Gaining lightning speed innovations in cross-border payments
Foreign currency transactions between individuals and businesses in different countries or jurisdictions have risen significantly, driven primarily by global e-commerce growth. These cross-border flows across segments — P2P, C2B, B2C, and B2B — are expected to amount to $156 trillion by 2022, with the B2B segment itself accounting for $150 trillion. Cross-border payments can be wholesale payments, typically between financial institutions, or retail payments, typically between individuals and businesses, including remittances.
With the rise in the exchange of products, services, capital, and people, the demand for cross-border payments has increased dramatically. However, when delving into the cross-border payments space, we find a lot of complexity. Different countries have different payment systems, regulatory requirements, taxes, service charges, and compliance needs. With significant operational costs for the technical infrastructure required to service these differences, the costs of transfers between different currencies can be relatively high, ranging between 6.5-11 percent. In addition, international transfers have traditionally suffered from high processing times, long delays, and reduced transparency in case of payment declines. Also, B2B customers work with poorly designed products that do not integrate well with their regular banking channels.
More recently, the pandemic and its impact on the global economy has signified the urgent need to improve systems, and with them, the costs, speed, and transparency of international fund transfers.
Innovations in cross-border payments
The inefficiencies of the current payment systems using outdated technologies make way for several innovative solutions. Before looking at some of these, let us first look at the current landscape.
A wire transfer has been among the oldest ways to transfer funds across borders electronically. Using the SWIFT code of the recipient’s bank and other details such as IFSC, IBAN, and account numbers, the sender can directly transfer funds to the recipient. However, SWIFT transfers are slow — typically taking days — and anomalies are difficult to trace and resolve quickly.
Several new alternatives have come up in the past few years to disrupt the complex legacy systems.
SWIFT global payments initiative
In 2017, SWIFT launched its global payments initiative (GPI) to address its older system’s challenges. Today, with over 4,000 financial institutions signed up, nearly 60% of all international transfers on SWIFT use GPI. These transfers are completed within few minutes, but some may take up to a day. Further, these payments are now completely traceable end-to-end.
Another mode of cross-border payments gaining a lot of popularity among underbanked customers is the digital wallet. Several multi-currency wallets now offer cross-border payment capabilities without the need to create local accounts. Such payments are not only faster, but they are also cheaper, more accessible, and offer a better experience. Examples of digital wallets for businesses and consumers include Airwallex, PayPal, Alipay, WorldRemit, and Skrill. Also, fintech solutions like Revolut and Wise challenge traditional remittance providers like Western Union (WU) and MoneyGram that have always faced the last mile problem.
Money transfer organizations (MTOs) and crossborder payment networks
As a result of the payment services directive 2 (PSD2) regulation, open banking application programming interfaces (APIs) — software interfaces enabling external access to a bank’s products and services — aid in transforming cross-border payments. Payers can use open banking APIs to bypass the traditional correspondent banking network (CBN) channels and instead connect directly and efficiently with their partners to provide fast and flexible payment solutions. Both Visa and Mastercard strive to get ahead in this space and connect with several companies using APIs. Doing this helps them capitalize on their network routing capabilities which they plan to offer as a service to existing MTOs such as WU and MoneyGram.
Visa and Mastercard have also come up with solutions for real-time B2B and B2C cross-border payments. For instance, Visa Direct utilizes Visa’s global payments infrastructure to seamlessly send and receive funds to billions of endpoints in over 160 supported currencies. Similarly, MasterCard’s Send platform enables immediate international person-to-person payments and business disbursements. These services roughly cost between 1-2 percent of the transactional value, which is more economical than traditional alternatives.
Real-time payment (RTP) rails going global
RTP networks in domestic markets already provide real-time transfers but achieving global interoperability remains a huge issue. Some remittance providers utilize domestic RTPs to offer a real-time fund transfer experience to the end customer. However, these are not real-time transfers in the true sense. The remittance providers settle the customer account in individual countries through their respective escrow accounts using the RTP rails. However, the foreign exchange (FX) settlement between the escrow accounts in two currencies happens through traditional CBN.
If RTP networks across the globe are connected in a hub-and-spoke model through an aggregator wherein the RTP network of one jurisdiction can feed directly into another, then instant FX transfers can be enabled. There are a few examples of different jurisdictions already cooperating to make instant payments across borders possible. For instance, P27 in the Nordics provides instant cross-border payments between Denmark, Finland, and Sweden, while European Payments Initiative offers a pan-European payment solution. Thailand and Singapore also linked their real-time payment systems in April 2021 to give rise to the first instant cross-border payments infrastructure.
