LONDON: Banks' foreign exchange business models that depend for their success on very low margins bulked up by ever rising turnover may need some tweaking if those trade volumes fail to keep growing.

The outlier risk is that the recent triennial report on forex markets issued by the Bank of International Settlements (BIS) proves to be the high water mark for trading volumes.

The BIS said earlier this month that trading in foreign exchange markets jumped by more than a third in the past three years to $5.3 trillion a day.

That expansion has no doubt helped fuel banks' enthusiasm to grow foreign exchange business.

Yet, the FX settlement system CLS, the Thomson Reuters trading platform and the EBS platform owned by ICAP have all since reported falls in forex trading activity in August.

Admittedly, August is not a typical month with many traders on holiday, but EBS data additionally showed an 18 percent drop in volume compared with the same month in 2012.

While September data remains to be collated, anecdotal evidence from interbank and central bank sources suggests forex volumes remain subdued.

Bank treasurers beginning to work on plans for 2014 may start to wonder if their assumptions of further rises in forex volumes can be depended on.

Volumes aside, fine margins are embedded in a commoditized foreign exchange market where clients can access a wide selection of e-commerce systems to ensure they always get the best prices, whatever their deal-size.

At the same time, ensuring a bank's electronic foreign exchange pricing is sophisticated enough to win deals but also cover them profitably is a money pit.

Guaranteeing success in the ultra-competitive e-commerce market requires hiring well paid, highly qualified quant traders and regular and large injections of capital to keep the technology cutting edge.

Bank treasurers are also extremely aware that in the post-Lehman public backlash against the bonus culture in dealing rooms, fixed costs have risen as basic pensionable salaries had to be raised to compensate rainmakers for lost bonus potential.

If forex volumes remain subdued into year-end, some banks may decide that the margins do not justify the continued scale of investment or headcount.

There is also the issue of rising regulatory costs as banks are required both to beef up capital and to expand compliance departments to ensure adherence to a plethora of new rules.

Both Deutsche Bank and Standard Chartered, to name but two, have highlighted the impact of rising regulatory costs this year.

More broadly, the world's biggest banks need to boost capital by 115 billion euros ($155 billion) to reach a minimum core capital level of 7 percent, the Basel Committee of global regulators said on Wednesday.

Banks could also shrink their balance sheets to lessen the need to raise new money to meet core capital requirements.

Either way, meeting higher capital requirements can only make banks even more focused on maximizing returns on increasingly precious capital.

Ultra-fine foreign exchange trade margins may not necessarily tick that box, especially if economies of scale are adversely impacted by less buoyant trading volumes.

Foreign exchange traders will be hoping for a big pick-up in volumes and, by extension, profitability in the last quarter of 2013 as they attempt to meet their budget targets for the year.

There may be even more at stake.

Competition among banks to win share in the foreign exchange market is akin to an arms race, with all sides forced to spend more and more money in an attempt to stay in the game.

Unfortunately, arms races can end in mutually assured destruction.

— Neal Kimberley is an FX market analyst for Reuters. The opinions expressed are his own.