The future of cross-border payments

In prior decades, large global banks have traditionally been the main players in the cross-border payments space, facilitating payments across the globe for consumers and businesses alike. Since there were no direct competitors to banks, clients had no other choice but to rely on these banks to execute their cross-border payments. Given the lack of competition, the pain points – including long settlement times, a lack of transparency and high transaction fees – were accepted as the norm by clients, meaning that these large global banks were also not put under pressure to innovate.

To put the size of the challenge into perspective, a transaction from a local bank account in any part of the world to a bank account in some countries in Latin America, some parts of Asia or a remote part of Africa could incur costs equivalent to more than US$100 (depending on the transaction value) and take between 5-10 days to settle – if not more if there is a local regulatory requirement on the beneficiary to provide details or documentation. And even then, the sender would often not receive a confirmation of the transaction’s success if the beneficiary bank is not part of Swift GPI.

Today, the landscape is rapidly shifting. Customers are increasingly looking for speed (in the form of real-time domestic and cross-border payments), convenience (to be able to make payments via multiple channels and modes), transparency (in terms of fees and FX costs), resiliency (to be able to make an infinite number of payments into specific corridors) and to be able to do all of this at an extremely low cost per transaction. In response, a variety of new players are entering the space to meet the changing needs of today and solve longstanding pain points in the trillion-dollar cross-border payments market.

The evolving cross-border payment landscape:

Given the vast size of the cross-border payment market, and the opportunity to disintermediate traditional players, we have seen several new players (Fintechs and Digital Banks) emerge in recent years focusing on specific countries and regions, payment segments and transaction sizes. The result of the emerging competition is a rapidly evolving but fragmented landscape. Using conservative estimates from Ernst & Young (EY), the total cross border payment flows across the world was estimated to be US$156trn in 2022. Assuming a very conservative growth of 5% per annum, we can expect these flows to hit at the very least US$230trn by the year 2030.

While some entrants are attempting to change the dynamics of the entire cross border payments market across geographies, most of the new players are focused on low value transactions in the Person to Person (P2P), Business to Person (B2P) and Business to Business (B2B) segments that are currently underserved by banks and traditional payment providers. With the industry on the brink of transformation, these low value payments from, to and between emerging markets offer new entrants the highest potential for disruption driven primarily by rapidly changing consumer demands, accessibility to mobile phones and e-payment solutions, more financial inclusion and increased trade with emerging markets.

With B2B payments accounting for 96.5% of the total estimated US$156trn in cross-border payment flows in 2022, this is not a segment that any player in the cross-border payments space can afford to ignore. And since business expectations are heavily influenced by what we as consumers experience, disruption is on its way for this segment as well.

Keeping Pace with Changing Demands:

In today’s digital world, consumer expectations are largely being driven by technology companies and not by banks. The apps developed by these companies – including WhatsApp, Instagram and Facebook – are used day in and day out and have set new expectations for real-time feedback loops and status alerts.

Certain messaging applications, for example, allow for the sender of a message to know when it has been delivered and when it has been read – and this all happens in real time. So, when the same individual opens a mobile banking application to transfer money to a beneficiary overseas, they expect the same real-time experience that they are used to receiving from the other mobile apps that they use every day.

This then translates into an expectation for businesses as well. Whether big or small, businesses too have an ever-increasing expectation that payments can be made in real-time, at any time and with instant feedback loops. To operate efficiently in a 24/7 economy, businesses want to make payments as late as possible to improve cashflow and reduce their cash conversion cycles. In many cases, business even want to make their cash conversion cycle negative so that they can use the extra cash generated to fuel their growth expansion plans. Amazon is an excellent example of a company that has a negative cash conversion cycle that generates excess cash, which is then used to fuel the company’s growth and expansion.

However, with different operating hours and multiple time zones, real-time payments with real-time feedback loops are challenging. It shines a spotlight on the need for real time as not only a geographic specific problem, but rather a global pain point that requires a harmonized solution.

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The challenge of instant cross-border payments:

As the demand for faster cross-border payments increases, the big question is how this can be made a reality? The cross-border payment experience should be no different to a real-time domestic payment experience – particularly as businesses find that their supply chains are increasingly becoming international, and not just tied to a single geography.

?Unfortunately, it is not that simple. Cross-border payments pose a wider array of challenges than domestic payments to satisfy real-time demands –currency liquidity, visibility and the lack of a single payment system operating 24/7 across all countries.

?Further adding to this complexity, many real-time or instant domestic schemes have been built for domestic use and do not have some of the fields required to facilitate cross-border payments. This means that even where a domestic real-time scheme is leveraged for cross-border flows, crucial payment information will likely be truncated, which can cause issues from a screening perspective.

?Frictions in the cross-border payments space such as these must be paid for – and often that cost is taken from the businesses involved (either the remitter or the beneficiary). This is a key concern for players in the B2B payment space as it removes transparency, visibility into cashflow and what is paid and unpaid from a reconciliation perspective.

