Reinventing correspondent banking: Where next?
By Emmanuel de Bouard, Head of Cash Clearing Services for SG GTB
“In the current environment correspondent banking has to evolve, but it will continue to exist because it is doubtful there is any other way of reaching any bank or beneficiary in the world without a correspondent banking network.”
Under ever greater pressure from their corporate customers to improve the cross-border payments experience – and challenged by the growing number of digital innovators – over 45 of world’s largest transaction banks teamed up in December 2015 to rethink the traditional correspondent banking model. Committed to offering new B2B cross-border payments with greater speed, transparency and predictability, the piloting of the new service is already underway, and the first results will be shared at Sibos. While the train has clearly left the station, technological developments and customer expectations are evolving at an exponential rate and many questions remain: Will banks be able to keep up? Is there a business case for coopetition with fin-tech companies? Where can back-offices be streamlined? What the banking industry’s next move should be.
- There is an impetus to rejuvenate correspondent banking because of new technology, such as blockchain, and new entrants including financial technology companies and payment services providers. SWIFT’s Global Payments Innovation Initiative (GPII) is an answer to this. For SWIFT it may look as a type of defence, but it is rather an approach that will improve correspondent banking by finding common standards between correspondent banks so that information can be disseminated to their clients more quickly.
- Among new technologies, those that enable instant payments have attracted a great deal of attention in retail payments, but in corporate banking, instant payments has a different meaning. Getting information out to clients quickly is the key; a merchant doesn’t really need to see the money in its account immediately, but does want a guarantee that the payment will be delivered. Real-time functionality is difficult to achieve in the current environment. There are 1000s of banks in Europe alone, for example, and clearing systems clear payments through the day, rather than instantly. Not all banks are signed up to these clearing systems either. This is why GPII is so important because it will guarantee that payments have moved from the right place to the right person. If a corporate receives information that a payment will arrive at a particular time, it can reuse those funds immediately, even if not yet posted to its account.
- Blockchain technology has been mooted as a potential challenger to the correspondent banking model as it is envisaged that all of the participants to a transaction can be informed of its status in real time. But one of the drawbacks is that the technology has not yet proved it can handle the high volume of transactions associated with correspondent banking. With GPII, on the other hand, all of the information will be stored in the cloud. Each participant can access the transaction information when needed. This approach means that participants in the transaction will not be flooded with information that may not be relevant to them.
- GPII will enable correspondent banks to tailor services to individual customers. Because information can be downloaded from the cloud as required, some clients will be able to receive information in real time while others may prefer to access the information when they need it.
- New entrants in payments tend to be closed communities. If all of the actors connected to a transaction are within that network costs are low as transactions are passed between them and do not go outside the network. However, virtual currencies are not always accepted by everyone therefore at a certain point transactions will be relayed to banks. In international payments, on the other hand, banks must send transactions to other institutions anywhere in the world and often in different currencies. Nostro accounts are set up to deal with different currencies and the need to settle in different countries. The correspondent banking model was set up to ensure banks have the network and systems to deliver secure payments. This is a real advantage over the new entrants.
- My belief is that over time the new players will start to work with banks. Financial institutions have the network to provide reachability and financial technology companies have the technology to speed up payments. This partnership will work on different levels. For example, some banks including Societe Generale, are investing in financial technology and buying companies. They intend to incorporate the technology and the personnel of these companies into their own IT teams. There is a conflict between fintechs and banks, however. A financial technology company will say its primary aim is to satisfy a customer need and making money is secondary. For a bank, it not only has to satisfy a customer need but also provide a business case.
- Security is another area of conflict between banks and fintechs. Banks are highly regulated and reputation is important. Some fintechs have run into problems regarding the end use of their systems (for money laundering and fraud, for example). Security is stronger on the bank side and information security is increasingly important. The information stored on the GPII cloud will be subject to very high levels of security. But when the idea of exchanging information between different clouds is considered, banks will be concerned about security issues, all clouds not being protected with the same confidentiality level.
- Real-time payments raise important issues around controls and data protection. There are major fraud attempts on an international basis weekly – some for very large amounts of money. Banks must increase automation as much as possible, deploying artificial intelligence, but also increase the number of people in their back offices.
Because the penalties for violating anti-money laundering laws and sanctions are now very high, Banks need efficient tools but also people with the knowledge to detect Money Laundering in transactions. All of this within seconds and not to mention the associated costs!
- Claims that correspondent banking is dying have been around since the launch of the Euro in 1999, but it is here to stay. New technologies, new entrants and regulators will push the industry into evolving to a new model. GPII is a good example of that.