Small downticks in the Chinese economy are felt immediately in Brazil. Downward shifts in the value of the US dollar (USD) or the pound (GBP) make foreign exchange (FX) rates and futures markets increasingly unpredictable. China has begun to position the renminbi (RMB) as a second global currency, the ramifications of which are far from clear. The crisis in the eurozone continues unresolved. And regulatory scrutiny such as that brought about by the Dodd-Frank Act, the Credit Card Accountability and Disclosure Act, Basel III, and the single euro payments area (SEPA), however necessary they all are in the long term, create complications and expense for the banking industry in the short term.
Alongside these regulatory developments, client demands on banks continue to increase. Corporate treasuries are requiring more refined and customised solutions without a commensurate willingness to pay increased fees. A treasurer’s position is strengthened by the growing presence of non-bank payment providers, a sector benefiting from the Payment Services Directive (PSD) of the European Commission (EC), which is opening payment markets to new providers as a stimulus to competition. In addition, there is increased demand that banks be multi-currency providers and that they be able to offer regulatory assistance and training in payments and trade services.1 In short, today’s banks are expected, in the face of increased competition, to provide more and better services, with fewer resources and greater constraints.
Added to these demands on resource-strapped banks, the payments business fell at a compound annual growth rate (CAGR) of 7% between 2008 and 2010; yet payments remains an integral part of banks’ overall business.2 The global transaction business suffered in the recent downturn and transaction volumes have barely recovered since 2008-2009. Nevertheless, when compared to other banking businesses during the same period, international cross-border transaction revenues have remained relatively stable, even healthy, with an earnings before interest, taxes, depreciation, and amortisation (EBITDA) margin average of 38%.3 Payments make up fully a third to a half of most banks’ revenues.4 So, despite the increasingly thin profit margins resulting from increased demand and competition, and the press of new regulation, few banks can afford to exit the payments business, although many are finding it difficult to see how to stay in.
Size, Scale and Depth
To survive, banks need to cultivate advanced solutions that will set them above and apart from their competition. For all banks, the immediate challenges are size and reach. The demands of corporates for more sophisticated solutions often require an investment in capability that can go beyond the capacity of a single bank to provide.
In creating innovative banking solutions, where needs not only must be fully understood but anticipated, a deep and innate knowledge of the market matters. Furthermore, when transferring funds across borders, it helps immeasurably to have a centre of knowledge in each region of operation. Banks indigenous to a specific country have deep and first-hand knowledge of local markets, customs and language, and often have close relationships with local manufacturers, both importers and exporters. They understand tax provisions and prevailing laws, and they are familiar with their competition in a more immediate way than a branch of a large bank would be.
All these factors have great value in the marketplace, which the branch networks of large global banks cannot easily duplicate. So even though a large bank may have the size and resources to implement a capability, it is likely not to have the market penetration or the specific expertise to achieve the true innovation of co-operating correspondent banks. There is a compelling need, then, for banks to work together.
The selection of bank partners needs to be judicious though. With cost-cutting and business streamlining also comes a need to consolidate correspondent relationships. Banks need to eliminate those relationships that are redundant and to standardise the terms and agreements that govern the ones that remain. Global banks need to create scale, foster expertise, and, manage their relationships efficiently. Even the largest banks are not in a position to align with every interested correspondent bank and make the investment in bringing each of their platforms into efficient alignment. The correct balance is fewer correspondent relationships, but with deeper ties and greater opportunities for innovative collaboration.
The common thread in both bank innovation and client demand is the processing, movement, and transparency of information. Historically, the payments business has operated without a clear knowledge of downstream bank fees, rates of exchange, and processing deductions. Without this information, a sending bank could not know, and certainly could not guarantee a client, exactly how large or small a beneficiary payment would be and when it would clear and settle.
Addressing this situation is what much of the current regulatory efforts are intended to accomplish (Dodd-Frank Act, Section 1073). While this creates immediate headaches for payments processors, regulatory efforts are, from the point of view of client satisfaction, in their long-term interests. By wedding correspondent banks to common systems, transparency will improve and, after investment costs, become profitable, particularly if the solution can be redistributed to peer banks.
