De-banking in cross-border payments: Why the system needs reform
June 25, 2024
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Banks de-bank payment providers, disrupting cross-border transactions and financial inclusion.
What is this article about?
The de-banking of payment providers by traditional banks.
Why is it important?
It highlights the disruption of cross-border transactions and financial inclusion.
What’s next?
Innovative solutions and partnerships are needed to address these challenges.
Tensions in the cross-border payments sector are rising. Traditional banks are increasingly withdrawing banking services from other payment providers like money transmitters and fintech companies.
Strict regulations, outdated infrastructure, and growing risks have pushed banks towards a risk-averse approach, avoiding clients in complex cross-border spaces where possible.
This trend of de-banking has created difficulties for payment firms that rely on banking access to facilitate international money transfers through the correspondent banking network.
Without these vital accounts, companies face challenges in enabling services like remittances that support financial inclusion. Emerging fintech solutions also still require banking relationships, which have become more difficult to obtain.
There is a mismatch between the needs for open access to payment systems, regulatory priorities around risk management, and banks’ own priorities to minimise exposure.
As de-banking continues, non-bank payment providers face ongoing hurdles in cross-border operations. However, no clear resolution has emerged due to the complex trade-offs between these competing demands from different players.
Unless innovative solutions can balance risks, rules and user needs, de-banking looks set to remain a significant constraint for the industry. Both payment providers and the unbanked populations they serve will feel the effects until a sustainable path forward is found.
Currently, the cross-border payments sector stands at $160 trillion annually but is projected to increase significantly to $250 trillion by 2030, according to Payall CEO Gary Palmer.
However, while most transfers are facilitated through financial institutions, Swift membership has been declining. Only a small fraction of banks worldwide actually offer cross-border payment services to their customers. The availability of correspondent banks to provide liquidity and processing is also shrinking. This is having a profound knock-on effect on firms operating across jurisdictions.
Palmer believes this is because “the economics don’t work”. In his view, deal terms with correspondent banks and the overhead at the originator to support risk management, compliance tasks and customer inquiries make the product unprofitable.
“Moreover, customers aren’t happy with slow delivery and lack of information regarding status – so why offer an unprofitable product customers don’t like?” he asks.
Previously, Swift played an important role given the lack of modern communication technologies when it launched, but Palmer emphasises that core banking systems and digital platforms were never built to support today’s needs.
Palmer emphasises that core banking systems and digital platforms were never built to support today’s needs.
He says: “SWIFT was created as a secure messaging system between banks before reliable, fast, and safe communication technologies existed. But the root causes of why cross-border payments are slow, expensive, and opaque are not because of SWIFT, but because core banking systems and digital banking platforms that support the classic correspondent bank model were never built for cross-border payments.”
The decline in correspondent banks can be attributed to various reasons, Palmer says. Some banks have exited the business due to their reliance on intermediate banks and their services. Others have been pressured by regulators to leave because they failed to adhere to their own internal policies and procedures, such as conducting regular audits of foreign financial institutions, monitoring transactions, and implementing other controls.
“No core bank system or digital bank platform was ever designed for this business. And we as humans make mistakes. Others have exited because they’ve been fined (substantially) for these policy execution failures or they’ve facilitated money laundering or some other nefarious activity.”
Statistics from the United Nations Office on Drugs and Crime indicate that the estimated amount of money laundered globally in one year is 2-5% of global GDP, or $800 billion—$2 trillion in current US dollars.
“No wonder there’s been a decline in SWIFT membership and correspondent banks,” Palmer says.
According to the panel discussion, cross-border payments are considered high risk by regulators primarily due to a lack of transparency. The clearing institution facilitating a cross-border transfer does not have visibility into key details about the foreign sender or receiver in a timely manner.
Crucial information like the identities and business profiles of parties involved, details confirming what sanctions and risk checks were performed, and the underlying purpose and source of funds, are only available to regulators months or years later in a small fraction of cases.
This opacity makes it difficult for authorities to adequately assess risks like money laundering, terrorism financing, or sanctions evasion associated with international payment flows. The issue is compounded by cross-border transfers also tending to be inefficient and slow due to outdated infrastructure not purpose-built for such payments.
With estimates that up to 5% of global GDP may be laundered through banks annually, regulators view cross-border channels as inherently high risk conduits that require more timely transparency to properly oversee.
Despite their importance, regulators and central banks consider cross-border payments high-risk due to their opacity and inefficiency. This high-risk classification is a significant concern given the volume and necessity of these transactions, according to Palmer.
Banks may decide to de-bank, or in their eyes, ‘de-risk’ a company for a number of compliance and risk-based reasons. Chief among these is the perceived financial crime or money laundering risk associated with the company’s operations and customer base.
Graham Ridley, strategy director at IFX Payments believes the risk of fraudulent transactions, combined with the cost to serve customers plays a big role in the decision to de-bank a firm. “Because they face severe penalties for any lapses, this contributes to banks’ risk-averse approach and de-risking clients,” he tells Payments Intelligence.
