Cross-border payments services offer immense benefits to worldwide business operations. Rapid systems for money transfers increase the mobility of goods and services, giving retailers access to global markets that can boost overall economic activity. It is no surprise that the value of cross-border payment flows is expected to reach $156 trillion in 2022.
While simple methods for exchanging money between countries encourage global product output, the entire system is unrefined, and at times, quite complicated. Users often speak of difficulties with sending money abroad, and there are still several barriers that prevent equal remittances between countries. The market is ripe for disruption that could help create a usable and inclusive system.
Read on to learn all you need to know about cross-border payments, how they work, challenges to sending global payments, and payment process flows that can help you transfer money.
Table of Contents
- What are cross-border payments & remittances?
- How do cross-border payments work?
- Cross-border payment process flow
- What are the biggest cross border payment challenges
- How much does it cost to send cross-border payments?
- Best cross-border payment services
What are cross-border payments & remittances?
Cross-border payments are money transfers initiated between institutions located in different countries or jurisdictions. At the business level, this involves activities such as currency exchange trading, investing in global assets, and debt and equity market access within foreign countries. To supply capital for such operations, organizations rely on cross-border payment systems to transfer funds into different banking systems and currencies.
A remittance follows the same payment process as a cross-border transfer, though it refers more to transactions sent and received by individuals rather than financial institutions. People will use the standard banks and transfer services such as wire payments, e-transfers, and money orders to make small global payments. Commonly, such transactions occur between families who live in separate home countries or from long-term travelers who make purchases outside of their home countries currency.
In both cases, the cross-border payment system helps collect and transfer money according to the different rules and regulations of the sender and recipient countries. As a result, supply chains can globalize, investment activity grows, and international trade supports better worldwide economic conditions.
How do cross-border payments work?
Cross-border payments help build relationships between closed financial services loops. Most banks operate on individual systems that are not compatible with foreign transfer methods, making transactions between different countries complex. Moreover, each country has its own set of compliance laws that require navigation, and there is also the direct act of exchanging separate currencies, which complicates forex markets. Cross-border payments attempt to bridge between such isolated systems.
At its simplest, some banks have an international presence that makes bank-to-bank transfers easy to execute. An institution that owns Canadian and American banks branches an equal supply of CAD and USD currency can facilitate cross-border transfers with relative ease.
But if an institution does not have a global presence, it will need to use correspondence banks or intermediaries who have the ability to route transactions to the correct country. Payment flows through an intermediary are known as payment corridors. Of course, the longer a payment corridor, the more complex the system and the more fees.
As payment corridors started to expand, entire networks of correspondence banks developed that helped send and transfer money supply between countries. Forex trading price swings result from the actions made by correspondence networks as the supply of a particular currency adjusts based on demand. The entire industry of cross-border banking occurs through the payment corridors built between financial institutions and correspondence networks.
Cross-border payment process flow
There are several different players involved in the payment process system. Each institution helps initiate different cross-border transfer types.
Bank channels are the direct methods of access a consumer uses to interact with a financial institution, including ATMs, online services, and branches. A banking channel is a primary source for most remittances, whether that involves currency exchanges through a foreign ATM or a direct e-transfer between institutions. Many large-scale banks have interlinked banking channels to other worldwide financial services, helping facilitate a large majority of simple cross-border payment flows.
Money Transfer Operators
Money Transfer Operators (MTOs) are secondary transfer companies designed to facilitate payment transactions. MTO agents have a separate network for currency transfers, which sets them apart from financial institutions (you can find MTO agents in post offices, travel agencies, drug stores, etc). In many cases, banks and other financial services will use an MTO agent and their network to complete cross-border payments since it decreases administrative labor and the cost of settlements. Money transfer operators also localize, giving them proximity to consumers (i.e. same culture, language, currency denomination) that helps with ground-level efficiency.
The postal network
Due to the existing infrastructure created by the post office for global shipping, a secondary branch for money transfers evolved. The most obvious and simple example is mailing cheques to worldwide locations, a method used by those who deliver remittances to remote and unbanked areas. Still, cashing a foreign cheque causes currency exchange difficulties and supply settlement problems for banks, so the postal network now has several compliance laws it must follow (e.g. limiting the amount of fiat cash it will ship). Courier companies follow the same system as the postal network but often with faster delivery times. Since courier services are independent, they can provide better security, though you should expect higher fees for such rapid money transfers.
While credit unions are considered financial institutions similar to banks, they do not have the infrastructure for cross-border banking payment flows. In most cases, they will piggyback off of an existing banking channel, such as the Society for Worldwide Interbank Financial Telecommunication (SWIFT) network or the International Remittance Network (IRnet).
Mobile applications and smartphones have allowed telecommunication carriers to offer cross-border payments. In particular, unbanked locations use SMS text message systems to notify on-location agents of money transfers or loan payments. While less formalized, the speed of the messaging system has led to a high rate of innovation.
