Cross-border payments shouldn’t be a cryptic element for those who wish to resort to them, especially given how much of an impact they can have on your business and even on your everyday life.
As such, if you wish to improve your business’ cross-border payout capabilities, it is quintessential that you fully understand the process, the challenges it faces, and what you need to do to go around them.
Cross-Border Payments Explained
Cross-border payments are in essence financial transactions in which the sender and recipient are in different countries (this goes for wholesale as well as retail payments).
Why Cross-Border Payments Are Important
We live in a global economy and over the years the added mobility of goods and services has made many of them popular beyond borders. Accordingly, cross-border payments follow suit as they contribute to the growing interdependent global economy.
As manufacturers are expanding their supply chains to other countries, migrants keep sending money via remittances, and international trade is strengthening on the back of e-commerce, it is easy to see how important cross-border payments are.
Remittances are crucial to those in low-income economies as they occasionally become individuals’ main source of development finance.
As such, the increased demand for safe, efficient and trustworthy cross-border payment solutions has paved the way for many innovative business models and market participants to emerge.
How Can Cross-Border Payments be Made?
There are many ways one can go about a cross-border payout, namely credit card payment, bank transfer, as well as other alternative payment solutions like crypto or e-money wallets.
Types of Cross-Border Payments
Generally, they come in two different ways:
1. Wholesale cross-border payments: which are usually done between financial institutions as a way of supporting the activities of their customers or their own. This in turn means that wholesale cross-border payouts are used for borrowing, lending, the trading of debt and equity, commodities, derivatives, foreign exchange and securities.
Large transactions are also done via wholesale by both governments and considerably large non-financial companies, generally pegged to trading in financial markets or to importing and exporting goods and services.
2. Retail cross-border payments: which are done between individuals and businesses. They can range from person to business, business to business, and person to person, remittances included.
How Cross-Border Payments Work
Currencies operate in what can be described as a closed loop system. As domestic payment systems don’t usually connect directly with their foreign counterparts, when one attempts to transfer between two different jurisdictions, international banks will arrange things as to the transfer to be made.
This is obviously not done by physically sending the money across the border but rather by having the bank’s own accounts credited and debited the specified amounts as necessary.
In what concerns Fintechs’ operations and other money transfer agents, the standard method is to use this very same interbank network to provide individuals and businesses with their payment services.
As such, a simple cross-border payment structure is as follows:
· Bank 1 sends Bank 2 a message with instructions.
· Instructions should read which account will receive payment.
· Subsequently, Bank 2 will proceed to credit its client’s account with the money from the account Bank 1 is holding at Bank 2.
However, it might be the case that neither bank has a direct relationship with the other.
Cross-Border Payments and Interbank Networks
When that happens, an arrangement must be made via an intermediary, also known as a correspondent bank. The correspondent bank will then provide accounts for both Banks (1 and 2).
Accordingly, one can understand easily how the nature of correspondent banking is crucial to the global payment landscape in terms of cross-border transactions.
It is important to highlight that there is a direct positive correlation between the number of intermediaries which get involved across the chain with the cost of the transaction and the necessary time to fulfil it, meaning that the higher the number the slower and costlier it will get.
This happens in the case of, for example, a slightly less common currency pair as banks must face higher costs and extra delays along the chain given the necessity of checking against financial crime requirements locally and the updating of each account’s balance in each domestic payment system.
Challenges That Cross-Border Payments Face
When comparing cross-border payments with domestic payments, one can see how the latter is a faster cheaper widely more accessible and transparent variant.
Evidently, it is harder and costlier to make payments from one country to another and given that the G20 set a goal of enhancing cross-border payments, it became essential to identify and overcome any friction in this process.
Fragmented Data Formats
Payments are made via messages. Financial institutions trade messages back and forth to update the accounts of both senders and recipients. Accordingly, the messages need to convey information such as the identity of each party and the confirmation of the payment and its legitimacy.
Since there are significant variations between formats and data standards across systems, here lies a massive problem.
Translations cause delays in processing as divergences in spellings which should be accurate need to be double-checked, meaning that staffing costs rise with the need for state-of-the-art technology.
