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There is probably a widespread consensus that cross-border payments need to be reformed but there is less agreement on whether such an overhaul should take place through transformative changes to the existing infrastructure or a whole new technology.
The modernisation of cross-border payments has become a hot topic in recent years, with both private and public sector participants looking for ways to improve it.
“A new era in cross-border payments is coming and it is coming fast,” Clive Horwood, managing editor at OMFIF, said in a report published on December 14. OMFIF, the Official Monetary and Financial Institutions Forum, is an independent forum for central banking, economic policy and public investment.
This reform could take place through “a great leap forward” in the adoption of digital currencies, tokenisation and blockchain technology, something OMFIF calls a revolution, or via evolution, the transformative upgrading of existing infrastructure.
Addressing the pain points in the system
Regardless of whether it will be an evolution or a revolution, there are various challenges that a new cross-border payment system must address.
Current cross-border payments run through a chain of correspondent banks which often leads to high costs and a lack of transparency over the status of individual payments. There may be various discrepancies between different banks in the correspondent banking network and inefficiencies resulting from repeated efforts, for example, to comply with anti-money laundering or financial crime regulations within the payments chain.
Searching for new solutions to address inefficiencies in traditional cross-border payments, Oliver Wyman and J.P. Morgan found that global corporates spent $120bn on cross-border transaction fees in 2020, with an average cost of $27 per transaction. At the same time, the average settlement time for cross-border transactions was two to three days. By removing correspondent banks from the payment cycle, multi-central bank digital currency (mCBDC) solutions could reduce the cross-border transaction revenue by around 80 percent.
There are also concerns related to remittances. Currently, there are around 200m people across 40 countries who transfer money home to 800m people in 125 countries. Although these remittances represent a small portion of the overall cross-border transactions, OMFIF estimates that half of the total value of remittances is sent to rural areas, where much of the population is poor and often unbanked.
In 2020, people sent remittances worth $540bn to low- and middle-income countries. Although these are typically low-value payments, the proportionate cost is much higher, which creates a clear use case for cost reduction.
“With remittances, you get all the inherent difficulties of cross-border plus all the difficulties potentially with financial inclusion, and then they multiply,” Henry Holden, advisor at the BIS Innovation Hub, explained at an OMFIF event discussing the future of cross-border payments.
There is not enough competition for these services and there is a “weird dichotomy” with cross-border transactions. There is correspondent banking on one hand, and de-risking on the other hand, Holden went on. “It is like the Woody Allen joke: There is not enough of it and it is rubbish.”
Meanwhile, remittances are increasingly getting digital, Rajiv Garodia, global head of government solutions at Visa, pointed out. Although it is a welcome trend, as in general digital enablement reduces costs, if a remittance payment, initiated online or in a mobile app, ends in a cash transaction on the receiving end, it increases costs and causes inconvenience.
“This is where I think the governments could play a stronger role,” Garodia said. They should encourage people to have bank accounts, open mobile wallets, and build up an ecosystem that enables consumers to spend their money using these services. If consumers cannot pay for purchases at merchants or pay their bills digital, “you cannot have a remittance going end-to-end digital”, Garodia added.
Evolution or revolution?
Some may argue that there is no need for blockchain or CBDCs to make cross-border payments more efficient. Despite a number of pain points to address, global banks can already move money across borders with relative ease. There should be a compelling use case for a wholesale CBDC before central banks create a global network of blockchain systems.
One of these use cases could be the reduction of foreign exchange (FX) settlement risk, which is the risk of loss when a bank in a foreign exchange transaction pays the currency it sold but does not receive the currency it bought.
There are already initiatives in the private sector to eliminate this risk. For instance, the Continuous Linked Settlement (CLS) uses a "payment versus payment" method, which provides a simultaneous exchange of currency values through CLS Bank International.
Although CLS is very successful, it covers only a certain number of currencies and raises a financial stability issue. As foreign currencies are growing bigger, there is a need for settlement protection that creates an important use case for a wholesale CBDC.
“There is a potential to implement new infrastructure with CBDCs and in the wholesale space, it does matter. It matters what kind of money you have got,” Holden said, adding that “you need central bank money in systemically important markets”.
Similarly, when it comes to retail CBDCs, choice and competition help drive innovation, lead to better products and lower prices.
There is a good infrastructure that multinational big banks can use easily to transfer money abroad, but a retail CBDC could help financial services disruptors and new innovative service providers to enter the market, according to Holden.
“That is what central banks are doing. It is like a foundational layer. There is safe money, and they are trying to offer it in such a way that businesses can drive new efficiencies.”
There are various ways to bring about a global cross-border payments system fit for the digital age. Whether it will be an evolution or revolution it remains to be seen. At the moment, there are initiatives and experiments taking place in both spaces and OMFIF says “the likelihood is that these two paths will run together”.
