A roadmap to frictionless cross-border payments

Trillions of dollars are sent internationally each year—but the process remains costly and slow. Find out how new technology can streamline these payments.

Katie Llanos-Small is a journalist and the editor of iupana, which features detailed reporting on technology in Latin American financial services.

You can track your Uber driver or pizza delivery in real time. Why can’t you do the same with the money you send abroad?

It may seem unlikely, but it’s true. If you ask your bank how many euros will arrive when you send $100 to Paris, they likely won’t be able to tell you. The process could take days, and on average, you will spend 7% in fees.

For most, this represents a rare inconvenience. But for those who make regular cross-border transfers—people who send money to relatives abroad, companies that export and import goods—it is a major, costly headache. It also represents an opportunity for providers. (article continues below)

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Trillions of dollars are sent internationally every year. Global revenues from cross-border payments come to $200 billion a year, according to McKinsey. When will costs and transaction times come down? When will we be able to track our payments the same way we track an Amazon delivery?

There are many parts to a cross-border transfer, and traditionally, each has been regulated by the governments of at least two countries: small wonder, then, that it has taken so long for this sector of payments to be disrupted by fintech. But change is coming. In order to streamline the process and deliver cross-border payments that are truly frictionless, the following hurdles must be cleared:

  1. Compliance checks
  2. Currency conversion
  3. Payments processing

Let’s walk through a cross-border payment to see how what’s changing—and which areas still need work.

Know your customer.

“Payments compliance” may not be the sexiest words in the English language, but they are critical for banks and other money transfers. Just ask HSBC, who had to pay $1.9 billion as a penalty for money laundering violations.

For that reason, banks run know-your-customer (KYC), anti-money-laundering (AML), and combating the financing of terrorism (CFT) checks every time you put money into your account. It’s the same if you use a cash drop-off location to wire money overseas.

There are many parts to a cross-border transfer, and each is regulated by the governments of at least two countries. Small wonder, then, that it has taken so long for this sector of payments to be disrupted by fintech.

KYC, AML, and CFT involve several steps, but the essence is verifying that you are who you say you are, as well as monitoring for suspicious transactions. For example, a UK bank recently observed that suspiciously high volumes of cash were being deposited in a few of its local branches and then transferred elsewhere. Police followed the money and discovered a highly-organized money laundering operation.

Until recently, compliance checks were one of the slowest parts of cross-border payments; but digital processes are speeding them up. Today, details can be quickly cross-checked against online databases, and a raft of online startups are increasingly offering compliance services.

More can be done. In the future, blockchain and other emerging technologies are likely to improve digital identification and authentication processes, making compliance even smoother. (article continues below)

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Currency conversion.

After compliance checks are complete, the payment is converted from one currency to another. Unfortunately, this is less straightforward than it may sound.

For example, xe.com tells you that your $100 is worth €88.8—but head to the bank, and they might only offer you €87.46. The reason is that the bank or the currency converter is setting themselves a favorable exchange rate and keeping the difference. Once you factor in currency exchange fees, the final amount is often significantly less than that suggested by a commercial exchange rate. Why?

Banks will tell you that it’s a risky business. Currencies (mostly) trade freely in the market, and in the past, trades could take several days. If the market happened to move during your trade, you could end up losing a fair amount of money. Banks account for this risk by hedging—paying to insure themselves against adverse price fluctuations—but that comes at a cost, one they pass along to consumers.

Identifying and innovating through these pain points represents an opportunity for payments providers.

These days, depending on the currency and processor, cross-border payments can take less than a day to clear, reducing the risk of a significant market move. As technology improves and that time continues to come down—to hours or even minutes—the risk will only decrease.

The cost is also high because of a lack of competition: not just anyone can convert between currencies. At a minimum, a payments processor needs an office in each country, a stockpile of other currencies to trade, and (usually) a license.

Still, to many, the cost seems artificially high, and startups are keen to disrupt this slow-to-change corner of financial services.

In Peru, the best foreign exchange (FX) rates are often found with licensed money changers who stand on street corners. Rextie aims to change this. Through extensive automation and digitalization, this startup says they can change currency in an online process that’s many times cheaper than what banks charge—and safer than taking wads of cash out on the road. (article continues below)

diagram courtesy of John Piazza

Follow the money.

