In this series, we are going to be taking a close look at the current state of cross-border payments. In this first installment, we consider how the growth of cross-border commerce and globalization has changed payments forever. In the posts that will follow, we will be looking at some of the biggest challenges that hinder cross-border payments, and how these effect businesses, the global economy, and growth. The purpose of these blogs is to identify the solutions to these challenges, and show how payments is well-positioned to solve many of the unmet needs.
There is an exciting new piece of technology that has been rumored for a long time, and is now finally just appearing on the horizon. The long-awaited Apple Watch will be on sale come April 24th this year – in a few select countries. If you’re lucky enough to be living in the US, UK, Australia, Canada, China, France, Germany, Hong Kong, or Japan, and have from $349 to $10,000 in your back pocket, then, come that fated day, you will be able to pop down to your local Apple Store and buy one immediately (while stocks last, of course).
However, if you’re an Apple aficionado living outside of those nine countries mentioned above, then, you’re either going to have to wait for it to become available where you are, or get online and order one for yourself from abroad, so that you get it without too much wait.
And the good news is that e-commerce is now at a point where this has never been easier.
It’s a Small World After All
In short, e-commerce has made our business world smaller and tighter than ever before. Whether it’s consumer goods like the latest offerings from Apple, large shipments, or even outsourcing labor and expertise, when it comes to the world of electronic commerce, everything is there for us at the touch of a button.
Trading online has broken down barriers for the international exchange of both physical and digital goods. Cross-border e-commerce – which, put simply, refers to consumers buying online from merchants that are located in other countries – is now achievable for even the smallest of businesses, which can now expand rapidly on an international level, making the potential for growth almost endless.
However, one of the key drivers for success in such expansion is, of course, payments – and in particular, faster, safer, smarter payments that provide transparency throughout the process, and keep costs to a minimum. Payments is the “last mile,” the last obstacle for cross-border e-commerce, for which solutions must be provided in order for the true value of such trade to be released throughout the economy. While cross-border commerce is providing much more choice for the consumer and business efficiencies for merchants, there are real issues when it comes to doing business abroad in an efficient and affordable manner.
The Enormous Growth of Payments
Let’s take a look at some numbers here. As reported by The Boston Consulting Group, payments and transaction-banking businesses generated $301 billion in transaction-specific revenues, as well as $223 billion in account-related revenues. When combined, the $524 billion total represents roughly one-quarter of global-banking revenues for the year. And these figures are only set to rise – by 2022, it is predicted that payments and transaction-banking revenues will reach $1.1 trillion.
In terms of specifically cross-border payments, the projected compound annual growth rate (CAGR) matches the overall growth of payments precisely, at 8% between 2012 and 2022. There has been an unprecedented rise in global trade flows, and, as such, the demand for cross-border payments services has risen accordingly.
Figure 1: The volume and value of Cross-Border Payments Transactions are growing steadily (Source)
While cross-border payments are still a fraction of the total payments market today, they are increasing at a much faster pace than domestic payments. Let’s examine the various types of cross-border payments today.
Cross-Border Payments Categories
Figure 2: Four Major Categories of Cross-Border Payments (Source)
A. B2B Payments. These payments are made simply when one business enterprise pays another for a supply of goods or services. Typically, the supplier will extend credit to the buyer in these transactions, or otherwise acquire another form of credit assurance, as in Supply Chain Finance.
B. eCommerce. This includes the purchases of physical goods (with costs of shipping, customs, and taxation included) as well as any digital goods, services or domains, and entertainment and travel purchases.
C. Benefits, Payroll, and Retirement Payments. Enterprises sometimes make these types of payments to counterparties in other countries. The payees are normally individuals, though sometimes this category will include B2B-like payments to franchise participants, licensees, and digital contract laborers.
D. International Remittances. These payments are made by foreign workers to their families back home.
These four categories of cross-border payments may all have different purposes at their core, but the functions for completion are actually quite similar. So, let’s now take a look at how cross-border payments work.
How Cross-Border Payments Work
Cross-border payments are complex in nature. This is because national payments systems do not usually support direct participation by foreign banks. This means that every single non-cash cross-border payment transaction must be handled via international corresponding banking networks of some sort or another.
International Correspondent Banking
Given that there are only a handful of truly global banks in the world today, financial institutions will often need a ‘correspondent bank’ that is situated in the foreign country, which provides services on its behalf. The correspondent bank can conduct business transactions, gather documents, accept deposits, etc., on behalf of the domestic financial institution. They essentially work as a domestic bank’s agent abroad.
The reason for this is because the domestic bank will normally have only limited access to foreign financial markets, and will not be able to service its client’s accounts without opening up a branch in that country. Each bank will be making an independent decision about how to send, receive, and settle payments – this results in a staggering amount of variations and combinations of payments between foreign and domestic banks.
Complex indeed. And this is just one of the many challenges that faces cross-border payments today. We will be looking in closer detail at more of these challenges in Part 2 of this Cross-Border Payments series, which will be coming shortly.