Swap banks are financial institutions that are used as the intermediary agency when conducting a currency or interest swap between two parties. Often, a swap bank is actively involved in identifying and arranging for the two parties involved to discuss the terms of the exchange, as well as helping execute the actual swap. In exchange for executing the business deal, the swap bank normally receives some type of compensation from one or both parties.
In order to understand how a swap bank provides a useful function, it is necessary to define what is meant by currency and interest swaps. An interest swap is a situation in which two debt obligations with different payment streams are exchanged, to the mutual benefit of both parties. Each party obtains an obligation that includes a type of interest that he or she desires. For example, an interest swap may allow a lender with a debt that carries a fixed rate of interest to swap that debt for one that carries a variable rate of interest.
With a currency swap, the transaction involves exchanging the cash flows as well as the principal of one type of currency with the cash flows and the principal associated with a different currency. Like the interest swap, the idea behind the currency swap is to allow two parties to swap assets to their mutual benefit. Both the currency swap and the interest swap often involve provisions that allow the two parties to reverse the exchange at some specified point in the future, a process that the swap bank is also likely to manage.
There are a couple of advantages to utilizing a swap bank to manage currency and interest swaps. One has to do with the ability to find parties who are interested in a swap and have the financial stability to engage in the process. The bank is in a position to ensure that there are no issues of ownership with the assets that are exchanged, and that each party will be able to fulfill his or her responsibilities in regard to the trade. This can save any entity that wishes to engage in a swap a great deal of time, as well as minimize the chances for issues to arise at a later date.
The compensation received by a swap bank is often based on the complexity inherent in the swap itself. Relatively simplistic swaps that require little effort may be compensated with some type of premium related to one or both of the assets that are exchanged. Some banks prefer to charge flat fees up front, while others may assess a percentage of the overall value of the assets involved. In many cases, the fees charged by a swap bank are relatively inexpensive when compared with the resources that both parties would have expended in attempting to find a suitable swap on their own.
