Everyday Life⏱ 4 min read
How Exchange Rates Work and How Banks Make Money on Currency
The mid-market rate you see on Google is not what you get. Banks and bureaux take a spread on every transaction. Here is how to calculate the true cost of exchanging currency.
Every currency exchange involves two prices: the buy rate and the sell rate. The gap between them is the spread -- the invisible fee that replaces or supplements the explicit commission. Understanding the calculation reveals the real cost.
The Mid-Market Rate and the Spread
Mid-market rate (also called interbank rate):
The midpoint between buy and sell wholesale prices.
This is what Google, XE.com, and financial news sites show.
Buy rate (bank buys from you): below mid-market
Sell rate (bank sells to you): above mid-market
Example: GBP/EUR mid-market rate = 1.1700
Bank sell rate (you buy euros): 1.1480
Bank buy rate (you sell euros): 1.1320
Spread = Sell rate - Buy rate = 1.1480 - 1.1320 = 0.0160
Spread as % of mid-rate: 0.0160 / 1.1700 x 100 = 1.37%
On a £1,000 transaction:
You receive: 1,000 x 1.148 = EUR 1,148
Mid-market equivalent: 1,000 x 1.170 = EUR 1,170
Hidden cost: EUR 22 = approximately £19.14
Comparing Exchange Rate Providers
Provider TypeTypical SpreadOn £1,000 GBP/EUR
Airport bureau (UK)4-8%EUR 47-93 lost
High street bank2-4%EUR 23-47 lost
Post Office1.5-3%EUR 17-35 lost
Online specialists (Wise, Revolut)0.3-0.8%EUR 3-9 lost
Wise (large transfers)0.2-0.5%EUR 2-6 lost
Calculating Effective Exchange Rate
You want to convert £2,000 to EUR.
Provider quotes: "EUR 1.15 per pound, no commission"
Mid-market rate: EUR 1.172
Effective rate: 1.15 vs 1.172
Spread cost: (1.172 - 1.15) / 1.172 x 100 = 1.88%
Cost in EUR: 2,000 x (1.172 - 1.15) = EUR 44
Cost in GBP: 44 / 1.172 = £37.54
Always calculate: (Mid-market rate - Offered rate) x Amount
Then express as a percentage or absolute amount.
"No commission" often just means the fee is in the rate, not charged separately.
When to Use Forward Contracts
If you need to pay a known foreign currency amount in 3-6 months:
(e.g. buying property abroad, paying overseas supplier)
Forward contract: locks in today's rate for future delivery
Useful when:
- You need budget certainty
- You think the rate may move against you
Break-even: forward rate better than spot rate + expected movement
Typical forward premium/discount:
Based on interest rate differential between countries
Higher UK rates vs EUR rates = GBP trades at a small forward discount
(You get slightly fewer EUR in 6 months vs today -- normal)