Cross Border Payments

What are Cross-Border Payments?

Cross-border payments are financial transactions where the payer and the recipient are based in separate countries. They cover both wholesale and retail payments, including remittances.

Cross-border payments can be made in several different ways. Bank transfers, credit card payments, and alternative payment methods such as e-money wallets and mobile payments are currently the most prevalent ways of transferring funds across borders.

Experts predict?that global cross-border payment flows are expected to reach US$156 trillion by 2022.

The cross-border payments market has always been fraught with pain points and inefficiencies from both a cost and time perspective, resulting in expensive transaction fees and complicated, lengthy payment processing methods.

The global move to improve cross-border payments strategies will see businesses achieving a better ROI and gaining more control over international payments and payment security.

The two main types of cross-border payments are:

1.???Wholesale cross-border payments: These are typically between financial institutions, either to support the financial institution’s customers’ activities, or its own cross-border activities (such as borrowing and lending, foreign exchange, and the trading of equity and debt, derivatives, commodities, and securities).

Governments and larger non-financial companies also use wholesale cross-border payments for large transactions generated by the import and export of goods and services or trading in financial markets.

2.???Retail cross-border payments: These are typically between individuals and businesses. The key types are person-to-person, person-to-business, and business-to-business. They include remittances, most notably money that migrants send back to their home countries.

Why do Cross-Border Payments matter?

Over the past few decades, the increased international mobility of goods and services, capital, and people have contributed to the growing economic importance of cross-border payments. The value of cross-border payments is?estimated to increase

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?from almost $150 trillion in 2017 to over $250 trillion by 2027, equating to a rise of over $100 trillion in just 10 years.

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Factors that have been intensifying over recent years include:

·????????Manufacturers expanding their supply chains across borders

·????????Cross-border asset management and global investment flows

·????????International trade and e-commerce

·????????Migrants sending money via international remittances?

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These trends have increased the demand for cross-border payments and the need for end users to have access to cross-border payment services that are as efficient and safe as comparable domestic services. Remittances in particular play a vital role in low and middle-income economies and in some cases are becoming the primary source of development finance.?

Growth and revenue expansion is also driving competitive interest in this market. Innovative new business models and participants are emerging in response.

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?How do Cross-Border Payments work?

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Currencies are closed-loop systems. Domestic payment systems are not traditionally directly connected with the systems of other countries so when making a transfer between two jurisdictions, the currency is not physically transferred overseas.

Instead, international banks provide accounts for foreign counterparts and have their own accounts with their foreign counterparts, which enable banks to make payments in foreign currency. The funds are not sent across borders; instead, accounts are credited in one jurisdiction and debited the corresponding amount in the other. Other payment providers such as Fintechs and money transfer agents use this interbank network to provide payment services to businesses and individuals.

For example, in Figure 1 Bank A will send a message to Bank B instructing them to make a payment for a customer. Bank B will then credit the end customer’s account with money from the account Bank A holds at Bank B.

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Figure 1: A simple cross-border payment using accounts held at each bank

A payment message sends an instruction to debit an account in Bank A and credit an account in Bank B. However, not every bank has a direct relationship, so sometimes they need to transact via an intermediary, a ‘correspondent’ bank. This is a bank that provides accounts for Bank A and Bank B if they do not have a direct relationship with each other. This is known as correspondent banking and is an essential component of the global payment system for cross-border transactions.

Figure 2: A cross-border payment using a correspondent bank

Bank A and Bank B do not have accounts with each other so they use a bank where they both hold accounts — the correspondent bank. The more intermediaries that are involved in a cross-border transaction, the slower and more expensive it will be. For currency pairs with high volumes of payments (for example, US dollar to British pound sterling), there will usually be a shorter chain. But for conversions between currencies with a lower volume of payments, there are more correspondent banks involved. The more correspondent banks are involved the longer the transaction will take, and more costs will be involved at each stage of the chain. The set of payment flows between one country and another is referred to as the ‘country corridor’ or ‘payment corridor’.

Figure 3: Cross-border payment using the correspondent-banking network

The less common the currency pair, the more correspondent banks will be required to make the payment, incurring costs and delays at each stage. At each bank in the chain, fees will be taken for processing and foreign exchange, the payment messages will need to be checked against local financial crime requirements and each bank will need to update the balances in the accounts of the incoming and outgoing payees using their domestic payment systems which are only open during normal business hours. The sender’s bank will need to hold enough cash to cover these unknown costs until the payment is complete.

Benefits of Cross-Border Payments

As globalization is increasingly intertwined into the everyday operations of businesses, refining?cross-border payment management practices are becoming more important. According to the research, 73% of US-based companies regularly make cross-border payments?of some kind. Refining management practices can lead to significant savings and improve international tax and regulatory compliance.

With a solid?international payment?strategy, businesses can achieve:

·????????Increased ROI

·????????Reduced need for resources

·????????Increased control over international transactions

·????????Advanced reporting tools

·????????Enhanced payment security

?Interested in making your?global payment?management practices more efficient? Keep reading to learn how.

