Cross-border payments are an intrinsic part of today’s global economy. Increasing international trade, expanding supply chains across borders, and the new ease with which consumers can conduct global eCommerce are all contributing to a rise in international transactions. There are no official figures on the size of the international payments market. Still, Ernst & Young estimates volumes will reach US$155.9 trillion in 2022 up from USD$127.8 trillion in 2018, demonstrating a strong upwards trajectory.
B2B payments account for the vast majority of these transactions, but there is also rising demand from consumers and small businesses. The remittance market is also impacting cross-border payments growth, with international consumer-to-consumer payments worth an estimated USD$800 billion in 2022.
Yet behind this promising growth story, the cross-border payments market faces several challenges driven in part by significant changes to regulation, as well as difficulties in scaling underlying systems and processes to meet today’s demand.
Cross-border payments: Slow, expensive and opaque
The modernisation of the cross-border payments infrastructure has lagged that of domestic payments systems. Much of the technology used in the industry is decades old and has been cobbled together over the years, making it slow and cumbersome and not fit for purpose. The current limitations obviously present challenges for banks and payments providers operating in the space, and while there is a widely-recognised need and drive for transformation, this puts the burden of change on already stretched market participants.
The issues confronting cross-border transactions were highlighted in 2020 by the G20 Group of Countries, which has since tasked the Financial Stability Board (FSB) with putting in place a road map for change. The FSB’s efforts and cross-border projects from the Bank for International Settlements (BIS) are bringing impetus to the drive for transformation. Alongside this, SWIFT itself is making strides to modernise, its imminent migration to the ISO 20022 messaging format being a case in point. New competitors are also emerging to challenge incumbent players by providing a better customer experience, with providers such as Wise and Ripple offering alternative networks. The high-value, B2B payment space, dominated by SWIFT, is a more complex area to tackle, but here too alternatives, such as Visa B2B Connect, are coming onto the market.
SWIFT works best with well-established payment corridors and currency pairs, such as the US to the Eurozone, typically settling on the same day. However, for less well-travelled corridors, it is a different story. Transactions often have to pass through a long chain of banks, which means they can take days to settle and incur notable fees along the way. The process is also opaque, and it is hard to move the Know Your Customer (KYC) and Know Your Transaction (KYT) information needed by each player with a payment, meaning banks often hold up payments while they check on data, slowing them down and making it hard for customers to know when money will arrive at its destination. This is a crucial consideration as KYC / KYT information is needed by each player in the payment chain and the local regulator in every jurisdiction through which it travels.
The decline of correspondent banking services
The challenges with today’s cross-border payments infrastructure are further compounded by the recent decline in correspondent banking networks serving perceived high-risk markets. This decline has reduced the availability of cross-border payment services and driven up costs for end customers.
The correspondent banking decline stems partly from large-scale de-risking exercises undertaken by some larger banks. The BIS estimates that between 2010 and 2020 alone, correspondent banking networks shrank by up to a fifth. The high cost of compliance was a primary driver behind this trend. The inability to see nested accounts and trouble identifying the underlying customer left banks unable to fulfil compliance requirements within their risk tolerance. While de-risking exercises make sense from an individual bank’s perspective, it has left certain regions with much-reduced correspondent banking services, severely hampering their ability to move money across borders.
Crime, regulation, and the shift to digital
These specific challenges facing cross-border payments are set against a backdrop of broader industry change. Since 2020 there has been an acceleration in digital adoption within financial services. Individuals are more accustomed to digital products and services, and the pressure is on financial institutions to up their digital game.
Accompanying this increase in digital activity is an unwanted increase in cybercrime. The UK’s National Fraud and Intelligence Bureau reported a threefold increase in cybercrime in the first half of 2021 compared to the previous year. As a result, fraud and security are high on the agenda as banks and financial institutions fight back against cybercriminals.
Lastly, there are also ongoing regulation and compliance changes to deal with. New and updated regulations related to Anti-Money Laundering (AML) and Counter-Terrorism Financing continue to come into force, with examples including the 6th Anti-Money Laundering Directive (AMLD) in the European Union and updates to reporting formats due to ISO 20022 happening in many jurisdictions. Regulatory scrutiny is also sharper than ever, with a bumper level of fines and enforcement actions issued for non-compliance with financial crime reporting regulations in 2020.
ISO 20022 is only at the start of a transformation
ISO 20022 marked the start of a significant transformation within the cross-border payments industry. Without modernisation occurring at a broader level across technological systems, the risk of excessive costs and an inability to meet customer demand grows. The key for financial institutions will be to align with changing regulations while also managing internal uplift projects. Although difficult to manage, both elements are necessary to ensure systems can handle the increasing volumes of data in the cross-border payments environment.
About the Author: John Rayment is the CEO and Managing Director at Identitii.