But, as noted in a report by the Aite Group5, “payment systems and processes alone are not differentiators for banks.” For banks’ clients, good information and the availability of payments-related data (initiation, exceptions and errors, discounts taken, etc) are critical for accurate payments posting and updating credit positions. But improved processing procedures can create precisely this benefit, and the data analysed can be as fundamental as the destination country of the payment and the currency denomination of the beneficiary’s account.
The following example, payment redirection and conversion, shows how collaboration and innovative thinking can yield a solution that benefits all participants.
Cross-border Payment Redirection and Conversion
Designed for use in countries with a large inflow of commercial USD payments to accounts not typically held in USD, cross-border payment redirection provides an opportunity for revenue and reciprocity that leverages the value of USD commercial payments sent (and the deposits received) by a global bank for its client base. The global bank selects, as an intermediary to given payments transactions, a designated correspondent bank, usually a major bank with an understanding of the account structures of peer banks in its country or regional market. The correspondent will make available to its partner bank its knowledge of the local economy, of local regulations and laws, of other banks in the country, and of their respective account structures (indicating the currency of the account).
The bank then routes all its eligible MT103 USD payments through this selected correspondent bank. The correspondent converts eligible USD payments into local currency and distributes the converted funds to the beneficiary at its local bank (see Figure 1).
Figure 1: How Redirection Works
Source: BNY Mellon
This collaborative process also allows the global bank to monitor more closely the quality of USD processing in specific countries and, where required, to take steps to ensure a uniformly high standard of service for the majority of payments into a specific country. It avoids or mitigates many of the problems that make cross-border payments an inefficient process, such as:
- Lack of a single global payment system with agreed-upon standards.
- Misunderstood local laws, rules and practices.
- A lack of clear information and data; and domestic infrastructures that are not designed to handle cross-border payments.
These things create obstacles to automating and simplifying the process and constrain speed, control and quality.
Payment redirection and conversion also provide value for all involved parties. For the correspondent bank, it creates found value, since this bank becomes the designated intermediary party to payments with which it was not previously associated. It earns revenue on the FX margin of converted payments and on any deductions taken on the payments. These revenues may be partially distributed back to the main bank through referral fees, or the bank can leverage this value as a reciprocity source to secure other business with the designated correspondent. The sender and beneficiary benefit from often faster settlement times, a favourable FX rate on the conversion of the payment, and lower bene deduct fees (if any) charged by the intermediary bank.
For the sending bank, in addition to creating new revenue streams and demonstrating thought leadership in payments, such cross-border payment redirection, over time, provides the bank with a network of preferred payment correspondents in various countries. This, in turn, should result in greater business opportunities in USD or multicurrency payments for the sending bank, as well as provide a means for it to monitor more closely the quality of USD processing and ensure a uniformly high standard of service, faster clearing times, better customer service, a more favourable exchange rate and lower bene deduct fees, to the benefit of its clients making payments into that region.
Payment redirection and conversion is a working example of how innovation and collaboration can generate an array of benefits that touch all participants. It does not require an outlay of resources for research or the development of new technologies. Rather, existing resources are joined in a new idea, an innovative insight into how the movement of funds cross-border might better be conducted.
As with all new ideas, there are wrinkles to be worked out. Best practices for managing such relationships must be developed and care needs be taken in selecting appropriate partners. But with experience and standardised guidelines for interaction and service, the process can be both simplified and streamlined. And creating a series of such relationships can yield a rejuvenated and profitable correspondent network that greatly improves the quality of service provided to banks’ corporate clients wherever they are in the world.
1 ‘Bank-to-Bank Services: 2011 Global Perspective’, FImetrix, February, 2012.
2 ‘BCG Report, Global Payments 2011: Winning After the Storm’, The Boston Consulting Group, February, 2011.
3 ‘Riding the Wave of Global Transaction Services and Payment Systems’, International Payments Frameworks Association, November 2011
4 ‘BCG Report, Global Payments 2011: Winning After the Storm’, The Boston Consulting Group, February, 2011.
5 ‘Top 10 Trends in Wholesale Banking, 20012’, Aite Group, LLC, 2012.
To read more from BNY Mellon, please visit the company’s gtnews microsite.
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