According to The World Bank, 1.7 billion people globally don’t have access to the most basic financial services. Without access to savings and credit, economic mobility is next to impossible - leaving the unbanked trapped in a cycle of poverty. This is a huge issue not only for developing countries where the proportion of the unbanked is larger but also in developed markets such as the UK, where 2 million people don’t have a bank account. Increasing access to financial services for the worlds’ unbanked population also has the potential to boost the global economy by over $600bn per year.
One of the key ways to tackle this problem is to make it easier for people to pay and be paid for the work they do, and to receive money from relatives working abroad. This is because receiving money remitted internationally is critical for most emerging market communities,
boosting local economies and bringing communities out of poverty. In Nepal, for instance, the value of remittances contributed 28 percent to total GDP in 2018 according to WorldBank data, while for the Philippines it’s 10.2 percent.
However today’s international payment networks, built on old technology and even older business models, can’t deliver the big improvements needed to have a real impact. To achieve this, we need to rethink the payment infrastructure that underpins global remittances.
The traditional corresponding banking model is not fit for purpose
Despite the ubiquity of money transfer networks, most global banks are not able to serve, in a cost-effective way, many of the developing markets with the highest proportion of unbanked population. This is not because they don’t want to but because the existing corresponding banking model is costly and inefficient.
This is because the current cross-border payments infrastructure is built on a system of bilateral relationships between banks which was developed in the nineteenth century and automated in the 1970s. This system typically requires multiple banks in different countries to process an international payment. Each bank and payment provider involved in the process needs to manage lots of complexity with hidden costs and high fees common, along with delays and uncertainty. The result is that remittance costs are disproportionately high compared to the small values of these payments. For example, it does not make sense to pay a £25 fee to send £50 internationally. And yet this is the current experience.
They are also very slow. For instance, a bank transfer between Thailand and Germany can take up to four working days to clear under this current system. This is shocking in today’s digital age where we are able to exchange information world-wide in near real-time over the internet.
Additionally, the costs for processing small-value remittance payments on the part of the financial institutions involved are too high to deliver any return on investment.
Many banks and payment providers are trying to address this issue by developing proprietary payment networks that sit on top of legacy correspondent banking networks in order to speed up cross-border payments. The problem with this approach is that the benefits of these closed networks apply only to their direct participants or members. This creates multiple ‘islands of value’ where each network only improves payments between senders and receivers who belong to it, and cannot extend these benefits to senders or receivers who do not belong to it.
The result is fragmentation in financial services, resulting in more delays, added costs and an underwhelming experience.
Blockchain is no longer just a concept
The good news is that technology has evolved to allow true interoperability throughout the global financial services system, enabling banks and payment providers to send and receive payments for their customers to any other bank payment provider in the world, instantly. The introduction of blockchain and the interledger protocol - an open protocol suite for sending payments across different ledgers - allows financial institutions to connect the many ‘islands of value’ in the payments market and provides interconnectivity between all industry participants - creating an Internet of Value, much like the Internet protocol led to the Internet of Information in the early 21st century.
This, coupled with the wider adoption of digital assets, can significantly speed up the settlement of international payments, allowing financial institutions to exchange monetary value as easily as we exchange information over the internet. In this scenario the digital asset serves as a ‘bridge’ between the two currencies, allowing almost immediate currency exchange when sending money abroad.
Blockchain and digital assets can play a key role in driving financial inclusion in two ways. Firstly, they can make remittance payments significantly cheaper, more transparent and much faster as all transactions can be tracked, and financial institutions do not have to manoeuvre the aforementioned ‘islands of value’ through correspondent banks. This empowers payment providers to offer low cost remittance services to more customers in markets which were previously hard to serve. There are a lot of use cases that demonstrate these benefits.
By bringing down the cost and speed of remittance payments dramatically, this technology can enable banks to start serving the unbanked population in a profitable way while keeping transaction costs very low. It’s a win-win situation for all parties.
For the unbanked and the remittance market, this technology has the power to unlock a wealth of opportunity. It can facilitate financial inclusion, access to the global payments ecosystem and alleviate the current challenges with sending cross-border payments. It just needs banks and financial institutions to continue to be bold and recognise that with investment in new solutions, it is possible to maintain a competitive service while contributing positively to a better global society.