Once compliance checks are complete and the payment has been converted to the desired currency, it’s time to send it to the target bank account.

Traditionally, this would have been accomplished through the Society for Worldwide Interbank Financial Telecommunication (SWIFT), a standardized electronic message system for banks. SWIFT is also the main reason why past cross-border payments have been so slow and opaque.

The organization placed heavy emphasis on security and traceability of its system to facilitate payments. Speed and transparency were less of a priority.

Recognizing this problem, SWIFT launched a new system in 2016. The Global Payments Innovation Initiative (gpi) uses upgraded infrastructure to make cross-border transfers faster—in some cases, almost instant—and cheaper. Around half of SWIFT traffic now moves through gpi, which has cut costs and improved transparency for international payments. Still, competitors large and small are biting at its heels.

By reducing friction, lowering costs, and enhancing transparency, payments providers will continue to disrupt and evolve different aspects of the cross-border transfer experience.

You may have heard of TransferWise, which bills itself as a faster and cheaper solution for cross-border payments. They accomplish that by using a float of cash in each country to manage peer-to-peer (P2P) transfers. Rather than send the money through SWIFT or gpi, Transferwise holds onto your $100 in San Francisco and gives it to the recipient of another transaction. Meanwhile, they take the €88 that someone else is sending from Paris and direct it to your recipient.

Flywire helps companies get paid by people in other countries. Say that you are a university that needs to accept payments from international students. Flywire integrates with your website and processes your cross-border payments with the goal of making them feel just like local ones—for both senders and receivers.

Ultimately, improvements in cross-border payments will be driven by such large-scale competition. As more startups like Transferwise and Flywire target specific areas of the industry, the frictionless service, lower costs, and tracking capabilities they offer are likely to become the industry standard.

Crypto to the rescue.

New technology, notably blockchain and cryptocurrency, also has the potential to disrupt the cross-border payments industry.

Since they were created, cryptocurrencies have been viewed with suspicion or outright hostility by the financial establishment. Banks have made efforts to distance themselves from Bitcoin, with its sharp price volatility and claims of anonymity. But cross-border payments may change that. In fact, cryptocurrencies may find their first widespread use case in this sector.

In this case, the virtue of crypto is that it exists irrespective of borders, a currency without a country attached. So instead of sending dollars through SWIFT or gpi, you could purchase Ethereum and transfer it to your friend in Paris. She could then sell it for euros.

Ultimately, improvements in cross-border payments will be driven by such large-scale competition. As more startups like Transferwise and Flywire target specific areas of the industry, the frictionless service, lower costs, and tracking capabilities they offer are likely to become the industry standard.

The Ethereum payment could be accomplished in a matter of minutes; it’s fully traceable and transparent; and the fees are often significantly lower than traditional methods.

Nor is it limited to P2P. RippleNet offers a blockchain-based platform that banks can use to facilitate cross-border payments for their clients: Santander and MUFG are among their most prominent customers.

A new entrant backed by IBM, the Blockchain World Wire, offers a similar service and boasts Banco Bradesco, Bank Busan, and Rizal Commercial Banking Corporation (RCBC) among its top clients.

If cryptocurrencies are to become a preferred medium for cross-border payments, they will have to achieve wider adoption and overcome the challenge of price volatility. But with major banks on board and live use cases, the technology shows promise to help drive frictionless global payments.

The road ahead.

What would a truly frictionless cross-border payment experience be like?

I imagine it would be a bit like using Whatsapp. Select the bank account you want to use, enter the payment amount, confirm it, and send $200 to your friend in Paris. Two blue check marks, and your cash has landed. We’re not there yet, but increasingly it looks like a “when,” not an “if.”

Today, the process of making an international payment remains rife with friction, hidden costs, and inefficiencies. Just one example from a recent study by Visa: because cross-border payments are currently so difficult and expensive, consumers tend to make fewer of them than they would like, and only in larger amounts.

Identifying and innovating through those pain points represents an opportunity for payments providers old and new. By reducing friction, lowering costs, and enhancing transparency, they will continue to disrupt and evolve different aspects of the cross-border payments experience.

Katie Llanos-Small is a journalist and the editor of iupana, which features detailed reporting on technology in Latin American financial services.

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