Rethinking Correspondent Banking 3
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Rethinking correspondent banking 3 Rethinking correspondent banking Correspondent banking—in which one financial institution carries out transactions on behalf of another, often because it has no local presence—has been used as the instrument for cross-border payments since the time of the Medicis. The intervening centuries have brought surprisingly little in the way of fundamental change, and banks still generate considerable value from cross- border payments. According to the 2015 McKinsey Global Payments Map, these transactions represent 20 percent of total transaction volumes in the payments industry, yet they generate 50 percent of its transaction-related revenues (Exhibit 1, page 4). Olivier Denecker What’s more, revenue margins in cross- growing as domestic retail payments un - bor der payments have remained healthy dergo rapid digitization. Florent Istace over time. As margins for domestic pay - • Regulatory compliance is driving up the Pavan K. Masanam ments were squeezed by regulation and cost of cross-border payments systems Marc Niederkorn competition in recent decades, banks were and forcing banks to review their corre - forced to pare back costs and improve the ef - spondent relations. ficiency of their systems and products. But cross-border payments have not yet experi - • Digital innovators are attracting cus - enced such pressures, so banks have had lit - tomers with new solutions and enhanced value propositions that threaten not only tle incentive to work on their back-end to cut banks out of their correspondent systems and processes or to develop innova - banking relationships but also to loosen tive customer offerings. banks’ ties with end customers, at least That is now changing. The traditional corre - where payments-related activities are spondent banking model for cross-border concerned. payments has come under acute pressure If these growing pressures were to drive from customers, regulators and competitors cross-border revenue margins down to do - alike: mestic levels, industry revenues would drop • Customer expectations for real-time, digi - by 70 percent, inflicting losses of $230 bil - tally enabled cross-border payments are lion on banks globally. To avert this stark 4 McKinsey on Payments June 2016 Exhibit 1 Payments Trade finance3 xx Revenue margin, bps Cross-border Domestic Cross-border payments represent 20141 20142 20141 20142 20% of global payments transactional payments transactional payments flows but flows revenues flows revenues 50% of transactional $ trillion $ billion $ trillion $ billion revenues 240 110 75 From and to 22 325 consumer 2 550 285 30 160 1 Excluding flows between banks. 2 Includes transaction fees, float income and 120 255 FX fees; excludes revenues not directly Business- 2 20 linked to individual transactions, mostly maintenance fees, net interest income, to-business and incident fees related to cards. 3 Includes fee revenue from documentary business but not revenues from Share of total domestic and cross-border payments 20% 50% trade-related financing. Source: McKinsey Global Payments Map scenario, banks need to embrace change great experience in terms of transparency, and grow the market by delivering new cus - convenience, price and speed. These bene - tomer solutions through far more efficient fits are gradually becoming table stakes for operations. This article examines how cor - all participants in the industry. Meanwhile, respondent banking is changing and pro - domestic payments are moving to real-time poses options for banks to consider to solutions at marginal cost to the user. defend and enhance their position in cross- Cross-border payments have yet to embrace border pay ments. these developments, and the gap between customers’ expectations and their experi - Drivers of change ence is widening. Three forces are driving change in corre - spondent banking: the customer impera - In fact, cross-border payments continue to tive, the efficiency squeeze and the be expensive, slow and lacking in trans - nonbank offer. parency on both costs and delivery times. In 2015, a McKinsey survey on consumer cross- The customer imperative border payments found that consumers typi - As consumers and businesses grow accus - cally pay a fee of €20 to €60 on top of the tomed to the benefits of using technology in prevailing foreign-exchange spread. And this their daily lives, their expectations rise. In fee does not even guarantee timely delivery: financial services, digital entrants are offer - although most cross-border payments could ing products and services with thoughtfully in theory be executed in one to two days, the designed user interfaces that provide a survey revealed that a typical retail cross- Rethinking correspondent banking 5 border payment took three to five working 2015 study by Traxpay indicates that about days to complete. 