A Vision for the Future of Cross-Border Payments Foreword

A vision for the future of cross-border payments Foreword

The past five years have brought increasing multiple geographies. To encourage a frank change to the world of cross-border payments. exchange of ideas we assured anonymity of The trusted and tested correspondent bank- responses. While we found consensus in most ing approach has encountered challenges from areas, there was no shortage of provocative emerging alternative solutions and new players ideas or alternative viewpoints. upending some of the industry’s fundamentals. The nature and direction of these changes, how- Our ambition with this effort is not so much to ever, remains unclear in many cases. establish the facts of a new reality, but rather to foster a discussion on the future and the SWIFT and McKinsey & Company jointly under- forces poised to shape the industry over the next took this piece of research not to focus on the decade. We hope you find these perspectives cross-border industry’s past, but to set out a thought-provoking and informative. view of how the industry could develop if certain emerging trends take root. For this effort, Harry Newman we leveraged the collective experience of both Head of Banking organizations, and interviewed leaders from SWIFT firms engaged in international payments. These Olivier Denecker interviews—conducted individually—included Partner representatives from banks, established nonbank McKinsey & Company providers and relative newcomers, representing

A vision for the future of cross-border payments 1 The future of cross-border payments

International payments have long served as Margins have traditionally been robust in the engine enabling cross-border trade and cross-border; and occasional price pressures investment, and have been instrumental in the have weighed on margins, but not to the extent emergence of today’s global economy. An exten- of requiring radical cost transformation observed sive list of requirements—a ubiquitous network in domestic payments.1 Although cross-border of trusted parties spanning the entire world, flows represent only one-sixth of total transaction substantial regulatory and technical infrastruc- values, international payments revenues total ture, and a mandate for ample liquidity—have up to $200 billion globally, split roughly evenly historically made banks the natural “owners” between transaction fees and foreign exchange of the cross-border market (augmented by (FX) revenues. This equates to 27 percent of some specialized firms active mostly in tertiary global transaction revenues and is increasing by remittance markets). 6 percent annually (Exhibit 1).

Exhibit 1 Cross-border revenues remain concentrated in business-to-business.

Global cross-border payments revenues, 2017

Cross-border revenue3 Trade ﬁnance $ billion FX + oat Fee TO Revenue margin (revenue on ﬂow) Consumer Business2

FROM 6.0% 3.5%

Consumer 54 12 14 26 24 30

1.5% 0.1% 127 21 Business2 50 7 9 16 56

Share of cross-border in total4 27%

1 Includes payments initiated by treasury for intercorporate and intracorporate lending, investment, liquidity ows, etc. 2 Excluding FI to FI ows and related revenues. 3 Includes transaction fees, F X fees and oat income and documentary business fees. 4 Total transactional revenue from payments excluding interest income, annual and maintenance fees. Source: McKinsey Global Payments Map

1 McKinsey Global Payments Map

2 A vision for the future of cross-border payments Today, the global cross-border payment land- ■ ■ ■ scape is at the center of a number of trends 1. There will be many more cross-border that could fundamentally change competitive payments than today, but growth might not dynamics: increasing pressure from emerg- come from the expected sources ing technologies (including distributed ledger technology—DLT—and card and network Despite geopolitical turmoil, strong global GDP innovations); shifting regulatory and sanctions and associated trade growth will continue frameworks; accelerating international commerce to drive increases in international payments (retail as well as corporate); and, especially, (Exhibit 3, page 5). Today, there are 0.7 annual changing customer demands. In addition, cross-border transactions per capita on aver- firms new to the cross-border market, such as age globally (up from 0.5 in 2014) and total TransferWise, Alibaba and Amazon, are increas- cross-border payments value averaging 1.8 times ing competitive pressure on incumbents. global nominal GDP. This multiple varies markedly between geographies, however, ranging from Although estimated revenue per cross-border 0.7 of nominal GDP in Latin America to 5.50 in 2 transaction remains healthy at more than $20, Western Europe. evidence of changing dynamics and increasing pressure in the most established segments Large value credit and capital transfers have (such as B2B and remittances) is growing and experienced narrowing FX margins. At the same becoming increasingly commonplace across the time, ongoing uncertainty and the accumulation value chain. With these trends occurring against of international barriers, compliance and cyber a background of growing investment needs and risks, coupled with growing mistrust among compliance challenges, the industry needs to countries exemplified by sanctions, compliance engage in a strategic reflection on a vision for the norms, trade wars, and declining correspon- future of the industry. dent relationships, are all adding to the cost and complexity of offering cross-border pay- Given this outlook, we aim to look beyond next ments. The resilience of the global economy has year’s incremental changes, exploring a world enabled this category to show continued growth, where international payments dynamics are fun- although we expect it to slow from 6 to 7 percent damentally altered; where increasing customer to 4 to 5 percent in the coming years. Overall, demands serve as the catalyst for technology business-to-business (B2B) transactions remain replacement, and new partnerships and economic the most relevant category. According to one of models change service provider expectations. our interviewees, “While the cross-border payment market might turn out to be smaller one While this radical future may not yet be a reality, year from now, in ten years it must be substan- we believe there are eight longer-term trends for tially bigger than today.” which there is significant supporting evidence (Exhibit 2, page 4). Even if these trends do not This implies that the industry’s accelerated play out in full, or exactly as described, the mar- growth is being driven by a handful of key factors, ket’s direction is clear and will shape a new future in particular: for the sector.

