As digital connections have fostered a global community, the demand for cross-border payments has surged. And yet, the cross-border payments paradigm—where correspondent and intermediary banks work with originating banks to process payments—has remained largely unchanged for the past 50 years.

In a recent PaymentsJournal podcast, Gary Palmer, President and CEO of Payall Payment Systems, and James Wester, Co-Head of Payments at Javelin Strategy & Research, discussed the limitations of global payments systems, the emerging solutions to cross-border payment challenges, and the potential impacts on the global payment landscape.

The current model for cross-border payments relies on a patchwork of banks. One of the main issues is that many of the core banking systems these institutions depend on have been in place for decades.

Another issue is that many banks operating in the cross-border space have a limited scope. They tend to focus solely on the specific products they are licensed to offer in a given area—such as bank accounts, car loans, or mortgages.

The combination of outdated technology and narrow focus has made an already complex process even more daunting, leading many institutions to hesitate before entering the market.

“I have coined a phrase—that cross-border payments and correspondent banking for cross-border payments are governed by fear and friction,” Palmer said. “When you introduce the concept of cross-border payments, now you’re dealing with multi-jurisdictional issues, you’re dealing with multiple currencies, you’re dealing with Know Your Transaction complexities that change all the time. You’re dealing with sanctions checks that extend beyond your border.”

“It’s a whole area of subject matter expertise that the core banking systems and the usual players in this technology have never addressed,” he said. “It’s the elephant in the room of why there’s fear and friction.”

Adding to the friction, over the last decade there has been a 25% reduction in the number of correspondent banks. Even as cross-border trade has grown—and is likely to continue growing—the entities that facilitate it have declined.

This puts even more pressure on the existing correspondent banks, which are already struggling under the weight of manual processes. For example, a correspondent bank looking to onboard an originating bank must verify that it is a legitimate entity—a process includes a 100- to 300-question due diligence Excel worksheet and extensive document requests.

“They make sure they have good AML policies, they complete the Wolfsberg Questionnaire, they go through critical infrastructure,” Palmer said. “Then they say, ‘OK, Mr. Bank, we trust that you’re not going to do bad things or lie or that your customers do bad things when you send money around the world.”

“That’s generally how the system works, it’s manual” he said. “The whole relationship is built on an inefficient relationship of manual documents, manual checks, and manual revisits of that relationship. The counterparty risk of a manual system like that is the foundation of why there’s fear and friction.”

In addition to inefficiencies, there is a lack of transparency. For instance, an originating institution might make a payment through a correspondent bank to an intermediate bank, ultimately reaching a final financial institution.

The bank at the last leg of the process has limited visibility into how effectively the originating institution executed their Know Your Customer, Anti-Money Laundering, and other compliance checks.

“It is amazing to me how little people understand correspondent banking,” Wester said. “When they need to send a payment overseas or over a border into another country, how little they get what’s going on in the background. The fact that it has been so resistant to change, given how much everything else has changed around the world in technology and in financial services specifically, means cross-border remains this sort of opaque and mysterious world.”

Even though many institutions want to dispel the opacity around cross-border payments, there are three conditions that prevent banks from having the capital and the resources to innovate.

“One, it’s protecting their systems and their data from the bad actors all around the world,” Palmer said. “Two, some banks have hundreds, others have thousands of third-party and home-grown systems, and these systems have to be fed and maintained with updates and patches and reboots, and that sucks a lot of resources away. The third thing is the bank’s existing core products are constantly facing regulatory changes.”

Many financial institutions are also resistant to change. As a result, cross-border payments under the current framework tend to be expensive, the service is often inadequate, delivery times are slow, and there is a pervasive lack of transparency.

However, not all of these aspects are necessarily seen as disadvantages—especially in the case of delayed settlement, which can sometimes be beneficial.

“People coming into the space might look at that and say, “Oh, that seems to be a big bug in the system,’” Wester said. “But when you’re coming at things from ‘my job as a financial institution is to mitigate all the risk on my side’, what you’ll find is that a lot of the folks don’t look at all of that as a bug. That’s a feature that’s protecting them.”

“They aren’t looking at it from the perspective of ‘Gary needs to send money overseas, let’s make it easy on Gary,’” he said. “They look at it from a money and a risk mitigation standpoint. It’s ‘I’m not really worried about Gary. He can’t go anywhere else, so he’s going to have to deal with the system the way it is.’”

While payment delays may give an institution the time it needs to conduct manual compliance and risk mitigation checks, they can cause substantial frustration for the sender. This frustration is only exacerbated by the efficiency of consumer payment systems where transactions are increasingly moving toward real-time, transparent settlement.

These heightened expectations, coupled with surging cross-border payments demand, are driving a shift in the paradigm.

“The topic that we’ve called opaque and filled with friction in the last 50 years has become a topic that every financial institution, every fintech, every financial technology vendor, everybody wants to talk about,” Wester said. “I think it’s just the sheer weight of everyone realizing that things have been broken, or at least weren’t delivered as well as they could have been.”

“Everybody’s now beginning to realize that cross-border transactions are the low-hanging fruit,” he said. “They are an opportunity.”

Two of the main organizations taking advantage of this opportunity are Mastercard and Visa. These credit card companies have built global cross-border payments empires based on three main assets.

First, in nearly every country where they operate, they are connected to local bank transfer systems. This allows them to pull money from a card issuer and send it to a card acquirer located elsewhere in the world.

Second, Mastercard and Visa maintain substantial global liquidity in every currency they trade. This enables them to pull money in the card issuer’s currency, convert it, and deliver it in the local currency of the country where the card was used—whether at an ATM or point of sale.

The third asset is their role as credit card companies managing roughly $2 trillion of foreign currency trade, which allows them to set foreign exchange rates.

“If we forget for a second that Visa and Mastercard have a card business and just think about those three assets—bank transfer connectivity, massive FX trading efficiency, volume and foreign liquidity capacity—these three assets are extraordinary,” Palmer said. “When you combine that together, it looks like the coolest, biggest, most powerful correspondent bank on the planet.”

These cross-border networks have advanced to the point where credit card companies have given them their own brands: Visa Direct and Mastercard Move. For banks and credit unions, these systems can represent a significant upgrade from the traditional correspondent banking model.

This means a bank could contact Mastercard Move and specify the sender’s and recipient’s currencies and locations. The platform can then deliver the payment to a bank account, a mobile money account, a digital wallet, or even as cash. This functionality is available in roughly 60 countries, and most transactions are processed in real time.

Additionally, all parties will receive an email or text message confirming delivery. The platform can also specify the exact amount the recipient will receive, without FX volatility or foreign transaction fees charged by the receiving bank.

“Mastercard has developed a cross-border product and Payall makes it easy for financial institutions to get live with Mastercard whilst providing a host of other risk and compliance capabilities,” Palmer said. “Think of us as the cross-border processor into Mastercard Move to allow a bank to deliver a payment to 90% of the world’s population, whether they’re banked or unbanked. It’s nearly real-time and super-efficient, with great FX rates and confirmed delivery.”

“It’s all the things that a bank customer wants and needs, and it’s priced in a way that the smallest credit union to the strongest regional bank can still make good money on it,” he said. “This is a breakthrough. This is a new paradigm, a new alternative to correspondent banks, and it’s taking the market by storm.”