Cross-border payments: the final mile in the developing world
There are two major trends developing in the cross-border payments world.
Firstly, there is explosive growth in the number of cross-border payments between developed and developing countries. The Boston Consulting Group estimates that the market will grow to 20.7 billion transactions per year by 2022 with a volume of almost 55 trillion Dollars. This implies a CAGR of 10% between 2012 and 20221.
The trend in payments is driven by an ever-increasing global commerce and the ability of people in developing countries to offer their products and services on a global basis. The countries of the developing world and their financial markets – with some exceptions – are becoming more stable, enabling their work forces to compete globally. Eventually a commercial or service transaction is complemented by a financial transaction – the result: a cross-border payment.
Secondly, governments, regulators and commercial actors increasingly favour payments being executed in local currency and discourage the use of US dollars to settle local obligations (in a non-dollar country).
This stems from a desire for greater control and transparency. Local governments find greater ease in monitoring financial activity in their own, rather than someone else’s currency, whilst transactions in local currency can reduce the cost for the sender, with the beneficiary able to price their service accurately against their cost base, as opposed to including an exchange rate premium in their price. Further, the payment is often cheaper and more direct and easier to trace, avoiding chains of correspondent banks not involved in the transaction itself.
The above leaves the banking world with a tremendous challenge: how to enable customers to pay all over the world in local currency in a cost effective manner, whilst battling for market share with new, non-bank, payment providers attempting to offer competing products, who do so without the overhang of historic and sizeable overheads.
In the current economic and regulatory environment, financial institutions are hesitant to build their own infrastructure to cover all the countries around the world. The burden of building a correspondent banking network to be able to pay to all of these countries is prohibitive. Bank relationships need to be established and bank (Nostro) accounts opened and reconciled. Many banks do not have a presence in country and find that handling the task from far away is daunting. Additionally, the bank has to ensure compliance with both local and international regulations and registration and has to stay on top of changes and modifications.
Banking institutions can often see the potential growth in the sector but have difficulties justifying creating this infrastructure for existing payment volumes. If the number of transactions in a given country is low and this infrastructure has to be retained, the cost of doing so can easily outweigh the potential profit, rendering it uneconomic for the bank and/or their client.
In recent years non-bank payments companies have focused on remittance and p2p payments, with some companies starting to develop and engineer payment channels that make the transfer of these smaller payments more cost efficient. However, in the institutional b2b or b2p space, where beneficiaries maintain their accounts with banks, innovation has been slower to develop as any solution used still needs access to a reliable infrastructure to complete the final mile of the payment. The only model to make the process more cost efficient is pooling of payments and sharing correspondent banking infrastructure cost among a number of banks or institutions.
Such pooling allows for a economies of scale that are hard to achieve individually, creating better foreign exchange conversion rates and a reduction in fees charged by correspondent banks. Connectivity in country between Swift and local ACH payment systems and the development of other technologies that make the process across all these different payment platforms more cost effective, can now be shared, and the investment made by the local banks in new technology can be justified by the increased payment volumes.
In the end the ordering customer, financial institution and beneficiary all benefit from a better process.
1. Source: Boston Consulting Group Global Payments, 2012