2 Across all segments, including niche corridors, all payment methods, all values and any fees.

A vision for the future of cross-border payments 3 Exhibit 2 Our fundamental beliefs on the likely nature of change in cross-border payments.

1 2 3 4

Shifting growth: Customers rule: Integrated Single Global We expect growth to Customers will experience, Payment Area, shift towards new dene the nature fragmented desired, but unlikely: corridors and of future services, production: While benets of a segments (from trade not providers Fragmentation of the single market and set to commerce) value chain will of rules is recognized, continue, but it will be global geopolitics integrated into user make this solutions; differences increasingly unlikely in production might not be visible to end users

5 6 7 8

Solutions for A one-dollar Liquidity Regulatory level fragmenting transaction could differentiates: playing eld? standards: become pro table, Even in a time of A level playing eld, Differentiating for some: low interest rates, including non-banks, payment solution Making international banks’ capacity to remains elusive as continue to emerge, payments as efcient provide liquidity to regulators are thus focus may shift as domestic payments large volume and focused more on from standard is unavoidable as value payments can customer concerns setting toward revenue models shift not be overlooked than on competitive creating connections as a source concerns between different of differentiation infrastructures and payment solutions

Source: McKinsey Global Payments Map

Retail remittances, sustained by increas- mobile consumers is also driving up average ing migration flows as well as more mobile remittance values and advancing growth of affluent classes. For instance, China’s urban digital solutions (instead of cash). upper middle class population will more than quadruple from 2012 to 2022, while their per- Global ecommerce: Fifteen to twenty percent sonal consumption grows by 7 times during of ecommerce transaction value in absolute the same period.3 This group’s increasing terms is already international. This trend is international focus also leads to cross-bor- steadily progressing across B2B and C2B use der education and bill payments exceeding cases, driven by low-cost transport, small-item traditional remittance growth. The growing purchases, increasing comfort with transaction purchasing power of these internationally security, and the general easing of red tape.

3 Dominic Barton, Yougang Chen, and Amy Jin, “Mapping China’s middle class,” McKinsey.com.

4 A vision for the future of cross-border payments Exhibit 3 Cross-border payments volume is poised for strong growth.

Ratio of cross-border payments ows1 to global nominal GDP Number of cross-border transactions Payments ows share of GDP

Number of Payments ow as cross-border share of GDP transactions % Billion

200 6000

150 5000

100 4000

50 3000

0 2000 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022

Transactions 0.45 0.52 0.60 0.72 per capita

1 Includes payments initiated by treasury for intercorporate and intracorporate lending, investment, liquidity ows, etc.; excluding FI-to-FI ows. Data for 45 countries accounting for ~90% of global GDP. Source: McKinsey Global Payments Map

Cross-border payments growth is particularly benefit the most from cross-border payments’ compelling in marketplace payments and convergence and simplification—given that the gig economy. Amazon, eBay, Expedia, larger corporates have long had access to and Airbnb are the drivers behind travel and most of these capabilities. Solutions like ecommerce, comprising around 50 percent of SWIFT’s gpi and Mastercard’s B2B Hub are the marketplace disbursements space, while providing more flexible and SME-appropriate niche players like Etsy and Upwork are also payments options. growing strongly—fueling cross-border commerce and employment and driving C2B, B2C For large corporates, the increasing spe- and business-to-small-business payments. cialization and internationalization of value chains will continue, despite potential trade The growing role of SMEs in international barriers. Aided by increasing payments business. SMEs have long comprised a transparency, more robust trade and inter- lower share of cross-border payments than national supply-chain finance platforms, their share of GDP would indicate. Although and improved logistics, these trends will scale will continue to pose challenges for lead to the shift of a growing share of large the international presence of SMEs, break- corporate payments from domestic to inter- throughs may be on the horizon as SME’s national. Many of our interviewees see the access to affordable international payments integration of large corporate platforms as a improves. The SME segment stands to natural evolution. According to one executive,

