What are the key challenges for cross-border payments?
Cross-border payments lag domestic ones in terms of cost, speed, access and transparency. It is typically more difficult to make a payment from one country to another compared to making a similar payment within one country. In some instances, a cross-border payment can take several days and can cost up to 10 times more than a domestic payment.
Enhancing cross-border payments was set as a priority in 2020 by the G20. This work included identifying the challenges associated with cross-border payments that arise from a series of frictions in existing processes and developing a set of building blocks to address them. The key frictions are:
Fragmented and truncated data formats
Payments are made by messages sent between financial institutions to update the accounts of the sender and recipient. These payment messages need to contain sufficient information to confirm the identity of parties to the payment and confirm the legitimacy of the payment. Data standards and formats vary significantly across jurisdictions, systems and message networks.
For example, some formats only allow Latin characters, and some formats allow more data than others, meaning names and addresses in other scripts have to be translated, leading to divergences in precise spellings. This makes it difficult to set up automated processes, causing delays in processing and increased technology and staffing costs.
Complex processing of compliance checks
Uneven implementation of regulatory regimes for sanctions screening and financial crime mean the same transaction may need to be checked several times to ensure that the parties are not exposing themselves to illicit finance.
Banks may use different sources for conducting their checks which can lead to payments being incorrectly flagged (for example where entities have similar names to those on sanctions or financial crime databases). This complexity increases with the number of intermediaries in a chain, as the original data provided to meet initial checks may not contain elements needed for checks under other national regimes. This makes compliance checks more costly to design, hampers automation and leads to delays or the rejection of payments.
Limited operating hours
Balances in bank accounts can only be updated during the hours when the underlying settlement systems are available.
In most countries, the underlying settlement system’s operating hours are typically aligned to normal business hours in that country. Even where extended hours have been implemented, this has often been done only for specific critical payments. This creates delays in clearing and settling cross-border payments, particularly in corridors with large time-zone differences. This causes delays and also means banks need to hold enough cash to cover the unknown costs of the eventual foreign exchange rate, which fluctuates during this time, driving up the overall cost of the transaction. This is known as trapped liquidity.
Legacy technology platforms
A significant proportion of the technology supporting cross-border payment systems remains on legacy platforms built when paper-based payment processes were first migrated to electronic systems.
These platforms have fundamental limitations, such as a reliance on batch processing, a lack of real-time monitoring, and low data processing capacity. This creates delays in settlement and trapped liquidity. These limitations affect domestic operations, but become even more of a barrier to achieving cross-border automation of payments when different legacy infrastructures need to interact with each other. The requirement to interface with legacy technology can act as barriers for emerging business models and technologies to enter the market.
High funding costs
To enable quick settlement, banks are required to provide funding in advance, often across multiple currencies, or to have access to foreign currency markets. This creates risks for the banks that they will need to put aside capital to cover; which means that capital cannot be used to support other activities. The uncertainty about when incoming funds will be received often leads to overfunding of positions, which increases costs.
Long transaction chains
These frictions make it costly for banks to have relationships in every jurisdiction. This is why the correspondent banking model is used but this results in longer transaction chains, which in turn increases cost and delays, creating additional funding needs (including to cover unpredictable fees deducted along the chain), repeated validation checks and the potential for data to be corrupted through its journey.
Weak competition
There are significant barriers to entry for firms seeking to provide cross-border payment services. It is also difficult for end users sending payments to accurately assess the cost of initiating a payment, which makes it difficult to gauge the value for money on offer by different providers. These barriers can increase prices for end users and firms and dampen investment in modernising cross-border payments processes.
Why have improvements in cross-border payments been slower to materialise than in domestic payments?
Cross-border payments are by definition more complex than purely domestic ones. They involve more, and in some cases numerous, intermediaries, time zones, jurisdictions and regulations.
While domestic payments have improved in many jurisdictions, with many more initiatives on the way, cross-border payments are lagging behind.
Other elements that introduce frictions include:
- capital controls
- requests for documentation
- balance of payments reporting
- other compliance processes that can cause significant payment delays
The multi-dimensional nature of these challenges also mean that international collaboration is needed to improve cross-border payments.
