Improvement in monetary transactions and cross-border payments lies at the core of the ever-evolving digital financial system. Over the last few years, and perhaps more recently following the pandemic, a rush of new fintech companies and digital payment platforms have given headway to resolve long-standing financial pain points.
The development of technological mechanisms has allowed banks to bring more of their traditional services online, while fintech innovators provide more borderless products for consumers across a vast landscape.
Advancements have allowed us to improve how users can conduct transactions, while further democratizing specific economic services and products, and allowing banks as well as money transfer operators to align future strategies based on key consumer trends and financial metrics.
However, perhaps now, more than ever, competition among institutional players will need to be repurposed to better understand how potential risks and challenges, beyond cybersecurity concerns, can help the financial system evolve in the coming years.
How to Identify Risks and Challenges in Cross-Border Payments
The rapid rise in digital payments, and perhaps more importantly, cross-border payments have led to a flood of new entrants looking to redefine how consumers can conduct transactions with their money.
Yet, in a very short time, and with the introduction of dozens of new monetary service providers, there has been perhaps a lack of identifying potential long-term risks, and how near-term challenges could pose a threat to individuals, banks, and global monetary systems.
As non-bank financial intermediation grows, systemic risk propagation has changed in character: fluctuations in leverage, working via shifts in risk-taking capacity, can be a potent channel for propagating financial stress https://t.co/eOqd6RCgXh pic.twitter.com/2MXL3aodkV
— Bank for International Settlements (@BIS_org) September 7, 2023
As financial digital infrastructure continues to evolve and become increasingly complex, identifying critical issues and understanding the possible solutions could help provide more clarity in which direction these financial service providers can grow towards.
Compliance and Standardization
Managing compliance and standardization across multiple jurisdictions continues to be a near-term challenge for many financial businesses. What’s more, at the same time these businesses are experiencing an increase in cross-border transactions and demand for advanced products, challenges in understanding compliance are becoming more commonplace within the value chain.
Also, there would need to be a strategic deployment of compliance and standardization framework, which would allow the consideration of multiple financial jurisdictions, but develop a long-term vision for the development of regulatory statutes within the industry.
This in itself is not only a monstrous undertaking but requires near-endless key data points to fully understand the reflection of how compliance and standardization of these practices can be improved.
Current policies that regulate cross-border and digital payments are self-governed by regional laws and monitored by financial providers. However, with the growing demand for these services, fragmented understanding would pose increased security risks for users, businesses, and key stakeholders.
Accountability
Keeping on the topic of compliance and standardization, development in terms of accountability does not take into consideration the advancement of these digital payment tools and platforms.
In this regard, consumers and organizations are placed within a vulnerable gray area whereby third-party service providers such as fintech companies are not able to fully protect stakeholders.
Additional loopholes in the regulatory framework that govern the use of technology within the financial ecosystem only create further challenges for stakeholders, as they are unable to accurately pinpoint who can be held accountable for the risk of loss, damage, or any potential threat.
The requirement would see policymakers taking more aggressive action towards these existing loopholes, and further ensure that those most at risk can rely on regulation to hold service providers accountable for any sort of discrepancies.
Defective Customer Due Diligence
Intergovernmental initiatives, such as those highlighted by the Financial Action Task Force (FATF), carry explicit guidelines for both users and financial service providers on the protection of crucial data.
Yet, in recent years, the development of digital financial services has far outpaced the effective deployment of such guidelines. Growing concerns over defective customer due diligence (CDD) have increased risks for consumers, and pose an even bigger threat to domestic banking systems.
The framework developed by the FATF in 2019, expresses the concerns over cross-border payments and wire transfers using insufficient CDD infrastructure.
The consideration here is that both banks and financial service providers, in this case, fintech companies, will need to develop CDD infrastructure and encourage the responsible use of these services through the deployment of cyber security networks.