A vision for the future of cross-border payments 5 “A multitude of specialized use cases are likely While large and multinational corporations have to emerge based on the ‘consolidated infra- always aimed to seamlessly connect to banks for structures,’ with unified back-end providers international payments needs, they have usu- delivering solutions to a multitude of smaller ally consented to use only the limited number of front-end players.” payments partners/rails/standards integrated with their enterprise resource planning (ERP) systems. At the same time customers are increasingly Increasingly, this is a simple hygiene factor. demanding transparency, specifically in trade Instead, corporates expect the data embedded in to disbursement and “request to pay” transac- payments transactions to link into any ecosystem tions. Such sales totaled $300 billion in 2015 and in which they participate. In the future, payments are poised to exceed $900 billion by 2020. The will be open-system based and embedded within situations creating momentum for international corporate processes. At the same time, banks disbursements are not so much traditional use may need to be wary of platforms or layers cases like centralized payroll or corporate bene- involved in corporate ERP systems or buy- fits, but rather marketplaces paying their global er-supplier networks. Service providers in these participants, wallets collecting for international layers hold the potential to become the new deci- merchants, and the centralization of customer sion-makers or solution integrators determining care (including claims). who will process the payment, whether based on price or convenience (Exhibit 4). 2. Customers, not providers, will shape future services SMEs in particular need easier access to international payments. In the age of International payments used to be defined by the smartphone, standards are no longer set agreements between banks for B2B payments or, exclusively by traditional brick-and-mortar corre- in the case of remittances, outlined by a few key spondent players. Even in the corporate space, providers. It is interesting, however, to imagine a the end-to-end experience has gained impor- market in which customers set the expectations tance relative to individual factors such as price, and standards. How would the customers design speed, and time. Ecommerce is a key channel for such international payment solutions? smaller retailers, either directly or through platforms such as Rakuten or Amazon. And unlike In our view, customers are seeking a seamless those large players, smaller retailers seldom have and transparent experience. If people value on-the-ground infrastructure that utilizes local real-time payments experiences domestically, payments, instead relying on international pay- there is reason to believe they will value them ments channels (including credit cards). in an international context as well. Examples of services that customers value include reliable Retail and corporate customers want trans- payments delivery, access to preferred payments actions to be adapted to the use cases and methods, and the ability to track exchange rates the contexts to which they are applied. Small- and schedule payments based on this info. These value one-click payments, or platform solutions services are already available for remittances, and for SMEs, are about seamless integration, while will become increasingly so for cross-border bill large transactors expect faster options, delivery payments and other use cases as well. guarantees, and solutions embedded into their processes; for example, trade or procurement,

6 A vision for the future of cross-border payments Exhibit 4 Many rms have emerged to address a variety of use cases in cross-border payments. Accelerated growth

To Consumer Business

Services Example providersServicesExample providers Ant Financial, Ecommerce Mastercard, PayPal

Western Ant Financial, Low-value Union, Online marketplaces Banking Circle, remittances PayPal, Amazon Mastercard Western Union, Bill payments PayPal Consumer Mastercard, Physical POS PayPal Verticals (e.g., High-value TransferWise, health, education) Flywire, PayPal remittances Revolut Loan repayments Mastercard

From One-time payments/ investments

Payoneer, Marketplace SME trade TransferWise, disbursements Hyperwallet PayPal Salaries Banks Verticals (e.g., Corporate trade Banks Western Union pensions, legal) Interest payouts and Banks Business social bene ts SME investment Western Union, PayPal Refunds Mastercard, PayPal Dividends and claims Banks Corporate investment One-time Numerous Banks disbursements

Source: McKinsey including the ability to add currency-hedging and increasing the number of transactions. It options. Enabling such functionality may entail also reduces required liquidity for many play- closed-loop solutions. ers, further pushing growth and inviting entry of non-banking firms. Examples include Hyperwallet, The push for transparency, speed, and lower which creates customer journeys based on set transaction cost is leading to a shift from bulk characteristics, which emerging marketplaces transactions to individual processing, which can use to pay their consumers or small business is more likely to be spread across a variety of sellers. Exception items are particularly relevant payments rails. This results in fragmentation for large corporates, whose nostro/vostro liquidity across payments rails, lowering average values requirements remain large.

