Point of View

Evolving Cross Border Payments

Debasis Sarangi & Rahul Kaushal

Introduction

Globalization and disruptive innovations are expected to result in explosive growth in volume of international transactions. As per estimates by Boston Consulting Group volume of international payments (Cross Border Payments) will reach 20.7 billion with a value of $55 trillion by 2022. McKinsey estimated that banks' share of income from international payments will jump to 14% in 2019 from 5% in 2013.While there is frantic pace of growth in volume of international payments, the pace at which money moves in this method still remains slow. This method of money transfer is mostly carried out by financial institutions and they still use the traditional methods of correspondent banking and swift network which makes the process slow and opaque. Recent innovations have offered solutions that address the problems inherent in the present model. This development has created a space for non-banking institutions to offer alternate solutions which are simple,

fast and responsive to future requirements. Banks have started to realize the potential of the new technologies and have shown interest to explore and invest in new mechanisms that will cater to the changing requirements.

Some of the big banking giants like Citi Bank, BNP Paribas, UBS etc. have started investing in pilot projects and experiments towards adopting block chain and distributed ledgers. R3 a financial innovation firm has formed a consortium of banks to develop standards and use cases on the principle of distributed ledger technology.42 banks have already signed up for this project which includes some of the major banks like JP Morgan, Citi Bank, Wells Fargo, ING Bank to name a few. EdgeVerve, the product subsidiary of Infosys recently launched blockchain framework which will enable banks to quickly deploy block chain based services for different business areas. It has functionalities to support cross border transactions and is scalable enough to cater to future requirements.

New technological innovations have brought a paradigm change in the Cross border payments mechanism. These methods are disrupting the way the traditional cross border payments take place. This paper talks about some of the alternatives to the present international payment methods that have emerged and how banks are rising up to the challenge and investing in technology to stay relevant. The paper also suggests some the opportunities this new eco system provides for the technology players.

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Challenges in Present Model

Challenges New Cross Border Requirements

· Speedü Current model takes longer for Cross

Border Payments.

· Regulatory & Complianceü Subject to various cross border

compliances like AML and KYC

· Opaqueü No clear visibility to downstream banks

ü Fluctuating foreign exchange

· Costü High Transaction fee

· Volume of Scaleü Higher volumes of remittances

ü Frequent Low value retail payments

· Transparentü Visibility of Cash

ü No impact of fluctuating forex markets

· Regulatory & Complianceü Easier Reconciliation

ü Quicker dissemination of information

between stakeholders

· Costü Low Transaction fee

· Mobile Enabledü Accessible through mobile

In the existing model money travels through multiple banks before it is credited to payee's accounts. During the process, money is converted to currency and is subject to regulations of countries of each correspondent banks. Result is delay in credit which lowers the customer experience.

Recent technological innovations like distributed ledger technology have challenged role of correspondent banks and addressed the counter-party risk by making transactions real-time. In this model settlement is done without a third party agent. Models offered by new entrants are free, neutral, and global.

Global ACH solution connects local and international payment infrastructures andlet clients access all global payment options through a single managed service. This results in faster and cheaper payment processing and better visibility of cash.

Table : New Cross Border Requirements

As shown in the figure below customer can transmit payments through its bank to any bank across the globe where the global ACH service is offered. Customer's bank ties up with Global ACH service provider, which routes the transaction to the beneficiary. The global ACH provider manages the entire compliance management, network management, FX service, and liquidity management on behalf of the bank. It has the capability to handle and process any type payment methods and any payment messages.

This model helps banks to offer new value added service to customers on the same infrastructure and results in reduced operational burden of the banks. As a result banks can offer remittances at a cheaper cost. Earthport through this service is enabling banks and payment service providers to offer cross border payment service faster & with less cost. Financial Institutions like Bank of America and Japan Post Bank have partnered with Earthportto offer similar service.

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Global ACHPayer

Single ContractSingle RelationshipSingle Integration

Figure 1: Global ACH Model

Bitcoin

Bitcoin is a decentralized digital currency. It is based on blockchain concept and is backed by concept of public ledger. Public ledger is group of networked computers which validates and approves all transactions and can be accessed by all. Once transaction is approved and block is updated, it becomes immutable. As depicted in the Figure 3 - Header of the blockchain records all completed transactions and are referred as Blocks. In the whole blockchain, each block represents approved transactions and blocks are joined in chronological order with each block containing a hash value from the previous block.

Blockchain uses the concept of advanced cryptography, digital signatures and distributed database concepts to ensure there is no duplication or manipulation of data.

