As money continuously moves around, the demand for secure and fast cross-border transactions has grown staggeringly. Want to understand the industry and where it’s going? Keep reading!
Introduction
In the last few years, moving your business and money into the global economy has become easier than ever before.
That’s why banks and fintechs are shifting their focus and investments into finding more efficient technologies to move money from one country to another. Historically, cross-border payments were slow, complex, inefficient, costly, and time-consuming.
Moving money often involved several different banks, with non-transparent banking fees and overly complex local taxation rules that encouraged global companies to avoid those transactions by all means.
Today, the banking landscape has shifted significantly. The whole financial industry is moving towards digitized solutions that enable companies to move money across countries and continents with much less friction. Banking is now cheaper, available 24/7, and almost instantaneous, plus the process has become much more transparent.
In a recent Juniper Research article, it was said that global spending on B2B cross-border payments will exceed $40 trillion by the end of this year. This will be an increase from $37 trillion in 2022, out of which 9% ($3 trillion) had been driven by the growing popularity of e-commerce marketplaces.
Another significant change in the financial sector is the higher set of expectations related to the quality and convenience of financial services. Entrepreneurs, SMEs, and corporations expect the same levels of transparency and service quality regarding both domestic and international payments.
They want the money to be transferred instantly, regardless of the time zone, bank, or country. And financial institutions are fighting hard to develop solutions that will enable them to do their business internationally.
What Are Cross-Border Payments & How Do They Work?
Cross-border payments can be defined as transactions where money goes from one country to another. Nowadays, money can be moved through bank transfers, alternative payment methods, card payments, and mobile payments. Once it goes through complex processes and approvals, it can then reach its destination and become available.
According to a report from the Committee on Payments and Market Infrastructures, there are still big differences regarding payment processing time - and this is exactly why standardization in fintech is necessary.
Although cross-border payments have become generally more accessible for various businesses, development is not evenly spread across the world. The report shows that prolonged processing time usually happens in lower-income countries. For example, in North America it takes an average of 12 minutes to send money, while in South Africa, it can take as long as 22 hours.
Even though payment systems may be lagging in some developing countries, the CAGR of emerging markets is growing significantly, meaning greater development may be on the way.
From 2018 to 2022, the overall compound annual growth rate (CAGR) of global cross-border payment flows is expected to reach five percent. In emerging markets, the CAGR is set to exceed ten percent. In comparison, developed markets would grow two percent in the same period.
The Two Main Types of Cross-Border Payments
There are two main types of cross-border payments: wholesale and retail.
Wholesale cross-border payments happen between financial institutions and include lending, borrowing, debt, commodities, and foreign exchange. This type of payment is used by non-financial institutions and governments for large imports, exports, and general trading.
Retail cross-border payments are the most common on the market. This type of payment includes any transaction between individuals and businesses, like remittances and a variety of online purchases.
What are the Innovations in Cross-Border Payments?
Businesses operate in a global market and rely on suppliers from other countries. To make sure the money flows, companies are pushing banks to make international transactions easy and simple. The following are two solutions that serve as good examples of innovation that will drive the industry forward.
APIs and real-time FX rates. API has become a buzzword in the banking world. The way they can influence cross-border payments is related to integrations into treasury infrastructure. APIs can allow access to real-time visibility of FX rates to better help the management of reconciliation.
Virtual accounts. Virtual accounts can provide clients with new levels of flexibility since they would be able to manage cash flow across currencies. This type of account would enable businesses to reduce exposure to risks, increase liquidity, and use currencies that correspond to their business needs.
What Technical Problems are on the Horizon?
Strong competition has created both opportunities and challenges in fintech. We see banks, neobanks, payment processors, and non-traditional financial players adding new solutions to make the cross-border flow easier.
Sending money across borders comes with a unique set of problems. According to Endava’s 2022 Global Payments Report, the top problems are:
- Data security
- Transparency across international payments
- Fraud prevention
- Local taxation
Most financial institutions follow industry trends and are in the midst of digitalization, but that doesn’t mean that everyone in the industry is tech savvy which opens up a lot of technical problems. For example, different national requirements and inconsistencies in standard implementation are slowing down the development of new cross-border payment solutions.
Here are some of the most common problems that are creating difficulties in cross-border payment innovation.
1. Legacy Technology
Many legacy applications are behind the times when it comes to cross-border payment features and functionality. For example, they may be unable to give their customers access to real-time monitoring tools, automation, and AI/ ML, making payments slower and more tedious.
2. TTPs in a Long Chain of Responsibility
To enable money to move around, banks often use third-party providers (TPPs) and long authentication processes. Banks deal with multiple parties which can be challenging to handle, and is often the reason why money sometimes needs a few days to go from one account to another.
