Technology Advancements in Cross-Border Transactions

Once upon a time, in the 90s, my father was working in the Merchant Navy. He would spend months at sea, travelling to different parts of the world. It also meant that he had to be away from his family for long periods of time.

To support us, he would send money to his non-resident bank account in India every month. My mother would then go to the bank and collect the funds based on the exchange rate for that day. This process would take around 7-14 days, and it was not always smooth sailing. Sometimes, the money would get delayed, or the exchange rate would be unfavorable.

Growing up, I saw how reliant our family was on the money sent by my father. It paid for our education, our food, and our shelter. But I also saw how difficult it was for him to send the money. He had to go through a painful, opaque, and expensive process to transfer the funds across borders.

This experience gave me an eye-opening understanding of cross-border remittances. I realized that many families like ours depended on these transfers to survive and that the process was often a cumbersome and frustrating one.

Fast forward to 2022, and I found myself travelling to India. This time, I decided to use a service provider through a platform to transfer money to my family. While the process was faster than what my father had to go through, I was shocked to see how quickly money reached my family. Importantly, as a technologist, this also helped me to realize and understand the potential global advancements that are happening in the area of cross-border transactions.

Through this article I would like to share some of those advancements that are changing the landscape of cross-border transactions.

Let’s start with how these transactions work. Cross-border transactions are payment transactions between people or businesses that are located in different countries. For example, Payer A is in the United States using Bank A. Payer A wants to transfer US$ 1000 to Payee B who is residing in Japan and using Bank B which is in Japan. Normally, in this case, Payer A will choose a service provider or a local American bank to initiate the payment. Payer A provides all the details of the payee including the payee's bank account number, the reason for the transaction, the exchange rate at which they want to transfer the amount, and chooses the available days (normally 1-2 days if its fast delivery or 5-7 days for regular delivery) in which Payee B will receive the amount.

At a high-level image 1 illustrates the payment message link between Bank A and Bank B.

Image 1- Source: Bank Of England https://www.bankofengland.co.uk/payment-and-settlement/cross-border-payments

Now assume that Bank A used by Payer A has no direct link with Bank B used by Payee B. This challenge is currently resolved by linking each bank through a correspondent banking network (CBN) which acts as an intermediary between these banks in different countries(Image 2).

Image 2- Source: Bank Of England https://www.bankofengland.co.uk/payment-and-settlement/cross-border-payments

Again assume that the primary correspondent bank is adding additional correspondent banks/intermediaries to link to Bank B (Image 3).

Image 3- Source: Bank Of England https://www.bankofengland.co.uk/payment-and-settlement/cross-border-payments

The more the number of corresponding banks, the longer the transaction chain and the more challenging the cross-border network becomes. Cross-border payments are more complex than any regular domestic transaction. They involve more and in some cases numerous, intermediaries, time zones, jurisdictions, currency exchanges, and regulations.

The scale of this industry is an indicator of the essential role remittance plays in our economy and society. As per recent prediction- The value of cross-border payments is estimated to increase from almost $150 trillion in 2017 to over $250 trillion by 2027, equating to a rise of over $100 trillion in just 10 years. Source: cross border payments https://www.bcg.com/industries/financial-institutions/transaction-banking

So what are some of the challenges currently the industry is facing?

The challenges and friction within this industry were brought to attention during the Global 20(G20) Summit and some of them were prominent for the industry and existed over several decades. In the stage 1 report published in April 2020 by Financial Stability Board, 4 major challenges were identified as -high costs, low speed, limited access, and insufficient transparency. The friction that contributes to those challenges includes - fragmented data standards or lack of interoperability, complexities in meeting compliance requirements including *AML/CFT and data protection purposes, different operating hours across time zones and outdated legacy technology platforms. Additionally, the friction increases the need for intermediaries involved in cross-border payments to hold precautionary funding-often in multiple currencies.

Source: CPMI based on FSB 2020b https://www.fsb.org/wp-content/uploads/P131020-1.pdf

A shift in the landscape since 2020….

During G20 Summit, a high-level roadmap was developed by the financial stability Board FSB, in coordination with the committee on payments and finance market Infrastructure and other relevant international organizations and standard-setting bodies. The overall goal of it was to address the key challenges faced by cross-border payments and identify the major triggers/friction in the existing landscape. This direction has opened further discussions and added a new agenda for every G20 country in achieving and building faster, cheaper, more transparent, and more inclusive cross-border payment services while maintaining their safety and security which in the long term supports economic growth, international trade, global development, and financial inclusion.