What are the key challenges for cross-border payments?

Cross-border payments lag domestic ones in terms of cost, speed, access and transparency. It is typically more difficult to make a payment from one country to another compared to making a similar payment within one country. In some instances, a cross-border payment can take several days and can cost up to 10 times more than a domestic payment.

Enhancing cross-border payments was set as a priority in 2020 by the G20. This work included identifying the challenges associated with cross-border payments that arise from a series of frictions in existing processes and developing a set of building blocks to address them. The key frictions are:

·????????Fragmented and truncated data formats

Payments are made by messages sent between financial institutions to update the accounts of the sender and recipient. These payment messages need to contain sufficient information to confirm the identity of parties to the payment and confirm the legitimacy of the payment. Data standards and formats vary significantly across jurisdictions, systems and message networks.

For example, some formats only allow Latin characters, and some formats allow more data than others, meaning names and addresses in other scripts have to be translated, leading to divergences in precise spellings. This makes it difficult to set up automated processes, causing delays in processing and increased technology and staffing costs.

·????????Complex processing of compliance checks

Uneven implementation of regulatory regimes for sanctions screening and financial crime means the same transaction may need to be checked several times to ensure that the parties are not exposing themselves to illicit finance.

Banks may use different sources for conducting their checks which can lead to payments being incorrectly flagged (for example where entities have similar names to those on sanctions or financial crime databases). This complexity increases with the number of intermediaries in a chain, as the original data provided to meet initial checks may not contain elements needed for checks under other national regimes. This makes compliance checks costlier to design, hampers automation, and leads to delays or the rejection of payments.

·????????Limited operating hours

Balances in bank accounts can only be updated during the hours when the underlying settlement systems are available.

In most countries, the underlying settlement system’s operating hours are typically aligned to normal business hours in that country. Even where extended hours have been implemented, this has often been done only for specific critical payments. This creates delays in clearing and settling cross-border payments, particularly in corridors with large time-zone differences. This causes delays and also means banks need to hold enough cash to cover the unknown costs of the eventual foreign exchange rate, which fluctuates during this time, driving up the overall cost of the transaction. This is known as trapped liquidity.

·????????Legacy technology platforms

A significant proportion of the technology supporting cross-border payment systems remains on legacy platforms built when paper-based payment processes were first migrated to electronic systems.

These platforms have fundamental limitations, such as a reliance on batch processing, a lack of real-time monitoring, and low data processing capacity. This creates delays in settlement and trapped liquidity. These limitations affect domestic operations but become even more of a barrier to achieving cross-border automation of payments when different legacy infrastructures need to interact with each other. The requirement to interface with legacy technology can act as barrier for emerging business models and technologies to enter the market.

·????????High funding costs

To enable quick settlement, banks are required to provide funding in advance, often across multiple currencies, or to have access to foreign currency markets. This creates risks for the banks that they will need to put aside capital to cover; which means that capital cannot be used to support other activities. The uncertainty about when incoming funds will be received often leads to overfunding of positions, which increases costs.

·????????Long transaction chains

These frictions make it costly for banks to have relationships in every jurisdiction. This is why the correspondent banking model is used but this results in longer transaction chains, which in turn increases cost and delays, creating additional funding needs (including covering unpredictable fees deducted along the chain), repeated validation checks, and the potential for data to be corrupted through its journey.

·????????Weak competition

There are significant barriers to entry for firms seeking to provide cross-border payment services. It is also difficult for end users sending payments to accurately assess the cost of initiating a payment, which makes it difficult to gauge the value for money on offer by different providers. These barriers can increase prices for end users and firms and dampen investment in modernizing cross-border payment processes.

How Blockchain works in Cross-Border Payments

The term Blockchain has been widely discussed for the past few years. The importance of using this concept in day-to-day business transactions has increased recently in scope because the cost incurred for an organization is decreasing, allowing the technology to be used in many beneficial ways. The major areas and sectors where Blockchain applications can be used effectively are:

·????????Sharing medical data

·????????Music royalties tracking

·????????Voting mechanism

·????????Real estate processing platform

Before proceeding with how this concept will help the banking Industry, let us consider what a Blockchain is. A Blockchain is a digital record of transactions. The name was derived from its structure, in which the individual records called blocks are linked together in a single list called a chain. Each of these data blocks is secured and bound to each other using cryptographic principles—the Blockchain technology warrants the facilitation of fast, secure, and low-cost cross-border payment processing services. The technology can also be used in areas like “Anti-Money Laundering”.

The future of Blockchain technology is quite promising for cross-border payments as this concept uses encrypted distributed ledgers that provide trusted real-time verification of transactions without the need for intermediaries such as correspondent banks. It allows for verification without having to be dependent on third parties. At the same time, the technology won’t kill the concept of Banking, as anyone can use it for integrating their product to their advantage. Already some banks in Japan, and Korea have started using this technology for their payment transactions.

This systematic diagram shows how a transaction created gets converted into a block for further processing and the same gets broadcasted. Once the network nodes approve the block, the same gets added to the chain and finally gets entered into the ledger.

