Banks brace for billion-dollar forex probe

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Already hammered by their role in the 2008 financial crisis and the rigging of the key bank rate LIBOR, the global banking sector looks set to take another battering to its reputation as investigations start into the fixing of foreign exchange.

Barclays, UBS and Deutsche Bank have all announced that they are in the early stages of reviewing their trading practices after being contacted by regulators. U.K. lender Royal Bank of Scotland has also confirmed to CNBC that it is currently "considering processes" around its foreign exchange trading operations.

Panagiotis Spiliopoulos, head of investment banking research at Bank Vontobel told CNBC that any fallout from the probe will likely weigh on analysts' outlooks for banking stocks.

"It extends the timeframe until banks can start to pay dividends and it requires banks to hold even more capital," he told CNBC.

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Regulators launched a formal investigation this month after media reports back in June highlighted the alleged wrongdoing in foreign exchange trading. The U.S. Justice Department, the U.K.'s Financial Conduct Authority (FCA), Switzerland's Financial Market Supervisory Authority, the Monetary Authority of Singapore and the Hong Kong Monetary Authority have all confirmed their involvement in the probe.

"We are gathering information from a wide range of sources including market participants. Our investigations are at an early stage and it will be some time before we conclude whether there has been any misconduct which will lead to enforcement action," a spokesperson for the FCA told CNBC.

Barclays said on Wednesday that it could not predict the impact of these latest investigations. The bank was made to pay a fine of 290 million pounds ($450 million) due to the Libor rigging investigations.

UBS said in its earnings report that it had been asked to hold 50 percent more capital by the Swiss regulator because of "known or unknown litigation, compliance and other operational risk matters". This caused it to push back its profitability target for shareholders of 15 percent by a year to 2016. Citi declined to comment when contacted by CNBC.

(Read More: Barclays profit falls, cooperating in forex probe)

Allegations of collusion

Every day, $5.3 trillion is traded in foreign exchange markets, according to the Bank of International Settlements, with around 41 percent of trades being processed through sales desks in the United Kingdom and 18 percent in the U.S. Deutsche Bank is the world's leading foreign exchange house, according to a Euromoney, with 15.18 percent. Second-placed Citi has a market share of 14.9 percent with Barclays and UBS just behind.

The allegations detail concerns regarding the "4 p.m. London fix" - a daily snapshot of exchange rates that is used as a benchmark for a much larger set of currency deals as well as the foreign holdings of mutual funds. It's alleged that proprietary traders at large banks may have colluded over information on its investors' trades, to enable them to alter the price of a given currency pairing ahead of the 4 p.m. fix.

Traders could have therefore used advance knowledge of customer orders to make money for their banks' own accounts, known as "front-running", and aggressively traded around this one minute window to try and influence the benchmark rate. With such a large amount of money changing hands, a fractional difference can add huge sums to the bank's commission – and the trader's bonus.

"Regulators are slow off the mark; reactive rather than proactive and this another demonstration of failure to get a whiff before," Joe Rundle, head of trading at ETX Capital told CNBC.

"That said, this is a constructive step in order to safeguard the system from further losses in the future."

Rundle added that the investigation could lead to management restructuring at banks with some executives being dismissed, as well as funds being set aside for litigation charges.

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"Smaller institutions may have to take hit to earnings which will be at the angst of shareholders," he said.

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Michael Moore, a professor of finance at the U.K.'s Warwick Business School told CNBC that "front running" wasn't technically illegal in the currency markets. It might be "bad form", he said. He added that the "4 p.m. fix" is only really used for reporting purposes and doesn't have the same gravitas as other benchmarks. He conceded that collusion between banks could be illegal, but this would be akin to "giving away the family silver" if undertaken.

Billion-dollar fines

Ian Gordon, a banking analyst at Investec told CNBC that it's currently too early to tell the exact impact of the latest revelations.

"We appear to be in the very early stages of a potentially long and complex investigation which could lead to nothing at all, or could ultimately trigger multi-billion fines spread across a very large number of banks," he said.

Meanwhile, investment bank Nomura has suggested a sum litigation risk of £1.5 billion for Barclays' capital position after its earnings report. The bank still maintains "stable" and "buy" ratings for Deutsche Bank, Barclays and UBS, as do analysts at Societe Generale.

Rundle told CNBC that the currently the market doesn't appear too concerned about the fresh allegations. "We are sort of numb to the illegal funk emanating out of the global banking system," he said.

By's Matt Clinch. Follow him on Twitter @mattclinch81