Cross-Border Payments, New Models and the Future

As time progresses and new industries or business models emerge, the old methods are struggling to find their place in the new world. The primary propulsion behind these changes is technology. Another one is demanding customers, constantly pushing financial institutions to be faster and accurate. While the incumbents are quick and very open-minded when it comes to transforming their business models and forming collaboration with the newcomers, a.k.a. fintechs. However, the industry as a whole is under the pressure of constantly maintaining a balance between the rapid adoption to the new order and the regulatory priorities that are forcing them to be safer and more secure.

This brings financial institutions and cross-border transactions under the focus;  

  1. how will correspondent banking cope with the changes to come in the future
  2. how will cross-border payments be conducted while trying to maintain a balance between speed, security and customer demands?

The State of Cross-Border Payments Landscape

While the banks are still the major players when it comes to international payments, Fintech companies gained great momentum and also became formidable players. Structures like SWIFT have made great progress in regards to maintaining a balance between security, compliance while increasing the speed of transactions. During this time of change and adaptation, a new kind of player has emerged. Money Transfer Operator (MTOs), who had the scale to manage huge international cash flows across borders. MTOs have created their own business model for small payments for consumers seeking alternative ways to move money across borders.

One may think that relatively new players will take time to have an impact on the business but the data covering 300 global banks around 92 countries, published by International Finance Corporation (IFC) in 2017 reveals a drop in the number of correspondent banking relationships they have. Apparently, MTOs’ model does have an impact on the business. Considering their claims of making international payments more reliable and less costly, and their efforts to bringing together other payments initiatives and partnerships globally may be taken as a sign that their and MTOs’ influence will grow stronger.

Situation Regarding Cross-Border Payments

International payments have been a crucial element in the growth and sustainability behind today’s global economy. With a globally widespread network and with even larger networks formed through correspondent banking, banks have been the dominant player in the cross-border market which is estimated to be around  $200 billion globally split between transaction fees and foreign exchange (FX) revenues.

Ongoing uncertainty and the increasing amount of international and compliance barriers, cybersecurity risks and shifting political balances, alliances or animosities between countries manifesting themselves as sanctions, compliance norms, trade wars, and declining correspondent relationships, are all making the cross-border payment ecosystem a challenging environment.

Although there are political incidents and issues that may look like the globalisation of the world’s finance is disrupted, the bigger picture still sustains an image of a more connected worldwide economy. E-commerce is a major force that helps to sustain this image. 15 to 20% of e-commerce transaction volume is international. This increasing volume seems to be driven by low-cost transport, small-item purchases, increasing comfort with transaction security, and the general easing of red tape. E-commerce and sharing economy platforms like Amazon, eBay, Alibaba, Expedia, Airbnb, Etsy and Upwork keep driving the cross-border commerce and employment and generating C2B, B2C and business-to-small-business payments.

Impact of SWIFT gpi

SWIFT gpi is an attempt to make the cross-border payments more fast and transparent. But it also has other impacts. It is a step forward in regards to the speed and flexibility of the cross-border payment environment. SWIFT also has shown what can be achieved and how fast can the industry progress forward by taking advantage of technology. It also flared the dreams of a unified and global cross-border payment system that is the answer to all the problems of the industry and its clients. Yet experts still label a unified cross-border payment system as a utopia. The idea of organizing financial institutions is a double-edged sword apparently. While there is a trend towards globalization through worldwide organizations there is also a trend towards localization driven by the recent appeals of political leaders to create regional payments and trade platforms. These attempts to strengthen the local currencies and economies also creates an axis and a focus of appeal towards localization.

Blockchain and DLT (Distributed Ledger Technology)

The terms blockchain and cryptocurrency are usually perceived as same, or the elements of the same technology, but they are not. Blockchain was first outlined by Stuart Haber and W. Scott Stornetta in 1991, as a system where document timestamps could be distributed but could not be tampered with.

Bitcoin however, which was launched in 2009 was built on blockchain system as a cryptocurrency. Bitcoin depends on the blockchain system because it eliminates the need for a third party (such as banks and financial institutions) to keep and secure the accounts and ledgers.

Creating much controversy, blockchain technology have many potentials from becoming the next generation in currency, an instrument of investment, a fad that will blow out in a couple of decades and even a toy or financial instrument of people and organizations involved in illegal or terrorist activities. On the other hand, Blockchain Technology has the potential to dramatically decrease the cost of cross-border payments. While it seems far fetched that blockchain will eliminate the banks and other financial institutions or their role in cross-border payments, banks have seen their potential and have been working hard to devise a way to adopt the system to be able to decrease their costs dramatically.

Blockchain and Distributed Ledger Technology (DLT) can sometimes be used interchangeably. To explain in the shortest way possible, blockchain aims to completely remove the requirement for a body of regulation and totally relies on simultaneously updated ledgers consisting of blocks that cannot be edited or tampered with but can only be updated and distributed when a transaction occurs. DLT, on the other hand, consists of distributed ledgers distributed to all parties but can be managed or curated by a managing body. Many initiatives and financial entities have also shown interest in DLT since it also has the same potential with blockchain but still enables a more centralized structure.

Technology is the Answer

Technology is reshaping the banking industry and the finance landscape. While new business and process models are emerging, the older ones are evolving with the new abilities gained through technology.

Blockchain model has already seen applications other than the controversial Bitcoin model like the, which is a joint venture between 9 banks with the target audience of small and medium-sized enterprises linking trading partners across a supply chain.