The development of a cross-border payments infrastructure has lagged that of domestic payments systems and is in need of modernisation. 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 too brings the burden of enacting change.
In this article, John Rayment, CEO of Identitii – a firm focused on eliminating anti-money laundering (AML) and counter terrorist financing (CTF) – examines crime, regulation and the shift to digital, the decline of correspondent banking services and how the cross-border payments industry is at the start of a significant transformation with a number of drivers for change from the push for modernisation and the increasing digital expectations of individuals to the ever-sharper scrutiny of regulators.
Cross-border payments are an intrinsic part of today’s global economy. Increasing international trade, the expansion of supply chains across borders, and the new ease with which consumers can conduct global e-commerce are all contributing to a rise in international transactions.
There are no official figures on the size of the international payments market, but Ernst & Young estimates volumes will reach $155.9trillion in 2022 up from $127.8trillion 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 $800billion in 2022.
Yet behind this promising growth story, the cross-border payments market faces a number of 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. New technology players aside, much of the technology used in the industry is decades old and has been cobbled together over the years, making it slow and cumbersome. 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, as well as cross-border projects from the Bank for International Settlements (BIS), are bringing impetus to the drive for transformation.
Alongside this, SWIFT is making strides to modernise, its imminent global migration to the ISO 20022 messaging format being a case in point. New competitors are also emerging in a bid to challenge incumbent players by providing a much better customer experience, with providers such as Wise and Ripple offering alternative value propositions.
The high-value, B2B payment space, traditionally dominated by SWIFT, is a more complex area to tackle, but here too alternatives, such as Mastercard’s Cross-Border Services and Visa B2B Connect, are growing their share of the market.
SWIFT works best with well-established payment corridors and currency pairs, such as the US to the Eurozone, typically settling the same day. However, for less well-travelled corridors, it is a different story. Transactions often have to pass through a long chain of intermediary 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, making it difficult for customers to know when money will arrive at its destination. This is a key 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 in part, 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 more than 20 per cent.
The high cost of compliance was a primary driver behind this trend, with the inability to see nested accounts and trouble identifying the underlying customer leaving 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 wider industry change. There has been an acceleration in digital adoption within financial services, as individuals become more accustomed to digital products and services. The pressure is on financial institutions worldwide 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 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 transformation
ISO 20022 marked the start of a significant transformation within the cross-border payments industry. Without modernisation occurring at a wider level across technological systems, the risk of exorbitant 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.