| What determines the rate of exchange
between currencies will be examined later in this booklet, but first it is
useful to consider the mechanics of international transactions. To enable a UK
importer to pay his American supplier, for example, the facilities of two or
more banks are used, firstly in handling the often complex documentation and
secondly, through the foreign exchange market, in obtaining the currency
required. At one time payments to and from other countries were made by bills of
exchange; hence in part the term "exchange rate", which was maintained even
though other methods of payment have largely superseded the bill of exchange.
The British importer will probably need to pay his American supplier in dollars
and his British bank can offer him several alternative methods of settlement. It
can provide him with a banker's draft drawn in dollars. The bank is able
to do this because it will have an account with another bank (called a
correspondent bank) in an American city and it simply issues a dollar cheque or
draft drawn on that account. The British importer can then send this draft by
airmail to the supplier. Since there is a danger that the draft may be lost or fall into the wrong hands' the safer and more normal method would be for the British bank to arrange for payment by mail transfer. Instructions are sent by airmail to the correspondent bank in the US to pay on behalf of its customer the required sum to the named recipient from the British bank's dollar account. This mail transfer system is very flexible since the instructions for payment can be varied or elaborated to suit practically every kind of requirement. |