Correspondent banking services are essential for companies and individuals to transact internationally and make cross-border payments. Recently read a report “Cross-Border  Interbank Payments and Settlements – Emerging Opportunities for Digital Transformation” which highlighted many issues related to existing cross border payments and how Central Banks around the world are working towards solving these problems.

This article highlights issues related to Cross Border payments from  the perspective of Sender and Beneficiary, Commercial Banks and what initiatives are underway to solve those problems.

What is Correspondent Bank ?

Wolfsberg group of banks defines correspondent banking as

“the provision of a current or other liability account, and related services, to another financial institution, including affiliates, used for the execution of third party payments and trade finance, as well as its own cash clearing, liquidity management and short term borrowing or investment needs in a particular currency.”

Correspondent Banking is required by banks across the world for

• Clearing and Settlement.
• Cash management services.
• International wire transfers and, for banking authorities and local/regional banks.
• Trade Finance.

Customer and Commercial Banks are facing below issues with existing correspondent banking structure:

1. Lack of transparency regarding payment status, visibility and certainty of outcome

• End-users and banks cannot see the status of the payment.
• The exact route of the payment is not known upfront because routing is not determined by the originating bank but by correspondent banks along the chain.

Sender and Beneficiary

• Lack of payment status visibility.
• Uncertainty about whether and when the beneficiary will be credited with funds.
• Charges applied to payments are not known upfront.

Banks

• Inability to provide current payment status to customers.
• Cost involved in manually tracking payment status across the value chain.
• Reduced resilience against fraud or payment error.

2. Limited availability of cross-border payment services

• Cross-border payments are subject to cut-off times, which reduces the likelihood that payment instructions will be received and processed and payment sent to the beneficiary or correspondent bank the same day.
• Payment instructions received after the cut-off time are processed the next working day.
• Cross-border payment services may not be available on weekends.

Sender and Beneficiary

• Limits the availability (and perceived flexibility) around when payment transactions are completed and funds credited.
• Reduces the efficiency of working capital and the optimization of cash flows.

Banks

• Must ensure adequate liquidity in correspondent bank accounts to meet payment obligations within cut-off times (if same day).
• May limit effective deployment of bank liquidity as funds are tied up longer.
• Limited overlap of service times with other jurisdictions.
• Increased associated operational costs.

3. Time taken for payment processing

Sender and Beneficiary

• Delay crediting funds to the beneficiary.
• Requests for additional information to satisfy due diligence or regulatory requirements.

Banks

• Inability to straight-through process payments.
• Increased cost of end-to-end payments processing through manual intervention e.g. sanctions screening for exceptions, payment repairs, reconciliation etc.
• Investment in message mapping protocols between different payment networks.
• The longer payments take, the longer participants are exposed to Herstatt risk from their correspondents.

4. High costs associated with the correspondent banking model

• Costs can be separated into
  • (i) balance sheet costs, such as trapped liquidity; and
  • (ii) operating costs, such as managing diverse messaging standards, dealing with complex infrastructure and complying with regulatory requirements.

Sender and Beneficiary

• Significant cost of cross-border payments passed on to end-users.

Banks

• Increased costs (explicit and implicit).
• These costs are a result of:
  • Opportunity cost of liquidity trapped in nostro accounts maintained with correspondent banks (the counter to this is pre-funded vostro accounts).
  • Periodic KYC and customer due diligence (CDD) on  correspondent banks.
  • Counterparty credit risk and settlement risk.
  • Costs are relatively higher for local banks due to increased reliance on correspondent banking arrangements.

5. Challenges associated with legacy payments infrastructure across networks, central banks and commercial banks.

• There is an increase in the scale, nature and sophistication of new types of risks to payment systems like RTGS (e.g., cyber-attacks)
• There are technical barriers to entry to central banks, for smaller banks and non-bank payment service providers

Sender and Beneficiary

• Risk to business operations arising from payment system outages.
• Limited availability of innovative new services and business models.

Banks

• Risk to operations arising from payment system outages.
• Significant cost and complexity of incorporating new technology into existing architecture estate.

Current Initiatives to Solve Above problem

1. Domestic RTGS enhancements
   • How existing systems might interact with new, innovative platforms such as those using Distributed Ledger Technology (DLT).
   • Moving towards ISO20022 messaging standards.
   • Opening access to settlement accounts for non-bank payment service providers.
   • Extending their operating hours in response to demand from commercial banks.
2. ISO 20022 messaging standards
   • By 2023, the ISO 20022 messaging standard is expected to be about 79 per cent of all high-value payments.
   • There are proposals to migrate the SWIFT cross-border network to this standard by 2025.
   • Messaging Standard implemented in systems connected to domestic and international payment networks will boost interoperability between systems and reducing costs and complexity for banks using these systems.
   • Richness of the data contained within ISO 20022 messages can enhance KYC and other due diligence functions.
   • More structured data could support more automated processing and reconciliation.
3. Continuous Linked Settlement (CLS) developments
   • Adding more currencies.
   • CLSNow, is a product CLS plans to offer same-day service to CLS currencies.
4. Payment visibility and speed: SWIFT gpi
   • Enables visibility of a payment across the SWIFT network.
   • Credit confirmation provided as soon as the beneficiary has been paid.
   • Plans to increase the range of features, including stop and recall.
   • Aims to provide transparency regarding bank fees charged and the FX rates applied.
5. Centralized customer due diligence utility
   1. Harmonizing and standardizing the quality and types of data a firm can access regarding a client enhances KYC processes for banks.
   2. Centralizing such utilities provides a vehicle for firms to share information about the data they hold and the screening they have undertaken on an end- user, with the intention of reducing costly and inefficient repetition of processes by banks in the correspondent chain.
6. RippleNet with xCurrent and xRapid (Not part of report)
7. IBM World Wire Project (Not part of report)

Reference

1. New correspondent banking data – the decline continues
2. Cross-Border Interbank Payments and Settlements: Emerging opportunities for digital transformation
3. Correspondent Banking: BIS Report: 2016
4. World Bank Report: The Decline in Access to Correspondent Banking Services in Emerging Markets: Trends, Impacts, and Solutions : 2018
5. SWIFT “SWIFT ISO 20022 Migration Study: Consultation” April 2018
6. FAFT Guidance: Correspondent Bank Services: 2016
7. Wolfsberg Anti-Money Laundering Principles for Correspondent Banking: 2014