Realtime Payments: A Threat to Traditional Cross Border Payments

1. Introduction

It is no secret to many scholars and stakeholders in the banking industry that technology is quickly reshaping the sector. Indeed, technological advances have given rise to what today has come to be known as realtime payments. Essentially, realtime payments refer to electronic payments that are almost instantly settled once they are initiated. In most cases, such transfers of funds are executed over a payment system that operates 24 hours a day and seven days a week. While the traditional cross border payment systems continue to rely on the  Automated Clearing House (ACH) and Society for Worldwide Interbank Financial Telecommunication (SWIFT) networks that are characterized by batch/individual  processing of payments, realtime payments are becoming more prevalent. As of now, many countries are already reaping the benefits of realtime payments. For instance, the United Kingdom adopted the Faster Payments system in 2008 and is currently riding on that success by implementing the real-time payments system. On the other hand, The Clearing House in the United States, which is a United States of America banking trade association, owns and operates realtime payments which commenced operations in 2017. This is a clear indication that the payment industry is rapidly transitioning to real-time payments both domestically and globally. Well, with every drastic technological change comes a fair share of opportunities and hazards. This paper examines how realtime payments are a threat to traditional cross border payments. My focus will be on how the technological shifts will render the traditional cross border payment systems obsolete and the bottlenecks facing the realization of such a revolutionary change. On that account, having in mind the current and expected benefits of realtime payments compared to the traditional systems, the paper illustrates the march that key traditional cross border payment stakeholders  have to undertake in order to remain relevant. However, as will be seen, the task facing the realization of a realtime cross border payments system is not a walk in the park due to some long standing challenges and the reluctance by major stakeholders in the traditional systems to shift to the new technology.

1.1. Definition of Realtime Payments

In 2018, the Federal Reserve announced that they would be implementing a new payment system for American banks, known as the Faster Payments System. This system offers the ability to have "Instant" payments that are available 24/7, making use of "Realtime" payment systems. This does not require parties to have an account with the same bank, but rather pushes and pulls money from one bank to another using an approach known as Interbank Settlement. By working like this it allows the funds to be accessible almost instantly, instead of taking days to clear like in traditional payment systems. Another benefit is the increasing trend of moving away from physical money, towards using credit and debit cards, mobile phones, web-based payments, etc. With more payments being digital, the popularity of realtime payment systems will only increase. Students should appreciate this is particularly important in the world of business, where companies may make, on a typical day; somewhere between 5000 and 20000 payments. If the companies are using traditional payment systems where these might take 3-5 days to clear, then companies would require much larger teams of accountants to make sure that companies and customers don't overspend- due to not being able to regularly track their current finances. However, with the ability to use realtime payments, accounting is much easier and removes the need to overstaff the accounts department.

1.2. Overview of Traditional Cross Border Payments

Therefore, a full cross border payment end to end process can easily require several days between clearing systems, correspondent banks and beneficiary banks and can potentially involve significant costs. Furthermore, traditional cross border payment services can be challenging to monitor for both the payment originator and the beneficiary and individual payment statuses can be difficult to identify, often providing limited transparency over the stage that a payment has reached. Lastly, existing cross border payment services often require manual input of payment details and lack uniform standardisation across different payment systems as well as offering only limited remittance data during a payment message. This creates an inability to refer to specific transactions in omni channel disputes and returns management. The need to ensure certainty for high value transactions together with the inefficiency of existing cross border payment systems and substantial costs, has led to the creation of payment services that focus on facilitating a more efficient and effective means of payment. Realtime payments have emerged to allow a person to person, person to business, or business to business payment to be made, received and settled in the simplest way possible; enabling consumers to see their full financial position in real time, at any moment and most importantly, allowing consumers to receive their incomes and make and receive payments immediately; bringing flexibility and transparency within the payment market.

2. Advantages of Realtime Payments

Realtime payments boost the efficient functioning of the economy. Speed and efficiency allow for faster transactions, especially in emergency scenarios, and help boost consumer confidence and also reduce the risk of defaulted payments. With lower transaction fees or no transaction fees, as well, the method is cheaper. Also, if there is instant notification for successful payments made, then this could effectively reduce the possibilities of fraud since it would be easier to track when payments were successful. Lower transaction costs and cheaper payments (especially in a globalised economy) not only serves to maximize profitability for firms, but if such cost savings could be passed on to customers, it would make products and services cheaper and more appealing to consumers. Finally, the process could also be less open to abuses as a result of the increased transparency provided by instant payment processing times and instant notifications for successful payments made. New payment method arrangements and a shift towards standardizing them globally could serve to facilitate the standardization of platforms across sectors and thus boost the capacity for compatibility between different payment systems, recently emerging ones, and the existing ones used worldwide. Adaption of newer payment systems could also create a higher skills demand, a seed for economic growth and further build on the existing knowledge and expertise in the economy. By standardizing payment platforms to fit global requirement, nations should able to collaborate better to maintain security and process integrity in terms of online payments crossing national borders.

