Remittance
Why are cross-border payments complicated vis-a-vis domestic payments?
How would you make a payment for any goods or services in India? You would pay by cash, by debit or credit card, by using your bank’s Internet banking app or by using a Unified Payment Interface (UPI) app like GPay, BHIM, PhonePe, Paytm etc. Simple, right? No fuss and super-fast - the payment goes through in the blink of an eye.
Now how would you carry out a similar payment for a cross-border transaction? Most of you would not be comfortable and justifiably so. A cross-border payment, as the name suggests, is a payment made to an entity or individual in a foreign country. Such payments are much more complicated vis-a-vis the domestic transaction mentioned above.
This move reflects a broader trend in the financial sector, where institutions strategically leverage digital projects to serve clients better. Such progressive initiatives underscore the vital role FinTech plays in fortifying MSME capabilities, positioning them as more agile and competitive players on the global stage. This evolution positions India's financial services sector for a dynamic and globally competitive future, where MSMEs are pivotal in cross-border economic activities.
Before we find out exactly what contributes to making such payments complicated, let us take a quick look at the different types of cross-border payments:
Commercial payments or trade payments are those which are on account of the export of goods, services, data and intellectual property (IP) predominantly catering to customers in the corporate or wholesale sectors or for governments. They also include the movement of capital across countries – in the form of intra-corporate transfers and Foreign Direct Investment (FDI). These are typically very high value payments.
Treasury payments are inter-bank settlements of trades, securities, foreign exchange and money markets.
Retail payments are all those other payments that you can think of. Here the end user of the goods or services is usually directly involved as a party in the transaction. These include all types of payments such as B2B (Business-to-Business), C2B (Consumer-to-Business), B2C (Business-to-Consumer) as well as C2C (Consumer-to-Consumer) payments. This has the highest number of cross-border transactions yet the payment size is smaller. For example, this includes all E-Commerce payments and payments you would send to a relative who is abroad.
The treasury payments and most commercial payments are between banks and large corporates respectively, basically large payments, and do not face complications. It is the remaining portion of the commercial payments and the retail payments, mainly carried out by the SME sector, the small & micro businesses and individuals, mostly the payments with the smaller ticket size, where the remitters find the process of cross-border payments to be complicated. Such cross-border transactions include a significant portion of payments towards e-commerce, in the region of fifteen to twenty per cent of all e-commerce transactions around the world, as per some estimates.
You will now read about the various reasons for which cross-border payments are more complicated than domestic payments.
Different Jurisdictions and Laws
Cross-border payments are subject to different jurisdictions and laws. A domestic payment is subject to the laws of the same country. Different jurisdictions mean issues relating to the resolution of disputes and interpretation of contracts. The very legal nature of currency is sovereign and there exists no global currency. You are conversant with the laws of your own country, but when making cross-border payments you would more often than not be unaware of the total extent of foreign laws. Disputes arising from such unknowing errors of omission often lead to months of delay in resolution as there is no common central authority to adjudicate on the same.
Compliance with International Regulations and Standards
The geopolitical scenario internationally leads to sudden restrictions on the transfer and convertibility of certain currencies. Such scenarios include but are not limited to simple matters like trade or product protection and may on the other side of the scale include sanctions for reasons like war or an acute human rights crisis.
You will have noticed such a situation recently after Russia invaded Ukraine in 2022. International sanctions have been imposed against officials, businesses and individuals who are Russian or are based in Russia. Major Russian banks have been cut off from SWIFT (The international payment messaging network). In February 2022, The Central Bank of the Russian Federation was not allowed to access around USD 400 billion of its foreign exchange reserves held in banks abroad. The Russian Rouble has buckled under the pressures of sanctions and declining exports and is tumbling against the USD. A payment against Russian Roubles is not only uncertain, but the value of the payment too is falling as the value has fluctuated from when the transaction was initiated and will be executed.
Such a scenario is not possible in a domestic payment within the same country.
Complex Web of Interlinked Banks
A domestic payment, regardless of whichever payment channel you choose to use, moves directly from the bank of the remitter to the bank of the person receiving the payment. Such payments are simple, and in the age of UPI apps are actually settled in real-time.
Compare this to the widespread and complex web (much like a spider's web) of interlinked banks involved in cross-border payment. Banks have reciprocal arrangements for the movement of such payments. There are also a lot of geographies where such correspondent and respondent relationships between banks do not exist. In such cases, banks seek out an even more complex web of intermediary banks. Funds flow accompanied by the messages in the SWIFT network. These processes take time and further delays often occur due to holidays in different geographies anywhere in the network of remitting banks, multiple intermediary banks and the beneficiary bank.
If you in India were to enter into an international trade transaction with someone in Algeria, the payments for the same would flow from your bank in India to New York (USA) to Paris (France) and onwards to your trading correspondent’s bank account in Algeria, all throughout utilising correspondent – respondent banks as well as multiple intermediary banks.
Compliance Checks
Cross-border payments are subject to numerous compliance checks – both automated and manual. This is part of a diligent and multi-layered process to review the transaction and transaction pattern to be able to detect any suspicious activities and prevent the same from getting executed. Such activities include but are not limited to money laundering, proceeds from the sale of conflict diamonds, drug trafficking, human trafficking, terrorist financing, etc.
These checks while being indispensable do lead to a lot of delays ranging from 1 – 5 working days and often unnecessary transaction declines. Automated alerts are based on patterns and Artificial Intelligence (AI) which often identifies genuine transactions as suspicious leading to delays and declines. Banks often tend to be overzealous in their approach in the name and guise of due diligence for cross-border payments.
In contrast to this domestic payments are much faster and while Anti Money Laundering (AML) and Know Your Customer (KYC) checks are carried out, the delays are insignificant as the transaction originates and comes to its conclusion within the same country and economy.
Cost of Transactions
Cross-border payments are subject to various fees such as foreign exchange fees, transfer fees, bank fees, etc. Payments, especially those for SME and Micro business and retail customers are subject to adverse foreign exchange conversion rates. Even payments made through international credit cards using the VISA, Mastercard or American Express settlement platforms are subject to very high fees and conversion rates.
For example, if you were to receive a payment through PayPal in India as an individual or owner of a small or micro business, PayPal charges 5.5% of the total payment. The typical conversion percentage margin for the foreign exchange by your bank is 3.6%.
Compare this with the negligible, mostly zero fees for a domestic payment.
You are now aware of the various reasons why cross-border payments are considered to be more complicated vis a vis domestic payments. The process is being simplified and a number of non-bank Fintech companies are in the process of providing an ecosystem for international trade and payments with the help of Application Programming Interface (API) apps and advanced cryptography and tokenization.