60 percent of business-to-business (B2B) payments require some kind of manual in - More positively, the correspondent banking tervention, each taking at least 15 to 20 network still provides distinctive benefits to minutes. Major variations in account struc - users. It remains the only solution that is tures, messaging and bank systems generate genuinely ubiquitous. It can reach any coun - far more corrections, investigations, returns try or currency and can be used by anyone with a bank account. It is also safe. Banks and stalled payments than are seen in do - act as trusted providers of both bank ac - mestic payments or in payments where one counts and the elaborate compliance-driven party controls the transaction from begin - regulatory framework that guarantees neces - ning to end. Over 90 percent of the resulting sary security for the cross-border payments costs are incurred in banks’ efforts to man - that underpin the global economy. age counter-party bank relationships in the back office, rather than in the technologies and networks that handle the value transfers Even leading transaction banks can no between banks. As a result, the cost of han - dling international payments is counted in longer afford to maintain large dollars, not cents. international correspondent bank The nonbank offer networks, and have been closing down The high margins and low efficiency of less profitable locations. cross-border payments have long attracted the attention of money-transfer operators (MTOs) such as MoneyGram and Western The efficiency squeeze Union. In the past, these companies mostly Maintaining an open global network across targeted unbanked or under-banked con - many different standards and under a strict sumers and differentiated their offerings by regulatory framework incurs high costs for speed, convenience and predictability rather banks, making cross-border transactions than price. They barely competed with considerably more expensive than domestic banks, as each institution targeted different payments. Even leading transaction banks segments: banked customers and businesses can no longer afford to maintain large inter - for banks, and unbanked customers using national correspondent bank networks, and cash-to-cash payments for MTOs. Today have been closing down less profitable loca - MTOs command some 40 percent of global tions and reducing the extent of their net - revenues for cross-border consumer-to- works. During 2013 and 2014, one leading con sumer (C2C) payments, but less than 5 U.S.-based global bank stated that it had cut percent in the business-to-consumer (B2C) ties with 500 network banks, mostly in the and B2B segments. Middle East. But things are changing. PayPal was the The complexity of cross-border transactions first successful digital player to threaten brings with it a relatively high failure rate. A banks’ payments business. More recently, 6 McKinsey on Payments June 2016 Exhibit 2 New solutions Customer-to-customer cross-border payments; customer Worse than the average for new solutions experience ranked 1 to 5 (1 lowest, 5 highest)1 outperform Better than the average for new solutions correspondent Remittance banks New solutions banking on most (ICICI Bank Customer experience Correspondent Money2India, State TransferWise dimensions of dimensions banking Bank of India) PayPal Western Union Bitcoin customer experience 5 Speed 1 5 4 4 1 Price 5 5 3 5 Security and 1 5 4 3 compliance 5 Transparency and 4 5 3 5 1 McKinsey researchers acted as retail predictability 2 customers and transferred €100 or the local currency equivalent back and forth Convenience and 2 across a set of corridors (routes between ubiquity 4 5 2 3 the sending and receiving countries, such as UK to India) chosen to be representative Openness and of the market conditions encountered by inclusivity 4 4 4 3 3 customers across the globe. Source: McKinsey Global Payments Practice digitally enabled attackers have intensified This disruption is now moving up at an ac - competition by altering the ways that pay - celerated pace from C2C to business-driven ments are made. Companies such as Trans - cross-border payments, starting with small ferWise and Xoom have gained traction and medium-sized enterprises (SMEs) ( Ex - with banked as well as unbanked cus - hibit 3). Companies such as Traxpay and tomers by offering superior consumer value Taulia provide business solutions for finan - propositions for C2C cross-border trans - cial supply chains that mimic the features of fers, outperforming traditional correspon - consumer digital offerings, including pay - dent banking offerings on key dimensions ments functions. Western Union’s wu.com such as price, speed, convenience