Retail banking and consumer finance innovation has come along in leaps and bounds, but the fragmentation of payment services available in the market, coupled with the stagnation of processing capabilities has resulted in an inability for financial institutions
to collaborate for effective correspondent banking.
With the multitude of alternative services that are available today, to a traditional lender, these competing networks have found a way of offering cross-border payments and correspondent services to their customers in a faster, cheaper, and more efficient
way.
Ahead of Sibos in Toronto, Canada, Finextra caught up with Mick Fennell, business line director - payments at Temenos, to discuss how evolving correspondent banking technology is crucial for banks that would like to access financial services in different
geographies and provide cross-border payments services to their customers.
Further to this, as Fennell explained, even payments solutions that do not require customers to have bank accounts to transfer funds – such as cash remittances – utilise correspondent banking networks. Banks have historically had a strong and extensive network
of correspondent relationships, but this is changing and there is evidence that banks are reducing the number of these partnerships.
This is occurring within respondent banks that do not generate sufficient volumes to recover the cost of compliance and are in regions that do not have sufficient information or processes to reduce KYC risk. This has led to the reduction in correspondent
banking relationships.
How have correspondent banking processes become fragmented?
Fennell referenced Bank of International Settlements research and said that “between 2011 and 2020, correspondent relationships have reduced by 25% and even during the pandemic year of 2020, there was a 4% decrease, whilst volumes increased by 2% during
the pandemic. What this means is that while some of this has been driven by the balance of trust and risk in individual relationships, banks are becoming more discerning about the markets they deal with.” But, what has led to this fragmentation?
As technology and cross border payments became increasingly prevalent in the 1970s, so did electronic correspondent banking. Alongside this, the emergence of the Swift network meant that financial institutions could send messages to each other in a standardised
format, and thus, the electronic correspondent banking network was born.
Over time, systems and standards evolved, but in some ways, much of the architecture remained the same and banks have continued to use these platforms for over 20, 30 years. This, according to Fennell, is where correspondent banking “has been left behind.
What we’ve seen in a lot of banks is that they’ve really invested in the consumer, especially around the distribution front end and the digitisation of banking, both retail and wholesale.
“The correspondent banking side of business is about sending and receiving cross border payments and then managing that cash for account holders. Platforms have tended to remain relatively static. Incrementally, banks have been adding to the functional capacity
of them when the standards change, and new services are added, many times with increasing difficulty.
“It’s now time for a revolution in that space. With the emergence of cloud technologies, the requirements for API engagement, and the need for full end-to-end digitisation, it’s now time for the underlying platforms that correspondent banking is built upon
within these financial institutions to really take a leap forward,” Fennell highlighted.
Today, correspondent banking is cross border payments, which means that the innovation that has been seen in this form of payments processing should be brought into correspondent banking processes. Historically, the market relied on the likes of HSBC
or JP Morgan’s with their large-scale correspondent banking networks, while more regional players like Standard Chartered in Asia or Standard Bank in Africa would be leveraged for their regional services.
However, fintech firms have now entered the market and as Fennell described, have created their own networks and attempted to resolve weaknesses in terms of efficiency and cost of delivery. He explained that there is a “huge range of cross border network
providers like Wise, Thunes, Visa Direct, Mastercard XBS, and Convera, which was part of Western Union and a specialist for B2B cross border payments.
“We’re now seeing a huge range of these companies, which have built up their own networks and are basically acting like a modernised correspondent bank,” Fennell said, and this is because many businesses still struggle to find efficient ways of sending payments
to customers and suppliers in different locations, at a cheap cost. These cross-border payment fintechs are addressing this need but their success is creating fragmentation in the market. How can banks take advantage of this fragmentation? The answer is through
collaboration.
Banks must not only collaborate with their traditional correspondent banking partners, but also with the fintech organisations and technology firms that are now leading the way when it comes to efficient alternative correspondent banking. This path forward
will enable banks to curate their services and keep pace with the dynamic world, alleviating the pressure to provide these services, as well as consume them. Banks must turn their focus to improving the speed of onboarding and efficiently managing these service
providers in order to elevate the payments services they offer their customers.
How can banks offer instant correspondent banking payments?
According to Fennell, organisations that offer correspondent banking are usually an “endpoint” in their domestic clearing market. Increasingly, companies, consumers and banks are looking for and, in some respects, expecting more real time execution of cross
border payments by these endpoints. Banks can ensure that they are able to offer these instant payments, or at least, near real-time payment services by connecting the instant payment rails in domestic markets to the incoming cross border flows, thus ensuring
the payments are executed to a much tighter timeline.”
Fennell continued to explain that when sending a payment to another country, that value should be credited to the beneficiary in real time. What this means is that the recipient of that payment must link the incoming order to their domestic clearing functions.
This is why straight through processing is of paramount importance. For this to be implemented, rerouting and validation must be automated, including callouts for anti-money laundering and sanction screening, which ensures that all is above board, and the
correct information is sent to the ordering bank and ultimately, the consumer. Moreover, API engagement with a bank’s customers also allows this information to be provided in real time.
“All of these systems that financial institutions run must be monitored, and also protected. That’s why the underlying move must be to the cloud. The cloud not only gives you scalability, but there are huge gains in terms of the security environment provided
by the hyperscalers – Microsoft Azure, Amazon Web Services, and Google Cloud.
“While most cross-border payments are B2B, much of the media coverage and noise in the market is about person-to-person cross border flows. We tend to think about remittance networks where people are sending cash back home from developed to emerging markets
and that’s obviously a huge part of this world, but most cross border payments are related to B2B and the funding of trading, supply chain finance, lending, credit lines. The investment and wholesale banking world servicing the corporate is where the big money
goes,” Fennell said.
He reiterated the importance of automation and alongside cloud, new technologies such as artificial intelligence (AI) can improve straight through processing rates and help to increase protection of the customer. In Fennell’s view, financial institutions
must leverage all these tools to search for the “most efficient and economical way of routing payments, but also to have the agility to switch between different services. Combining all these elements, banks should be asking themselves: is my platform fit for
purpose for now or for the next 10 to 15 years. That’s where we see the need for the revolution in correspondent banking platforms.
Where does ISO 20022 come in?
One key part of routing payments is and will continue to be leveraging ISO 20022 beyond the point of compliance. By providing a more comprehensive, structured, and harmonised data model, ISO 20022 is simplifying how different financial institutions and payment
systems communicate with each other. In addition to this, Swift’s Cross-border payments and reporting plus (CBPR+) project is helping to standardise and harmonise the set of international data that flows to domestic and regional real time gross
settlement (RTGS) and clearing services.
Fennell advised that with ISO 20022, processing is more efficient. “When we get a cross border payment request, we’re able to reroute it and transform it into what’s required to fulfil it within the local market. We’re able to do that much more easily because
there’s an alignment of the data set and an understanding of the data set within the domestic processing environment. That wasn’t the case historically.”
He also mentioned that with ISO 20022 now providing structured data banks no longer have to process address fields that are full of difficult unstructured text. Instead, as each element of the beneficiary, including the address, listed on the payment message is now split down into their granular constituent parts, technology partners such as Temenos are able to process payments more efficiently through machine coding.
“ISO 20022 has created the ability for people to automate and validate on a 24/7 basis and financial institutions are no longer manually figuring out where payments are meant to go,” Fennell concluded.