A vision for the future of cross-border payments 7 Security and choice remain paramount—not software), and with trade channels. The rails for only for large value transactions, but for smaller “clean” payments (those that process without ones as well. In this context, transparency and exceptions) will in many cases disappear behind real-time execution need to coincide with audit these trade platforms, with rail choices depen- protocols and transaction recall rights, while also dent on services provided: for those who want meeting customer expectations. The need for charge-back and delayed payment, card rails choice differentiates today’s landscape. Cus- offer a suitable solution; if there is a need for tomers will no longer settle for a single payment substantial reconciliation data, SWIFT remains option at a set price; they want a choice of pay- the solution of choice; and if the beneficiary is ments methods, speeds, and costs. in today’s ecosystem, a closed-loop payment can be used. Customers will make choices 3. There will be a single integrated expe- based on the service they prefer, not on the rience, no matter how fragmented the underlying infrastructure. Payments solutions value chain that can’t guarantee clean execution will strug- gle, possibly migrating to a “legacy” category It is easy to imagine a world in which most of solutions, as checks and drafts have done in payments could be completed through a variety domestic payments. of alternative payments rails, as users perceive ever fewer differences between card payments, 4. A Single Global Payment Area may be correspondent transfers, new options like Alipay desirable, but is unlikely and PayPal, or emerging distributed ledger technology-based exchange mechanisms. Customers The creation of a Single European Payments could then pick and choose among solutions, Area (SEPA) created substantial benefits for opting, for example, for low-cost rails or provid- trade within Europe, at the same time generat- ers that offer specific services (like FX), linking ing positive momentum for payments providers, them to different purchasing journeys. Access to particularly regarding efficiency. From a customer these payments rails would in turn be provided by service, efficiency, and transparency point of view, an increasingly differentiated set of players. The it is likely that a Single Global Payment Area would value chain might fragment, but the customer deliver similar benefits, particularly in a world would hardly notice. where “open banking” has become standard.

Examples include bank partnerships with high- However, in the words of one executive we value remittance specialists to power their interviewed on the topic, “the idea of global smaller-value international payments. While this macro-harmonization is still utopian.” While approach may initially be restricted to C2C and many regulators are pushing for the adoption of ecommerce, it will eventually mean that even aspects of open banking, the alignment neces- large corporates would not be required to differ- sary to create a single common regulatory and entiate between bank rails and newer solutions. market supervisory agenda is unlikely to be real- ized in the near term. It is imperative that the customer experience is integrated, with seamless integration into corpo- Given the volatility of present-day trade rela- rates’ back-end systems, with commerce and tions and the pushback against globalization on trade platforms (e.g., booking and accounting several fronts, regional schemes may hold an

8 A vision for the future of cross-border payments advantage for the time being. This is true for card Firms that embrace this scenario and respond schemes, where local initiatives are regaining quickly will be well-positioned to provide customers ground, but also for clearing solutions, where with access and security; that is, full connectivity multi-country initiatives (such as P27 in Scandi- through APIs across multiple payments rails (e.g., navia) are creating momentum for a shift away cards or local closed-loop systems) and to manage from domestic schemes, and also from global/ compliance across multiple jurisdictions. Stan- pan-regional efforts. Recent appeals of political dardization itself is becoming more difficult as the leaders to create regional payments and trade speed of innovation increases, so the importance platforms, and to create more resilient regulation of these intermediate layers will increase. However, in other areas of the world or in other currencies, the existence of alternative solutions will make it push in the same direction. While not a desirable easier to gradually test and implement new stan- outcome, payments service providers will need dards, rather than having to fix them in advance. to address the trend toward localism as they develop new interoperability solutions. 6. A one-dollar transaction could become profitable 5. Will solutions be needed for fragmenting standards and infrastructures? Transaction prices for international payments are under increased pressure, mimicking to some Clarity and uniformity of standards have been extent the recent trajectory of domestic payments. essential preconditions in global transaction To date most cross-border payments continue banking, and are part of the core mission of to carry price premiums, justified by their under- organizations like CLS and SWIFT. However, lying complexity, regulatory constraints, and the nature of global interoperability will inev- value-added services such as FX. However, if the itably evolve, driven by diverging customer current trajectory holds, we envision an end state requirements, fragmenting global trade rules, in which the base price of international payments and the multiplication of technology platforms will continue to decline, with even micropayments and acceleration of innovation. Meanwhile, the being executed profitably. In reality, some provid- healthy growth of numerous payments meth- ers, particularly fintechs, are already moving toward ods—both via corresponding banking and even the $1 target today, though mainly for narrow solu- faster-growing alternative methods—seems des- tion corridors that may be difficult to scale. tined to continue. The true $1 scenario could become true, how- Solution focus may change from common ever, under two conditions (Exhibit 5, page 10): standards to secure and easy interoperability to cater to this emerging fragmentation. Conse- The “average” applies only to “normal” quently, global infrastructure players may need to cross-border transactions. Higher price points expand their focus from standards setting toward will persist for specialized or out-of-norm creating connections across various (external) transactions, with extra charges applying for infrastructures, communication standards, and premium service levels. Already today, “clean” payments rails. Moreover, the fragmentation payments on main corridors (such as USD/ across payments rails does not hold across all EUR) occur at very low rates and for cer- cases. Consolidation within channels is still favor- tain use cases closed-loop solutions can be able as scale remains a decisive factor. applied. As cross-border payments volume

A vision for the future of cross-border payments 9 Exhibit 5 Although lower unit pricing is likely, even a one-dollar transaction could be pro table for some rms.

