Blog· min January 18, 2023
Improving access to international payments has been high on the agenda for governments, central banks and financial institutions for a number of years. As financial services become embedded within an increasingly digital economy, the pressure to build and provide resilient access to fast, secure and affordable international payments has soared.
The sector is experiencing monumental growth. McKinsey’s 2021 Global Payments Report predicts that by 2025 we will be seeing global payments revenue hit roughly $2.5 trillion – a significant increase on 2020’s $1.9 trillion.
Citing four key areas of speed, transparency, access, and cost, the Financial Stability Board’s G20 Roadmap for Enhancing Cross-Border Payments underscores the fundamental need for the private and public sector to come together to improve cross-border payments.
Such ongoing coordinated efforts across the globe to improve international payments highlight a significant opportunity for younger, more agile digital banks, payment service providers and fintechs to carve out a piece of this highly competitive, tightly held industry. Regulated change also signals supervisors’ receptiveness to new market entrants, opening the door to companies which are unencumbered by legacy technology and can allow their innovative products and services to drive evolution across the industry – winning market share all the while.
To make the most of this rare and significant opportunity, firms must ensure their offering is ready and equipped to cater to the technical, regulatory and market-driven pressures to set themselves apart from incumbents, and stake their claim of this booming global ecosystem.
In order to understand how we can best go about improving international payments, it is important to highlight the principles which currently allow real-time domestic systems to run without downtime on a 24/7/365 model. By adopting some of these foundational principles, international payments will be better placed to evolve to a state which is more aligned with the expectations of today’s financial services sector, as they mirror core features of domestic instant payments.
Migrating to cloud-based systems is a key element of any such evolution, with multi-cloud options giving financial institutions the ability to achieve a truly ‘active active active’ calibre of operation. Rather than adopting a single cloud strategy or relying on disaster recovery sites which would require significant downtime in order to make updates across the system, the availability of multi-cloud solutions ensures that banks aren’t put at a disadvantage when upgrading or maintaining their services. This is particularly vital when running microservices architecture where banks are afforded the ability to leverage more real-time processing.
Beyond reduction or elimination of downtime, cloud offers a plethora of other advantages which will be explored later on.
Extrapolating the differences between international and domestic payments can then be examined with respect to clearing and settlement systems, and how we go about shaping a more deeply connected landscape across borders. By lobbying in favour of 24/7 RTGS systems and overcoming the challenge of exercised control in a given jurisdiction by a central bank, we hope to see an operating model that allows for instant clearing and settlement.
A clear example where such progress has been made, can be seen with the announcement that EBA Clearing, Swift and The Clearing House (TCH) will launch the Immediate Cross Border Payments (IXB) pilot to leverage the existing real-time payment systems in the United States, (run by TCH), and RT1 in Europe, (run by EBA CLEARING). The corridor will process live transactions in both US dollar and Euro in the coming months, providing the highly anticipated linkage of these two domestic payment systems with cross-border legs.
The ability to utilise payments originated overseas and execute clearing in real-time domestic systems would revolutionise financial services, which has long laboured under outdated correspondent banking models, which are increasingly unsuitable for the demands of international banking and the movement of money.
Under such infrastructure, lower value cross border payments will also be able be cleared in real time.
While there is a significant amount of remaining work in order to get to 24/7/365 real-time cross-border processing, there are some good steps underway. The migration toward the common data language of ISO 20022 for instance, will open the door for system interoperability – an essential quality that must be achieved for seamless international payments.
We are currently experiencing what can only be described as a ‘perfect storm’ of forces, working to propel international payments to the top of the financial services agenda.
First, as consumers are given greater access and tailored services in their everyday lives, the push to bring this same level of innovation into the corporate space is becoming increasingly apparent. Corporate treasurers, for instance, face the frustrating reality of experiencing real-time services in their personal lives, yet, have to endure the reality of slow, clunky payments in their line of work.