Compliance Checks
Some transactions might be checked several times given how regulatory regimes for sanction screening is sometimes uneven. The same thing happens for financial crime screening, meaning that if parties do not wish to expose themselves to illicit practices, they need to take the necessary precautionary steps.
Despite meeting requirements in their respective country of origins, these can fail to do so for other regimes (for example, some key elements might be missing).
Logically, the higher number of intermediaries in the chain, the more complex this process becomes.
In turn, compliance checks become costly, their automation is profoundly hampered, delays are increased, payments might be rejected and so forth.
Limited Operating Hours
As banks update their balances, they communicate with one another constantly. However, these bank account balance updates can only be done when their settlement systems are operational.
Traditionally, these bank settlement systems operate in unison with their respective country’s normal business hours.
It may happen that an extension is required for critical payments, but that is the exception and not the rule.
The delays this ends up creating in terms of clearing and settling are massive.
It also requires banks to hold cash to cover any costs that might come along in the process.
Moreover, these problems are further aggravated in corridors that already face the inherent problems which significant time-zone differences entail.
Legacy Platforms
Legacy platforms are the backbone of cross-border payment systems.
Given that they were built at a time in which processes were paper-based, their fundamental limitations should be obvious.
Their data processing capacity is low, and they still rely on batch processing with no real-time monitoring.
All of these limitations already hamper their domestic operations, so it is easy to understand what they end up doing in terms of cross-border payments as different legacy platforms, and infrastructure became an obstacle to automation while also working as a barrier of entry for new technology to enter the market.
High Funding Costs
As pointed out earlier, banks that wish to speed up their settlement must have funds ready in advance (or access to the foreign currency market).
By doing so, banks face higher risks due to the capital that needs to be put up. By having to overfund their positions due to uncertainty in terms of costs, banks face high opportunity costs as the money cannot be invested in the pursuit of other activities.
Long Transaction Chains
It is simply too costly to pursue relationships in every possible jurisdiction.
As such, banks use correspondent banks which elongate the transaction chain and, consequently, delays the process even further.
Given that they might be met with unpredictable fees while also facing potential data failure along the way, the longevity of the transaction chain creates a lot of friction in the process.
Little to No Competition
Barriers of entry are high when it comes to starting a cross-border payment service. It is also quite troublesome to accurately estimate the final cost of a payment, meaning that gauging the value for money for different providers can also be tricky.
Cross-Border Payments vs. Domestic Payments
Cross-border payments see a lot more friction along the chain given the added intermediaries and different requirements and regulations between jurisdictions.
Compliance processes also take longer given the process’ multi-dimensional nature.
This, on one hand, highlights the importance of international collaboration and, on the other, opens a window of opportunity for disruptive processes like blockchain tech to sink their teeth into the market as highlighted here:
Improving Cross-Border Payment Capabilities
There are some ways this can be achieved:
Utilize Local Payment Methods
As many are still heavily relying on legacy methods like checks and wire transfers, if you’re looking for something useful on a global scale, you’ll need to think big. Going for mass cross-border payment will allow you to have a solution with all the local payout methods you’ll need at the ready.
Consider Partnering with a Fintech
With Fintech-as-a-Service, cross-border and cross-currency payouts’ frustrations are relieved. By working closely with a Fintech firm, your business can integrate cross-border transactions in a seamless way while getting a faster time to market.
In fact, the fintech as a service model has been becoming prominent as integration is flexible, multicurrency options are available, compliance and fraud monitoring are standard, and so forth, making it a one-stop shop for essential services.
Moreover, by going with a Fintech firm you will have all the room for growth and expansion as payout capabilities are scalable without the extra back-office costs.
Embrace Cross-Border Issuing
Cross-border issuing for virtual cards is a great solution if you want a no-nonsense, easy-to-implement solution. Issuing your own cards will get you in control of all employee expenses and simplify all payouts.
Furthermore, reward programs can be built, data can be mined from transactions, all of which can provide valuable insights for your processes.
Wrapping up
Make no mistake: modernizing your business payout capabilities can have a significant impact on your growth as your company will have access to a whole new world of opportunities.