Over the past two years, significant progress has been made in the advancements of this area, paving the way for new opportunities, and indicating a strong potential for continued rapid growth in the years ahead.

What advancements are occurring in this area and how is it evolving?

1. APIs Enable Real-Time Exchange Rates: One of the best strategies for optimizing the cross-currency workflow without disrupting the existing platform operations is by using APIs- Application Programming Interface. Over the past decade or so the advancements and enhancements through API-based frameworks are radically visible within the banking industry. The advantage of having an API-based model is that it is multi-folded. It can bring real-time visibility in FX(Exchange) rates directly from the existing systems, it can accelerate reconciliation due to having FX rates earlier in the process, and it can also give the flexibility to lock in FX rates for predetermined periods of time. Service providers such as Remitly, TransferWise, and other fintech companies are leveraging these capabilities today. The progress made in this single area has had a big impact in driving more scalable and innovative solutions within the ecosystem in the past few years and will continue to have a major positive impact. This also helps to create transparent, and more inclusive cross-border payment services where the customers are getting more value.

2. Data Standards Advancement- In today's world, data plays a vital role in solving various challenges. However, the current data standard ISO 8583, which is used for cross-border platforms, comes with limitations that need to be understood. The broken and rigid data format, can lead to more challenges and constraints in the way backend systems handle these data elements with less flexibility.

To overcome these challenges, it is essential to adopt newer standards such as ISO 20022, which supports XML language. The benefit of using ISO 20022 is that it allows for a granular breakdown of data, making it easier to analyze and understand. Additionally, it allows for the reusability of stack, making it more flexible and adaptable to various systems.

It is crucial to understand that data is the key to solving the challenges we face today and adopting newer standards such as ISO 20022 is integral to achieving this goal. By doing so, we can ensure that our backend systems are more efficient and effective in handling data, which is essential in building a fast, secure, and reliable service.

3. Government Initiated Innovation: Personally, I believe this has the highest impact on building a zero-cost and real-time transaction model. This is where the government is directly involved in the market-in building the tech stack, integrations with other technologies and driving the strategy at a global scale. This gives a clear vision of the scalability, agility, and interoperability of these Infrastructure stacks at a global scale.

2 months ago India (through UPI stack) and Singapore (PayNow) entered into one such cross-border partnership. UPI, a seven-year-old payments infrastructure developed by a coalition of retail banks, has become the most popular way Indians transact online. Singapore’s PayNow also offers interoperability between banks and payment apps in the nation, allowing users from one payment app to make transactions with those on other apps. The PayNow-UPI linkage is India’s first cross-border, real-time system linkage and Singapore’s second. It’s also the world’s first such linkage feature that is fully cloud-based.

Image Source:https://www.mas.gov.sg/-/media/mas/news/media- releases/2023/infographic_paynow-upi-linkage.pdf

4. Partnerships, Blockchain Create Instant Payments

Blockchain, or distributed ledger technology, is a game-changer move in cross-border payment transactions. Here, the centralized authority is replaced by a decentralized network. A group of nodes validates the monetary transaction. In a blockchain network, a transaction gets completed in real time due to fewer negotiators. Mainstream financial companies have already started using blockchain to pilot transactions. In 2018, Banco Santander a banking giant serving 140 M+ customers worldwide, partnered with Ripple to launch One Pay FX, a blockchain mobile app for cross-border payments. With the help of blockchain, Banco Santander managed to reduce the processing time for international bank transfers from 3-5 days to seconds and substantially decrease the fees for cross-border transactions(https://ripple.com/insights/santander-partners-with-ripple-to-bring-certainty-and-speed-to-international-payments/).

The key transaction parts are the gateway and the customer with no banking institution in between. A person in Japan can send money to Italy using an on-ramp service provider. The provider converts the fiat money into cryptocurrency which can be kept in any crypto wallet. One can choose a cryptocurrency and open an account and then initiate a transfer from a bank or a credit card. Finally, one needs a receiver’s wallet address to send the amount. Once the cryptocurrency reaches the receiver’s wallet, he/she can convert it into fiat money.

In conclusion, staying informed about the latest developments in cross-border transactions is crucial for individuals and businesses looking to thrive in the global economy. By embracing the advancements in technology, we can ensure that money flows seamlessly across borders, enabling greater financial stability and prosperity for all.