Context:

With the onset of industrialisation and wire transfers, banks began to facilitate cross-border fund transfers. However, despite technological advances, cross-border payments remain riddled with inefficiencies that hinder their effectiveness. Addressing these frictions is crucial for promoting financial inclusion and economic growth, making this a priority on the G-20 roadmap.

Cross-Border Payment Systems

The Cross-Border Payments in a Growing Market

As new technologies emerge and the demand for improved cross-border payment systems grows, various bilateral and multilateral initiatives are being undertaken to enhance cross-border payment capabilities. The global cross-border payments market was valued at $181.9 trillion in 2022 and is projected to reach $356.5 trillion by 2032, growing at a CAGR (Compound Annual Growth Rate) of 7.3% from 2023 to 2032.

Historically, cross-border payments were initiated through manual processes, involving letters of credit, checks, and extensive documentation. Over time, they have evolved, closely intertwined with the development of trade, currency exchange, and industrialisation. Despite advancements, cross-border payments continue to face significant inefficiencies.

Models of Cross-Border Payment Systems

According to the Bank of England and the Bank for International Settlements, retail cross-border payment systems are classified into four primary models:

• Correspondent Banking: This traditional model relies on intermediary banks to facilitate payments, which increases complexity and costs. Due to rising regulatory expenses and competition from fintech, this model is declining.
• Closed Loop/Single System Model: A single payment service provider manages the transaction, facing interoperability and regulatory hurdles.
• Interlinking Payment Infrastructures: Countries' systems are connected for seamless transactions but encounter technical and regulatory challenges.
• Peer-to-Peer (P2P): Direct payments using technologies like distributed ledger technology (DLT) allow faster and more cost-effective transfers.

The Evolution and Challenges of Cross-Border Payments

The Evolution of Cross-Border Payments

• Shifting Consumer Expectations: The cross-border payments market is rapidly evolving due to changing consumer demands. Consumers now expect fast, secure, and intuitive international payments, with less willingness to pay for costly banking services. The rise of smartphones and alternative payment methods (APMs) is driving demand, creating opportunities for providers that offer faster, cheaper, and more transparent solutions.
• Rising Trade with Emerging Markets: Emerging markets in Africa, Latin America, and Asia are becoming central to global transactions, driven by initiatives like the African Continental Free Trade Area and China’s Belt and Road Initiative. In contrast, protectionist policies in developed markets, such as Brexit and U.S. trade tensions, may slow trade growth in those regions.
• Growing Access to Mobile Phones and ePayments: The proliferation of smartphones worldwide has granted users unprecedented access to banking and ePayment services, with mobile wallets experiencing consistent growth. In eCommerce, mobile wallet usage is projected to reach around 52% globally by 2023 (Worldpay), further boosting cross-border commerce.

Global Challenges in Cross-Border Payments

The Financial Stability Board (FSB) has highlighted four key challenges that plague cross-border payments:

• High Costs: Transaction fees remain expensive, particularly for smaller amounts.
• Low Speed: Delays in payments due to complex processes hinder real-time transfers.
• Limited Access: Certain regions and users have limited access to efficient cross-border payment systems.
• Insufficient Transparency: Lack of clarity in fees and tracking complicates the process for users.
• Security Threat: Cross-border payments are prone to fraud due to limited fund visibility, decentralised networks, and the lack of a central regulatory authority.

Technological Evolution in Cross-Border Payments

New-Age Payment Models

As the global financial landscape evolves, new models are emerging, revolutionising traditional cross-border payment methods. These models can be categorised into three primary groups:

• Linking Fast Payment Systems (FPS) or Instant Payment Systems (IPS): Examples include the PayNow-PromptPay linkage between Singapore and Thailand, and the UPI-PayNow linkage between India and Singapore. These enable real-time cross-border transfers using mobile numbers or virtual payment addresses, providing a secure and cost-effective remittance solution.
• Central Bank Digital Currency (CBDC) Projects: CBDCs are being developed by many countries, often focusing on cross-border payments, with several projects utilising DLT.
• Distributed Ledger Technology (DLT) Based Projects: These projects leverage blockchain to make international transactions faster, more secure, and more efficient. Many DLT-based projects involve CBDCs, which enhance security and efficiency.

Key Pilot Projects

Various pilot projects demonstrate the potential of these new-age systems. These include the PayNow-PromptPay linkage between Singapore and Thailand and the UPI-PayNow linkage between India and Singapore, both designed to make cross-border transfers quicker, more affordable, and more accessible.

Regulatory and Legal Challenges

• Legal and regulatory complexities : Despite technological advancements, cross-border payments are burdened by legal and regulatory complexities. Providers must comply with various domestic laws related to anti-money laundering (AML), customer due diligence, data sharing, and settlement processes.
• Inconsistent Regulatory Frameworks : The inconsistent implementation of the AML and counter-terrorist financing (CFT) framework remains a significant challenge. According to the FSB, while AML/CFT requirements are based on Financial Action Task Force (FATF) principles, inconsistencies across jurisdictions create friction, particularly in wire transfer recordkeeping.
• Data Privacy and Compliance Issues : Varying standards for data sharing and privacy add another layer of complexity. Privacy laws may differ between jurisdictions, complicating compliance with AML/CFT regulations and leading to operational inefficiencies, delays, and additional queries.

Solutions to Enhance Cross-Border Payments

• Legal and Regulatory Frameworks : Legal frameworks must balance privacy with financial integrity. Countries should adopt a risk-based approach to AML/CFT compliance, ensuring consistent regulatory measures across jurisdictions. This includes clearly defining participant roles, enhancing sanctions screening through information sharing, and exploring Know Your Customer (KYC) utilities for streamlined verification.
• Security and Privacy Considerations : Governance frameworks must establish clear guidelines for data collection, processing, and sharing to ensure compliance with data protection laws. Privacy-by-design principles should be incorporated to address privacy concerns, and international cooperation on privacy through bilateral agreements is crucial.
• Enhancing Access and Reducing Costs : To improve access to cross-border payment systems, regulatory measures should be adapted to include non-bank entities. Simplifying compliance requirements and streamlining capital controls will facilitate smoother transactions.

Conclusion

In conclusion, while significant progress has been made, continued efforts are required to address the regulatory and technological challenges in cross-border payments. A combination of technological innovation, regulatory reforms, and international cooperation is essential for improving cross-border payment systems. As countries work towards addressing the challenges posed by high costs, low speeds, and regulatory inconsistencies, new technologies like DLT and CBDCs offer promising solutions. The key is to strike a balance between innovation and regulation to ensure that cross-border payments are secure, efficient, and accessible for all.

Source: The Hindu