2.1. Speed and Efficiency

The speed and efficiency of real-time payments compared to traditional methods mean that they can offer a highly effective solution for those looking to send and receive money abroad. In an age where consumers and businesses are used to information being available in real-time, international money transfers have often lagged behind with transaction times typically taking up to several working days. This is, in part, because the current system involves a number of different clearing houses and correspondent banks and a payment message - - being passed between them before the actual payment is made. However, the introduction of the SEPA Instant Credit Transfer scheme last year, where in-coming payments must be credited to a payees payment account in less than 20 seconds, has demonstrated the possibility for making extremely fast payments across Europe. By sending money directly from one bank account to another, much of the complexity and time involved in traditional payments can be removed and end-to-end payment times sped up, as shown with different models for real-time payments around the world. For example, the Faster Payments service in the UK which was the first real-time 24/7 service to be launched, and where a payment can be made and arrive in another account typically within a minute of it being sent. Similarly, the use of the Zelle network in the USA allows account holders to send money to friends and family quickly and easily using just their email address or mobile phone number, often completed within minutes.

2.2. Lower Costs

Furthermore, our research indicates that not only are banks and traditional cross border companies charging more for their services, but major exchange rate mark ups are also happening under customer's noses. It seems that as the technology available for traditional cross border payments has become more outdated, companies and banks have spotted an opportunity to either up the costs of their services or avoid updating to a new technology focused system. However, while realtime payments are making the future of cross border payments more questionable than ever before for traditional firms, it also gives banks and cross border companies alike a clear way to reduce costs, by updating their systems to accommodate newer technologies.

2.3. Enhanced Transparency

A noticeable advantage of realtime payment remittance schemes over traditional cross-border payments is the element of enhanced transparency. According to the World Bank, end-to-end transparency in cross-border payments is crucial in order to facilitate financial inclusion. Indeed, under realtime payment systems, all parties - including the remitting customer, the remitting payment service provider and the receiving beneficiary’s payment service provider - are able to monitor the various stages of a transaction up until its final execution. This is because most realtime payment schemes are either built upon or incorporate at some stage in the process, distributed ledger technology or DLT. DLT, often referred to as blockchain technology, is most commonly known as the technological foundation of virtual currencies. However, what is emergent is that this technology is also increasingly becoming the preferred operational platform for payment systems – and particularly cross-border payments. This is because the inherent encryption and duplicative data storage features of DLT which underlie the security of virtual currencies, also enable the storage and time-stamping of discrete transaction data ‘blocks’ in a difficult-to-alter chain of transaction history. This is significant from the perspective of regulatory compliance in that the remitting payment service provider is in a position to generate and supply - upon customer or regulatory request - a wealth of transaction-specific data to any relevant regulatory body. For instance, under the revised EU Payment Services Directive ‘PSD2’, it is now no longer incumbent on the payer to self-initiate a request for the release of data by their payment service provider, so-called ‘payment initiation service data’. This is because, in compliance with initiatives designed to open up and mandate access to payment services markets that hope to drive competition and innovation - facilitated by regulating payment service providers in a technology-neutral way – payment service providers are duty-bound to supply such data where the payment service user has validly requested their release to an authorised account information service provider. Such ‘payment initiation service data’ can encompass confirmation of the identity of the payment service provider in a given payment transaction and exact amounts paid and received. Therefore, the combination of DLT-enabled blocks of transactional data and the practical implementation of ‘access-request’ regulatory initiatives such as those seen in the EU facilitate an even more granular and user-enabling environment for cross-border payment transactions under remittance systems that are structured on the realtime payment model.

