Cross-border payments are financial transactions where the payer and the recipient are based in separate countries. They cover both wholesale and retail payments, including remittances — which is a term typically used to refer to money that migrants send back to their home country. Cross-border payments can be made in several different ways. Bank transfers, credit card payments and alternative payment methodsfootnote  are the most prevalent ways of transferring funds across borders.
There are two main types of cross-border payments:
Wholesale cross-border payments: These are typically between financial institutions, either to support the financial institution’s customers’ activities, or its own cross-border activities (such as borrowing and lending, foreign exchange, and the trading of equity and debt, derivatives, commodities and securities). Wholesale payments by multinational non-financial companies are typically either to support: a) trade or other business transactions or; b) the financial services for the company such as cash management, which require moving funds across international subsidiaries to support the company’s liquidity needs. Governments may also use wholesale markets for large transactions with other governments or overseas businesses.
Retail cross-border payments: These are typically between individuals and businesses. The key types are person-to-person, person-to-business and business-to-business.
Why do cross-border payments matter?
Over the past few decades, the increased international mobility of goods and services, capital and people has contributed to the growing economic importance of cross-border payments. Factors that have been intensifying over recent years include manufacturers expanding their supply chains across borders; cross-border asset management and global investment flows; international trade and e-commerce; and migrants sending money via international remittances. World Bank estimates for 2019 showed total remittance flows was US$714 billion, of which US$554 billion was to low and middle-income countries.footnote 
These trends have increased the demand for cross-border payments and the need for end users to have access to cross-border payment services that are as efficient and safe as comparable domestic services. Remittances in particular play a vital role in low and middle-income economies and in some cases are becoming the primary source of development finance.footnote 
In 2018 the estimated revenues generated in cross-border payments was US$230 billion, a growth of around 4% on 2017.footnote  Growth and revenue expansion is driving competitive interest in this market. Innovative new business models and participants are emerging in response.
How do cross-border payments work?
Currencies are closed-loop systems. Domestic payment systems are not directly connected with the systems of other countries so when making a transfer between two jurisdictions, the currency is not physically transferred overseas. Instead, large banks provide accounts for foreign counterparts and have their own accounts with their foreign counterparts, which enable banks to make payments in foreign currency. The funds are not sent across borders; instead accounts are credited in one jurisdiction and debited the corresponding amount in the other. For example, in Figure 1 Bank A will send a message to Bank B instructing them to make a payment for a customer. Bank B will then credit the end customer’s account with money from the account Bank A holds at Bank B.
Figure 1: A simple cross-border payment using accounts held at each bank
A payment message sends an instruction to debit an account in Bank A and credit an account in Bank B
However, not every bank has a direct relationship, so sometimes they need to transact with an intermediary, a ‘correspondent’ bank. This is a bank which provides accounts for Bank A and Bank B if they do not have a direct relationship with each other. This is known as correspondent banking and is an essential component of the global payment system for cross-border transactions.
Figure 2: A cross-border payment using a correspondent bank
Bank A and Bank B do not have accounts with each other so they use a bank where they both hold accounts — the correspondent bank
The more players that are involved in a cross-border transaction, the slower and more expensive it will be. For currency pairs with high volumes of payments (for example, dollar to sterling), there will usually be a shorter chain. But for conversions between currencies with a lower volume of payments there will need to be more correspondent banks involved. The more correspondent banks involved the longer the transaction will take, and more costs will be involved at each stage of the chain. The set of payment flows between one country and another is referred to as the ‘country corridor’ or ‘payment corridor’.
Figure 3: Cross-border payment using the correspondent-banking network
The less common the currency pair, the more correspondent banks will be required to make the payment, incurring costs and delays at each stage
At each bank in the chain, fees will be taken for processing and foreign exchange, the payment messages will need to be checked against local financial crime requirements and each bank will need to update the balances in the accounts of the incoming and outgoing payees using their domestic payment systems which are only open during normal business hours. The sender’s bank will need to hold enough cash to cover these unknown costs until the payment is complete.
What are the key challenges for cross-border payments?
Cross-border payments lag domestic ones in terms of cost, speed, access and transparency. It is typically more difficult to make a payment from one country to another compared to making the same payment within one country. In some instances a cross-border payment can take several days and can cost up to 10 times more than a domestic payment.
