The Future of Digital Banking

How blockchain is going to change the remittance

Every year hundreds of billions of dollars are transferred internationally by businesses and individuals who have emigrated from their home countries and cross-border money transfers are likely to experience double-digit annual growth rates over the next few years. Remittances reached a record high in 2018, according to the World Bank.

In a press release published in August 2019, the Bank said officially recorded annual remittance flows to low-and middle-income countries had grown to $529 billion during the year, a 9.6% increase on the previous record high of $483 billion in 2017. Meanwhile, total global remittances, which include flows to high-income countries, climbed to $689 billion from $633 billion in 2017.The World Bank found that banks were the most expensive remittance channels, charging an average fee of 11% in the first quarter of 2019.

Post offices were the next most expensive, costing more than 7%.In its Global Payments Report 2019, consulting firm KPMG estimated the size of business-to-business (B2B) cross-border payments to be as much as $15.5 trillion during 2018, a 5%-plus growth on the previous year. It calculated that revenues received from global payments amounted to $1.9 trillion in 2018 and were 6% higher than the past year.

However, until now, remittances to family members back home and B2B international payments have been at a great personal and economic cost. Fees on international bank transfers have been so onerous that the United Nations has set a 2030 Sustainable Development Goals' target to reduce the transaction costs of migrant remittances to less than 3% from their current estimated average 7.1%.Fees are high because several players are involved in the international payments process: the source bank, the central bank, correspondent banks and, finally, the destination bank. Each bank along the way charges a fee for their service.The time it takes to get the money from the source to the destination is also lengthy. Transactions take up to a week before the money ends up in the hands of the recipient.

Another key obstacle to the payment of remittances via formal banking channels is that the recipient needs to have a banking account to receive the payment. The unfortunate reality is that the vast majority of people receiving the money do not have bank accounts. Even if they do, many live in rural areas and have to travel long distances to get to the nearest bank branch to collect their money. As a result, many remittances are made using informal channels.

However, with the advent of mobile wallets powered by blockchain technology, the way international payments are made is set to change completely. Mobile wallets are installed on mobile phones and offer a variety of functionalities, including the ability to transfer money internationally. Blockchain is how this happens.Why are the payments processed using blockchain? Blockchain is the most efficient, transparent and secure way to facilitate international payments because it is based on distributed ledger technology (DLT). According to Get Elastic, a media platform focused on commerce trends, emerging technologies and digital insights for practitioners and developers, blockchain transactions are distributed, with records verified by a network of computers versus by one party or bank, and visible to all parties versus held in a central database.In an article that details how blockchain for B2B payments works, transactions that take place on DLT are immutable once recorded and cannot be altered, reversed or tampered with, which makes the payment process highly secure.

Author Linda Bustos explains the payment process in a nutshell: “When a buyer or seller submits payment information to the chain, a digital “block” is created and distributed to the network. Multiple computers compete to unscramble the block, and the first to successfully do so shares it with the network for verification. Verification includes confirming funds are available, sender and receiver are reputable, and the request is legitimate. Once verified, the transaction is authorized and posted to the ledger and designated parties are updated in real time.”Once associated only with cryptocurrencies, the blockchain technology is increasingly becoming accepted by regulators and the financial sector more broadly as a valuable means of processing financial transactions.

For instance, blockchain business-to-business payments, which rose to $171 billion in 2019, according to Juniper Research, are predicted to exceed $4.4 trillion by 2024.The key benefits for individuals and businesses making cross-border payments on blockchain-powered mobile wallets are that costs will come down substantially, and the payment will happen far quicker than conventional bank international payments or money transfers.

Blockchain removes multiple intermediaries that participate in traditional cross-border money transfers. Money is transferred directly via blockchain from Bank A to Bank B, eliminating the need to go through two other correspondent banks and reducing the time and cost of the transaction. The cost savings a customer can make by using blockchain-based cross-border payment solutions are substantial. For instance, a customer making a remittance payment of $20 000 would incur an average cost of 7.1%, or $1 420, as calculated by the World Bank. That compares with an estimated 2%, or $400, to 3%, $600, cost of remitting the payment via a blockchain-based remittance provider.