3. Stringent Compliance Checks
While compliance checks are necessary to ensure that the right amount of money goes to the correct account, they can significantly prolong the transaction time. As different countries use a variety of processes and regulations, there is an overall lack of consistency that adds additional friction to cross-border transactions.
4. Control of Data Security
In recent years, cyber-attacks have grown increasingly in number and in advanced techniques. Advanced protection from fraud can be difficult when platforms have not updated their legacy code, or outdated regulation is preventing them from doing so. Managing cybersecurity amid changing regulations is creating a lot of room for mistakes and fraudulent behavior will likely have grave consequences.
5. Automatic Approvals
Automatic approvals are a convenient feature that is quickly emerging for cross-payments. However, fraud detection tools must be implemented to ensure that the payments are secure.
Fraud detection tools most often utilize machine learning, big data, and algorithms in order to help verify cross-border payments in different ways.
ML can be used to analyze transaction data and identify patterns that indicate fraudulent activity. Big data is used to identify trends and patterns in payment data that help businesses optimize their payment processes. Algorithms are used to automate payment processing as they reduce the time and cost associated with manual processing.
Even with the additional security added for automated systems of cross-border payments, fraud detection tools are still being questioned on whether they truly have the ability to spot issues and block problematic transactions consistently.
Are Regulatory Changes Solving the Problems?
ISO 20022 - Consistent Data to Improve Transactions
With the complete shift to ISO 20022 in 2023, new opportunities may be unlocked for financial institutions. This is because a full application of ISO 20022 will give everyone in the industry consistent and structured data – including communication of cross-border payments – that can be used in a number of transactions.
The information gained from the uniformity of this standard will also help the industry better understand how to further improve and protect cross-payment systems to offer maximum security for each user.
However, this standard will not necessarily solve all the problems related to cross-border payments. The key to successful ISO 20022 implementation will be the standardization of its use as if it’s a universal language used to correspond to different markets.
CBDC - A Potential Disruptor to the Industry
It has appeared that Central Bank Digital Currencies (CBDCs) will contribute to transactions generally being smoother and faster, including cross-border payments.
CBDCs are designed to be used as legal tender and can be used for transactions just like physical cash. They can be issued in two forms: account-based and token-based. Account-based CBDCs are stored in a bank account while token ones are stored in a digital wallet.
CBDCs are expected to change the industry by providing a more secure, efficient, and cost-effective way of making payments. This would be by allowing banks to monitor transactions more closely than before.
The implementation of CBDCs can vary depending on the country’s needs. While some countries have implemented them to improve their financial performance and inclusion, others have implemented them to reduce the overall use of cash.
Many people wonder how CBDCs differ from cryptocurrency. While they are both digital currencies, they are quite different from one another.
Cryptocurrencies are decentralized, meaning they are not controlled by any central authority or government. They are based on blockchain technology, which is a distributed ledger that records transactions across a network of computers.
On the other hand, CBDCs are digital versions of fiat currencies that are issued and backed by central banks. They are centralized, meaning they are controlled by a central authority or government. CBDCs can be used for transactions just like physical cash, but they offer several advantages over traditional cash such as faster transaction times and lower costs.
CBDCs allow for payment settlements and foreign exchange, however, CBDC is still not a mainstream method for money transfers. If it grows globally in popularity, it may be a massive disruptor in the banking world.
How Will Fintechs Adapt to New Realities?
If it means faster and smoother payments, Fintechs are working to get ahead of the curve when it comes to innovation and features that appeal to clientele.
For example, many neobanks have new licenses and infrastructure that allow them to mitigate intermediary financial institutions and offer better services. Even some non-bank institutions already have the licenses and infrastructure that allow them to mitigate intermediaries and easily move money between countries.
Due to collaboration with skilled development teams, fintechs are able to use distributed ledger technologies and offer tracking and increased transparency of any transaction, even same-day settlements, for everyone using the banks in their network.
We can also see fintechs acclimating to strict regulations that will decrease the risk of fraud. They are actively investing in automated compliance, algorithm-based transaction reviews, and advanced KYC systems. Due to the digital environment and access to the latest technologies, fintechs are faster in developing solutions that banks can later use in cross-border transaction processes.
Final Word
In today’s fintech landscape, banks need to innovate as much as they can to defend their place at the top. Indeed, the industry’s focus has shifted, and this time banks have been shoved out of the spotlight by fintechs and neobanks. With enough money to invest, many banks are vying to stay in the game by partnering with promising fintechs who can provide advanced services and features for their users.
Cross-border payment is evolving as the market is changing the way money travels across borders and continents. But without technical guidance, little can be done to transform processes. This means that banks and financial institutions will need to invest in IT infrastructure and experts who understand the latest fintech innovation, in order to survive the massive transformation in the payments landscape.