Cost per international payments transaction

$25-$35 Payments operations

Nostro-vostro liquidity

-90-95%

Claims and treasury operations

$1-$2

Compliance

FX costs

Network management Overhead Existing Full migration Source: McKinsey Global Payments Map

continues its rapid growth, the share of clean commodity from service-based pricing, combined transactions will also increase. with an aggressive stance on efficiency for standardized payments, will allow providers to realize The cost of providing international payments margins on a par with historical levels, even as can be reduced to a level comparable with top-line revenues decline. This will require a fun- domestic payments, particularly in areas such damental commercial and operational redesign of as exception handling, liquidity management, many incumbents’ businesses, however. and claims and treasury operations. This will require new approaches to fraud, anti-money Our interviewees agreed that “premium banking laundering, and straight-through processing and pricing for professionals will continue,” and (STP) requirements, enabling costs to decline that “price competition will increase strongly in in parallel with prices. the B2B context.” However, consensus seemed to be that a $1 price in B2B “is unlikely within five The ability to price effectively for high-touch years, although the gap is narrowing.” niches and exception items, thereby differentiating

10 A vision for the future of cross-border payments Exhibit 6 Liquidity remains key for international payments.

As of 2017, global payments involved With billions of turnover daily held 0.6 extra correspondent banks on average at such correspondent banks to get to their destination

Average # of country changes Daily turnover of loro transactions,1 $ billion 868 1.6 794 752 728 0.6

1.0

All corridors

The 0.6 indicates an extra stop that the 2010 2012 2014 2016 payment takes in addition to the original sender and the nal bene ciary

1 Daily turnover for correspondent banking service providing large banks based on ECB survey of select correspondent banks. Source: SWIFT BI Watch

7. Liquidity cannot be overlooked as a source Since only banks can sustain these large transac- of differentiation tions, and this service is a prerequisite for market evolution, opportunities arise for banks not only Most new non-banking firms in international in optimizing prices for these transactions, but payments promise a better transaction expe- also in crafting improvements to global settlement rience or FX proposition. With few exceptions, schemes, possibly including consolidated nostro/ however, these firms cannot accommodate vostro set-up, more effective cash management, liquidity requirements necessary to manage large and quicker transfers. This may also address or intense payments flows such as international issues such as differences between geographies trade, direct investments, or high-volume com- in corporate current account balances and inter- merce. Banking executives should bear in mind bank balances vs. GDP. that their ability to move large amounts of money across multiple currencies is very difficult for firms 8. A level regulatory playing field remains without balance sheets to emulate (Exhibit 6). elusive, but there is progress This also implies that an interbank network remains necessary to sustain these large global Despite new technologies offering more trans- flows; in fact they are employed by many of the parency and control, including to regulators, alternative providers to enable the aggregated banks will need to continue to invest in regulatory transaction processing that sustains their efficient initiatives, likely driving compliance costs up to as smaller transactions. much as 10 percent of revenues. Recent cyber events and growing money-laundering concerns

A vision for the future of cross-border payments 11 have raised costs for all banks, at times resulting incorporating compliance terms and aligning with in smaller banks losing the status to maintain changing payments infrastructures. At the same connection to larger correspondent banks. time, pure payments players are entering the regulated banking world, often by getting banking Non-banks, on the other hand, have until now licenses, as PayPal and Adyen have done. While enjoyed lower compliance spending requirements firms like these that are new to the cross-border (averaging 3 to 5 percent of total revenues), market may not plan to offer all banking services, having experienced fewer fines overall and having a license allows then to have an active lacking risk-based direct-clearing relationships dialogue with regulators. to maintain. Non-bank firms have collectively paid about $65 million over the past three to Our executive interviews revealed the desire for four years as fines for AML and FX irregularities regulatory distinctions to be made across the spread across a large range of players; banks, value chain. “Regulation will really have to dif- meanwhile, have been fined over $1.5 billion in ferentiate between the ‘front end’ and the ‘back the first seven months of 2018 alone—mainly end.’ On the front end, players should really accruing to a handful of institutions. Over time, be treated like tech companies, looking a lot the regulatory pressure on banks and non-banks at the ‘data’ aspects, with lighter requirements is likely to converge. Recent initiatives such as as to AML/sanctions, in order to stay effective PSD2 in Europe and open banking in the UK and agile. The back-end should be more ‘ring- impose some degree of supervision on these new fenced,’ in particular with regard to balance-sheet firms (while also increasing compliance costs for commitments, counterparty exposure and liquid- banks), although still not at par with banks run- ity. This is the place to apply more ‘Basel-type’ ning similar businesses. regulation and compliance logic.”

On the other hand, smaller or less involved While the regulatory environment for banks, banks are increasingly finding options to reduce payments specialists-cum banks and non-banks regulatory pressure, for example by working may not merge entirely, the result of these two with fintechs to tap into regulatory arbitrage or shifts would be that the competitive advan- by working with other banks to build utilities to tage from regulation for non-bank players will insulate against payments standard changes, gradually erode.

