By Neil Burton,
director of Product Service Strategy,
Cross-border payments has become a hot topic – albeit gradually, so few people have noticed. While the press spotlight tends to focus on credit and debt, the banking industry simply would not function without its ‘underground pipework’. Transaction banking success, as with international flights, is defined by the unremarkable and only the unexpected is newsworthy.
This is no excuse for paying it no attention. For many bankers who specialise in transaction banking, rather than investment and merchant banking, and for banking regulators, the state of the plumbing is what keeps them awake at night.
Current models have significant drawbacks
The most widely used cross-border payments and collection mechanisms have significant weaknesses, especially when applied to transactions in the €500 – €5,000 range. Correspondent banking service fees and service levels are unpredictable – which may not matter much for a high value treasury transfer. For example, the chief executive officer (CEO) of a US community bank, faced with the challenge of transferring $300 to Scotland for one of his customers, apparently resorted to using his personal non-bank provider, as he was unable to source a cost-effective service through his correspondent banking relationships.
Bankers are well aware of the weaknesses, and have frequently commented that “correspondent banking is not fit for purpose for low value payments” (1).
At Sibos 2011, SWIFT’s annual conference, the brief for a panel discussion on the state of correspondent banking included ‘Yet cross-border bank payments often take several days, and there can be very little visibility on flows in transit. For how long can the existing correspondent banking model survive? Should banks take the lead in a profound redesign?’
(This – and many other – Sibos debates can be reviewed on Sibos TV, an excellent innovation – though access is disappointingly limited to Sibos delegates.)
The panel felt that, while correspondent banking is here at least for the foreseeable future, the prospects for payments made via the correspondent banking model are less clear cut. In order to serve their largest corporate customers, who seek best-of-breed banking services in all the countries in which they operate, partnering with other banks to deliver a comprehensive service is the obvious approach. But when making a payment – (on the face of it, a simple task of debiting one account and crediting another) in today’s Internet age, the inevitable complexity of having multiple parties involved in a chain is far outweighed by the simplicity, transparency and pricepoint of alternative models.
At Sibos in 2004, a senior banker from JPMorgan Chase posed the following questions:
• “Why do we seem to make our products so complex and difficult to use?”
• “How do we expect to help our customers become more efficient, when we are not efficient ourselves? “
• “Why is it that so many of the successful innovations in our industry are pioneered by non-banks? “
• “If the Internet is ubiquitous and free, why should we pay SWIFT for messaging?”
Fast forward to today and the 2011 panel acknowledged that there may be some parts of the correspondent banking model which banks may not service well, either through choice or omission. They commented particularly on lower value e-commerce and trade transfers, and retail person-to-person transfers. However, as highlighted by a question from the audience, at best banks face modest potential return-on-investment from this area, whilst simultaneously facing survival-threatening penalties for transgression of the increasing number and range of rules imposed by regulators.
It was felt that some non-bank providers are more lightly regulated and penalised, which is unfair (though for those based in Europe, following the advent of the Payments Services Directive in 2009, non-bank providers must comply with the equivalent regulation.) The moderator speculated that retail payments is perhaps the Achilles’ heel of the correspondent banking industry. Innovations in retail tend to creep up into ‘mainstream’ banking.
Recent research carried out by Glenbrook Partners, a payments consultancy, echoed the panel’s view;
“Payments professionals perceived the biggest cross-border payment challenges as time required for funds to clear, difficulty tracking payment progress and in-payment reconciliation, and lack of foreign exchange fee transparency. Respondents perceived large corporations, particularly those with their own treasury functions, to be well served by existing solutions. They perceived challenges for smaller businesses, particularly for those making payments of less than $10,000, especially those in the $500 to $2,000 range. The market is voicing concern over current practices and prices while showing interest in new lower-cost alternatives. We think the opportunities are considerable -one could argue that this is today’s largest unsatisfied opportunity in the payments industry” (2).
