When it comes to banking and payments, the question is no longer whether digitisation is the right thing to do. It is now universally recognised that digitisation presents a wealth of opportunities for businesses across every industry to reduce costs and engage with new customers. One of the more critical questions for stakeholders today is to what extent can digitally enhance the facilitation of cross-border payments?
According to the Bank of England, the value of cross-border payments is set to increase from approx. £150 trillion in 2017 to £250 trillion by 2027 – a rise of £100 trillion in just ten years. Some of the drivers behind this expected surge include:
- Changing consumer demands - consumers want speed and efficiency paired with low-cost, digitally intuitive services
- Trade with emerging markets – one of the biggest trends within cross-border payments is an increased focus on emerging markets such as Africa, Asia and Latin America
- Mobile device accessibility - As digital device ownership increases, more people worldwide now have easy access to online banking services and e-payment solutions.
Combined, these drivers create a growing need for end-users to have access to seamless, cross-border services that are safe and efficient and promote healthy competition. As a result, new specialist providers are emerging, and the traditional pain points around cross-border payments such as delays, cost and lack of transparency have given rise to new entrants who are challenging incumbents with innovative business models.
How do cross-border payments work?
If you are a merchant, whether wholesale or retail-focused, and the payer and recipient are based in different countries, cross-border payment services form an essential part of your business offering. These payments can be made in various ways such as bank transactions, card payments or via alternative means such as e-money wallets and mobile payments.
The cross-border payment market is highly competitive, which is great news for you as a merchant, as it means you can and should look to leverage the options available to ensure that you get the best possible deal.
Essentially, there are two major types of cross-border payments:
- Wholesale cross-border payments - these typically occur between financial institutions either to support their customers’ activities or to diversify cross-border activities via alternative means such as borrowing and lending, FX, trading of equity and debt, derivatives, securities, commodities, etc.
- Retail cross-border payments – these take place between individuals and businesses, e.g. person-to-person, person-to-business, business-to-business, and deal with remittance and currency.
Stick or twist – spot or forward?
There’s plenty of jargon in the payments world, such as “spot rate” or “forward rate” but you should not let that confuse you as the precedents behind many of the buzzwords are relatively straightforward.
Spot rate and forward rate designate the current and future exchange rates that may be used in foreign exchange transactions. Whilst the concepts are related, they differ in several ways, and getting to grips with them is important. Why? Because exchange rates are not always the same from one monetary union to another, holding one particular currency instead of another over a given period can be an advantage or a disadvantage, depending on the circumstances.
A ‘spot’ rate refers to the foreign exchange rate when the merchant processes a cross-border transaction. If the current exchange rate is favourable, the merchant will typically proceed.
In contrast, a ‘forward’ rate is a contracted price at a fixed rate for a transaction that will be completed at an agreed date.
You can choose to ringfence an amount of foreign exchange in advance at an agreed rate. And while you will pay a premium for that, this option allows you to budget, fix a cost, and protect you.
Most merchants who make cross-border payments use ‘forward’ rates to hedge risk and protect against potential fluctuations in currencies. But they will also choose not to do that for the full amount to retain some freedom of choice. This is because they can take advantage of the better rate.
Conversely, if things change to their detriment, the minute they ringfence the reserve for the premium, they can use preferential rates to make the payments. This may be a little more expensive but also offers protection if the rate moves heavily against them.
Businesses committed to overseas trading and cross-border payments will have to make payments monthly, if not weekly, basis. By hedging their bets, if the market is in their favour, they can do that at a favourable rate, whereas if the market is detrimental to them, they can dip into money they have reserved in a currency they use.
For example, if you are dealing with American suppliers for purchases worth several million US dollars, if the rate is particularly favourable on a given day, you can take advantage of that and pay them at that better exchange rate.
The choice between both options will depend on your risk appetite and your cash reserves. The best thing you could do as a merchant is to limit your exposure and select a policy that would give you some insurance and isolation against rates moving too far. Because if rates evolve in your favour, then you should have some flexibility available.
Finding the best way forward
Change within the cross-border payments market continuously creates new opportunities across the business value chain, possibly including new acquisition strategies. But, where there are opportunities, there are challenges for incumbents, new entrants and investors. The right path for your business will ultimately involve a well-thought-out strategy that draws upon deep market and industry knowledge and trusted partnerships.
Worldline [Euronext: WLN] is a global leader in the payments industry and the technology partner of choice for merchants, banks and acquirers. Powered by 20,000 employees in more than 50 countries, Worldline provides its clients with sustainable, trusted and innovative solutions fostering their growth. Services offered by Worldline include instore and online commercial acquiring, highly secure payment transaction processing and numerous digital services. In 2021 Worldline generated a proforma revenue close to 4 billion euros. worldline.com
Worldline’s corporate purpose (“raison d’être”) is to design and operate leading digital payment and transactional solutions that enable sustainable economic growth and reinforce trust and security in our societies. Worldline makes them environmentally friendly, widely accessible, and supports social transformation.