Cross-Border Payments — Part 2: SWIFT gpi, Innovation and Emerging Tech
How do cross-border payments work? What’s SWIFT? Blockchain for cross-border payments? In my latest two-part series on cross-border payments, I discuss the processes and arrangements involved in such transactions and highlight the role of emerging tech in this sector as well!
Cross-border payments refer to transactions where the two transacting parties are in different countries. In Part 1 of this two-part series, I delved into the processes involved in such transactions, took a deep dive into correspondent banking, its operations and drawbacks. I also introduced SWIFT, the messaging service. In this piece, I’ll cover some of the innovations developed to improve cross-border payments processing.
Just as a refresher, here are some of the major challenges associated with legacy cross-border transactions:
- Low accessibility
- Slow processes
- High cost
- Poor transparency
- Higher chances of failure
- Exchange rate uncertainty
Now, these challenges make cross border payments, well, annoying. To alleviate some of these issues, SWIFT introduced the SWIFT gpi in 2017.
Gpi = Global payment innovation.
Banks subscribing to SWIFT gpi must abide by a set of rules that seek to improve speed and transparency. The following measures are considered by gpi:
- Faster transactions through higher standards for communication between banks
- Greater transparency around fees and timing
- Real-time tracking of transactions through Unique End-to-End Transaction References (UETRs)
- Good maintenance of data records and better fraud prevention
SWIFT gpi has greatly improved cross border transactions. 92% of cross border payments are completed within a day and 40% of those transactions are executed within 30 minutes.
Again it’s imperative to note that all this does is improve the efficiency of information transfer and monitoring. It still operates over the traditional technology of correspondent banking. Further, the system isn’t connected to any underlying settlement process, thus making it hard to detect fraud. Unauthorised SWIFT transactions were a key component of the recent PNB fraud case.
So, if this is still legacy tech, what are the emerging technologies involved in cross border payments?
Fintechs and Innovation
Multiple fintechs have entered this space, disrupting legacy models of cross border payments. Fintechs and neobanks such as TransferWise, Revolut, Saxo, CurrencyFair, WorldRemit, and Traxpay have introduced interesting and efficient models for cross-border payments. Legacy players, not wanting to be left behind, have developed both in-house offerings (Visa B2B Connect) and services in partnership with fintechs (Santander’s partnership with Ripple) leveraging tech such as blockchain. Why SWIFT gpi is also partnering with fintechs to further build on its existing network! While these players employ different methods to improve the legacy model, blockchain technology can revolutionise the space.
Blockchain and Cryptos for Cross-Border Payments
So, how do cryptocurrencies and blockchains help with cross border payments?
Consider a private blockchain system with all the banks present on the network. Suppose you want to send money from your account at Bank A to your friend’s account at Bank B. Bank A creates a record mentioning the time of the transaction, the sending and receiving banks, account details, and the amount to be transferred. Following validation from the member nodes, this will be added to the blockchain and will be visible to all participants. Now, Bank B will see this and initiate proceedings from its end to finalise the transaction.
This Deloitte infographic shows remarkable improvements from the incorporation of blockchain.
There are numerous advantages to incorporating this technology:
- Fraud Prevention: Data stored in distributed ledgers are extremely hard to fudge. Further, any transaction that takes place must first be validated on the blockchain before funds are transferred. These aspects make engaging in fraudulent behaviour nearly impossible.
- Compliance: Precise data management enables better compliance with the myriad of rules and regulations put in place by different entities.
- Lower Fees: Since intermediaries are removed, there is no more stacking up of commissions and fees charged by each such entity.
- High Speed: Payments can be completed in seconds compared to hours or days with legacy methods due to the removal of intermediaries.
- Transparency: Since data on a blockchain is immutable and visible to all participants, there’s high transparency.
- Convenience: There wouldn’t be a need to manage multiple currency accounts if transactions are happening using cryptocurrencies as bridge currencies. One just needs to maintain a single cryptocurrency wallet.
RippleNet payments allow banks to utilize its blockchain network for cross border payments using its XRP tokens as a bridge currency. These tokens can then be converted into the respective fiat currencies. This can help curtail volatility in foreign exchange rates as well as in cryptocurrencies to a great extent.
Now, you may wonder, why not just directly transfer bitcoins to those residing in other countries? Well, while that’s indeed a possibility and one of the intended uses of cryptocurrencies, there are some hurdles to such widespread adoption:
- High volatility of cryptocurrencies: You’re probably aware of the quite literal rollercoaster ride undertaken by bitcoin prices in 2021.
- Lower awareness: Cryptos are a relatively novel concept in the mainstream arena and while awareness is booming, its familiarity is lower compared to traditional banks and services.
- Regulatory uncertainty: Some countries have christened bitcoins as legal tender (El Salvador), some are encouraging research, some are deliberately operating in the grey area while some are cracking down intensely on cryptos (China). Instead, CBDCs seem to be the focus areas for many governments.
- Slow transaction processing on a public blockchain: As of August 2020, the bitcoin network could process ~4 transactions per second. Visa could process 65,000 transactions per second. This is because a large number of nodes slows down performance.
- Two-way FX risk: For a transaction between the US and India, there must be a USD->BTC conversion as well as a BTC->INR conversion, if fiat currency transfer is the underlying goal.
- Cryptocurrencies != credit cards: BTC exchanges require funds to be present in the wallet before the payment/transfer is executed. This can hamper trade finance.
- Environmental considerations: You might be familiar with how cryptocurrency mining is a power guzzler. One Bitcoin transaction takes 1637.97 kWh to complete, which can power an average US household for over 56 days!
Nevertheless, cross-border payment is an area with high potential to solve efficiency issues. Many startups, legacy firms and innovators and working on improving the processes and strides are being taken. With this two-part series, I hope that you’ve gotten a better sense of the underlying mechanism of cross-border transactions.
Stay tuned for more such pieces on business, finance and technology :)