Crystal ball gazing is – ironically – an unpredictable business. If we consider that 2016 was one of the most disruptive years on record, with so many different factors influencing financial markets, geopolitics, business and social order, it is no surprise that the cross-border payments industry was also in a state of constant flux.
So as we look deep into 2017, with a regulatory environment that continues to impact financial institutions worldwide, we can safely anticipate continued change.
There is a number of indicators that 2017 is poised to be the year that move away from traditional correspondent banking for low value cross-border payments starts to gather pace. This has been simmering away for some time but in 2016, it became clear that the old ways were starting to become redundant and that the practicalities of the model we have used for decades no longer tick the right boxes for clients.
Why is this? There are many reasons why correspondent banking, in its old form, will be consigned to the history books – and most of them concern economics and efficiency.
Regulation, for example PSD2, Basel III or Dodd-Frank, will continue to influence the financial markets, and quite acutely, the banking sector. In fact, the tightening regulation around capital adequacy brought about by Basel III will focus banks on the problems in the traditional correspondent banking system, namely capacity around liquidity positions, uncertainties around settlement time and a lack of predictability with regards to fees and charges.
PSD2 has already created considerable angst among the banking sector but it represents an opportunity as well as a challenge. While PSD2 will trigger a new theatre of competition, one of its consequences, the increased use of APIs, will enable an entirely new ecosystem of innovation with the customer’s interest at its core.
Loss of (risk) appetite
While this is in process, banks continue to de-risk across their businesses, resulting in retractions from some markets and geographies, severely reduced client bases and hard-hitting – and perhaps damaging – cost-efficiency programmes.
Many banks are reducing their global footprint while they aggressively strive to reduce costs. While this may cause some pain, it may also create openings for other institutions and perhaps drive some consolidation. At the same time, there is a school of thought that suggests de-risking is actually creating other risks by pushing people towards a ‘grey economy’ that operates beneath the regulatory radar. It was interesting to hear in Davos that one leading bank CEO talked of a positive future for banks but admitted that getting to that point would be very uncomfortable.
Distributed ledger technology
Of course, the world is currently being seduced by distributed ledger technology (DLT). Certainly, DLT is part of the future landscape that we are heading for and in 2017 we shall see further steps towards embedding this new technology into everyday business. However, we must resist the temptation to bill DLT as a panacea, since payments involve a degree of complexity that requires more than this technology alone. It is likely to be just one weapon in our armoury as we move towards utility-type solutions that deliver more speed, efficiency and transparency, allowing us to capitalise on the exponential growth of cross-border payments. T
There are, however, many problems with the current model of cross-border payments that cannot be fixed by technology. They require a new approach or model of the type Earthport offers, incorporating hybrid delivery models that include DLT.
In 2017, we should see greater investment on the part of banks in exploring DLT as part of their digitalisation initiatives. In 2016, banks spent USD 75m on blockchain/DLT and this is expected to grow to USD 300m by 2018. At the moment, most are not sure how they can optimally use DLT, but you can be certain that once the first movers are in place, adoption will become contagious.
It has become increasingly obvious that the technology behind blockchain is capable of giving us so much more. DLT is a broad and deep conversation that is confronting the very nature and culture of financial markets, and in particular, international payments. The regulatory landscape demands there is a lot of hard work still required, including the validation of regulatory and legal compliance solutions, getting technology and infrastructure production-ready, migrating existing volume and revenue to the new DLT, as well as expanding to new use cases to finally monetise the investment and reap the reward. Many see DLT as being long overdue, but the metamorphosis is underway.
So it is clear now that the world has accepted that change is inevitable and already in progress. The question that needs to be answered is, who will provide the services that our customers now demand?
In 2016 a level of peaceful co-existence emerged between banks and fintechs. There is now a considerable amount of mutual back-scratching going on in the industry, as everyone starts to realise that both sides of the equation need each other. This sea change will surely flourish further in 2017, as banks and fintechs develop partnerships and reasons to collaborate. Banks have had so many issues to deal with, against a backdrop of heightened regulation, changing client behaviour, greater competition and technology challenges, that they need the sort of partnerships that fintechs can provide.
Likewise, we are now reaching a stage of the ‘fintech revolution’ where these dynamic new arrivals need the banks to acquire scale and customer access. This latest phase is basically everyone working together for a better tomorrow. At Earthport, we have already experienced, first-hand, just how compelling the link-up between banks, fintechs and payment providers can be.
Much will be determined by how the banking sector shakes out in 2017. Banks will continue to assess what they really want to do, and what they can do, in the years ahead. They will undoubtedly seek to concentrate their efforts on recurring transactional business, which – with its focus on fee-based business – should translate into growth for the global transaction banking industry. As a result, and for a number of reasons, banks will be naturally less reliant on risk-consumptive business.
Banks have been going through very draconian cost-examination exercises, looking at what type of business still makes sense. This won’t necessarily include low value cross-border payments and other low-margin corners of the payments sector. They may decide to partner with other firms or become part of consortiums for those areas of payments that are no longer viable as standalone operations.
Creating a better business world is also a priority for our clients. In 2017, as people become more open and inquisitive, we can expect to see more strategic dialogue between providers and their clients. They now recognise that a new breed of provider can add choice, greater flexibility and more efficiency to the payments experience.
Of course, without due focus on the safety and security of our industry, all of this could become compromised. Increasingly, our clients are concerned about the growing threat of cybercrime. Conversations at conferences and other events inevitably turn to security and that’s why greater resources are being devoted to ensuring the system maintains its integrity – after all, the more sophisticated our systems become, the more inventive criminals become.
Forecasting can be a tricky and risky business – in 2016 we all saw that the unexpected can happen and completely confound the experts. One thing, however, is clear: the dramatic rate of progress we have witnessed over the past few years will be sustained, which means that the cross-border payments arena will continue to be just as dynamic as it has been over the past 12 months.