Borderless Flow — The Cross-Border Payments
Have you ever been captivated by a kaleidoscope of stamps from around the world? Each unique image, a tiny portal to a different culture, language, and way of life. Well, guess what? You don’t have to just daydream about it — you can visit those countries!
Curious about how?
Enter the Bridge Builder — the Cross-Border Payments, making those dream destinations a reality!
So, buckle up, globetrotters! We’re about to embark on a whirlwind tour of cross-border payments!
Cross Border Payments
Cross-border payments are transactions where funds move between people, and companies, in different countries. Think of it like sending money to a friend who lives in another country or a company paying for goods from an overseas supplier. These payments usually go through banks or financial institutions, and they often involve converting one currency to another. For example, if you live in the United States and want to buy something from a European seller, you might need to convert your dollars into euros for the payment. Essentially, cross-border payments are any transactions where the sender and recipient are from different countries.
Got the cross-border payment basics down?
Let’s explore the broader perspective!
Types
There are two main categories for cross-border payments, distinguished by who is involved in the transaction:
1. Wholesale Cross-Border Payments
- Involve transactions between financial institutions.
- Facilitate activities for the institutions’ customers (like your international money transfer) or the institutions themselves (borrowing/lending across borders).
- Used by governments and large companies for large transactions related to:
a) Import/export of goods and services.
b) Trading in financial markets (stocks, bonds, etc.)
2. Retail Cross-Border Payments
- Involve transactions between individuals and businesses.
- Can be person-to-person (P2P), person-to-business (P2B), or business-to-business (B2B).
- A common example is remittances, where migrants send money back to their home countries.
Alright!
How exactly do funds make their way across borders? Let’s find out!
Cross-Border Payment Methods
The right method for a cross-border payment depends on factors like amount, speed, currencies involved, and fees. Here’s a breakdown of common methods and their ideal use cases:
1. Wire Transfers: Speedy and Secure for Large Transactions
- Use Case: Ideal for large, urgent payments requiring guaranteed delivery, often used for business transactions or high-value purchases.
2. Credit Cards: Convenience for International Purchases
- Use Case: Perfect for online and in-store purchases from international merchants, offering convenience and global reach.
3. E-wallets: Quick and Easy for Smaller Transfers
- Use Case: Well-suited for frequent, smaller transfers between individuals or for online payments to international businesses.
4. Money Orders: Traditional Option for Unbanked Recipients
- Use Case: Useful for sending funds to someone who doesn’t have a bank account or prefers a physical representation of the money.
5. International ACH (Automated Clearing House):
- Use Case: Suitable for regular, smaller payments between businesses or individuals in countries with established ACH networks.
6. Prepaid Cards: Controlled Spending for International Use
- Use Case: Helpful for managing travel expenses or sending funds to individuals who might not have access to credit cards.
7. Cryptocurrency: Potential for Fast and Low-Cost Transfers (Evolving)
- Use Case: May be suitable for tech-savvy individuals who value fast, potentially low-cost transfers with enhanced security (regulations and acceptance are still evolving).
Ahem!
You get to know how the funds fly across borders, let’s dissect how these payments get from point A to point B across borders!
How do Cross Border Payments Work?
1. Initiation:
- You (the payer) initiate a payment from your bank account (domestic bank) in your country (country A) to a recipient (payee) in another country (country B). This could be through online banking, a mobile app, or even a physical transfer slip.
- You specify the amount, the recipient’s details (name, bank account information), and the currency you want to send (e.g., USD).
2. Information Exchange:
- Your domestic bank sends a secure message containing the payment details to a cross-border payment network. This network acts as a facilitator, connecting financial institutions across borders. Popular networks include SWIFT and others.
3. Currency Conversion:
- The network facilitates a currency conversion which happens at a pre-determined exchange rate.
4. Correspondent Banking:
- The network identifies a correspondent bank in country B that has a relationship with your domestic bank. This correspondent bank acts as a local representative for your domestic bank in country B.
5. Funds Settlement:
- Your domestic bank debits your account for the payment amount (in your currency).
- The network transmits the converted funds (recipient’s currency) to the correspondent bank in country B.
6. Recipient Notification and Credit:
- The correspondent bank in country B receives the funds and credits the recipient’s bank account with the equivalent amount in their local currency.
- The recipient’s bank then notifies the recipient of the incoming payment.
7. Transaction Finalization:
- Once the recipient’s bank credits their account, the transaction is finalized, and you receive confirmation from your domestic bank as well.
Hurray!
We’ve peeked behind the curtain of cross-border payments! Now, let’s crack the code: what’s driving the surge in these international transactions?
The surge in demand for cross-border payments stems from a confluence of factors:
- Technological Advancements
- Regulatory Shifts
- Globalization Effects
- Consumer Demands
- Business Opportunities
- Faster Payment Systems (E.g.: UPI and FedNow)
In simpler terms, a combination of new technologies, a more globalized economy, and the demands from both consumers and businesses are all fuelling the growth of cross-border payments.
Almost there!
We’ve navigated most of the cross-border payment landscape. Now, let’s meet the big fish in this sea!
Cross Border Payment Fees
Even though cross-border payments are popular, they are expensive due to various fees. Here’s a breakdown of the costs involved:
- Bank Fees: These are typically the highest fees associated with cross-border transactions. Banks charge for processing international payments, often more than domestic ones.
- Cross-Border Fees: This is a percentage charged on transactions where a foreign card is used. The exact rate varies depending on the card network and the type of card.
- Currency Exchange: Each country has its currency, necessitating the calculation of exchange rates. While not a direct fee, fluctuations in exchange rates impact the cost of goods and services for consumers and businesses engaged in cross-border transactions.
- Taxes: International transactions can involve various taxes depending on the countries involved. This can include Value Added Tax (VAT) and customs duties, which vary by location.
Key Challenges
- Fragmented and truncated data formats
Inconsistent data formats across different countries and systems make it difficult to automate processes, leading to delays and increased costs.
- Complex processing of compliance checks
Overlapping regulations and checks across jurisdictions can slow down transactions and lead to errors.
- Limited operating hours
Differences in time zones and operating hours of settlement systems can cause delays and increase costs.
- Legacy technology platforms
Outdated technology infrastructure limits automation and real-time processing, hindering efficiency.
- High funding costs
Banks need to hold additional capital to facilitate quick settlements in different currencies, which increases costs.
- Long transaction chains
The use of correspondent banking models leads to longer transaction chains, increasing costs, delays, and potential errors.
In conclusion, cross-border payments play a crucial role in facilitating global economic transactions, fostering international trade, and connecting businesses and individuals across borders.
P.S: What topic do you think we should explore next? Let us know in the comments.
