Delivering cross border payments using correspondent arrangements forms
the basic plumbing of the financial services infrastructure. The past
decade, however, has seen no shortage of those forecasting the
extinction of this model at the hands of alternate payment providers
There is some justification for the doomsayers as correspondent banking is neither frictionless nor low cost. It is difficult for the remitter and for the beneficiary to always know what stage their payment is at, or what charges will be deducted along the way.
APPs come in many forms, and enable payment initiation across a range of channels. For example, a customer using Google Wallet or PayPal can make payments funded from a bank or a credit card, and can initiate these through the internet or a mobile application. Some APPs, including BitPay and M-Pesa, do not require traditional bank accounts, and transact in virtual currencies such as Bitcoin or mobile talktime. However, even the most successful ones have so far made their greatest impact on low-value retail payments within borders. Correspondent banks, on the other hand, have developed systems built around moving money across borders for corporates and institutions besides the retail sectors. They handle large-value payments which tend to be supported by complementary products and services like loans, lockbox collections, etc.
Along with the rise of APPs and their innovative solutions, there has been negative press around fines for sanctions and money laundering lapses in the banking industry. The emergence of virtual currencies, particularly the publicity surrounding Bitcoin, has increased the excitement and interest around different methods of transferring legal tender. In this context, given their use of friendlier consumer technology, the APPs appear increasingly attractive as a means of transacting payments.
The many requirements of corporate clients
Despite their seemingly game-changing innovations and drive to dominate the payments landscape, APPs still face barriers in key areas. They focus on niche segments, specifically retail payments that are mainly designed around enabling transfers among individuals. While they are extremely good at this, the requirements of corporate clients are very different.
The typical APP would find it difficult to penetrate the lucrative corporate cross-border segment. Data from Boston Consulting Group’s 2013 Global Payments Report shows that wholesale cross-border payments are estimated to have an aggregate notional value of US$46 trillion and volumes of 2.4bn by 2022, translating to at least US$25bn in potential annual transaction fee revenue (excluding FX). This revenue pool is still expected to be controlled by international correspondent banks.
With the huge emphasis on regulations and compliance for cross-border payments, corporates are demanding higher standards of payment processing and execution. Correspondent banks have the infrastructure and knowledge to ensure proper sanctions screening and anti-money laundering (AML) procedures are carried out. International banks also have the network and local market knowledge to provide the latest guidance on country regulatory requirements.
In addition, there is also regulation associated with ‘stored-value’; APPs are not defined or regulated as banks in most countries, and cannot hold deposits for consumers like banks do. As such, they must return the value of an inbound payment to clients immediately through a bank account.
In general, this implies that a bank’s involvement is still required. Most APPs still require a bank account to transact in mainstream currency and, in some scenarios, still require that its own customers have a bank account too. For example, a new Paypal user, upon setting up an account, is given a ‘sending limit’ dependent on various factors like location. To exceed the sending limit the user will usually need to link a bank account to the Paypal account. Paypal is effectively relying on the stringent account opening requirements stipulated by banks.
The hidden advantage for international banks
The declining use of letters of credit (LCs) and the increasing use of open account trade solutions have led to increasing payment volumes and values. According to Swift data, the volumes of MT700 (a SWIFT message format used by banks for a documentary LC) received by the major booking centres of the US, Germany and the UK decreased from 380,000 in 2010 to 348,000 in 2013, a drop of 8.5%. This decline has surely been replaced by commercial payments to settle balances under open account terms. The typical commercial payment handled has a value of around US$80,000 to US$100,000. Compare this statistic to the average retail cross-border payment which is less than US$200. With such high-value payments, a trusted relationship between client and provider is essential.
Trust is not always tangible and can easily be overlooked. Trust in a regulated bank provider remains one of the most vital criteria for corporates when choosing a payment provider. To build such trust, a provider must be credit worthy, perform consistently, and maintain a close working relationship with the client. Such a relationship is best built around dedicated sales and relationship teams which form the very basis of banking. An APP which specialises solely in payments simply cannot compete against this.
The complete package
International banks also have widespread networks; these not only comprise the clearing memberships and technical infrastructure that are necessary to enable fast cross-border payments, but also local knowledge and presence. Familiarity with the local regulations can make the difference for corporates; whether it is providing formatting requirements for payment instructions, or intervening directly with the local regulatory authorities to resolve issues.
In some cases, knowledge of the local banking practices can translate to innovative new products; for example guarantees that payments will reach the beneficiary within a certain timeframe. Due to the effects of time zones, US or European-based clients usually have to wait until the next business day, when they receive their bank statements, to ascertain if payments to Asia or Africa have been made successfully. Depending on the destination country, some of these guarantees can assure clients that payments will reach the beneficiary on the same business day.
There is also significant scope for banks to improve existing solutions in several areas; the use of technology or better solutions that integrate various locations or departments in a banking provider can usually significantly improve the value-add of a product or service to clients.
Cross-border liquidity management is one such area where banks have sought to more closely match client requirements. Payments generate liquidity positions and the owners of this liquidity (corporates or institutions) would like to optimise the yield on their balances across all their accounts. International banks have begun to offer products catering to cross-border liquidity management and interest optimisation.
While APPs are providing some competition to correspondent banking, banks are still able to fulfil vital functions that a typical APP cannot. New technologies used by the APPs have found niches but they still cannot displace trusted methods favoured by corporates, and banks are still best placed to serve this segment.
New technology and providers undoubtedly have their advantages, and banks should be examining ways of incorporating technology in correspondent banking. The more nimble banks already understand that the world is shifting towards frictionless methods of transacting business and are responding accordingly. The correspondent banking industry as a whole needs to do the same.
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