Covid-19 lit a fire under an already highly digital and highly demanding Gen Z and younger generations, which no longer accept anything but instant. They can do this thanks to a highly competitive market that allows them to switch to superior (and faster) providers.
Underscoring the pressures of customer expectation, international supervisory and regulatory bodies are more regularly acknowledging the shift toward global expectations, and the ways in which international connectivity must be improved to avoid fragmentation and nurture progress. The G20 and Financial Stability Board’s work on the subject is a frequently cited example. It’s 2021 Roadmap for cross-border payments states that not only is the enhancement of cross-border payments a priority, but that there is a need to coordinate on regulatory, supervisory and oversight frameworks.
This push from regulators can also be seen by recent news that the European Commission is preparing rules to require eurozone banks to offer instant payments in euros, in efforts to develop “competitive home-grown and pan-European market-based payments solutions.”
Migration toward the data rich ISO 20022 messaging standard represents another vast transition for the industry, which is being played out across both domestic and international services. By 2025 the high value payment systems of all major reserve currencies will have moved to ISO 20022. At a high level, ISO 20022 will improve customer experience, improve AML and compliance, bring more efficiency and harmonising the payments ecosystem, will work to encourage the creation of new services.
In addition to these pressures, liquidity management remains a core driver toward innovation for banks seeking to optimise their operations. Currently, banks are forced to park significant sums of capital in nostro accounts to cover the cost of international transactions. This is both because of the slow pace at which these transactions take, and the lack of traceability around them.
Moving toward a model with predictable forecasting around future needs, allows banks to better prepare themselves by optimising that held capital. It is also less onerous for banks to hold and park capital.
This combination of factors is resulting in the opening up of a once tightly controlled industry that was sluggish and resistant to change. Innovation is being pushed to the fore, allowing the industry to flourish and find invigoration through new operating models and positive competitive pressures.
The way banks and other financial institutions are approaching the de-risking of certain entity types has diverged into two key categories; actual risk and perceived risk.
Where a bank is processing funds which are deemed to be high risk, typically with emerging economies, it must consider whether it has sufficient KYC processes and controls in place to ensure their network is protected. They must also consider whether they can segregate funds which are going to high risk countries.
In such situations correspondent banks assess whether the risk of providing the service outweighs the revenue and its viability. This cost implication presents a continued challenge for smaller institutions, as it can result in increased segregation and financial exclusion from specific markets, pushing these communities further into unsecure, unregulated networks (like crypto for instance).
This is where smaller institutions also face the challenge of reducing or removing the perceived risk that they may not be as safe or secure as large banks – which have been working in the space for decades.
Conversely, this also means that the sector has the opportunity to develop innovative financial crime solutions which help financial institutions demonstrate that they are adhering to the highest level of standards available. Such a scenario may in fact present a particularly attractive option for smaller institutions, as their technology agility makes for a less complex integration.
We need to consider how we can collaborate with firms to build-in pre-integrated solutions that are both best of breed and help these communities remain bankable.
Accessing international payments can be challenging due to a suite of challenges faced by incumbents as they try to compete with digitally native or transformed firms for a highly demanding market.
Building a correspondent network to give customers the ability to process multiple currencies through nostro relationships is a hugely valuable and increasingly indispensable asset for financial institutions. However, this network based capability requires many accounts to be held at many institutions, coming in at a high cost.
This lack or reduction in access to liquidity presents a particularly acute challenge for smaller institutions, like neo and challenger banks, which operate on extremely tight margins and rely on liquid capital for operational costs.
Legacy technology also remains a significant impediment for progress around improving international payments. As core engines for these institutions were likely installed decades ago and are deeply embedded, they are ensconced in layers of connective technology from across the years. Most new technologies are cloud-native APIs which often do not integrate efficiently with the core engine. As a result, banks add wrappers and band aids around the outdated system to connect new features.
