Cross-border payments are often burdensome for corporate treasury. The main pain points include slow speed, high cost, uncertainty and potential for lost remittance information. Cross-border payments can also get held up for various reasons, and sometimes the correct amount may not arrive due to hidden fees. This is largely due to the fact that payments often need to flow through multiple banks, where the added steps in the process can lead to errors or illicit activity.
But now that arduous process may be changing. Multiple solutions have emerged to make cross-border transactions easier and faster. The most important question for corporate treasurers now is, which one will best suit their needs? In the latest AFP Payments Guide, underwritten by MUFG Union Bank, we take an in-depth look at some of the most prominent systems, and help you determine if you should consider shaking up the way you pay internationally.
Inefficiencies in the Correspondent Banking Model
Cross-border payments occur primarily through the correspondent banking model, in which banks set up accounts with selected counterparty banks to facilitate payments. The process begins with a corporate sending a payment from its own bank and payment system to a correspondent bank. If this bank is not the bank used by the payee, the payment goes to a second correspondent bank that converts the payment to the local currency and sends it to the payee’s bank via that nation’s payment system.
The most obvious issue is the time delay; the payment often has to flow through multiple channels. And if one link in the correspondent bank food chain has an issue, such as local regulatory requirements, the payment may be further delayed, or returned and not reach its destination at all if not addressed. Thus there remains a lot of uncertainty over when a payment will arrive using this current model. Even if the standard two to four-day settlement period is acceptable to both payer and payee, that doesn’t mean that it can’t actually take longer.
The high cost is another common problem in the correspondent banking model. The cost of sending international payments can be substantial; there are typically transaction fees at both the payer’s and payee’s banks, as well as fees at each of the correspondent banks and a fee for currency conversion. These fees can vary considerably, depending on banking relationships. Small and medium-sized businesses (SMBs) have been hit particularly hard be these costs; 2016 research by cross-border payments provider Covercy found that UK SMBs that make 20 $13,000 cross-border transactions a month pay over $2,700 a month in fees, on average.
These fees can in turn create other problems for companies. Oftentimes, additional “hidden” fees may result in a different amount being credited to a payee. That means that the payer will have to send a second payment to make up for the shortfall on the first one, and will be responsible for any fees that go along with that payment.
Of course, there are also other regulatory issues that go along with the correspondent banking model. As noted in a 2015 report on correspondent banking by Aite Group, banks are struggling with compiling know-your-customer (KYC) information. KYC is incredibly important in this process because correspondent banking can easily lend itself to money laundering and terrorist financing. Thus it is imperative that banks vet their customers.
KYC is also a common problem for corporate treasury professionals; oftentimes, banks are so desperate to make sure they have all their bases covered that they’ll ask corporate for information that the regulators don’t actually require for them. That leads to corporates compiling a plethora of private information just to ensure that transactions can be completed.
Lastly, given that there are so many links in the correspondent banking chain, transactions open themselves up to fraud. Banks typically have stronger protections than corporates when it comes to cybercrime, but as the 2016 Bangladesh Bank incident revealed, bank systems are not infallible.
Though the correspondent banking model has remained relatively unchanged for years, the attitudes of both corporates and consumers toward international payments appear to be shifting. As noted in a 2016 McKinsey report, customer expectations for faster or real-time payments have been steadily increasing. Moreover, the report warned that “digital innovators” have been attracting customers with new solutions that have the potential to cut banks out of their correspondent banking relationships and loosen their ties with customers.
Given the inefficiencies in the current system, it is no wonder why new cross-border payments services have been emerging, each with their own special features. While it’s far too early to tell which one(s) will outshine the others, it’s never a bad idea to see what they each have to offer corporate treasury.
Learn more about cross-border payments systems in AFP’s new Payments Guide, available for download here.