How new entrants are redefining cross-border payments (2024)

How do cross-border payments work?

Cross-border payments are currency transactions between people or businesses that are in different countries. The money sender typically will choose a front-end provider, such as a bank or a money transfer operator (e.g., Western Union, Transferwise), to initiate the payment. The receiver then receives the payment via the medium specified by the sender. Traditionally, cross-border payments flow via the correspondent banking network (CBN) which most front-end providers use to settle the payment. But, in recent years, we’ve seen new back-end networks emerge to optimize cross-border payments and enable interoperability between payment methods and provide senders with more possibilities to reach the receiver.

A trillion-dollar market ripe for disruption

Historically, banks have been at the center of the cross-border payments market, which was led by a few dominant global correspondent banks with little competition. This resulted in various pain points for both private consumers and businesses, including a lack of transparency, long settlement periods, high transaction costs, and limited accessibility. While these factors are less likely to be an issue for transactions within liquid currencies (e.g., USD/Euro), they are particularly prevalent in cross-border transactions of exotic currencies. For example, a transaction from a local bank account in Germany to a bank account in Senegal can incur costs of more than 100€, depending on the transaction value, and can take up to seven days to settle. And even then, the sender would often not receive a confirmation of the transaction’s success.

Such conditions are ripe for disruption and, in recent years, we’ve seen a variety of new players entering the market to do just that. The landscape has become increasingly fragmented and competitive with companies focusing on different geographies, transaction sizes, and payment segments.

The size of the market ensures its appeal to new entrants. The total global cross-border payment flow is growing around 5% (CAGR) a year and tipped to top US$156t by 2022. Within this total:

• Business-to-Business (B2B) transactions make up the largest share by far, expected to account for US$150t.
• Consumer-to-Business (C2B) transactions, such as cross-border e-commerce and offline tourism spend, are forecast to reach US$2.8t.
• Business-to-Consumer (B2C) transactions, which include wage salaries or interest payments, are expected to amount to US$1.6t in 2022.
• Consumer-to-Consumer (C2C), or remittance payments, contribute the least – expected to reach US$0.8t in 2022.

But while many new entrants aim to change the nature and inherent dynamics of the entire cross-border payments market, most are focusing on low-value transactions in the C2C, B2C, and B2B segments, which are currently underserved by banks and traditional payment providers. These low-value transactions from, to, and between emerging markets offer the highest disruption potential driven by consumer behavior, increased trade with emerging markets, and higher financial inclusion.

Three trends reshaping cross-border payments

Trend 1: Changing consumer demands

The increased pace of change in the cross-border payments market is closely connected to rapidly changing consumer demands. Consumers are less willing to pay for banking services while expecting them to be fast and intuitive. The increasing penetration of smartphones, and popularity of digital access points like alternative payments methods (APMs) for remittances, have created new demands that incumbents are struggling to meet. Alternative solution providers that offer faster, cheaper, and more transparent cross-border payment solutions can gain a competitive advantage over banks.

Trend 2: Increasing trade with emerging markets

One major trend within cross-border payments is the growing focus on emerging markets in Africa, Latin America, and Asia, as their share of international transactions increases. Overall, global cross-border trade is expected to grow by around 5% (CAGR) between 2018 and 2022, with much of this coming from emerging markets where growth is estimated at around 11% (CAGR) between 2018 and 2022, stimulated by initiatives such as the African Continental Free Trade Area and China’s Belt and Road Initiative. In contrast, protectionist policies in developed markets, including Brexit and US trade tensions, are expected to slow growth to around 2% (CAGR) between 2018 and 2022.

Trend 3: Accessibility of mobile phones and e-payments

As mobile phone ownership increases, more people around the world have access to banking services and e-payment solutions. The percentage of mobile phone ownership among adults in emerging economies has risen to around83%(PEW Research), boosting financial inclusion – by 2017, 69% of the world’s population had a bank account and/or mobile wallet, up from62% in 2014(Worldbank).

The figure is expected to increase in coming years with mobile wallets forecast for significant growth. Global mobile wallet usage at the point-of-sale (POS) is expected to shift from c. 22% in 2019 to c. 30% in 2023, while mobile wallet usage in e-commerce is forecast to grow to more than half (c. 52%) in 2023, from c. 42% in 2019 to c.52% in 2023(Worldpay). This growth is increasing cross-border commerce volumes.

Together, these trends create the need for new business models and value propositions that address the pain points of the existing process with correspondent banks.