Remittance tokens can also be incorporated into the transaction flow. This enables the sender of the money to buy remittance tokens, removing cash from the transaction and giving the sender the control and visibility over how the value is spent. These tokens can be denominated in different amounts and currencies and used during money transfers on a mobile wallet. Fulfilment is transparent and takes place in real time.The entire money transfer process becomes considerably more convenient and less administratively intensive. Given that payments are made from mobile wallet to mobile wallet, the recipient does not need a bank account.

How the banking as service works and the rise of banking as service

BaaS is an end-to-end model that allows digital banks and other third parties to connect with banks’ systems directly via APIs so they can build banking offerings on top of the providers’ regulated infrastructure, as well as unlock the open banking opportunity reshaping the global financial services landscape.

Tech-savvy legacy firms can fend off the encroaching threat of fintechs by moving into the BaaS space to share their data and infrastructure. In a matter of years, access to this level of information will become table stakes for digitally native customers — so banks that begin now will be ahead of the curve, and likely rewarded with high demand.

The BaaS model begins with a fintech, digital bank, or other third-party provider (TPP) paying a fee to access the BaaS platform. The financial institution opens its APIs to the TPP, thereby granting access to the systems and information necessary to build new banking products or offer white label banking services. In addition to getting ahead in open banking, legacy institutions that launch their own BaaS platforms are also opening up new revenue streams. The two main monetization strategies for BaaS include charging clients a monthly fee for access to the BaaS platform or charging a la carte for each service used.

Tech-savvy legacy banks that create their own BaaS platforms now will not only get ahead of the open banking opportunity before their competitors, but also unlock a new stream of revenue by monetizing their platforms.

In the UK, the new revenue potential generated through open banking-enabled small- and medium-sized business and retail customer propositions was £500 million ($700 million) in 2018, per PwC — and Insider Intelligence expects that to grow at a 25% compound annual growth rate to reach £1.9 billion ($2 billion) by 2024.

The G20 roadmap to enhance cross-border payments

Globally, cross-border payments lag significantly behind domestic payments in meeting user expectations for services that are cheap, fast, accessible and transparent. In October 2020, the G20 endorsed an ambitious ‘Roadmap’ to enhance cross-border payments around the world.[1] The Roadmap was developed by the FSB in coordination with the Committee on Payments and Market Infrastructures (CPMI) and other international bodies. It sets out a five-year program to address various frictions in retail and wholesale cross-border payment arrangements that contribute to the challenges of high cost, low speed, limited access and insufficient transparency

The Roadmap aims to address these inter-related problems through 19 ‘building blocks’ (i.e. work streams) run in parallel over the course of the plan by the relevant international organisation. The building blocks fall into five focus areas:

1. committing to a joint public- and private-sector vision to drive change
2. coordinating regulatory, supervisory and oversight frameworks to identify gaps or areas for further alignment, where appropriate
3. improving existing payment infrastructures and arrangements, with a focus on widening availability, strengthening links between payment systems and reducing settlement risks
4. increasing data quality and straight-through processing by enhancing data and market practices
5. exploring the potential role of new payment infrastructures and arrangements.

The G20 has requested the FSB monitor progress and report annually, with the first progress report expected to be published in October 2021. In addition, individual jurisdictions or operators of payment systems and arrangements are encouraged by the FSB to set out publicly the actions they intend to take to contribute to meeting the overall Roadmap goals. The FSB also highlights the need for the private sector to be involved in the Roadmap work through sharing insights and expertise, and implementing change.

The first major action in the Roadmap has been the release of the FSB's global quantitative targets for cost, speed, transparency and access.[2] The targets are intended to act as a foundation for the work on the subsequent building blocks, and generate momentum and accountability for overall outcomes. Performance indicators will be developed and data collected to measure progress.

The Bank is actively involved in the international work on the Roadmap. The staff are contributing to a number of international working groups, including those focused on improving access to payment systems for new cross-border payment service providers, standardising payment messaging practices, and exploring issues presented by possible new infrastructure for cross-border payments (e.g. global stablecoins and CBDCs). The Bank has also been coordinating with other Australian policy and regulatory agencies, and discussing the work with industry stakeholders, in order to progress Australia's contribution to the Roadmap.