12 A vision for the future of cross-border payments Harnessing the opportunity

We may soon live in a world where not only large Understand future revenue models corporates, but also retailers, SMEs, and individ- И волки сыты, и овцы целы/Both the wolves uals use international payments regularly, using a have eaten much and the sheep have not been range of solutions and providers through inte- touched—have your cake and eat it grated commerce or trade interfaces. Execution will be smooth, particularly for regional business. Or: Think beyond pricing for profits and treat the Extra services (such as FX quotes or hedging) customer holistically will generate additional revenue, supplementing By 2025, per-transaction pricing for cross-border reduced price points for basic services. payments will have eroded to a fraction of their Although a Single Global Payment Area is not historic levels, even for large value transactions, likely to emerge any time soon, parties should making low single-digit dollar transactions a likely nonetheless be able to pay everywhere, despite outcome. Such developments have been seen in varying standards and infrastructures. As one other industries, such as the cross-border tele- interviewee observed, “There will be much communications “roaming” model of the 2000s, stronger parallels to consumer behavior going where the industry displayed an efficiency gain forward; one can already see Apple’s impact of 40 to 60 percent between 1995 and 2005. on domestic payments and digitalization; the Empowered by the availability of VoIP solutions, rumored ‘consumerization’ of business payments large clients now pay close to cost-plus arrange- is happening.” ments, which have fallen effectively to nil. Carriers reacted by slashing costs, but also by developing Despite pricing pressures, the introduction of new new revenue models in data, mobile phone, and players and models, and the need for back-office infrastructure provision (e.g., fiber cables). transformation, banks will continue to play a role in cross-border payments and may even flourish Similarly, revenues from music in traditional as the intensity of change increases. recorded forms fell from $25.2 billion in 1999 to barely over $5 billion in 2017. Although For today’s cross-border leaders, and potential the recorded music industry has still suffered entrants, we see several imperatives for success: declines, after bottoming in 2014, annual sub- scriptions and revenues from other new models Understand future revenue models like streaming have helped the overall figure rebound to $17.3 billion. Revisit client propositions Extending this scenario to cross-border payments Upgrade the engine room implies a radical repositioning from transaction fees and FX margin toward a service-based Explore collaborative solutions approach and focus on high-growth areas. Establish a clear role in the value chain and While such price erosion may take longer to establish a partnership ecosystem evolve in payments, providers must investigate alternate revenue models and pricing strategies to drive profitability, including:

A vision for the future of cross-border payments 13 Provide payments services to third parties, providers, banks, telecom companies, retail- particularly where private and SME customers ers, and digital firms in terms of their access are using ecosystems that use cross-offerings to costumer and merchant data shows that or data to drive revenues. Services that can payments providers are well placed to capture use data to generate insights into consumer emerging data monetization opportunities. and corporate purchasing behavior, and (See “Monetizing data: A new source of couple these insights with supplemental data, value in payments,” McKinsey on Payments, can provide better services to customers; but July 2017.) they can also go a step further by capturing new opportunities to extract value through the Consider adopting a 1-to-1 pricing strat- monetization of the data itself. egy. This would require a deep understanding of client elasticity and needs (leveraging the Focus and expand service offerings. For large amount of data at banks’ disposal), to example, physical transfer operators may elect tailor highly specific value-based price points. to adopt an ethnic focus such as supporting foreign subsidiaries serving out-of-region While core revenues might fall, the key question workers and their families. Such a model for cross-border providers is whether the industry could then be linked to other bank offerings; will see SEPA-like growth and whether firms can for example, trade or structured finance, price effectively for niche, value-added services allowing providers to insulate themselves in or ecosystem offerings. It seems likely that not all part from downward price pressures through successful firms will be traditional players. the expansion of value-added services. Revisit client propositions Double down on niche pricing, as in the 顾客是玉，商品是草/Customers are jade; mer- overall payments world revenues are concen- chandise is grass—it is customer, not the trade. trated disproportionally in areas where the Or: It is not about the technology. greatest value is created or where the least efficient transactions congregate. These can Customer-facing firms must deal not only be in hard-to-serve trade corridors or indus- with increasing standardization, but also with tries where the payment enables the mere ever-shifting customer demands. Customer existence of the business, such as online expectations will be set by state of the art digital products like digital content or gambling. domestic developments and niche players. For These niches will also increasingly become the example, while DLT is unlikely to provide an domain of high-value specialists rather than international payments infrastructure at scale in mainstream providers. the short term, an expectation of low prices may well be established as consumers and corporates Price for relationships and data. The value experience these offerings. As a result, prices of access to payments information in a data- might fall to marginal cost levels quite rapidly. based economy makes it critical for banks and providers to retain access to account or wallet That said, banks and payments specialists still information (as opposed to aiming for higher own most of the customer relationships and can profit margins by prioritizing payment fees). An defend them with ambitious propositions such as: analysis of the relative strengths of payments

14 A vision for the future of cross-border payments Exhibit 7 Cross-border payments ows—B2B trade in particular—are shifting towards southern corridors.