3. Challenges for Traditional Cross Border Payments

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3.1. Slower Transaction Speeds

To elaborate, traditional cross border payments normally include a series of correspondent banks with which the sender and receiver banks have to open accounts. Each bank will take a ‘cut’ of the sum being transferred – from £10-£25 – which can exacerbate the issues of costs and increased risk of fraud. However, transaction speeds are the main reason why traditional cross border payments looks so outmoded in the face of the new systems coming onto the market. The legacy funds transfer system in banking,  can take up to 5 working days to clear a payment. With that length of time, it feels more like you’re waiting for snail mail than an international bank transfer! This is because traditional cross border   transfers require a number of human interactions to set up the payment information and of course, payment verification. Furthermore, there are significant time delays when the centrally processed transactions; which all traditional cross border payments netwrorks  transfers are, are trying to find and then open a secure channel to the recipients bank, on one of the global bank payment systems. Modern Realtime Gross Settlement systems – for instance, the UK’s Faster Payments – do not require this channel, reducing the time a payment takes to process significantly. On Faster Payments, payment requests are processed individually leading to payment completion within one minute. The emergence of truly instant payments in the UK and globally means that those who can adapt and embrace the technological change will benefit from the transparency and efficient payment services that real time bank transfers provide.

3.2. Higher Costs

The costs associated with slow payments are varied throughout every financial system in the world. Banks and financial institutions will often charge extra fees for customers wanting to make international payments at what’s considered to be a more reasonable speed; and cross border fees levied on transactions are often passed on to the user. Cross border fees refer to fees charged when a UK account makes a payment to a bank account registered outside of the SEPA area for example, the fees that businesses can be charged by banks when they want to make cross boarder transactions in currencies other than Sterling can range from around £10 to over £50. On top of that however, banks also have a habit of charging a significant margin on the exchange rate customer’s recieve when making such transactions as well. This explains why, when families or friends have helped me financially in order to support my studies and paid the additional fee for a faster payment, the money has typically arrived within one to two days – in comparison, it can be up to a week using the standard payment and the recipient is charged more in the long run. Such financial inefficiency causes adverse, human costs financially to people’s lives; and it can be seen that payments taken longer to process not only cost individuals more but cause a longer, more stressful wait for the money. It doesn’t seem fair that those who can’t afford to pay for a faster payment are forced to suffer a longer delay in finance.

3.3. Lack of Transparency

There are three parties involved in a traditional cross border payment. The currency exchange rate and the fees/costs charged by each party to complete the transaction are important to all of the parties. The party that is actually sending the money would want to know how much the recipient will get after the currency is exchanged and all fees are deducted. The recipient would want to know how much money will ultimately be received, taking into account any currency exchange or other fees that may be assessed.

organisations tend to have multiple concepts or voices for promoting consumer insight, agency or culture, thereby ensuring that the consumer’s needs and expectations are met. He added that it is important for companies to ensure that they communicate with consumers in a professional way by recognising who their consumers are and how they are positioning themselves as businesses. 

3.4. Increased Risk of Fraud

The complex network of banks and financial institutions involved in processing cross-border payments often brings about an increased exposure to criminal activity due to the prolonged payment process. An important feature of traditional cross border payment systems is that they are based on the 'sender-to-receiver' messaging model. This model was developed at a time when cyber security was not as advanced as it is today. It is widely recognised that this messaging model is vulnerable to exploitation by fraudsters. The model requires that the sender initiates the payment and transmits all of the payment details to each participant in the transaction chain. Each participant has sole responsibility over the onward transmission of the payment details to the next bank in the chain. However, that bank does not have to verify the authenticity of the payment order. As such, it is possible for fraudsters to intervene in the payment instructions and divert the funds. In addition, participants are able to identify each other because they require access to the payment information on the system. This can lead to people accessing and blocking accounts, or gaining customers' personal data. By contrast, real-time gross settlement systems process instructions across a number of countries simultaneously and on a cross-border basis because, among other things, they do not rely on the sending of beneficiary details for the underlying transaction to be initiated. As such, they provide less time and less opportunity for fraudsters to intervene in payments. In addition, the obligation on participants to execute requests for payment 'without undue delay' will transfer legal ownership of the funds more quickly, thereby lessening the effects of any successful cyber attack. This is known as pushing money to the intended beneficiary. Overall, without the need for the initial payment instructions to be sent and for beneficiary details to be transmitted down the chain of correspondent banks, the risks in cross border payments could be greatly reduced.

4. Implications and Future Outlook

While the faster payments network is slowly being adopted in the US, the introduction of this system may accelerate the implementation and use of such systems in other countries. 