Distributed ledger technology-based cross-border payments
The advent of distributed ledger technologies (DLTs) such as the blockchain enables B2B payments to bypass the layers of intermediaries in traditional cross-border payment rails. Blockchain transactions can be completed in minutes rather than days and with reduced operational costs. Several fintech and legacy players are now innovating with blockchain-based payments. Examples include RippleNet, IBM Blockchain World Wire, J.P. Morgan’s Liink network, and Visa B2B Connect.
RippleNet, a pioneer in this space, is a network of banks, payment providers, and other financial institutions that send and receive funds worldwide through Ripple’s distributed ledger technology. For each transaction, the network takes a small fee in the form of XRP, a pre-issued cryptocurrency (1 XRP = $0.81, as of early August 2021) from Ripple itself. The standard fee is 0.00001 XRP, a minuscule amount as compared to the fee charged by banks for cross-border transactions. However, the lack of uniform standards is a hurdle, as evidenced by the recent Securities and Exchanges Commission (SEC) lawsuit on Ripple. The nascent space is likely to see increasing regulatory interest and action as it evolves.
Leveraging DLT for payments leads to lower transactional costs since intermediaries are bypassed. However, due to a lack of transactional standards between various cryptocurrencies, the settlement in fiat currency must be handled outside the chain. Sometimes, this increases the logistics and overall cost of the transaction. So, there is an inherent delivery versus payment issue in the current setup of crypto-backed cross-border payments. There are no rules around taxation and consumer protections since the regulators remain a step behind blockchain technology. Other problems include poor scalability, limited liquidity, and transaction latency.
Competition between SWIFT and Ripple
The drawbacks notwithstanding, there has been significant progress in the usage of blockchain-enabled solutions recently. A pioneer in blockchain-enabled payments, RippleNet, acts as a solid alternative to SWIFT GPI. Although SWIFT GPI and RippleNet provide instant payments, the latter also offers instant settlement and accepts fiat and cryptocurrencies. However, RippleNet remains in an early stage of adoption. Though nearly three million transactions with a notional value of $2.4 billion were routed through RippleNet in 2020, this is only a tiny fraction compared to SWIFT’s numbers.
SWIFT has understood that it needs to adopt new technologies to compete in a rapidly evolving payments market. It has collaborated with R3, a blockchain enterprise software firm, on the Corda Settler platform, leading to the recent launch of SWIFT Go for low-value cross-border payments in seconds.
The big promise of central bank digital currencies (CBDC)
Payment networks across the world have little interconnectivity. Many problems with cross-border payments arise due to the differences in rules, laws, and procedures among different legislations. CBDCs can enhance the experience of cross-border payments through coordination between different national CBDC designs at the outset. Compatible CBDC systems will lead to less intermediation and improved efficiency and safety while mitigating the cross-currency risks as the payment exchange and forex settlement occur in the ledgers.
Currently, five countries have their own CBDCs, while 81 countries are in the exploration stage. The Central Bank of The Bahamas partnered with NZIA Ltd. and Zynesis Pte. Ltd. to launch the world’s first CBDC called Sand Dollar in October 2020. Fourteen more countries, including China, South Korea, and Sweden, have also launched pilots.
Industry experts have recognized and adapted to crypto innovation. Mastercard has launched a CBDC testing platform while Citi is working with some governments to create digital currencies. PayPal has plans to become the digital wallet for global CBDCs. ConsenSys is working on four CBDC projects based on the Quorum platform, which it acquired from J.P. Morgan. J.P. Morgan’s Onyx also recently supported a wholesale CBDC cross-border payment and settlement experiment undertaken by the central banks of Singapore and France.
As quick as lightning
As these innovative cross-border solutions from fintech and payment networks become more widely adopted, the need for correspondent, traditional money agents, and intermediary banks for cross-border payments will diminish. The threat is evident even without the much-talked-about frictionless system promised by CBDCs.
The financial services industry, already disrupted in several areas, is on the brink of another disruption in international fund transfers. Not too far from now, money will move as quickly as lightning across borders. Institutions will need to act fast to re-engineer, innovate, and be future-ready with their payment mechanisms through the right technology collaborations, to be able to leverage them for competitive advantage going forward.