Among other sources, Cross-border payments are a vital revenue stream for banks. In 2015, the payments constituted 20 percent of the entire transactions in the payments industry, generating 50 percent of transaction revenues. The Global Payments Report 2019 revealed revenues from global payments amounted to $1.9 trillion, while transaction fee growth stagnated as a result of competitive and regulatory pressures.
Despite this, banks have continued to use the old-style correspondent banking systems such as Visa, Mastercard, and SWIFT for international payments – despite their inherent weaknesses. Notably, these systems are expensive, slow, and complex. In fact, a World Bank report revealed that the Global average for sending payments stood at 6.82 percent in Q4 2019, which is still high.
Luckily, technology will soon change things – for the better. With the advent of mobile banking, e-commerce, and digital wallets, banks will have to rethink their correspondent banking system of making cross-border payments. Moreover, the emergence of blockchain technology has dramatically disrupted the cross-border payments system, causing banks to realign their products.
Let’s look at how blockchain technology will disrupt cross border payments by analyzing how it has solved the problems of correspondent banking.
1. Increased Transparency
For any business that is reliant on making and receiving international payments, transparency on transaction fees is a vital requirement. According to a SWIFT and EuroFinance joint survey, lack of payments traceability, invisibility on banking fees, and amount discrepancies are the key concerns in cross border payments.
The opaqueness of the costs associated with cross-border payments makes it difficult for corporates to determine the amount they will incur. In the correspondent banking system, both the originating bank and the foreign bank retain their own ledgers, from which they make reconciliations and settlements. This leads to a lack of transparency. The panacea to the problem lies in blockchain technology.
Blockchain, being a universal ledger in a distributed network, allows the sender and the receiver, as nodes in the network, to have a complete copy of the ledger. Moreover, other nodes in the network must verify any modifications through a consensus mechanism.
Also, in such a scenario, there are no correspondent banks/intermediaries involved, eliminating any chances of manipulation. Therefore, the distributed ledger facilitates the bilateral, immutable distribution of value with the assistance of a settlement agency.
2. Real-Time Payment Systems
Typically, banks use intermediaries to facilitate cross-border payments. However, according to a McKinsey Research, cross border-payments take 3–5 days, which is quite long for corporates seeking to receive money. In the event of a dispute or investigation, the duration can be longer. Blockchain technology has completely eliminated the need for intermediaries and facilitated a direct transfer over the platform.
A leading player in the blockchain payment system is Ripple. Through its RippleNet blockchain, customers can now use the technology to facilitate global payments at a rapid speed. RippleNet has a product called xRapid to offer instant liquidity to financial institutions for cross-border payments.
Unlike the correspondent banking system where a pre-funded nostro account is mandatory for the execution of cross-border payments, xRapid sources liquidity from XRP on exchanges across the globe. As a result, the transactions occur in a matter of minutes, saving time on recipients. Cuallix and Mercury FX participated in the pilot of xRrapid’s rollout, and both companies realized “immediate results in speed.”
In 2017, JP Morgan partnered with the Royal Bank of Canada in developing an Interbank Information Network (INN) through a blockchain project that will create a conjointly accessible ledger across banks.
Currently, the network of banks has grown to 365 (those who have signed a letter of intent to join), and they are now able to resolve problems that delayed cross-border payments, such as missing data and compliance checks. As more banks join the network, payment delays will reduce dramatically.
3. Low Transaction Costs
Typically, each intermediary bank charges a SWIFT transaction fee for the service they provide, which is passed to the customer, increasing the transaction cost. Instead of incurring these fees, blockchain eliminates intermediaries, allowing you to pay only a nominal fee or sometimes nil fees.
xRapid is already providing low-cost liquidity to financial institutions responsible for facilitating cross-border payments. Although payments require pre-funded local currency, xRapid can facilitate the process without relying on nostro accounts, thereby lowering the cost of cross-border transactions.
4. Secure Payments
The conventional cross-border payments involve a central authority, such as a bank, for settlement. However, the centralization introduces vulnerabilities such as hacks, which may compromise on users’ data.
Blockchain technology facilitates safe payments by securing all transactions on the network with cryptography. The transactions are then linked with previous transactions and are distributed to all the participants in the network. For a hacker to tamper with any transaction, he/she must alter all the previous ones, which is impossible.
5. SWIFT Responds To Blockchain Technology
SWIFT, a consortium of banks that manages global transactions, is still the dominant payment-processing ecosystem with more than 11,000 banks. Blockchain, through its distributed ledger, has disrupted SWIFT’s operations.
To neutralize the rapid adoption of blockchain in the cross-border payments industry, SWIFT developed a cloud solution called Global Payments Innovation (gpi) to connect all clients in the payment chain. Currently, gpi accounts for more than 55 percent of SWIFT cross-border payments. Half of these transactions are reaching the recipients within minutes, but all of them within 24 hours.
The Global Payments Innovation was devised to protect SWIFT’s monotony in the international payments ecosystem, specifically targeting Ripple’s onslaught of its market share. SWIFT, unlike Ripple, is not a blockchain.
Although Swift plans to rely on common standards, core architecture, and APIs to be a leader in the industry, it is also slowly embracing blockchain technology. The Brussels-based banking behemoth has launched a proof-of-concept (PoC) trial with R3′s Corda platform, which is blockchain-powered, to initiate payments that then go to gpi.
Currently, both Ripple and SWIFT are fiercely competing for the market by trying to woo banks to adopt their technology. However, new market entrants are also trying to foray into the cross-border payments industry, creating vicious competition for market share.
6. The Rise of other Fintech Startups
LightNet, a Stellar-driven blockchain startup in Thailand, has raised $31.2 million in series A funding led by financial behemoths in Southeast Asia to boost cross-border payments. The Fintech startup plans to replace the “inefficient” SWIFT.
LightNet strives to disrupt the global remittance market by focusing on the millions of unbanked remittance workers who depend on the outdated, fragmented, and costly service providers in Southeast Asian.
In conclusion, blockchain technology has many use cases in the banking industry. In the realm of cross-border payments, some financial institutions are working with blockchain providers to give their customers fast, secure, and cheap services. Other financial players have remained hesitant, choosing to revamp their core infrastructure.
However, it is clear that the scale seems to be tipping towards blockchain because most people prefer its transparency, speed, and cost of transactions. Inevitably, banks will have to reevaluate and revamp their payment systems to meet the needs of their customers.