4.1. Impact on Financial Institutions

The payment ecosystem is undergoing significant change, particularly with the move towards real-time payments. The main driver for this change is customer demand. Customers want payments to be received and for money to be accessible in real time. With both the Federal Reserve and The Clearing House planning to introduce real time gross settlement systems (RTGSS) in the near future, momentum to instant payments has quickly built across the United States. The Federal Reserve has recently created a set of strategies to create an environment for safe and ubiquitous faster payments in the United States. The introduction of real-time payments has significant implications for financial institutions. They will have to modify their operations and invest in new technology to support instant payments. However, many financial institutions in the United States could view real-time payments as a threat because they could potentially lose revenue from payment processing fees and may have to reduce the number of employees needed to process payments due to the automation benefits of instant payments. High value cross border payments cannot currently be processed through real time payments and there is no indication that this will be possible in the near future with RT1 as it only facilitates payments in euros within Europe. However, if high value cross border payments could be adapted to a real-time environment then providers of cross border payments may no longer have a unique selling point and could see a loss of custom. High value payments cannot be processed with RT1 due to the maximum amount being set at €100,000.00. RT1 facilitates low value euro payments (which covers a majority of payment services that customers would want to use instant payments for) and has a final cut-off point of 3.00pm Central European Summer Time. It is evident that faster payments will soon become available on a 24 hour basis, revolutionising when and how payments can be made and accessed. These types of payments are processed as individual, real-time gross settlement payments that are settled instantly and considered final when made.

4.2. Regulatory Considerations

From a regulatory perspective, the potential widespread adoption of instantaneous wire transfers poses several important issues for policymakers. Firstly, anti-money laundering policies require financial institutions to screen and monitor transactions. The hallmark of all the regulation and oversight in the funds transfer industry is based on the fact that transactions take place in batches at predetermined intervals throughout the day, normally every 15 minutes. This at least gives financial institutions and law enforcement agencies a chance to identify, stop and investigate an illicit transaction. However, with real time settlements, the notion of batch processing would become irrelevant and law enforcement agencies would have to be far more proactive, dynamic and efficient in their monitoring and investigate processes. Secondly, the cross border payment industry is situated in a legal and policy framework that was largely designed by and for domestic consumers and financial institutions. Jurisdictions have implemented different legal regimes depending on the technology of the time and the structure and desires of the domestic financial sector. However, cross border payments require interaction between multiple legal systems and regulatory bodies. Realtime payments are perceived as a gradual technological evolution from wire transfers, which means that the whole state of the industry could gradually change over a period of many years as real time solutions become more popular. Yet payments that use blockchain technology, such as new cryptocurrency based real time systems, represent a disruptive technology and could potentially cause radical changes to the entire regulatory landscape. Blockchain payments are fundamentally different as they act through a decentralised system with no intermediary, whereas realtime payments still use traditional financial networks. The creation of a multitude of distributed ledger payment systems that could exist outside the traditional international interbank network would mean that current oversight, namely the oversight of central clearing counterparties, would become less relevant. Also, the lack of an intermediary financial institution in the chain would render typical anti-money laundering and ‘know your client’ regulations completely redundant. This is because there would be no obligation on any entity within a blockchain payment system to identify and report suspicious activity.

4.3. Potential Disruption to the Cross Border Payments Landscape

With the revolution of a new wave of immediate payments, the traditional cross border payments landscape faces unprecedented level of threat and disruption. Firstly, some well-established cross border payment entities may find it hard attracting funds, as their business models might be affected. The traditional transaction fees i.e. the bulk processing fee and the flat fee charged by banks and other traditional players may no longer be sustainable. These legacy institutions and players are sandwiched between reducing their charges at the risk of diminishing revenue, or maintaining high transaction charges and watch their market share being eroded slowly over the years.

Alternative players, fintechs and even new banks that are customer-focused and known for agile and effective service delivery like Starling bank and Monzo have seen increased numbers in customer accounts thanks to the UK’s Faster Payment Initiative. With real-time payment systems increasingly gaining international popularity, the fierce competitive advantages that the traditional players had may be gradually eroded given the limiting factors these traditional players have. Such limiting factors include costly data infrastructure and maintaining personal and payment data required to meet the strict regulatory standards.

On the other hand, a bank or a funds transfer operator need to have several settlement accounts across the world in the clients’ jurisdictions for the purpose of liquidity and compliance to regulations. With the current ripple effect of governments and central banks increasingly committing to the faster and real time payment initiatives, it is possible that digital and crypt payment solutions can also capitalise on this and market themselves as future solutions to cross border payments and remittances.