When a core banking system or process requires updating, the entire infrastructure has to come down, and any change can impact a whole raft of other applications across the bank. This presents both a challenge and an opportunity for agile technology delivery, to migrate to cloud native core banking systems, reengineer or re-platform those core systems to enable a seamless future delivery.
While smaller, more agile players can hold the upper hand to pivot and take advantage of progress, they must also meet stringent security and compliance requirements that are resource heavy and costly.
Traditional forms of file security, such as secure file transfer protocol (SFTP), are no longer viewed as secure as certain approaches to API-based security. When considering the transfer of information files over a given network, files-at-rest attract a greater risk profile than in-transit API messages. It is more difficult intercept files in transit, and even if an in-transit API call was intercepted, it should be encrypted and unable to be read.
Agile players have the ability to leverage new compliance focused technologies which serves to both showcase adherence and give comfort to banks.
While just four or five years ago, central banks and other regulatory bodies were not comfortable with their view of the risk profile of cloud, today, we’re seeing a greater level of awareness around what cloud can deliver and the resilience they engender.
Cloud undeniably offers a huge benefit for firms, by reducing barriers to access, building resiliency, and offering scale to financial institutions, without having to completely re-architect in the short-to-medium term. This reduces costs to firms and allows flexibility to pivot as new opportunities arise in the market. In fact, recent research from GFT found that 81% of bankers adopted cloud technology to cut costs tied to data storage.
The Bank of England published a discussion paper in July, setting out how supervisory authorities in the UK could use proposed powers to assess and strengthen the resilience of services provided by ‘critical third parties’ – cloud service providers (CSPs) would fall into this category. The Paper explains that firms are becoming increasingly dependent on certain third parties such as CSPs for the delivery of functions and services that are vital to the stability to and confidence in the UK financial system.
The Financial Stability Institute of the Bank for International Settlements (BIS) further explains: “Growing reliance by a large number of financial institutions on technology services provided by a small number of big techs makes the continuity of those services systemically relevant. This dependency is forming single points of failure, and hence creating new forms of concentration risk at the technology services level. This type of concentration risk is particularly evident in the cloud services market, where four big techs control close to two thirds of the global market for cloud computing. Because there are no readily available substitutes or infrastructures for these services, a disruption in one of these big techs could have systemic implications for the financial system.”
While initial concern around cloud usage has significantly reduced, questions around resilience and the operational risk that comes with migrating off-prem persists. While its very unlikely that an AWS or an Azure would lose all of its availability zones, it’s a scenario that central banks are examining. Multi-cloud strategy, in addition to agnostic tooling, allows financial institutions to have certainty and control over the resilience of their failover plans.
Banks would no doubt be able to build a data centre quite cheaply, but it does not afford them the resiliency that comes with multi-cloud functionality.
Cloud offers global scaling without requiring physical presence in every jurisdiction. While there are some caveats to this expansion, for the most part it allows institutions to pick their markets and scale based on a number of factors beyond market size. Therefore, working with providers that understand the jurisdiction and have the local resource to grow the physical footprint is a significant benefit.
Despite these monumental industry updates, trends, and pressures, technology providers are providing increasingly sophisticated and customisable solutions which help institutions meet these challenges head on.
A shift in preference away from managing a portfolio of technology providers toward selecting and working with fewer, more holistic and well-resourced providers, underscores the desire of financial institutions to refine and streamline their offering. This reduces challenges around third party management, security frameworks and commercial dynamics. Banks are also more inclined to work more closely with fewer providers as they can collaborate more intimately and better shape products to suit their own needs.
Providers which can deliver managed services, microservice architectures and remove the burden of responsibility from the bank will be those that succeed in these partnerships. This is especially the case with fintech, where relationships are reciprocal and collaborative. Financial institutions which recognise the opportunity that this collaboration can bring, will be better equipped to deal with ongoing and future pressures that will inevitably shape the payments landscape in the coming years.