Correspondent banking is an expensive, inefficient, and antiquated system, but it is also the linchpin to today’s global trade, and the cross-border payments that support the global economy. This disjointed system also represents a critical source of revenue for banks, as they serve businesses from small-to-medium sized enterprises up to international corporations. But what is correspondent banking, and what impact does this process have on business payments, competition and innovation in cross-border payments?
What is correspondent banking?
Correspondent banking consists of a complex network of agreements, relationships and directives “…underlying the operational and commercial criteria by which one financial institution carries out transactions on behalf of a counterparty bank, often because it lacks local presence.”
In other words, correspondent banking is a network of banks who have agreed to perform transactions on behalf of their partner banks that are not locally connected. So, when a bank does not operate in a specific country, it builds a relationship with one that does. Of course, it’s not possible for each bank to have relationships in every county. Thus, a bank may need to connect with a bank that is connected with another bank to send money to a specific country.
As this network is a global one, a Canadian bank with no presence or connections in Mongolia can use multiple other banks to slowly (and expensively) send money from one institution to another across the world until the funds reach their final destination. Each bank that touches this money takes a cut, this process can take multiple business days to complete, and ultimately, all of the expense and inconvenience is passed down to the customer.
The cost of doing business
It’s no wonder that banks have tried their best to keep competition out and keep innovation to a minimum. Cross-border payments are an extremely lucrative space, with B2B (Business-to-Business) cross-border payments bringing more than $240 billion in revenue on $135 trillion in payments. According to McKinsey & Company, B2B payments represent 80% of all cross-border payment revenue, of which, banks own a 90% share. Up until now, there has been little innovation in this space, because there has been little need for banks to innovate.
However, times have once again changed. The cumbersome cross-border payment experience has soured the majority of organizations and the large banks’ sluggish pace of change has not made things any better. In fact, more than 70% of corporates are currently willing to consider alternative providers for cross-border payments. There does, however, appear to be immense pressure for banks to improve the correspondent banking system, as both customer expectations change, and new competition find their way into the tricky space.
Businesses shouldn’t settle
Businesses want to know where their money is, in real time, and they want the payment to be data-full─meaning that payments should be sent with mandatory, structured data that enables a simplified reconciliation process. Most importantly, businesses want their solution to be three things: cheaper, faster, and simpler. We at nanopay already see customers demanding a more streamlined and transparent user experience. Why should businesses settle for a cross-border payment that takes 2-5 business days to clear, at a cost of $25-80 per payment, with no visibility for the duration of the transaction? Finally, these problems are beginning to garner the attention they deserve, and that means new entrants in the market.
Is FinTech the answer?
The FinTech (financial technology) industry has set its eye on cross-border transactions as well, with improved cross-border payment products entering the market each year. There is little doubt that, for the foreseeable future, banks will continue to play a critical part in cross-border payments, especially for businesses. However, there is also little doubt that many aspects of this lucrative industry will change.
- Firstly, the current business model is far too costly, which leaves many opportunities for third-party service providers to take a slice of the pie. The number and volume of international payments continue to increase, and between transaction fees and Foreign Exchange (FX) rates, revenue from these transactions are increasing at 6% annually. This number may seem like a good thing for banks, but it’s a high cost for businesses to absorb.
- Secondly, the notion of choice is becoming increasingly important to businesses who send cross-border payments. “No longer will customers settle for a single payment option at a single price”, and nor should they. This is a strong reason why payment technology companies are looking to enter the market. Technology providers, like nanopay, are introducing improved solutions that compete with current options, but at a lower price. For decades, cross-border payments have been a closed platform, where only banks may participate, but that era is over.
Cross-border payments are slowly improving, but the current process is an ingrained part of legacy banking that is unlikely to change overnight. As FinTech firms, like nanopay, continue to innovate, banks must reflect upon whether they should revamp their own business model, exit the correspondent banking space, or partner with FinTechs to offer clients a new and improved cross-border experience. However, one thing is certain, this is a space ripe for change, and we expect that businesses will benefit the most from the innovation. American inventor, Dean Kamen, once said, “Every once in a while, a new technology, an old problem, and a big idea turn into an innovation.” New technologies are being created everyday, and the correspondent banking network is an old problem, thus, there seems to be only one direction left for cross-border payments…forward.