We live in an increasingly
connected chatty world. Exchanging information has gotten easy and that's important. Yet, we haven't gone much beyond it. Perhaps the most frustrating is why we still can't easily transact value. Even in relatively "free" parts of the world where exchange of information across borders is cheap and convenient, sending value, aka money, is not. As the saying goes: how come I can put money in an envelope and send it faster and cheaper to another country than I can do so with a bank-to-bank payment?!
This frustration is valid not only on the user side (consumer AND commercial) but also for businesses looking to put together a payments related service. I faced this problem first hand when I was a product manager for an NFC payments stack. The number of stakeholders, services and technologies you have to line up and get working together is prohibitive for a flat world of value. What's more befuddling is something I learned during my time at Ripple: payments was originally intended to be a part of the HTTP protocol in the form of error code 402 'Payment Required'. Compared to such an ambitious goal, how are we doing today?
McKinsey's Global Payments 2016 report does a great job at capturing a snapshot of where the world of payments is and the direction it's headed (caveat: mostly and understandably from the perspective of financial institutions). The report highlights mostly encouraging signs amidst flattening growth statistics: transaction growth and adoption of electronic channels is fueling a more interconnected world of value, despite macroeconomic setbacks. There are many eye-opening statistics and insights from the report (such as the below snapshot). For this post, I will be focusing on cross-border transactions, as it's core to its problem statement and highlighted as the most challenged revenue segment by McKinsey.
Payments without borders
Although challenged by the year 2016 (Brexit, US Elections, etc), globalization (in the neoliberal sense and not the capitalist one) continues to be a force for the betterment of human civilization. Making cross-border payments more efficient and cheaper will only accelerate this force, leading to a global economy for the benefit of not just the few.
The McKinsey report highlights a plethora of infrastructural changes that need to be implemented to ensure cross-border transactions meet the needs of its customers: "transparent, real-time, data-rich and easy to use". These are all very valid and will be implemented by either existing financial institutions themselves or by disruptors such as those in the Blockchain space. There are however, specific areas that can cause immediate impact to boost the inclusion of the many in the global economy, such as payments to merchants.
Global cross-border flows are segmented into four different quadrants by the report, exhibiting different payment volumes, revenue margins and stakeholders.
Business to business payments are observed to capture humongous share of the total flow, with a very minimal revenue margin. These payments can take many different shapes and forms, from SWIFT payments through the correspondent banking network to domestic payments (e.g. ACH), to even credit card payments. In this regard, they're structurally not that different from consumer to business payments, especially at an aggregated level. What constitutes the main difference, and hence the huge revenue margin offset, is the transaction amount.
At the highest end, a typical fee of $30 to $40 for transacting $15,000 to $20,000 is negligible for any payment originator (resulting in the highlighted margin of roughly 20 basis points). This forces payment originators (large business customer or payment gateway) to aggregate cross-border payments to other businesses until they have a lump sum of $15,000-20,000. What ends up happening is a recipient of a small $100 payment will have to wait until the total funds to be transacted to its country add up to a justifiable level for the transaction to go through - resulting in anywhere from 2-7 days, sometimes longer, waits. That is unless they want to pay a 40% transaction fee! (or worse: the author himself has recently paid ~$65 to transfer funds from a Turkish bank to a U.S one)
As McKinsey highlights, "the faster settlement of funds across accounts and institutions will also foster efficiency by unlocking non-productive balances that have become a permanent byproduct of the current process." This is especially true as businesses are increasingly formed around small fee goods such as digital ones or marketplaces, which demand and facilitate exponentially more cross-border payments.
In the next part of this analysis, I'll be looking at how certain players in the payments world (~cough~ payment gateways ~cough~) are in a very opportune spot to implement smart hacks that can enable a flatter world of value, in the near term. (Part 2)