The rise of the specialists: New entrants challenge incumbents with innovative business models

These trends and the traditional pain points around cross-border payments – delays, high costs, and lack of transparency – have ushered in the arrival of two groups of new specialized players: digitally-enabled money transfer operators and back-end networks.

Digitally-enabled money transfer operators

Deal directly with senders – the consumer or merchant – and offer digital cross-border payments as their core business. When working with liquid currency pairs (e.g., USD/EUR), these providers typically establish direct banking relationships within the sending and receiving countries, with net payment flowing between these countries. However, in many emerging markets, setting up a bank account can be challenging and capital controls often hinder outflows of payments. Financial inclusion in these countries also tends to below, and payment methods are highly fragmented. These conditions mean that digitally-enabled money transfer operators often rely on partners, such as back-end networks, in these countries.

Back-end networks

Typically do not have a direct relationship with the sending or receiving party, but instead partner with the bank or wallet providers of these parties. By establishing partner networks via direct connections with local banks and APMs in both liquid and illiquid markets, back-end networks enable interoperability within cross-border payments. For example, a Paypal account can transfer a deposit in Euro to an M-Pesa account in Kenia Schilling. As this is not possible with CBNs, front-end providers are increasingly using these alternative back-end networks instead of using traditional bank rails.

The high fragmentation of the global payments market and differing regulatory requirements mean back-end networks typically focus on a certain set of countries or regions. As a result, a sending partner, such as an MTO, will need to connect to a number of back-end networks to offer a truly global solution to customers.

Back-end networks typically utilize an aggregator model. Aggregating payments reduces costs, as most cross-border fees are incurred as a fixed fee per transaction. Also, to enable real-time confirmation of payments, back-end providers typically require prefunding of their sending partners as collateral. This prefunding by the sending partner allows back-end providers to credit the recipient's account in real-time once the transaction is initiated.

The aggregator business model is particularly applicable to transactions within the C2C, C2B, and B2C segments, which are typically of low-value. Back-end networks can settle these transactions faster, cheaper, and with more transparency than those processed by CBN's.

Aggregator models are less successful within the B2B segment, where average transaction values are often higher than US$50,000. Ensuring capacity to prefund such high values would require senders to significantly increase working capital requirements. These models also offer less potential to reduce costs, as the current unit economics for B2B transactions are better, due to the higher average value and fixed nature of fees. For these reasons, almost all high-value B2B cross-border payments are still processed through CBN's.

Greater collaboration expected as differentiated strategies emerge

Consumer-initiated cross-border payments

New entrants to the cross-border payments market will continue to put traditional money transfer operators like Western Union and Ria under pressure. While these players once monetized a large physical branch network, with high fees for senders and receivers, the growth of digitization and mobile wallet penetration in emerging markets is diminishing these advantages. Challengers are winning market share in the sender front-end while mobile wallets are gaining traction as a pay-out medium for remittance payments. We expect these trends to continue, with incumbent players lagging the innovation of new entrants.

In the back end, banks and MTOs are finding aggregators are a cheaper and more reliable option compared with managing their own direct connections, especially for low-value transactions. This is particularly true for exotic countries with challenging business environments. Cross-border back-end networks are also highly scalable, and the market generally shows “winner takes it all” characteristics. We expect to see the emergence of regional “aggregator champions” and a significant increase in collaborations between banks and MTOs and these aggregators.

Business-initiated cross-border payments

For cross-border transactions between developed markets, CBNs are still relatively efficient and reliable – we expect banks to keep dominating these segments.

In emerging markets, the picture is more differentiated. Banks are expected to continue to dominate within high-value transactions where costs are comparably low and high working capital requirements deter aggregators. However, if this working capital hurdle can be overcome, we expect a significant increase in collaborations between aggregators and banks as well as MTOs. In the meantime, these collaborations are likely within the low-value B2B transactions segment, as aggregators provide cheaper and more reliable solutions.

Vertical integration with limited feasibility

Aggregators may appear interesting targets for large MTOs and banks, but we do not expect many to want to sell to them. It’s the independence of these front-end players that is key – otherwise, they step into direct competition with their remaining partners, cannibalizing most of their opportunities. Any potential buyers would need credible independency, such as that of card networks.

We expect moderate M&A activity in the consumer front-end space at a regional level, driven by economies of scale within regions with similar regulatory environments, for example, regarding know-your-customer (KYC) rules.

Finding a way forward

Shifts within the mammoth cross-border payments market offer opportunities across the value chain, possibly including new acquisition strategies. But, such a highly complex and differentiated market also presents challenges for both incumbents, new entrants, and investors – finding the right way forward will require a careful strategy that draws upon deep local market and industry knowledge.