Cross-border trade ows,1 CAGR $ trillion 2017-22

100% = 14 18 17 24

25 26 24 6% North - North 32

37 38 37 7% North - South 38

38 37 39 8% South - South 31

2007 2012 2017 2022

1 Includes trade in goods only, services excluded. Source: McKinsey Global Payments Map

Fast and predictable as domestic payments, convenient compliance: automated con- with transaction operational costs approach- trols (e.g., taxation, AML) coordinating ing $1 per transaction, using a real-time disparate tax laws and addressing regula- international payments infrastructure and tory implications for both buyer and seller, making pricing much more transparent and enabling unprecedented confidence in secu- predictable, with limited exception fees. rity safeguards.

Focusing on rapidly growing payments Payments as adaptable as cash, with much corridors, which are largely clustered in higher versatility: providing clients with southern regions (Exhibit 7). control, visibility, and traceability into the transaction process, e.g., with solutions that Convenient purchase functionality (think allow recoverability or the use of smart data. Amazon’s “one click”), with high usability: providing more pay-in/pay-out options (akin Services embedded in daily life and routine. to cryptocurrencies), but also supporting use cases accommodating preferences for Such propositions will likely first emerge in niche cash-on-delivery models in emerging markets, segments—for example, retail, remittances and e.g., Russia and India. select SMEs. Disruption in the field of remittances has been led by user experience and Service as secure and reliable as the prom- online technology, moving the transaction from ise of distributed ledger technology, with cash-collection use cases to account-driven

A vision for the future of cross-border payments 15 digital interfaces. A number of new firms (e.g., Reduce exception costs for claims of pay- Worldremit, Azimo) have built viable businesses, ments services billing e.g. by introducing shifting competitive dynamics for estab- standardized billing formats and predefined lished businesses. charging formats.

One suggestion that arose from our interviews: Ease the cost of financial crime investiga- “Banks need to address the failure to connect tions, for example by using financial crime smaller emerging market situations (use case and utility services like common KYC directories or geography) to access the global financial network advanced analytics solutions based on trans- and to leverage their systems.” action trace retrieval vaults.

Upgrade the engine room Cut expenditures in treasury operations, A problem is solved when focusing on intra-day liquidity reporting and/يجرفنت ةمزأ اي يدتشا it gets tougher—when the going gets tough, the artificial utilization of liquidity. Particularly with tough get going. rising interest rates, an enhanced clearing and settlement model to complement the existing Or: The rising tide will lift some boats, but others nostro-vostro system could prove valuable, will run aground. as would a settlement set-up (centralized versus decentralized), new messaging (single In light of likely price erosion, international pay- standard versus proprietary set-up) and tech- ments schemes must close an efficiency and cost nology (point-to-point or distributed ledger). gap of over 90 percent versus their domestic counterparts. The main inefficiencies are linked This transformation will require more than dis- to lack of alignment across back-office opera- cipline. It calls for a fundamental upgrade of tions, the costs of managing interbank claims capabilities in the areas of automation and robot- and pricing, and fraud and AML management. ics, data and analytics, and customer design. Cost categories inherent to the cross-border This applies to technology as well as core people nature of payments, such as FX, network man- skills, organizational health, customer focus, agement, and compliance are also a factor, but and agility. less onerous. The cost of liquidity trapped in the nostro-vostro network can also be high, but it Agile operating models need to emphasize a is less relevant in low-interest currency zones. customer experience mindset, with go-to-market Lastly, scale is as important in cross-border times of three to six months, minimizing cam- payments as it is domestic payments and further paign development time, testing costs and consolidation will likely be required. We believe increasing marketing effectiveness. A select the main priorities for banks to close the perfor- group of global transaction banks is already mance gap between domestic and cross border moving in the direction of stringent, agile cus- payments are: tomer experience.

Increase STP and serviceability by creating “The banks capable of operating in real time, transparency to reduce inquiries, automate error-free, with services structurally integrated date completion with standard reference data with the channels, will be the players that will or simplified customer input formats, or by pre-validating.

