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Expert opinion

The happy death of correspondent banking

Wednesday 21 June 2017 | 08:59 AM CET

Michael Ting, Hyperwallet: As correspondent banking declines, it is up to the financial world to build a better cross-border payout solution

How many times have you sent an international wire in the last year? Trick question: the answer is—and can only be—zero.

That's because sending money between bank accounts in different countries is nothing like sending money between two domestic accounts. Consider the US, where an interbank clearing system (Automatic Clearing House, or ACH) enables American financial institutions to easily send, clear, and settle domestic payments amongst themselves. As Glenbrook Partners' Erin McCune highlighted in her 2014 blog post, “There is No Such Thing as an International Wire," there's no comparable central network for cross-border payments. These transfers never take place through a single transaction; instead, they ride the international financial rails of correspondent banking.

Or, at least, they did—until correspondent banking started to decline.

What is correspondent banking?

Correspondent banking and its 'synthetic network' of bilateral agreements between international banks facilitates cross-border money transfers on behalf of businesses and consumers. The model gives small banks the ability to leverage the scale and connections of larger banks to move money to destinations where it might be cost-prohibitive for them to establish a local relationship of their own.

In the world of large B2B transactions and massive aggregate remittance flows, correspondent banking has long been the de facto solution. But the financial landscape is rapidly changing: technology is blurring conventional borders and accelerating global commerce to unlock new geographies and participants. The result is an increase in transactions across an ever-widening map, with lower ticket values and a broader risk spectrum of users on both ends of the exchange. This ecosystem is one in which there is inherently less transparency among parties and more opportunism among bad actors, leading to higher regulatory standards and—ultimately—higher costs.

It shouldn’t come as a surprise, then, that many banks are choosing to opt out of correspondent relationships, indicating that the associated risks and costs have come to outweigh the benefits. According to a study by Accuity, there was a 46% decrease in correspondent banking arrangements between 2013 and 2016. In Western Europe, that decrease was 39% over the same period. The trend is expected to continue, making it increasingly difficult to transfer funds into developing countries around the world.

The emergent gig economy

As correspondent banking declines, another global phenomenon is further exacerbating this problem. Emergent business models, such as ecommerce marketplaces and software developer platforms, have given rise to a new pattern in global payments. The so-called 'gig economy' is changing the way companies utilise distributed workforces and freelancers to deliver services more efficiently. Independent workers are the engine of these new businesses—but with that comes the expectation that they will be paid quickly and cost-effectively, no matter where they live or how small an amount is owed to them. These expectations are inherently incompatible with the nature of correspondent banking. Still, gig economy companies need a way to move high volumes of low-value transfers to their globally-dispersed contractors, and there have been few alternatives for sending money across borders.

Adding to this frustration, regulatory bodies the world over are rethinking and adapting their rules to govern this rapidly-evolving marketplace ecosystem. The European Union is leading the way with new mandates like the Second Payment Services Directive (or PSD2), a piece of legislation directing member states to stipulate which parties are eligible to move money on behalf of their customers and suppliers. With a shrinking network of correspondent bank relationships and tightening regulatory standards, how can this new economy continue expanding at the fluid pace it’s enjoyed during its infancy?

A new cross-border payment solution

Could the financial industry have saved correspondent banking, upgrading it to correct the inefficiencies and reduce costs? Perhaps. But what if the model wasn’t worth saving to begin with? The reasons for the decline of correspondent banking arrangements—lack of transparency and uncontrollable costs, to name a few—are the very reasons the model has fallen out of favour with two-sided marketplaces and their payees. The gig economy may well have signalled the end of correspondent banking, but the demand for change was inevitable.

Is it possible that the financial world could build a better cross-border payout solution; one that solves the deficiencies of the dwindling correspondent bank model? The answer is most assuredly yes, but payout providers will first need to address some of correspondent banking's key flaws:

  1. Shift the burden of having to stitch together a network away from the banks. Any effort to make that work commercially, while figuring out where the limits of liability and indemnity lie, is destined to fail.

  2. The majority of banks are already connected to their country’s local clearing network. The practical global solution is connecting those networks, not the banks themselves.

  3.  Don’t rely on the bank account as the only way to move money. There are multiple methods for delivering payments, and the key to unlocking ubiquity is enabling all those payment types to be used on a global scale.

  4. Eliminate the antiquated requirement for the sender to have to know sensitive information about the recipient (e.g., bank account information). By enabling the recipient to control where and how they receive their money, the sender can initiate a payment to anyone by just knowing who the recipient is and how much to pay them. It's as simple as writing a check or paying in cash.

For companies like Hyperwallet—which recognised the early signals of a correspondent bank network in decline—the necessity of creating its own version of a global payment network was clear. Such a solution aimed to leverage the stability, rules, and standardisation of existing bank networks in each local jurisdiction to effectively reach every bank account in the world, rather than brokering an infinite number of bilateral agreements between every bank. To ensure it was built for the future, Hyperwallet adopted a philosophy that its network would be infinitely scalable. By supporting a wide variety of payment types, any one person or company can be paid while insulating the sender from the complexity of the network.

After a death, people grieve. In the case of correspondent banking, mourners appear to be few and far between. The opportunity to build a better, faster, and smarter cross-border payout network has enflamed a renewed desire for innovation amongst payments pioneers. When correspondent banking is finally lowered into the ground, there will be no tears.

About Michael Ting

Michael Ting is the Senior Vice President, Digital Markets at Hyperwallet, a leading global payouts provider. He is responsible for developing commercial and strategic partnerships with emerging growth companies in the high tech and marketplace sectors.

 

About Hyperwallet

At Hyperwallet, our goal is to provide organizations with a frictionless, transparent, and reliable way to distribute funds to their independent contractors, suppliers, and resellers. Available via a hosted online portal or through REST API integration, Hyperwallet’s payment architecture helps gig economy and marketplace companies enable localized, multi-currency funds distribution to payees globally.

With Hyperwallet, you can ensure that your payees get their money quickly and conveniently—wherever they are.

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