Bitcoin has primarily three use cases. First it can be used as a digital currency or stored value. It has an intrinsic value like gold which is finite and scarce. With the fear of devalued currency in recent times, it has assumed greater significance for people to have BitCoin. Owners of Bitcoin can send BitCoin directly to another party without any

intermediary. However, the Bitcoin protocol requires users to transact in the protocol's native digital currency, i.e. Bitcoin or BTC. Second is the ability of the BitCoin and block chain technology to offer a new method of bookkeeping starting from the origination of a transaction. In the Bitcoin protocol, interconnected computers on the network collectively manage ledger using block chain technology that constantly monitors and updates ownership of digital assets (BitCoin). This is a new concept of recording ownership of financial assets, processing of clearing and settlement and participants see this as an opportunity. This use case of blockchain is gaining lot of traction and R3 has formed a consortium of banks that is experimenting possible use of Bitcoin in areas like Anti Money Laundering, KYC Sharing, Regulatory & Compliance, Collateral management, clearing and settlement.

Third, Bitcoin can be used as a financial rail which has the potential to clear bottlenecks to move money around the world. This removes the need for a clearing agent and enables the peer-to-peer transfer of funds. This also eliminates many of the fees and counter party risks.

Figure 3: Bitcoin Transaction

PayerPayee

Bitcoin Account

Bitcoin Account

UK Payer US Payee

GBP to BitcoinBitcoin to $$

Conversion Fee

Conversion Fee

49The exhibit illustrates how an UK importer business can transfer funds to the US exporter business via the Bitcoin protocol. First, the UK business converts GBP into BTC using a Bitcoin service provider. BTC can then be transferred directly to the beneficiary's Bitcoin account. Next, the US business service provider converts the BTC into USD, and finally, the Bitcoin service provider delivers USD to the US business. The US business then deposits the amount into its US Bank. Bitcoin concept is gaining traction especially in P2P segment and customers are showing interest in this new payment method to remit funds across the border.

Ripple

Ripple is a universal protocol launched in 2012 that enables Financial Institutions(FI) to transact without any central authority or correspondent banks in near real time with full transparency and minimal cost. This is a distributed framework that enables users FIs, Market Makers and Business houses to exchange anything of value which can be currencies, digital currencies and gold. This is also compatible with existing global payment infrastructure and can be integrated with existing frameworks easily.Consider a scenario when Sandy (Payer) wants to remit funds from his account in Bank X to his friend Mark's account in Bank Y (Cross Border Payee).

Assuming both banks are connected to Ripple- Sandy simply has to instruct bank through any medium to send A Units of Currency from country X with details of Mark's Bank details. Ripple will calculate the fee and inform Sandy about the net amount which will be credited to Mark's account. On confirmation by Sandy – it will take 5 to 10 seconds for the amount to be actually available in Mark's account.Ripple offers three services which enable Cross Border Payments– Ripple Network, Ripple Stream and Ripple Connect.

Ripple network is a shared public ledger administered by group of servers. This is also known as Ripple consensus ledger. Because it works on the principle of distributed framework, there is no need of a central operator. It offers transactions which are near real time and are irreversible. Ripple Connect supports international payments for banks.This is used to exchange KYC, risk, fees, expected delivery time and other payment details between FIs.It communicates with Ripple stream through Ripple Network to get the lowest currency quotes in cross border settlement. Once information is collated, entire cost structure is presented back to payer's bank for confirmation. Transaction is settled or approved only after confirmation from Payer. Ripple connect uses Atomic process and consensus algorithm before approving the transaction.

PayerPayee

Payer from Country X

Payee from Country Y

FX Conversion

Transaction Fee

Traders

Figure 4: Ripple’s Payment Model

Ripple Stream supports market makers to submit bid/ask offers and can be integrated with the market makers' existing systems. Ripple's algorithm is designed to pick the best possible bid or ask rates for payments to move across the network. e.g. Sender of a payment holds USD, and the recipient needs to get in AUD. Ripple will analyze all combinations resulting from USD to AUD (for example. USD to INR + INR to JPY+ JPY to Pound + Pound to Euro + Euro to AUD) and won't limit the analysis to direct

transactions from USD to AUD. Once conversion leg is finalized – Ripple stream will execute multiple legs of the transactions simultaneously and will update distributed ledger with a single entry. With this simultaneous currency operation ripple makes sure counterparty risk to intermediaries is mitigated.10 out of top 50 banks have started engagements with Ripple.Fidor bank was first to engage with Ripple while other banks like CBW and Cross River Bank are already onboard.

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Challenges with Alternate channels

While there are many advantages in newer cross border payment methods there are some challenges as well.

Regulation – These are new mechanisms and the rules and regulations are not evolved that stringently up to the satisfaction of the stakeholders.

Relatively Nascent and illiquid Network --There is doubt over settlement risk that accompanies the new payment methods. In the case of banks, they are the custodians of money and guarantee payment in case of failure. Uncertainties persist if the new payment players can be trusted if something goes wrong.

