Anyone who has been abroad knows that currency conversion occurs whenever you pay with a credit or debit card. However, many don’t understand why charges are relatively high. To help explain the issue, let me explain how your payments happen overseas.
As soon as you return from your trip, you can compare receipts in foreign currency with your billing. A quick check will show that you have paid 5% more than you expected for the conversion. How did that happen?
For start, several different parties may contribute to the conversion, and they will all want to be paid. In a typical transaction there are 5 parties involved – a merchant’s venue, an acquiring bank, a payments system (VISA, MasterCard, etc), an issuing bank, and a cardholder. If you purchase something in Italy the transaction in Euros goes from a venue to an acquiring bank and then reaches a payments system. Then VISA, MasterCard or other system converts it into dollars (for example) and charges your issuing bank. This is the conversion point. VISA or MasterCard do actually get some real profit. It’s not your bank to blame for charging you so much in this case.
You could decide to save some money on currency conversion through VISA/MasterCard by opening an account in an issuing bank that allows you to make deals in Euros. This is quite possible in the UK, but it only saves you money as long as you use the account in Europe. If you use it in the UK it becomes expensive as your issuing bank receives a transaction in GBP but your account is in EUR, so the bank converts currency and gets an income with a conversion fee charged to you.
There is one more interesting option that might seem attractive at first: when you make a transaction overseas they can set a price in a merchant’s venue that is already converted into your local currency so you can see right there how much will be charged from your USD or GBP account, even if you make a transaction in Thailand or Russia. It is called Dynamic Currency Conversion. Unfortunately, there is no such thing as a free lunch. Just take your smartphone and check the conversion rate they have applied. You still will be charged for all the fees.
Now try to understand why VISA, MasterCard and banks charge you so much for currency conversion. The reason people assume is that it is an easy way to make money. But this is to ignore the fact that they are exposed to exchange rate fluctuation risks.
Imagine you are a citizen of Norway visiting the United States. You bought something in the US a week ago. At that moment only the online transaction reached your bank and some of your Norwegian Kroner were frozen. It took the merchant some time to send a real refund request to his bank, and then it passed all the global systems. Finally, a week later it gets to your account and charges it. But during this week due to constantly changing oil prices Norwegian Krone has lost 5% of its value compared to the US dollar. Thus they just add these 5% on top of the exchange rate to protect themselves from possible losses. It’s an easy way to mitigate risk.
Now let’s try to answer the question that you most likely have: what should I do to minimize my losses on exchange fees? If you are not a frequent traveler, you have to put up with the fact that our world is not perfect. But if you travel to Europe quite often, there is a way to minimize your losses. Find a bank, which has settlement in Euros, and open an account in this currency. In the UK there are companies that even specialize in issuing such prepaid cards for frequent travelers.
But if you travel to a country with a currency that is not so common, don’t forget to take some cash with you. Yes, it’s not a brand new payment technology, but you can find an exchange office that will convert it into local money for a small fee and you’ll be able to pay for food and goods in all small local shops and kiosks. But still pay for your hotel and car rental by card to minimize the risk of fraud.