The internet and its ability to facilitate digital transfers is now a crucial aspect of almost all modern payments flows. In practice, virtual payment centers (and most financial institutions) can make e-transfers between accounts, no matter the currency denomination or the location of the original cash investment. The flow between virtual accounts is fully digital, but it does cause some issues for currency settlement, so most services still use some banking channel network for physical supply exchanges.
Transport operators are standard transportation services that can send remittances to varying countries but do not fall under the same transfer networks as banks or MTOs. Bus lines and airline-based carriers fit the transport operator description, where they do not have official money transfer status but run a legitimate courier business. While it is limited in scope, the low cost is attractive to some users and those who live in border towns.
There are also several methods for cross-border payments that fall outside of standard licensing and regulation. In most cases, specialized brokers perform transactions based on a ledger system. With a partner in the second country, the brokers enact no currency exchange and instead settle accounts based on ledgers. No physical money changes hands, but the value of one currency is added or subtracted between countries. For all intents and purposes, a “transfer” initiates and the brokers simply adjust their respective currency supply (for a fee).
What are the biggest cross border payment challenges
While the system continues to evolve with the introduction of fintech applications and new internet-based transfers, there are still several barriers:
Different system formats
To complete a cross-border transfer in a safe and secure manner, banks and customers must supply detailed financial information to confirm the legitimacy of the payments. Unfortunately, not all countries follow the same data formats, and that can cause an increase in administrative tasks or incorrect transfers. Moreover, banks with their own network are not compatible with other institutions, adding further complexity. The obvious answer is a universal system, but the implementation of such a system is near impossible given the wide variety of technological ability and access globally.
Along the same lines as the varied formats, each country has its own set of sanctions and compliance laws concerning the safe transfer of foreign and domestic currency. Uneven regulation requires an extensive amount of additional work and often requires the inclusion of more intermediaries in the process flow to double-check each transfer against all local laws. Under such a system, automation is near impossible and often results in false payment rejections.
Much of the banking industry still relies on legacy systems to perform standard transactions. While fintech applications have shown the possible future of simple cross-border payments through updated technology, the cost of migrations deters banks and delays innovation. Outdated tech has bad security, slow transfer times, and traps liquidity, aspects that deter consumer use and prevents further investment.
Lack of alternatives
The high cost to initiate cross-border payments within the extensive correspondence networks deters startup firms and pushes innovative possibilities out of the market. The entire cross-border system can upgrade into more effective forms, but the overall complexity from its multiple partner networks prevents the economic incentive that leads to robust competition.
For banks to achieve currency exchange settlement, they rely on an aggressive amount of liquidity in a variety of currencies, in addition to open access to several different financial markets. The cost to enter cross-border payments is prohibitive and adds undue risk to financial services. Due to the extensive required startup capital, the market offers limited access, decreasing competition and possible digital transformation.
How much does it cost to send cross-border payments?
Cross-border payments are expensive, with the majority of costs due to fees associated with the various players used within the process flow. Banks themselves collect a fee for any foreign transfers, with high prices to use the SWIFT network (3% – 5% exchange rate costs in addition to flat fees). Currency exchange also takes a percentage of a transfer between different denominations. If an MTO is used, the agent will accept fees as well, in addition to any fees paid to a correspondence network.
Governments also take fees. Different countries may apply taxes depending on the transfer amount. Additional fees can arrive through customs or duty, a common cost associated with transactions made in the retail sector.
Lastly, the individual agents within the local community make a payment fee, whether that involves shipment payments on cash, ATM fees, or credit processing fees for denomination exchanges.
Best cross-border payment services
With digital applications and online services now entering the cross-border payments markets, you now have access to new and improved solutions for sending money abroad. The following payment services offer some of the best alternative methods for cross-border payments.
- Alipay: Alipay started as an online payments gateway but soon added an international payment system to give merchants access to global partners. The online platform supports 14 currencies that you can send in real-time across the globe.
- Ripple: Ripple uses blockchain-based technology to supply a new digital transfer network. Ripplenet offers low-cost transactions to 55 countries in over 120 different currencies.
- PayPal: PayPal has its Xoom service designed to initiate cross-border payments between PayPal accounts and financial institutions. All transactions are digital and fees range between 1% – 5%.
- WeChat: Wechat is a mobile telecommunications provider and social media app with international money transfer system integrations. You need a bank card that can connect to the app to send money, but it is one of the cheapest ways to transfer money via SMS.
- Western Union: Western Union is a financial services company known for its fast money transfers. It has low fees, though it does take a percentage on currency exchanges. Western Union serves remittances to over 200 hundred countries.
- MasterCard: As one of the major credit card companies, Master card offers secure and fast international transfers. While not ideal for individuals, it is a painless and speedy way for businesses to conduct cross-border banking.