The market has changed
Over the last 40 years there has been massive changes in the market, in effect making low value cross -border payments a market segment in its own right:
• Demographics; Far greater numbers of people now work, play and settle abroad. According to the Economist, the number of international migrants has doubled in the last quarter of a century, to more than 200m (3), and generating over two billion individual transactions per annum (4). The average fee paid to make a person-to-person payments is about nine per cent of GDP, a significant sum when the average value of a remittance is around $200. For some countries, the total fees paid can amount to more than one per cent of GDP.
• Trade; Global trade continues to grow, with export volumes growing by 14.5 per cent in 2010 and forecast to expand by 6.5 per cent in 2011. As it does so, the average value per transaction is falling, reflecting the ease with which exporters and buyers can reach other via the internet. Similarly, E-commerce is forecast to be a $900bn category, with a shift to lower average value per transaction. Indeed, according to the World Payments Report, 60 per cent of payments in TARGET2 were for amounts it considers to be retail payments and research from Glenbrook also says “The majority of cross border transactions are between $500 and $100,000 in value”.
Alternative models are proven
Other models for making payments are well established. For example, corporates with large centralised treasuries, have for years operated a model in which they net positions across accounts held at (usually) different banks – thereby getting the benefit of ‘local’ payments in each of the countries in which they hold accounts.
Some firms have adapted this model to provide payments services to others. By leveraging the standardisation and efficiency of domestic payments schemes coupled with netting of balances, such models typically have high transparency, high straight-through processing rates and hence low per-transaction charges. Therefore, they are particularly suited to low value transactions.
Although these services have been operating for many years, the advent of the PSD (Payments Services Directive) in Europe established a new regulatory regime covering these ‘non-bank’ payments providers, imposing rules on the conduct of business guidelines, capital adequacy and other requirements on top of already-mandatory AML and sanctions compliance. The PSD, therefore, gives a further level of assurance to users.
Should banks adopt a new model?
Banks face a range of dilemmas:
• Doubtful business case; Cross-border payments are only about one per cent of total payments, require far more complex business processes than domestic, are subject to particularly onerous regulatory penalties, and hence economies of scale are hard to capture.
• Uncertain internal sponsorship; Many banks are organised in silos; retail banks typically have a domestic mandate, for which cross-border is out of scope.The cash management group typically focuses on multinational corporates and large value transactions, so low value transfers are out of scope.
• Potential product cannibalisation; According to Glenbrook, “…incumbent providers will be caught on the horns of a classic strategic dilemma. Will they follow the market, and risk reducing revenues? Or will newer players, at less risk for loss of current revenue, gain significant share?” (5)
Other organisations may see the opportunity differently and be better placed to capitalise on it. For some, the revenue opportunity from the informational flow associated with the transaction is more attractive than the potential fee income from the transaction itself. Mobile phone SMS messages “tripled over the past three years to reach a staggering 6.1 trillion in 2010.” According to the World Payments Report, the global volume of non-cash payments transactions grew by five per cent in 2009 to 260 billion (6).
Providers of cloud computing services may also have an edge. One such provider has around 50,000 clients, of which about 40 per cent are central banks, banks, brokers, asset managers, hedge funds, and exchanges, and 60 per cent are governments and corporates ranging from SME to MNC. Such a provider might see value for its customers in layering transaction services on top.
In conclusion, the world has undergone massive change in the last 40 years, which is approximately the age of the current correspondent banking model. It is right to challenge whether correspondent banking based payments are still best-in-class for a much changed market. In the area of low value cross- border payments, it is clear that the gap between customer expectation and provider service levels is widening. Change seems inevitable.
1. This comment was most recently made at the Business & Operational Excellence in Payments Event, October 2011 Link. It has also also been made in similar presentations by executives from Deutsche Bank and Citigroup
2. Glenbrook Partners – State of the Market for Cross Border Payments – Sep, 2011
3. The Economist – Open Up – January, 2008
4. Earthport calculation, derived from a) annual remittances amount to $440bn (World Bank) and the average value of a remittance which is approximately $200
5. Glenbrook Partners – State of the Market for Cross Border Payments – Sep, 2011
6. World Payments Report 2011