Progress made in real-time cross-border payments:

Though challenges remain, instant cross-border payments have been made possible in some instances through intra-regional collaborations across various geographies. ?These include the linking of domestic instant payment schemes in South-East Asia led by Malaysia, Singapore, and Thailand (primarily supporting low-value transactions) to facilitate a cross-border instant payment and the recent integration of India’s Unified Payment Interface (UPI) with Singapore’s PayNow. Similar intra-regional efforts are underway in other regions such as Project BUNA, which services the Arab region. While these intra-regional collaborations have proven successful, they need wider support internationally, as well as to enable high-value transactions, if they are to truly disrupt the cross-border payments industry. In response, pilot programs have been established for immediate cross-border payments, to promote harmonization internationally and begin “connecting the dots” between various intra-regional efforts with a desire to increase transaction limits to support additional use cases globally.

Emerging technologies are also proving to be a game changer in this respect. As significant improvements are made in the technology space – whether it is mobile technology, distributed ledger technology (DLT), application programming interfaces (APIs), artificial intelligence (AI) or real-time cloud time computing – the needs and expectations of our clients, as well as their clients and their suppliers, are evolving. In tandem, evolving regulatory frameworks are accommodating these new realities (for example, the emergence of domestic instant payment schemes across countries and the use of these schemes for processing cross border originated payments). For instance, e-commerce ride-hailing companies that used to make payments to their drivers once every week or every couple of weeks a few years ago have since evolved to paying drivers instantly when they request for a payment – which could potentially be several times in a day. Together, these trends are creating the need for new business models and value propositions that address front-end pain points associated with the existing processes.

The work does not stop here either. To facilitate payments on a real-time basis, financial institutions must also think about moving their own payment and technology platforms from batch settlement to real-time settlement, as well as find ways to remove friction in the end-to-end payment experience and ensure straight-through processing. To unlock straight-through processing, digitizing the front end alone is not sufficient. Streamlining back-end platforms and processes is also a key part of the puzzle to provide an end-to-end digital experience for clients. To this end, financial institutions have invested heavily in AI and machine learning technologies to remove or reduce back-end frictions, such as false positives related to sanctions and anti-money laundering (AML) screening.

Enabling standardization and interoperability:

Standardization and interoperability are critical for increasing the efficiency and scale of cross-border payments. Without system and message compatibility any payments made between systems would require translation, which is time intensive and increases the transaction risk due to the higher possibility of errors.

So what does the landscape look like today? Most cross-border payments are processed using the Swift MT103 messaging format, which, while highly reliable, is rather limited in terms of the amount of information it can carry. Any information that cannot be captured through the MT103 message format is either delivered via a MT199 free format message or sent via other bespoke solutions. This provision of either limited or disparate payment data means that performing either fundamental or value-added tasks on these payments is not always efficient or effective.?

The introduction of ISO 20022 – the new global messaging standard – is a step towards mitigating these challenges. One of the key benefits of moving to ISO 20022 is that is gives participants richer and more structured data than is currently available. The richness and structure of the data also facilitates faster and easier end-to-end reconciliation from an end beneficiary perspective.

From an operational efficiency perspective, the structured data facilitates several upfront validations necessary for seamless execution of the payment. Many of these validations are currently performed downstream and cannot always be done as efficiently, which, in turn, impacts the end client.

Structured data also means improved compliance processes with a significant reduction in false positives from a sanctions and AML screening perspective. False positives are a significant concern today impacting not only the ultimate remitter but also the end beneficiary because they require time, cost and human effort to investigate and override. The rich data provided via ISO 20022 messages is designed to help to reduce false positives, meaning that banks will be able to reduce costs and redirect valuable resources towards analyzing real risks. Hence, the ISO 20022 format facilitates better upfront validation, less downstream friction and enhanced reconciliation in the end for beneficiaries: thereby facilitating a significantly enhanced and faster payment experience for clients.

With high quality payment data through the ISO 20022 format becoming a reality sooner rather than later, the opportunities for banks are enormous. Most banks spend significant resources analyzing data pertaining to their underlying clients. Every large bank has entire teams dedicated to making sense out of existing data to derive meaningful client insights i.e., who do clients transact with, when do they transact and how do they transact? And, as we continue to move forward on the journey to ISO 20022, the industry has only just started scratching the surface in terms of the type and number of actionable insights that can be derived from the enhanced data it brings.

The road ahead:

The long-term future for cross-border payments is bright – and it is also extremely competitive, as historical players and new entrants race to improve cross-border payments. While the monopoly of banks in cross-border payments may be a thing of the past, there is still a critical role for banks to play. The players that can begin to solve these friction points for businesses are the ones that are going to define the future of the cross-border payments – and, ultimately, capture market share in the future.

In view of this, financial institutions are investing heavily in this space to roll out the next generation of payment products. This includes instant cross-border payments into bank accounts and wallets, with the overarching aim to make all types of payments as quick, seamless and transparent as possible. ?

It’s an exciting time to be in transaction banking, given all that has happened over the last five years not only from a Technology perspective but also considering some of the challenges that we had to endure specifically surrounding covid and its impact on humanity and the workplace in more ways than one. In some years, a lot more happens than what happens in some decades, and we have seen that specifically happen in the last 3 years.

Bibliography/ References:

• How new entrants are redefining cross border payments: Florian Seeh Engagement Manager, Strategy, EY?Parthenon Financial Services GmbH
• The Future of B2B Payments: Andrew Smith