However, these standards only often remain suggestions in the larger picture, as the effective application thereof and the implementation of FATF standards would need to be equally applied by both regulators and lawmakers.
Credit Fraud
Another prevalent challenge is the rise in credit-related fraud that has taken place on cross-border payment platforms. Seeing as these systems often operate over multiple jurisdictions, there are still limited channels through which service providers can share and evaluate the credit status of cross-border transactions.
This in itself creates further legal and regulatory loopholes, for all involved stakeholders. Institutional players will need to develop a working mechanism that allows them to evaluate and track the credit status of these transactions, especially against a backdrop of rising cybersecurity risks.
Unclear guidelines on how third-party players can actively work to formulate a working plan are withholding forward-looking developments and further placing consumers and businesses that make use of these systems at risk of credit-related fraud by malicious entrants.
Transparency and Complexity
In the past, cross-border transactions were met with complex challenges, such as security concerns and fluctuating exchange rates. However, in more recent times, these obstacles have been resolved through workable solutions, yet there remains a high level of complexity that not only challenges the way the industry develops, but the technology that is used to power these systems.
The ability to reduce complexity comes at the cost of security, which only further creates more problems in the near term. Furthermore, reducing the complexity of sending and receiving cross-border payments should instead be approached as an industry-wide priority, instead of financial service providers looking to tackle these issues individually.
This would ultimately boil down to the ability of cross-border payment companies to provide users with accessible and transparent services that minimize risks, but furthermore ensure the safety, reliability, and efficiency of their transactions. Increased transparency over transactions can help users determine the deliverability of their funds, which could help to garner long-term customer loyalty for businesses.
Efficiency
In a report by Mastercard, data suggests that more than one-third of small businesses have started using more international suppliers following the pandemic. The rise of e-commerce and the ability to send and receive transactions more seamlessly has allowed many small and medium enterprise businesses to widen their customer audience.
These estimates are only predicted to further increase in the coming year, as financial services become more borderless, and third-party businesses find actionable solutions that ensure the safety and security of digital wire transfers and cross-border transactions.
Unfortunately, these developments, while already at an inflection point, remain somewhat inefficient due to a lack of digital infrastructure in some countries. Reaching international end-points requires these service providers to equip localized regions with the necessary digital infrastructure to grow their efficiency.
It would seem that the challenge of efficiency will remain a continuous work in progress for many service providers in the coming years as they bring more services online and democratize financial transactions.
This would mean that by increasing the efficiency of these activities, many stakeholders will be left unrepresented, which could increase competition in local markets, and security concerns where inadequate regulation is not yet in place.
Transaction Costs
Over the last few years, there has been a decrease in the cost of cross-border transactions as more international players enter the market.
According to a report by the World Bank, international payment platforms had the lowest transactional cost, which was roughly 5.39% of total transactions. Banks, on the other hand, were more on the expensive end of the scale, with an average transfer cost of 6.3% of total transactions.
While there is an indication that the average cost of these transactions has declined in recent years, it’s often still somewhat out of range for many consumers and businesses that expect to get the most out of foreign transactions.
Merchants that are unable to absorb these costs will often pass them down to consumers, increasing their service and product fees. Users that receive foreign income or international wire payments will lose more of their valuable income, over time, due to high transactional costs.
Fees and higher costs of these transactions would seem more reasonable in instances where the total transaction amount is larger. However, for users that send and receive smaller amounts, these costs could remain a financial burden in the long run.
Final Thoughts
The rapid advancements of cross-border payments have allowed consumers and merchants to operate within proximity of one another, despite being outside of their geographical location.
There are, however, remaining risks and challenges that would require the attention of businesses to ensure the safety of users, but also the long-term financial benefit of using these services.
Instead of approaching these ideas individually, it would be more sensible for financial service providers and third-party agents to develop solutions that are not marginalized within a specific geographical region, but rather help to ensure the forward-looking improvement of the entire digital financial industry.
