Could a new approach to cross border payments spell the end for the correspondent banking model?

In a presentation I recently delivered at the European Payments Summit on the pressures facing correspondent banking, I asked delegates to share their opinions on the current model. What we found was that 62.5% of delegates said the current correspondent banking relationship model was a barrier to cross border trade. Although two-thirds of delegates said they would prefer to manage only one or two banking relationships to facilitate cross border payments, one-third of said they used more than five banking relationships or partners.

With the responses demonstrating how challenging and complex cross border payments can be, it came as no surprise that correspondent banking was under pressure, and that something needed to be done. However, the correspondent banking model does not lend itself well to innovation due to the legacy infrastructure that underpins the payment rails. The question is, could a new approach reinvent the correspondent banking model without disrupting – and perhaps even enhancing – the business operations of incumbent banks?

The challenges faced by banks

Increased compliance costs, operational costs, low-interest rates, regulatory changes, and digitisation are all eating into bank profits, making it less attractive to expand into new territories, or maintain relationships in established ones. Many banks such as HSBC and Deutsche Bank have scaled back activities in some markets to focus on their core markets whilst facing increasing costs and regulatory burdens.

Although some tier one banks such as HSBC and Deutsche Bank have been impacted by these challenges, it is the tier two and three banks that are the most likely to be affected by these factors, as tier one banks have the ability to deliver global infrastructure services by leveraging their scale. As a consequence, tier two and three banks seem to be reliant on tier one banks for access to international markets.

But tier one banks are not the only option for collaboration when it comes to accessing a global marketplace without a local presence. Financial utilities, like Banking Circle, are allowing tier two and three banks to compete by providing the pipes that connect to payments rails, thus eliminating the cost and complexity of developing infrastructure in-house.

The emergence of the financial utility not only supports tier two and three banks. FinTech businesses and challenger banks can also enter the global marketplace to deliver cross border payment solutions to their clients at a significantly lower cost and in a much faster timescale. And this addresses another issue – even when incumbents are able to offer new entrants cross border requirements, new issues are presented due to the sheer size and restrictions imposed by legacy infrastructures, making them restrictive and not as flexible and responsive as required by FinTechs, who are nimbler and quicker to adapt to changing market conditions.

Banks will always play an important role in business, but utilities can be positioned alongside core services to complement the traditional banks’ offering and maximise profit potential and international growth. The digital space is shifting the payments landscape, and this shift could spell the end for the correspondent banking model in the not too distant future.

Get in touch

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