If correspondent banking is not the future – what is?
At regular intervals the long-term survival of the current correspondent banking model is questioned. Whilst initiatives like SWIFTgpi improve the speed, transparency and traceability of cross-border payments and non-banks offer alternative payment services, they still rely on the underlying settlement mechanism of nostro-vostro accounts held by correspondent banks. At the same time, compliance and KYC costs are leading banks to revisit and rationalise their correspondent network. What are the different visions for the future of the correspondent banking model? Which alternative options exist? And is the desire from banks and end-customers for a new platform great enough to make such fundamental change?
The death of correspondent banking has been predicted for many years, but has never happened. However, the threat has never been so big as it is now, particularly with the development of instant payments (IP) schemes and new entrants. Existing IP schemes are not yet close to becoming the sole way of sending international payments and it is likely there will be an intermediate period during which the correspondent banking and IP systems will coexist. One day, IP could replace correspondent banking in certain corridors but not all of them.
SWIFT’s global payments innovation (SWIFTgpi) initiative will address several needs of end users, which have been targeted by newcomers and alternative providers: speed, transparency and traceability. It also addresses two other important expectations of customers: reachability and security. One of the main strengths of SWIFT is its shared standards, which is hugely powerful in joining the purses of 11,000 banks around the world. These banks are communicating with each other using the same standards; even the most successful alternative providers can gather only a handful of partners and seem to be, until now, nowhere near able to provide the reachability of SWIFT.
At present, SWIFTgpi is based on old MT103 standards, which eventually will lose ground to the XML format. All the benefits of the initiative should be translated into the XML format to meet the expectations of clients. For example, the XML format will enable banks to convey more easily within a payment additional information linked to compliance, such as the full address and other details of the beneficiary. At the same time, while IP schemes are being set up, banks still rely on payments market infrastructures (PMIs) for settlement or on the correspondent banking network. There are some alternatives, but they also have failed to attract sufficient participants. It is unclear whether new technologies will provide all the services needed to replace existing systems for payments.
Correspondent banking business models will be revisited as the higher transparency given to end-customers renders some traditional practices obsolete. Certain client groups such as private individuals have much higher expectations in terms of speed of transactions, transparency and reduced costs. Correspondent banks will have to adapt technically to meet these requirements. SWIFTgpi and newcomers in the payments world are threatening some of the old practices of correspondent banking. Downward pressure on pricing is likely to continue, particularly around low value payments.
Correspondent banking is a very demanding activity, requiring substantial investment in technology and compliance. Banks require a sizeable volume of business to justify these levels of investment and if their levels of business are not high enough, they will pull out of certain activities or countries.
Head of Cash Clearing Services
To survive in the future, correspondent banks have two options: compensating a decrease in prices by adding volumes, and by innovating and enriching their correspondent banking offerings. Correspondent banking industry leaders that can prove they are truly committed to the business and have the capacity to invest and prepare for the future as a reliable partner will be able to add volumes going forward. Alternatively, being creative and enriching the offering with products such as competitive FX solutions, or being able to prioritise certain payments (and marketing this capacity), will also compensate for lower prices.
The cost of maintaining accounts and processing international payments is increasing year on year as the KYC monitoring and filtering expectations of regulators become more stringent. Correspondent banks must continue to invest heavily to remain compliant and offer innovative services. If it cannot, it will pull out of certain activities, geographies, or products. This must be balanced with clients’ requirements for reachability. To address the needs of clients, and of clients’ clients, leaders in correspondent banking must maintain a sizeable network whereas the respondent banks are progressively optimizing their network of providers, for cost and KYP reasons