What role will the Blockchain play in this space go forward?

There is no question that the Blockchain and crypto can change the way that money moves. We want to enable the ability to send value wherever you want in the world - instantly and cost-effectively. The way we work to make that happen is by using the cryptocurrency - XRP - as a bridge between two fiat currencies, enabling both movements of funds between parties and currencies.

When you think about cross-border payments, one of the most important factors is a settlement (when funds are actually clear). The traditional manner of pre-emptively parking funds, which can be incredibly expensive, is an estimated $10T market, but by using a digital currency, one can settle these transactions instantaneously in real time.

?How Ripple’s Cross-Border Payments solution works

Ripple offers a cross-border payments product that allows enterprise customers to move money across borders and currencies with the instant settlement, on a 24/7/365 basis. We have solved this by using the cryptocurrency - XRP - as a bridge asset between two fiat currency pairs. In turn, our customers don’t have to lock up capital in pre-funded destination currency accounts, thus freeing up working capital to deploy as they see fit. Additionally, we give our customers access to optional credit lines, which helps solve their liquidity challenges not just in payments, but throughout their organization (such as internal treasury management).

When you think about sending a payment cross-border, you’re mostly looking at an international wire as an alternative or an aggregator that is using a service like parking capital, you are adding a lot of cost to your business. We provide a modern application — built with technology that was literally created for value movement – which lets you settle funds and payout right away, all while saving the organization money.

How to make International Payments

You will need details of the person receiving the payment, their International Bank Account Number (IBAN), and their Bank Identifier Code (BIC) to make an international bank transfer.?A consumer who is making a payment to an eCommerce site in another country will have to do very little to complete the transaction as most of the work will be handled by the merchant and their PSP.

Merchants can also make SWIFT payments to their customers or other businesses. In the (hopefully not too distant) future, Visa Direct and MasterCard Send will be more widely adopted, allowing for secure and fast payments to be made directly to a card.

?How long do international payments take?

International payments normally take between two to five business days to clear. The timeframe is dependent on where the funds are being sent to and the number of intermediary banks in between. The more financial institutions that the payment has to pass through, the longer the transaction will take to clear.

Real-time cross-border payments

The goal of being able to make real-time cross-border payments is almost within reach. As discussed above, international payments take longer to clear than domestic payments due to the involvement of more parties and compliance processing. SWIFT GPI is opening the doors for many eCommerce businesses to conduct operations more efficiently on a global scale. They are capitalizing on the existing infrastructure that is already in place for processing real-time domestic transactions. SWIFT GPI is aiming to increase transparency by providing real-time payment tracking and information about the fees that will be charged.

Another service facilitating real-time cross-border payments is?Visa Direct?which enables person-to-person, business-to-consumer, and business-to-business international payments. Operating within the Visa network, funds can be transferred internationally and reach the recipient’s account in as little as 30 minutes.

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Cross-Border Payments regulation

There are a number of different regulations in place to ensure that the transfer of financial details is as secure as possible. The European Union (EU) has its own set of regulations that ensure that payments between participating countries will be protected.

·????????EU cross-border payments

The Single Euro Payment Area (SEPA) was created by the EU to harmonize and simplify payments between their member states.?In March 2018, the EU proposed an amendment to their Regulation on cross-border payments which will enable non-euro area Member States to benefit from cheaper payments within the EU. As of 15th December 2019, they will be charged the cheaper intra-euro rates.

The aim is to create a more level playing field between all Member States and charge fees that are comparative to domestic rates. The revisions also demand a higher level of transparency on all cross-border payments. The Amending Regulation is closely tied in with the recent EU directive PSD2, which we will get into in more detail below.

·????????PSD2 and cross-border payments

The new laws detailed under PSD2 will be implemented across cross-border payments made within the EU. If at least one leg of the payment journey is outside of the EU, the cardholder will not have to go through the two-factor authentication process. However, for those placing payments from one EU Member State to another, the rules will apply. It is an attempt to make a more seamless and secure payment experience, as well as move further towards the goal of a single digital market.

Implementing?3DS2?is the best way to ensure that merchants are complying with?the Strong Customer Authentication (SCA)?requirements introduced in PSD2. This two-factor authentication process will apply to a large number of online transactions and will require consumers to prove their identity using something they know, own, or are (e.g. password, card, and fingerprint). There are exemptions to SCA, including recurring transactions or single online payments under 30 euros.

Conclusion

Cross-border payment automation gives you a single platform to make both domestic and international money transfers. This streamlines the AP workflow and provides better AP transparency. You’ll also be able to view payments in real-time, including those that have been reconciled and those that are still due.

Lastly, using global payments automation through a services provider like Tipalti gives you the ability to leverage a payment system that is built to scale. You don’t have to burden your software team with development or maintenance tasks. You’ll have access to a platform that eliminates financial and compliance risks reduce payment reconciliation times, improves supplier relationships, and most importantly, increases the ROI on your AP processes.