Viewpoint / Now, Even the Dealing Rooms Are Seeing Red

The real pros of Israel's currency market, namely the market makers at the big banks' dealing rooms, usually make money, sometimes lots of it, from their trading operations.

Israel's currency arena is, like most of its counterparts abroad, the biggest and most liquid market in the nation. It is therefore the hardest to call in advance, and hardest to milk from its fluctuations.

Millions of companies and people operate in the global currency market, which boasts a total turnover of some $1.3 trillion a day. Of that, some $0.5 billion to $1 billion land in the shekel-dollar market. In markets this size, speculators can hardly make a safe living, certainly not over time.

Dealers do, though. Despite the market's vastness and liquidity, Israeli banks such as Bank Leumi (TASE: LUMI ) and Bank Hapoalim (TASE: POLI ), and foreign banks such as Citibank, Barclays, Chase and Goldman Sachs, usually consistently post profits.

How? Who knows. Dealing rooms charge fees. They operate as market makers, benefiting from buy-ask spreads. They have access to information and advanced computers, and they know what their major customers are up to, giving them a competitive edge.

Banks do not divulge the profits of their dealing rooms in annual reports, but sources in the sector know that for years, they have not been small. Israel's big banks have been making millions of shekels each year. The liberalization of the currency market sharply boosted transaction volumes, and the adoption of advanced financial instruments, such as options and futures, did well by the dealing rooms.

Their profitability was exceptionally prominent in 2002, a year in which the banks were cutting back, hacking, hunkering down - but not their dealing rooms, which chalked up another great year. The dealing managers' worst problem was how the devil they could give nice bonuses to their dealers while the rest of the bank units were forcing workers to accept early retirement.


They won't face that problem in the first quarter of 2002. After ages of consistent profits, many of Israel's dealing rooms found themselves in the red from trade, with "burned asses," as one of the memorably phrased it.

What happened? The pattern of shekel-dollar trade from the start of 2003 did badly by Israel's banks. Too many times they found themselves belatedly chasing the foreign banks, which were setting the trend. In other cases, cowed by the towering uncertainty, the Israeli banks feared to act against the trend, and joined the action too late, at inopportune prices.

Look at what happened Thursday, a week and a half ago. The rumor was that the U.S.-Iraq war would start Saturday night. The banks were hit by tremendous demand for foreign currency. At first they met the demand, but when the dollar climbed to 4.90 shekels, they joined the herd of buyers. In choppy trade between the banks and themselves, by Friday's closing the banks had lifted the dollar's exchange rate to NIS 4.94.

Yet the sun hadn't set on Friday before the banks learned the war had been postponed. Monday the dollar opened at NIS 4.87, resulting in an excruciating loss for the dealing rooms.

"The Israeli dealing rooms aren't leading the market. They are chasing their own tails and behaving the way the provident funds used to behave - they're always the last to get the goods," scoffed one active trader.

If they lost, who won? In the currency market, for every loser there's a winner. In this case, the winners were evidently the foreign banks, some corporations, and some speculators, who reacted to gut feeling and didn't dawdle until fully grasping the trend or developments.

Is there a lesson for Israel's dealers in the days to come? Not really - they are a seasoned crew. They'll lick their wounds and move on. But Israel's banks are becoming especially jittery, and their edgy managements are quaking over credit difficulties. Some may well demand that their dealers put a cap on the amounts they risk.

And if that happens, it could impact badly on the market. A decline in the clout of the market makers, of players acting against the trend, and in the supply of liquidity, would widen the bid-ask spreads, exacerbate the volatility, and ultimately accelerate the shekel's depreciation in the event of negative developments. And there are, as we know, no lack of these in Israel.