Bank Fee and Each Leg of the Swap
An intermediated swap has two legs, the fixed leg and the floating leg. The dealer bank quotes different rates on each side. On the fixed leg the bank receives a slightly higher fixed rate from one counterparty than it pays the other. On the floating leg both rates are typically BBSW flat, with the bank's spread embedded in the fixed-leg differential. The bank fee equals the total quality spread differential (QSD) minus the savings passed to the two end-users. Vanilla bid-offer spreads for liquid Australian dollar swaps are typically only a few basis points per annum.
Why it matters
The bank is a swap market maker. Like a foreign-exchange dealer that buys USD at one rate and sells at a slightly higher rate, the swap dealer receives fixed at one quote from Party A and pays fixed at a lower quote to Party B. The two sides are otherwise identical so they net out on the floating leg, leaving the bank with a small fixed-rate annuity equal to the bid-offer spread times the notional. Competition between dealers, central clearing, and electronic trading platforms have compressed these spreads to a handful of basis points for vanilla product.
Formulas
Worked examples
Quality spread differential between Company A and Company B is $1.2\%$. Each party negotiates a saving of $0.45\%$ p.a. on a A$10 million notional. Tenor 5 years.
Bank fee per annum. In dollar terms the bank earns $10{,}000{,}000 \times 0.0030 = A\$30{,}000$ per year, or A$15,000 on each back-to-back leg. Over the 5-year swap life that is roughly A$150,000 in gross revenue before hedging costs, funding costs, and capital charges. Notice the fee is small relative to the notional and shrinks further when the contract is centrally cleared, which reduces the bank's credit-risk capital.
Common mistakes
- ✗The bank fee is always large. Vanilla AUD interest rate swap spreads are typically 1 to 5 basis points per annum for standard tenors traded on electronic platforms. Competition and central clearing have crushed margins since the GFC. The textbook 0.20% example is closer to a complex bespoke swap than a vanilla 5-year contract.
- ✗The two legs are economically distinct hedges. They are paired by design in a back-to-back intermediated swap. The bank only earns the spread between the two fixed quotes. The floating legs (both at BBSW flat) cancel, leaving zero net rate risk to the bank apart from basis and credit risk.
- ✗The fee is paid as an up-front lump sum. In a standard swap, the fee is amortised through the periodic settlements. The bank's running margin shows up each period as a small adjustment between what A pays and what B receives in fixed.
Revision bullets
- •Fixed leg and floating leg make up the two sides of the swap
- •Bank earns the bid-offer spread on the fixed leg
- •Fee = QSD − sum of party savings
- •Typical vanilla AUD swap spreads are only 1–5 bps
- •Central clearing compresses the fee further
- •Fee is amortised through periodic settlements
Quick check
In an intermediated swap, the bank's gain equals:
Connected topics
In learning paths
Sources
- Hull, John C. Options, Futures, and Other Derivatives. 11th ed. Pearson, 2022. ISBN 978-0-13-693997-9.Worked example showing how a dealer bank captures part of the QSD as a bid-offer spread on the fixed leg of an intermediated swap.
- International Swaps and Derivatives Association. 2021 ISDA Interest Rate Derivatives Definitions. ISDA, June 2021.Modern documentation standard that defines fixed and floating legs, payment dates, and reset mechanics underlying vanilla swap quoting.
- Bank for International Settlements. OTC interest rate derivatives turnover in April 2025. BIS, 2025.Reports that single-currency interest rate swaps dominate OTC turnover and that dealer concentration plus central clearing have driven spreads tighter in vanilla product.