Interoperability would have a deep impact on current operating models and facilitate growth of the small-value transfers.
Cost and Complexity of Current Cross-Border Payments
The demand for low-value cross-border transfers remains a massive unmet opportunity. In developing markets in Africa and Asia, for instance, where daily household earnings average between USD 5 and USD 20, an amount as modest as USD 50 can extend to cover critical household expenditure — utility bills, grocery purchases as well as school fees — for an entire month. The high associate costs (between 8% and 20%) of transferring small amounts, however, make these beneficial flows infrequent and lumpy. Considering it costs 10% and higher to remit USD 200, price-conscious migrants either pace the frequency of money transfers until they have have saved a significant amount or channelize transfers over informal networks to evade costs.
For direct providers of international payment services, significant payment scale economies are essential to advance the formal cross-border micro-transfer market. Such economies are achieved when the average cost of producing a payment service declines with aggregate volumes. The economics governing the traditional industry operating structure, however, present significant constraints in reversing the high-value, lower-frequency transaction model. In the context of transfers, the costs are multidimensional in nature.
Cross-border payments are more complicated to process than domestic payments because there is no institution like a global central bank. Furthermore the geographically dispersed nature of the industry, over-reliance on cash and limited banking and card infrastructure in many send and beneficiary markets and the need to build-out collection and disbursement networks inflate transaction costs for customers. The payment acceptance and disbursement costs account for 40% and 60% of total operational expense growing proportionately with number of countries covered and volumes transacted. Product consumption also skews towards the head of the distribution curve, with top 10-20 agents generating between 40% and 60% of revenues, indicative of the onerous high investments that service providers need to make to cater to the long tail of corridors.
Service Provider Locations Long Tail
RIA 292,000 locations in 32 countries
Western Union 500,000 agents in 95 countries Top 40 agents generate 60% of revenue
Money Gram 350,000 locations in 200 countries Top 10 agents account for 37% of revenues
Source: MTO 10K reports 2015
With expanded coverage, service providers also have to contend with added costs of complex multi-jurisdictional legal and regulatory frameworks. The lack of a global standard framework imposes a wide range of regulatory controls related to money transfer licensing laws, currency controls, anti-money laundering (AML) including customer authentication and transaction screening requirements. This requires high investments in compliance infrastructure and processes. Over the last three years, budgetary outlays for implementing internal controls for compliance and risk governance have escalated by 50%. Empirical evidence suggests smaller service providers spend as high as 40% of the total on compliance infrastructure, particularly as they seek to establish a footprint in new markets.
Most money transfer operators have adopted a “do it yourself” or a “bilateral” operating model to build service delivery capabilities. These costs need to be replicated with every new cross-border link, creating barriers to entry and impeding competition. This has led to asymmetric market structures, with a small number of large competitors and a large number of small and niche competitors. Across geographies the market share of top three providers ranges between 40% and 60% and a host of players — money transfer operators, digital entrants including wallet providers, banks, and postal networks — vie for the remaining. In several markets, collusive pricing behaviour by incumbents with a dominant market share has impacted services affordability.
Cross-border payment networks display the same characteristics as any two-sided market platform. To obtain the optimal scale needed to support low-value transfers, senders and receivers, and their respective payment service providers, must participate in the same network arrangement. This requires a shift from the classic “do it yourself” to an “open ecosystem” model, where success is based on improving the density of inter-connections between players. Collaboration between financial institutions, mobile network operators, card networks, mobile wallet providers, and innovative start-ups can transform the cost dynamic, ensuring lower prices, better services, increased efficiency and expanded service options for senders and receivers.
Interoperability in the international transfer marketplace can assume varying levels of depth and sophistication. Several money transfer operators, for instance, have taken the lead and established bilateral agreements with non-banking market actors, for example, mobile network operators, to scale services. Likewise, operators from different groups are interconnecting their mobile wallet services to offer cross-border remittances. Another interesting partnership that has gathered momentum in the past few years is between mobile money providers and Fintech companies offering instant, online transfers to mobile money accounts.
As an approach, bilateral alliances, however, have several limitations. The services remain proprietary to individual players and cannot be accessed by customers of another service provider. The non-standardized nature of service deployments introduces added integration costs. Prolonged business and technical negotiations in operationalising services restrict partnerships to larger players along specific high-volume corridors. Also the duplication of set-up costs at per partner, per corridor level prevents market participants from reaping the benefits of scale economics.
A more ambitious approach to improve scale and achieve lower costs involves building industry- wide open networks that interconnect diverse market participants to maximize the economic value from inter-connections. The ultimate goal of the new infrastructure is to allow payers and payees to send and receive monies irrespective of its value, payment instrument or currency mechanism. At the backend this can be achieved via full access to the open ecosystem through a single contract, a single technical integration, and a single service relationship. Transactions costs are mitigated by exploiting economies of scale and scope (i.e. through shared infrastructure) and network effects in demand (i.e. through increased coverage).