The challenges associated with cross-border payments arise from a series of frictions in existing processes. These frictions are:
Fragmented and truncated data formats
Payments are made by messages sent between financial institutions to update the accounts of the sender and recipient. These payment messages need to contain sufficient information to confirm the identity of parties to the payment and confirm the legitimacy of the payment. Data standards and formats vary significantly across jurisdictions, systems and message networks. For example, some formats only allow Latin characters, and some formats allow more data than others, meaning names and addresses in other scripts have to be translated, leading to divergences in precise spellings. This makes it difficult to set up automated processes, causing delays in processing and increased technology and staffing costs.
Complex processing of compliance checks
Uneven implementation of regulatory regimes for sanctions screening and financial crime mean the same transaction may need to be checked several times to ensure that the parties are not exposing themselves to illicit finance. Banks may use different sources for conducting their checks which can lead to payments being incorrectly flagged (for example where entities have similar names to those on sanctions or financial crime databases). This complexity increases with the number of intermediaries in a chain, as the original data provided to meet initial checks may not contain elements needed for checks under other national regimes. This makes compliance checks more costly to design, hampers automation and leads to delays or the rejection of payments.
Limited operating hours
Balances in bank accounts can only be updated during the hours when the underlying settlement systems are available. In most countries, the underlying settlement system’s operating hours are typically aligned to normal business hours in that country. Even where extended hours have been implemented, this has often been done only for specific critical payments. This creates delays in clearing and settling cross-border payments, particularly in corridors with large time-zone differences. This causes delays and also means banks need to hold enough cash to cover the unknown costs of the eventual foreign exchange rate, which fluctuates during this time, driving up the overall cost of the transaction. This is known as trapped liquidity.
Legacy technology platforms
A significant proportion of the technology supporting cross-border payment systems remains on legacy platforms built when paper-based payment processes were first migrated to electronic systems and with a domestic focus. These platforms have fundamental limitations, such as a reliance on batch processing, a lack of real-time monitoring, and low data processing capacity. This creates delays in settlement and trapped liquidity. These limitations affect domestic operations, but become even greater limitations to achieving cross-border automation of payments when different legacy infrastructures need to interact with each other. The requirement to interface with legacy technology can act as barriers for emerging business models and technologies to enter the market.
High funding costs
To enable quick settlement, banks are required to provide funding in advance, often across multiple currencies, or to have access to foreign currency markets. This creates risks for the bank and the bank will need to put aside capital to cover this risk; which means that capital cannot be used to support other activities. The uncertainty about when incoming funds will be received often leads to overfunding of positions, which increases costs.
Long transaction chains
These frictions make it costly for banks to have relationships in every jurisdiction. This is why the correspondent banking model is used but this results in longer transaction chains, which in turn increases cost and delays, creating additional funding needs (including to cover unpredictable fees deducted along the chain), repeated validation checks and the potential for data to be corrupted through its journey.
There are significant barriers to entry for firms seeking to provide cross-border payment services. It is also difficult for end users sending payments to accurately assess the cost of initiating a payment, which makes it difficult to gauge the value for money on offer by different providers. These barriers can increase prices for end users and firms and dampen investment in modernising cross-border payments processes.
Why have improvements in cross-border payments been slower to materialise than in domestic payments?
Cross-border payments are by definition more complex than purely domestic ones. They involve more, and in some cases numerous, players, time zones, jurisdictions and regulations. While domestic payments have improved in many jurisdictions, with many more initiatives on their way, cross-border payments are lagging behind. Other elements that introduce frictions include capital controls, requests for documentation, balance of payments reporting and other compliance processes that can cause significant payment delays.
The multi-dimensional nature of these challenges also mean that international collaboration is needed to improve cross-border payments.
What is being done internationally to improve cross-border payments?
Improving cross-border payments was set as a priority for the G20 in 2020, and has been well supported by the Financial Stability Board (FSB), the Committee on Payments and Market Infrastructures (CPMI) and other standard setting bodies.
The FSB has developed a global roadmap for enhancing cross-border payments over a three-stage process: assessment of challenges and frictions (stage 1), identifying the building blocks to improve the current global cross-border payment arrangements and address these frictions (stage 2, led by the CPMI), and setting out the roadmap to pave the way forward (stage 3). The roadmap was published in October 2020 and international bodies are now taking forward the implementation of the actions.
What is the Bank of England doing to help tackle the frictions in cross-border payments?
The Bank is committed to enhancing the payments system for the digital age. We actively supported the G20 initiative for enhancing cross-border payments, and we are committed to implementing the actions set out in the stage 3 roadmap. But enhancements to cross-border payments cannot be fully realised without co-ordinated action and we will therefore continue to work with the public and private sector in the UK, and international bodies to deliver the actions set out in the roadmap.