Due to a lack of transparency, a bank may be unable to properly analyse transactions, monitor activities, and comply with know-your-customer (KYC) regulations for a particular organisation, increasing liability risks.
Maintaining such high-risk relationships also involves significant compliance costs that many banks wish to avoid. Banks may also seek to limit overall exposure if a company works in sectors like remittances classified as inherently risky by regulators.
Outdated banking infrastructure can further hinder a bank’s ability to conduct thorough due diligence, audits, and oversight of an account. Thus, when risks are deemed too large and opaque relative to resources, banks often pursue a risk-averse approach through de-banking to withdraw from involvements seen as unsafe or non-compliant from a regulatory perspective. This is proving to be tough for firms.
De-banking has significant impacts on non-bank payment providers and their ability to facilitate cross-border money transfers. When traditional banks withdraw correspondent banking services and accounts from payment firms, it disrupts these companies’ operations by removing the critical banking infrastructure they rely on.
Financial inclusion efforts that use remittances and money transfers are also impacted, as payment firms cannot support such services when their banking access is withdrawn.
Perhaps most challenging, de-banking forces non-bank payment companies like money transmitters and fintechs to find alternative, more complex solutions to enable cross-border transfers without stable banking partnerships to provide the foundation for cross-border payment networks.
According to Ridley, small businesses face the concerning prospect of de-banking, a threat that should not be part of their reality. He believes that gaining more clarity on this issue is vital.
“We want to see more guidance from the regulator in order to further highlight the importance of getting this right for small businesses especially.”
According to Palmer, the corresponding banking system can be fixed with the implementation of new software to help automate processes involved with cross-border transactions. This could help address banks’ risk concerns while reducing costs.
“If you look at the current correspondent banking construct, the number of manual transactions from even boarding a financial institution onto another correspondent bank, financial institution, platform and the absence of software to automate that process and enable transparency is a big issue,” he explains.
If the software allows for the execution of the automation of risk, compliance rules and data sharing is recognised as a solution, new paradigms will emerge, and it will be transformative, Palmer admits.
In order to create this efficiency gain, software must be implemented to allow for a correspondent bank to properly manage its relationships with all of its partner banks. This will enable, for the first time ever, banks to share in some of the foreign exchange with the originating bank they’re not sharing in today.
Palmer says: “The fact is, there was never software as part of any core bank system, digital bank platform, or other bank-tech designed for each participant in the cross-border ecosystem – originating institution, correspondent bank, intermediate bank, or others – such as independent FX traders and liquidity providers, regulators, or even central banks. As a result, the industry and customers have suffered under the weight of manual processes.”
With the right software solutions in place, regulators and central banks could gain improved oversight abilities and more efficiently manage risks associated with non-bank providers like EMIs and PSPs. Correspondent banks could similarly streamline relationships and compliance activities through more data-driven, automated processes.
According to Palmer, well-designed infrastructure changes could also transform how transactions are processed across institutions, facilitating compliance more seamlessly.
Emerging models outside traditional correspondent banking, such as Mastercard’s domestic network connections, can also potentially force improvements in the legacy system.
Some fintech companies have found ways to bypass the hurdles created by the corresponding banks by delivering funds more directly into wallets or banks across borders using their own proprietary rails while also managing compliance requirements.
Forming partnerships between traditional financial institutions, fintech payment providers, and other specialists is also proposed as a potential solution if firms can leverage different organisations’ respective strengths to offer compliant and efficient solutions.
The continued innovation spearheaded by fintech leaders in areas like direct connectivity to wallets or domestic networks bypassing international correspondent banking could also have a profound effect.
The de-banking trend presents significant challenges for the cross-border payments sector, where traditional banks’ withdrawal from providing services to non-bank payment providers impedes financial inclusion and operational efficiency. Stricter regulations, outdated infrastructure, and the perceived high risks associated with cross-border transactions compel banks to adopt a risk-averse approach, excluding many payment firms from essential banking services.
According to some, the current cross-border payments framework is ill-suited for today’s needs. The industry’s projected growth and declining Swift membership and correspondent banks underscores the urgent need for reform. Non-bank payment providers must navigate these hurdles to facilitate crucial international money transfers, particularly for unbanked populations reliant on remittances.
Innovative software solutions and strategic partnerships between fintechs and traditional banks offer potential pathways to address these issues. Automating processes, enhancing transparency, and leveraging new technologies can mitigate risks and reduce compliance costs.
Additionally, emerging models bypassing traditional correspondent banking and focusing on direct connectivity and domestic network integration can drive transformative change.
Ultimately, balancing regulatory requirements, risk management, and the need for open access to payment systems will be critical. Until a sustainable and inclusive framework is established, de-banking will remain a significant constraint, impacting both payment providers and the communities they serve.
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