Open Networks Optimise Costs
Under the framework of an open network model, money transfer operators compete directly for customers and market share but collaborate upstream to process, clear and settle transactions. The open network model can transform back-end operations improving efficiency and financial viability of small-value cross-border payment products along multiple dimensions.
Low-cost payment infrastructure: Given the fragmented international payment environment, the up-front, fixed costs of setting up an open network to process payments can be substantive. Mobile operators with wide-scale financial services networks have designed their business and operating models to support micro-payments. Currently 471 telco led mobile wallet deployments reach 411M customers globally. The mobile can bridge asymmetries in access to payment infrastructure between remittance sending and receiving countries. According to the GSMA, the average value of international transfers using mobile money is relatively low (US$82 in June 2015) compared to the average size of international transfers across all channels (around US$500). Interlinking incumbent service providers to mobile wallets at scale would lower access costs.
New service models often face significant barriers. Many times, system owners will want to keep their specific processes, for fear that standardization might compromise their own business. Open networks “plug into” the current payment structures and do not require customers to divest investments in current infrastructure or processes. In addition, as the service is cloud-based, as new partners and network routes are added, clients can launch payment products in new regions at zero additional infrastructure costs. For example a participant offering services between UK and Bangladesh can launch services in UAE as soon as partners from the region are on-boarded.
Standardization: Given the diverse nature of institutions, a particular problem in cross-border transactions are the different message formats that individual payment systems use. Open network promote a set of common operating, business and technical standards. The network exposes a suite of application programming interfaces to standardize message formats to process payment instructions and facilitate multilateral play between network participants. Standardization also creates a level playing field for new entrants by lowering upfront investment costs and strengthening competition which typically optimises service costs.
The standardization can extend to the payment interface; enabling service providers create a simple and uniform transaction experience. As an example, open networks such as TerraPay promote the use of a globally available virtual private address to facilitate transactions between customers using different networks and payment instruments. Customers can link their preferred payment instrument – bank accounts, store value accounts, mobile wallets, debit and credit cards– to a single virtual address — example a mobile number. To send money customers enter the amount and the virtual private address, eliminating the need to know the IBAN or any other payment identifier. The open network maintains the payment identifier repository and routes the transaction to the intended destination and payee.
Broadening economies of scope: Open networks also provide an opportunity for improving economies of scope in payment, clearing and settlement. For example, a single payment processing facility can be used to process and settle transactions arising from several types of competing payment instruments (e.g. bank accounts, credit transfers, direct debits, cash transfers, and mobile wallets).
Further the same infrastructure can be leveraged to extend additional products. As an example, Ooredoo Qatar recently launched a new payroll service to allow migrant workers to receive their salaries digitally, directly onto their mobile money account.
Shared Acceptance and Disbursement: The ability to pool infrastructure mutualize critical costs. For example shared distribution assets allow service providers to broaden services reach without additional heavy investment in building dedicated agent networks across locations, optimising existing cost structures.
Payment Hub as a Service: Open networks can streamline transaction and operations support costs – legal compliance and foreign exchange – which forms between 40% and 60% of the total. This includes:
Forex Sourcing: Money transfer firms buy and sell multiple global currencies to facilitate the funding of money transfers. By aggregating transactions, open networks can book FX trade at more attractive rates, allowing participants to significantly save costs.
Risk Compliance: Service providers have to comply with a range of rigorous compliance regimes under which they operate. Open networks improve enforcement, and strengthen risk management, without requiring additional investments in compliance infrastructure. For example, transactions can be proactively monitored to determine if a customer attempts to bypass per transaction and volume/velocity restrictions by using the same or multiple instruments over different networks. Moreover open networks may implement additional controls for payee KYC and reject credit requests to high-risk payee accounts, safeguarding sending networks that traditionally have minimal payee information but are lawfully liable for the transaction
Pre-funding Requirements: Many service providers have launched instant transfers by means of which the account of the final beneficiary is credited immediately while settlement occurs at a later stage. To discharge payment obligations to customers service providers maintain pre-funded accounts in the beneficiary country. Pre-funding entails a high cost — namely, the cost of borrowing funds or the opportunity cost of being unable to channel reserves to satisfy other liquidity needs. Open networks with centralized treasury operations enable a large volume of payments to be cleared with lower liquidity reserves.
Collectively the cost efficiencies made possible by open networks makes low-value transfers possible. Although the need among low income households for remitting small-values is high, the ability to remit any denomination to any place would unlock hundreds of use cases. For example, e-lance workers can receive payments in real-time from customers abroad. Digitisation of payments, collaboration between incumbents and digital entrants and growing regulatory consensus in favour of interoperable services are positive indicators that a new world of international payments is beginning to open.
Written by Ambar Sur Founder and CEO, TerraPay