16 A vision for the future of cross-border payments operate and earn sufficient margin in the coming particularly as transaction size continues to shrink years. Other banks, particularly the small ones, (Exhibit 8, page 18). A few firms will be able to will be disintermediated by the players still in strengthen their position across the entire value the market.” chain. More often, firms will concentrate on certain points of the value chain and may need Explore collaborative solutions to consider significant divestments as well. Likely ‘Union fait la force’/Unity makes strength focal points include:

As standards are complicated and central Customer front-end providers must offer infrastructures remain hard to set up, focused better connectivity to the payment rails, which collaboration by groups of banks can deliver a will expand the universe of players to include strong step toward the aspired service levels and banks, tech firms, payment specialists and efficiency. This has been part of driving payments even new adjacent players such as export efficiency for domestic payments across much of credit agencies, supply chain providers and the world, and could have the same effect in the administrative software providers. The model cross-border area. will still favor banks for servicing large corporates, but also create potential openings SWIFT’s gpi is one example of such an industry for ecommerce gateway providers such as collaboration, connecting more than 250 banks, Wirecard and Adyen, and fintechs addressing and currently sending more than $100 billion SME needs. per day in cross-border payments, representing over 30 percent of SWIFT’s total cross-border Service aggregators will work with firms payments traffic.4 Participating banks commit to create connector models for banks, cus- to adhere to a set of multilateral service level tomers and potentially others, insulating agreements (SLAs) to provide fast, transpar- them from ongoing payments standards and ent and traceable cross-border payments. The formats or regulatory changes and offering secure end-to-end tracking significantly reduces a consistent experience without the need to the number of interbank investigations and the continually change or upgrade systems. For common rulebook and real-time processing example, a fintech might partner with two or allows over half of these international payments three banks to create an API solution linked to to be credited to the beneficiary’s account in less the banks’ existing net banking or corporate than 30 minutes, many within seconds. direct connections (e.g., host-to-host); the fintech would maintain and upgrade the solution Establish a clear role in the value chain and es- as domestic payments systems or standards tablish your partnership ecosystem and formats change. A new “Zollverein”5/Alliances for a new era Infrastructure providers may continue to There will be significant pressure on the value dominate the bulk of cross-border payments. chain to fragment, particularly at the back Regional market utilities or outsourcing provid- end, where economies of scale matter most, ers may also emerge, akin to earlier moves in

4 Data from SWIFT. 5 German Customs Union formed in the early 19th century.

A vision for the future of cross-border payments 17 Exhibit 8 Growth is increasingly driven by lower-value payments, mirroring past EU experience.

Average ticket size of transactions involving EU correspondent banks,1 $ thousand

61 -6% p.a.

45 46 38 33

2007 2010 2012 2014 20 16

1 Domestic and regional banks. Source: SWIFT; ECB Correspondent banking survey; McKinsey

security services with the DTCC, Euroclear, payments can be built into a variety of ser- and Clearstream. In addition to CLS, SWIFT, vices, such as B2B (particularly cash and and card schemes, large global transaction liquidity management, but also documentary banks also participate in this space. They face business), global corporate services, travel specific constraints as this model is depen- and digital content. dent on digitization and economies of scale. In an extreme scenario of market evolution, they ■ ■ ■ face stark choices: becoming a top-ten player; You don’t stop playing because you get old, you finding a regional, product, or segment niche get old because you stop playing. (for instance, SMEs); or pursuing partnerships to gain scale and reach. Over the past 15 years, international payments have grown dramatically, yet the Ecosystem providers may bundle an over- underlying industry remains largely intact and arching portfolio of services. Open banking fairly fragmented. will accelerate such moves both in the retail and corporate world. Intensifying partnerships Now, new payments rails, innovative technology, with fintechs and digital banks (particularly in and shifting customer demand threaten to upend the SME space) may also drive such bundling. this model. The associated volatility presents a Incidentally, such ecosystems are unlikely substantial opportunity to develop more effective to be anchored on cross-border payments. customer propositions, economic models, opera- According to McKinsey research, international tional systems, and segment focus.

18 A vision for the future of cross-border payments Incumbents must treat these shifts as a call for banks can succeed without rethinking their place reflection. To succeed, they will need to lever- in the cross-border sector, and committing to the age account ownership and weave cross-border changes necessary to adapt. The focus will be payments into the commerce flow. Several of on customer experience versus pure payments, our interviewees made statements to the effect and success will require integrating the payments that “banks are here to stay, particularly for large process and rails into the end-to-end process. corporates.” This does not mean however, that

A vision for the future of cross-border payments 19 Authors

For McKinsey & Company: For SWIFT:

Nunzio Digiacomo Luc Meurant Associate Partner, Rome Chief Marketing Officer [email protected] [email protected]

Olivier Denecker Harry Newman Partner, Brussels Head of Banking [email protected] [email protected]

Reinhard Höll Wim Raymaekers Associate Partner, Dusseldorf Global Head of Banking Market [email protected] [email protected]

Marc Niederkorn Partner, Luxembourg [email protected]

The authors would like to acknowledge the contributions of Phil Bruno, Jonathan Brugge, Pavan Masanam, Glen Sarvady, and Sebastian Scheurle. We would also like to extend our thanks to the executives who agreed to be interviewed for the report.