate when transferring money internationally. 

In today’s globalized world, digital banking has enabled effortless international money transfers and borderless finance. However, with opportunities come complexities – especially when it comes to foreign exchange. 

If you’ve ever sent money abroad, you may have wondered about cross rates and how they differ from direct exchange rates.

By the end, you’ll have a solid understanding of this behind-the-scenes component of cross-border payments.

What is the Meaning of a Cross Rate in Digital Banking?

At its simplest, a cross rate refers to the exchange rate between two currencies that are not directly quoted against each other in the foreign exchange (forex) market. When exchanging one currency for another directly quoted pair, the transaction uses a “direct exchange rate.” But when exchanging between two currencies that must first be converted through a third “bridge” currency, this indirect rate is called a cross rate.

For example, if you want to exchange US Dollars (USD) to Mexican Pesos (MXN), the major digital banking platforms and currency exchanges will provide a direct exchange rate since USD/MXN is a heavily traded currency pair. 

However, if you need to exchange Indonesian Rupiah (IDR) to Polish Zloty (PLN), there is no direct rate between these currencies. Instead, the exchange would occur by first converting IDR to a bridge currency like USD, then converting those USD to PLN – this resulting rate is the IDR/PLN cross rate.

How is a Cross Rate Calculated?

Now that we understand the concept, let’s look at how to actually calculate a cross rate in practice. The most common method involves using the US Dollar (USD) as a third “crossing” currency since it tends to be the most liquid and widely traded currency globally.

For example, say we need an exchange rate between the Canadian Dollar (CAD) and South African Rand (ZAR). Neither CAD/ZAR is a directly quoted pair, so we’ll derive the cross rate using USD as an intermediary.

If the current rates are:

• USD/CAD = 1.35
• USD/ZAR = 17.70

To calculate the CAD/ZAR cross rate, we take the exchange rates involving USD and perform the calculation:

• CAD/ZAR = (USD/ZAR) / (USD/CAD)

Plugging in the numbers:

• CAD/ZAR = 17.70 / 1.35 = 13.11

So the cross rate between CAD and ZAR is 13.11. This approach can be applied to derive any cross rate between two currencies not directly quoted, by using a common “crossing” currency in between.

How Does a Cross Rate Differ From a Direct Exchange Rate?

The key difference is that a direct exchange rate represents the value of one currency quoted against another that it can be directly converted to on the forex market. 

A cross rate, on the other hand, is an indirect rate calculated mathematically using quoted exchange rates that involve a third “bridging” currency.

Direct rates tend to be more accurate since they reflect real-time supply and demand between those exact currency pairs on the open market. 

Cross rates, while still providing a way to facilitate currency conversions, are derivative of other exchange rates and therefore may lag slightly behind true market prices.

They also carry additional foreign exchange risk. Since cross rates depend on two or more currency conversions instead of just one, you’re exposed to fluctuation from both sets of underlying pairs during the time it takes to complete the transaction. Direct rates only bear the risk of change in that singular currency pair.

Why are Cross Rates Important in Digital Banking?

There are a few key reasons why cross rates hold significance for digital banking customers:

• Expanded currency options – Cross rates allow transactions involving obscure or exotic currencies that lack direct quotes. This empowers clients to send funds virtually anywhere in the world.
• Improved exchange accuracy – Calculating cross rates with upto-the-second underlying rates yields more precise currency conversions versus estimating or outdated reference rates.
• Streamlined global payments – Cross rate functionality within digital banking platforms automates currency exchanges between any currency pair for frictionless international money transfers.
• Consolidated portfolio views – For customers with globally diversified investments, cross rates enable consolidated account statements and performance tracking across different currencies within a single digital banking portal.
• Hedging opportunities – Sophisticated traders can strategize cross rate positions between unquoted currency pairs to capitalize on arbitrage opportunities or mitigate currency risk.

By incorporating cross rate calculations, services like The Kingdom Bank offer truly global transaction capabilities well beyond simple currency pairs for substantial convenience and opportunities to its clients.

How Can I Ensure I Get the Best Cross Rate When Using Digital Banking Services?

To maximize the value of your international transactions and exchanges, keep these tips in mind:

• Consider timing – Rates fluctuate constantly based on market forces. Try executing currency conversions during peak forex trading hours for potentially better cross rates.
• Compare providers – Not all digital banks calculate cross rates identically or offer the same underlying direct exchange rates. Shop around to identify the most competitive cross rate providers.
• Understand rate composition – Inquire how cross rates are derived (i.e. interbank vs retail rates used) and whether fees are baked into displayed prices.
• Watch for spreads – Providers may apply wider spreads on less liquid pairs than popular currency conversions to protect themselves. Narrow spreads indicate better pricing.
• Consider volume discounts – Some digital banks offer preferential rates or rebates for customers with high monthly transaction volumes. Maintain active accounts.
• Use automated tools – Many top services provide rate alerts if underlying market prices shift significantly from executed rates. Bookmark rates to potentially re-enter trades.

By taking an informed approach, digital banking customers can maximize the value of their cross-border activities and access truly global money movement and investing capabilities. 

Platforms streamlining cross rate handling like The Kingdom Bank deliver unmatched convenience for the connected world.

Understanding cross rates provides essential context for leveraging today’s digital banking solutions and opportunities to transact seamlessly anywhere currencies are exchanged. 

Empower your global financial activities by integrating this powerful foreign exchange concept.