Frictionless Cross-Border Payments: Alternatives to Correspondent Banking
04 March 2021
by Erika Baumann, Senior Research Analyst, Aite Group
Financial services companies are finally cashing in on cross-border payments. There is more innovation and change than ever in the global payment industry. In 2014, there were only 14 local real-time payment schemes. There are now more than 60, with 20 of those networks launching in the last 18 to 24 months amid advances in payment technologies, including messaging standards and cloud computing, and continued globalization of the payment industry.
Progress toward more frictionless payments has been mainly focused on domestic payments within countries. It is now time for the industry to widen the focus to include cross-border payments.
Historically, payments between countries typically have been slower, more expensive, and less transparent than domestic payments. However, there is pressure on payment providers to use technology to accelerate payments and make them easier to use. If banks can’t respond, outside financial services like financial technology firms will step in to fill the gap.
Cross-border payments are a key part of the global economy. Historically, these transactions have been high-value, high-dollar payments, but this is changing. The number of low-value payments is increasing.
In the decade before the COVID-19 pandemic, the volume and value of cross-border payments grew steadily. In 2019, cross-border payments totaled US$130 trillion and generated US$224 billion in revenue, according to the research conducted by Aite Group and commisioned by Volante.
In 2020, the number of payments declined for most of the year as many countries ordered citizens to stay home and many businesses closed. Aite Group’s research shows that revenue generated by cross-border payments in 2020 is expected to be approximately 7% lower than in 2019. However, revenue from cross-border payments and related foreign exchange fees are expected to recover and grow steadily over the next four years, providing a potential steady revenue stream for banks.
Despite advances in cross-border payments, the system is still slowed down by the multistep and cumbersome “correspondent” banking models, in which a business sends payment instructions to its bank. The bank, which likely does not have a presence in the country of the recipient, will send that payment to a correspondent bank, which converts the payment into the recipient’s currency. The payment then goes to the recipient’s bank and is credited to the recipient’s account. It is a laborious and inefficient process.
Drawbacks of the 30-plus-year correspondent banking system include its high and unpredictable costs, clearing and settlement of payments taking at least two days, and a lack of transparency about where a payment is until it has been settled.
Businesses want to remove the friction and pain points of cross-border payments. They want predictable fees, a fast and secure settlement, transparency into payment status, and robust data attached to that payment. Surely that’s not too much to ask.
The global cross-border payments industry has several layers. At the top are the established correspondent banking-based networks, followed by domestic real-time payments infrastructures that are expanding to become regional players (P27 in the Nordics, AFAQ and Buna in the Middle East, among others), blockchain-based payment providers (including Ripple, Visa B2B Connect, Mastercard Track); card networks (including Mastercard Send and Visa Direct); and “nonbank” payment providers (including Western Union and StoneX, formerly INTL FCStone).
Modernize banking systems
To capitalize on the growing cross-border market, banks must create alternatives to the correspondent banking model that include regional solutions through central infrastructure, blockchain solutions, card network-based solutions, and nonbank solutions.
Access to these technologies has become more affordable and accessible―particularly by partnering with suppliers of cloud-based Payment as a Service (PaaS) products, which enable banks of all sizes to improve cross-border payment capabilities and increase cross-selling potential.
Modernizing payment infrastructure will help banks offer their business clients more efficient payments and value-added services, such as a choice of clearing options or FX services. The ability to provide value-added data services based on ISO20022 standards for exchanging electronic data between financial institutions will also help modernize cross-border payments.