More competition -- Because of huge opportunity this method of payment promises, more and more non-banks are offering innovative solutions to the customers. This competition is going to become fiercer between the players in the coming days.

Security Theft – This is an area of concern in this age of universal access of internet. There is fear of unlawful activity or hacking by criminals of the network.

Comparison of Different Models

The diagram below captures various models discussed in the whitepaper.

Payer from Country X Payee from Country Y

Payer Payee

CorrespondentBank

Correspondent Bank

CSM CSM

Global ACH

Ripple

Bitcoin

Present Cross border Model

Figure 5: Different Cross Border Payments Model

The table below captures various models discussed in the whitepaper.

Correspondent

BankingGlobal ACH Bitcoin Ripple

Accepted Currencies Fiat currencies Fiat currencies Bitcoin only Currency Agnostic

Settlement Time 2 to 5 days More than 2 days Near Real time (10-60 minutes) Real time (3-6 seconds)

Cost Transaction fee,

FX conversion fee, Corresponding Banking fee

Operator fee,

FX conversion fee

FX conversion fee Conversion fee

Operator fee

Tracking of Payments Not Present Present Present Present

Info with Payments Limited Present Present Present

Challenges Delay in clearing

and settlement

Compliance CostCounterparty Risk

Compliance Cost

Counterparty Risk

Compliance Cost

Internet threat

Internet threat

Currency Volatility

Opportunities for Technology Companies

In recent years various countries are upgrading their domestic payment infrastructures and technology companies are the main agents of this transformation.

Similarly in new cross border payment methods, they will help to put in place the required infrastructure. The new payment methods envisions to build an ecosystem of payments platform where there will be an owner, providers, producers and consumers. We believe the role of technology players is to build this platform is pivotal.

51As discussed in the challenges section, enhanced security is the main area of focus and technology players can provide services like data encryption, decryption, tokenization features in the network. They can help to integrate various interfacing systems involved in the new processes.

Reconciliation Service – As new methods of payments offer clearing and settlement in very short time, it requires complex software logic to be run at the backend to process the cross border transactions. Technology players can provide this service because of their expertise.

Maintenance of Software and Hardware – Technology players can be entrusted on this task to provide the backbone for 24*7*365 days operation. They can forge partnerships with various service providers to put in place robust contingency plans for business continuity.

Internet protocols are the enablers in these new payment methods and software companies can develop new protocols that can be universal in nature. They can take the lead to have an industry forum that can look after standardization of service offerings and improvement in technology and devise solutions.

Infosys view point

Blockchain and distributed ledger as a technology have the potential to disrupt the payments landscape by becoming

the platform for value exchange. Solution providers and technology players should work with regulators to put in place solutions for financial integrity and protection of customer information in block chain technology. The sharing of information between different entities through distributed ledger would bring out new forms of innovation in different industries like financial services, digital asset holdings, healthcare, real estate, trade finance. Hence collaboration between banks, new entrants and technology will be the key to success for a more agile cross border payment mechanism and customer centric financial eco system.

References

1. Boston Consulting Group Global Payments, 20122 Global_payments_2015_A_healthy_industry_confronts_disruption – McKinsey Report3. http://www.coindesk.com/8-banking-giants-Bitcoin-blockchain/4. http://www.businessinsider.in/The-technology-behind-Bitcoin-is-c o m i n g - t o - h i g h - f i n a n c e - f a s t e r - t h a n - a n y o n e -predicted/articleshow/50659638.cms5. http://www.earthport.com/why-earthport/clients/6. http://www.businessinsider.in/Santander-has-20-to-25-uses-for-the-technology-behind-Bitcoin/articleshow/47703731.cms7. https://ripple.com/8. http://www.aitegroup.com/9. https://www.swift.com/10. h t t p : / / s a n t a n d e r i n n o v e n t u r e s . c o m / w p -content/uploads/2015/06/The-Fintech-2-0-Paper.pdf11. https://ripple.com/files/xrp_cost_model_paper.pdf

Debasis Sarangi is a lead consultant in Cards and Payments Practice at Infosys. He has around nine years of experience in business analysis and consulting experience across Payments, Cards and Retail Banking domains. He specializes in new payment methods like real-time immediate payments and evolving payment mechanisms initiated by non-banks.

He can be reached at debasis. sarangi@infosys.com.

Rahul Kaushal is a consultant in Cards and Payments Practice at Infosys. He has around six years of experience in business analysis and consulting experience across Cards & Payments domains. He is a regular contributor on recent trends in cards and payments to Infosys KM portal.

He can be reached at Rahul_kaushal01@infosys.com.