Technology adoption is rapidly increasing. The activity most affected by technological innovation and adoption has been payments. Money has taken many forms from objects like seashells, precious metals, paper, and now digital currencies, all to handle obligations between parties. Merchants are no doubt the lifeblood of economies. And one language every merchant speak is “payment”. The pandemic has accelerated the transformation of payments, with many countries looking into upgrading real-time gross settlement systems.
Cross-border payments, however, remain expensive, slow, and opaque. 1.7 billion adults globally are tied to cash as their only means of payment, as they do not have a transaction account – World Bank (2018). These challenges are worth tackling in emerging markets and developing economies (EMDEs), where remittances account for a substantial proportion of GDP.
New payment methods, platforms, and interfaces are rapidly increasing. Interestingly, “stablecoin” (digital currency) initiatives highlight the shortcomings of cross-border payments and the importance of improving access to transaction accounts. Safer, faster, and cheaper payments are what the world craves for now. International coordination is required for improving cross-border payments. Central Banks are embracing central bank digital currency. Bank of England is serious about this.
Cross-border payments remain a key factor for developing economies. Cross-border payments system can be classified into four models, each with its peculiar pros and cons.
Classification of Cross-Border Payment Models
Correspondent banking:
Correspondent banking is an arrangement whereby one bank (the correspondent) holds deposits owned by other banks (the respondents) and provides payment and other services to them. This is the traditional prevailing back-end system for cross-border payments. However, correspondent banking relationships are declining globally. There are big risks associated with this system. The risks include foreign government blockage of fund transfers, the exchange rates of the foreign country, some restrictive practices, correspondent banks prone to abuse, severe and large criminal or regulatory sanctions, reputational and financial damage to the correspondent banks, to mention a few.
Closed loop
Sometimes known as an in-house transfer system because a single central PSP provides services to both the payee and the payer. Western Union and MoneyGram have a long history of providing remittances via closed-loop systems. These providers must have a physical presence in each of the jurisdictions they serve, though they do not require users to open an account. More recently, AliPay and WeChat Pay have been very successful in using a closed-loop model for domestic payments in China. Alipay and WeChat Pay together account for 92% of mobile payments in China. M-Pesa in Kenya is also a closed-loop system; it processes payments equivalent to just under half of Kenya’s GDP. It would require payers and payees around the world to all use the same PSP, and this would be a coordination challenge. Notwithstanding, it is difficult to scale this system as a feasible global solution to cross-border solutions.
Infrastructure
The infrastructure model involves building a linking payment system to operate cross-border. The link facilitates (remote) access to domestic systems for banks located abroad. For example, links FedACH (automated clearing house service) in the United States with the Mexican RTGS (Real-Time Gross Settlement) system to facilitate remittances from the US to Mexico. Nigeria, Africa’s largest economy, has its RTGS system as well. However, RTGS itself does not provide the facility to track the transaction to its customers. There can be issues and delays due to frozen accounts and a lack of funds. There are more pros and cons.
Peer-to-peer
In contrast to the other models, the peer-to-peer system cut out the financial intermediary between the payer and the payee. “Stablecoins” such as Libra are examples of peer-to-peer. Peer-to-peer is a recent iteration in cross-border payments enabled by blockchain technology. Central banks are exploring taking on central bank digital currencies (CBDCs) that could support cross-border payments.
International coordination and legislative framework remain the major factor to improve universal and frequent usage.
Concerns and Benefits for Government
Entrepreneurs building fintech solutions should consider the following government concerns.
Cross-border remittance
Cross-border payments are vital for global commerce and finance and for migrants
who send remittances home. Remittances are an integral part of life for many citizens in developing economies. Take Nigeria for example, with 23.7% of the population who are unbanked, received remittances of over USD17.2 billion in 2020 The World Bank. The government will want to keep an eye on this. Recently, The Central Bank of Nigeria (CBN) listed increased cross-border trade as one of the benefits of the Central Bank Digital Currency (CBDC). According to discussions from the Official Monetary and Financial Institutions Forum (OMFIF) Digital Monetary Institute, The Bank of England is adopting an international payment landscape to enhance cross-border payments. OMFIF is the global central banking think tank.
Tax Collection
Tax evasion, cost, and manpower are major shortcomings faced with tax collection. With digital currency, automatic routing of tax payments to tax authorities at the point of sale would be a laudable achievement for the government, as this will boost revenue as well.
Financial Inclusion
Traditional monetary system has had costs and requirements that exclude many from financial opportunities. With digital currency, financial inclusion will accelerate and in turn give the government more applause for economic development. this development would lead to prosperity for the unbanked and automatically increases government tax revenue.
Price Stability
The challenge with Bitcoin and other cryptocurrencies (altcoins) is that they are too volatile. Okon can generate an invoice to receive $200 from Idara. At the time of generating the invoice, the altcoin he wishes to use in receiving was say $2. By the time Idara makes the transfer, there is the possibility that the altcoin could have a change in price as much as $0.8 depending on its PVI (price volatility index). Most altcoins are used for speculative trading in exchanges and this triggers instability in price due to supply and demand. This contributed to the adoption of “stablecoins”, cryptocurrencies whose value is tied to a fiat currency. Libra(Diem) is an example of “stablecoins”. Libra is a consortium led by Facebook that proposed a private global stablecoin. It proposed creating its own unit of account that avoids the need to deal with different currencies when settling cross-border payments.
Monetary Policy
The real-time nature of digital currency makes can help the government get data like the velocity of money circulation and the flow of transactions, amongst other things. with this government can monitor the effects of monetary policies and make changes swiftly.
Anti-money laundering & Counterfeiting
The ability to track digital currency in real-time enhances facilitating better compliance with Anti-Money Laundering (AML). The cryptographic nature of digital currency improves the ability to verify and authenticate transactions. Moreover, the origin of each issued digital currency is available in the digital ledger, which takes care of counterfeiting.
The sovereignty of its currency
The value of a currency is also tied to the national interest. Currencies thrive on trust. Every country aims to secure the sovereignty of its currency. This also justifies why 85% of central banks are willing to embrace central bank digital currency (CBDC), as they do not want to be left out in the global digital currency wave.
Conclusion
Coordinating efforts internationally to address the issues limiting cross-border payments is challenging. However, more research and experiments are needed to help understand the extent and the drivers of the problems targeted at individual jurisdictions. Extensive works in fintech are also likely to improve things.
About TechAssembly
TechAssembly is a technology development company that works on digital transformation, tech skill acquisition, and tech talent acquisition. TechAssembly specializes in communication solutions, economic tech, FinTech, business solutions, Web and Mobile development (One Stop Shop for all technology development needs).
Our clientele includes funded start-ups and SMEs, some of which are within and outside Africa.
