By Shehnaz Ahmed & Swarna Sengupta
Recently, Reserve Bank of India (RBI) and the Bank for International Settlements (BIS) jointly launched the G20 TechSprint, inviting innovative solutions for improving cross-border payments. Recent initiatives by India indicate that enhancing the efficiency of cross-border payments is on its priority agenda. Earlier this year, India and Singapore linked their fast payment systems (FPS) —Unified Payment Interface and PayNow respectively—to facilitate instant and low-cost fund transfer between the two countries.
Further, RBI and the Central Bank of United Arab Emirates have signed an MoU to conduct pilots to test central bank digital currency (CBDC) transactions for cross-border payments.
Globally also, cross-border payments has been on the G20’s agenda since 2020. There are several ongoing bilateral and multilateral experiments between countries under the aegis of BIS to test newer modes of cross-border payments—whether through interlinking national FPS or CBDCs. These initiatives aim to address challenges associated with traditional cross-border payment mechanisms that rely on a global network of correspondent banks which is plagued with high costs, low speed and transparency, and operational complexities.
To leverage the potential of such initiatives on building more efficient cross-border payment systems, there is a need for coordinated multilateral efforts at a political and legal level.
Cross-border payments are crucial for the global economy. Total global remittances were estimated at $781 billion in 2021, which rose to $794 billion in 2022. It has been estimated that the value of cross-border payments will reach over $250 trillion by 2027. Today, most cross-border payments happen through correspondent banking arrangements, where one bank (correspondent bank) “holds deposits owned by other banks (respondents) and provides payment and other services to those respondent banks”. With transacting parties and payment systems situated in different jurisdictions, technically, there is no direct transfer of funds from one bank to another. Instead, funds get transferred through correspondent banking arrangements, where each correspondent bank receives a fee for its services. Such banks have to comply with several layers of national laws such as anti-money laundering (AML), know your customer (KYC), and data protection compliances. They also incur associated legal costs. Contrary to domestic FPS, the settlement of cross-border payments continues to happen in a non-instantaneous manner due to fragmented data and message formats and varying operating hours of banks and national real-time gross settlement systems in different time zones.
Owing to these factors, cross-border payments are time-consuming and costly. As per some estimates, settlement can take as long as 10 days and cost can vary anywhere between 0.3-20% of the transaction amount. It is further estimated that a user may need to pay almost up to $7 for every $100 she transfers across countries.
As the number of correspondent banks increases with the involvement of multiple countries, there are higher costs with longer transaction time and greater credit risk. To address these issues, new cross-border payment initiatives are exploring ways to allow banks and payment service providers to transact directly with each other without requiring them to rely on such intermediaries or participate in closed-loop systems.
Many cross-border payment pilots carried out globally have highlighted divergent legal regimes in participating countries as an impediment. Some common legal challenges facing cross-border payments include divergence in AML and KYC requirements, access rules (who can access the payment systems), settlement finality rules, and data protection standards. For instance, there may be differences between national AML laws relating to sanction screening lists, purpose codes that countries are required to declare for international fund transfers, encryption methods, and format for information recording.
During the interlinking of Singapore and Thailand’s FPS (PayNow-PromptPay linkage), it was found that the national AML laws in both countries have different requirements relating to the nature of customer information that was supposed to be recorded under the law—while PromptPay displayed the receiver’s full name, PayNow displayed the nickname of the receiver. Similarly, data protection standards for cross-border data transfer are also not uniform across countries. Since most of the new cross-border projects aim to provide real-time or instantaneous fund transfers, having conflicting or differential requirements is time-consuming and may result in funds being transferred without completely adhering to the participating jurisdiction’s compliances, raising questions on the validity of such transactions. Therefore, addressing the frictions that arise from divergent legal and regulatory requirements for cross-border payment processing is critical.
Further, since any cross-border payment model will involve the participation of different sovereign jurisdictions, frictions may also arise concerning who will have control over the design and functioning of the payments network, oversight, enforcement, and operational management. Therefore determining the governance structure and rules of the platform is also an important point of consideration. As central banks explore the role of decentralised technologies in facilitating cross-border payments, newer legal issues relating to the identification of the point of regulation, risk allocation between participants and enforcement related challenges are likely to also arise.
This calls for multilateral efforts to design a rulebook outlining common regulatory standards for cross-border payments. These will be minimum standards that must inform bilateral or multilateral agreements between countries to operationalise cross-border payment initiatives. It will encompass standards setting out access criteria, rights and obligations of participants, attribution of liabilities, and risk allocation between players.
The standards should also address matters relating to data governance, KYC, AML compliances, onboarding mechanisms, settlement finality, fees, risk mitigation strategies, dispute resolution, enforcement mechanism, interoperability standards, ownership and management of platform rules, and reporting obligations. It should also provide guidance on how the cross-border payment initiative can be legally structured. In designing the rulebook, adequate care must be taken to respect monetary sovereignty of countries and their domestic laws.
A global cross-border payments rulebook will not only be instrumental to realise the potential of newer cross-border payment initiatives, but will ensure that such models can be adopted and scaled in a legally sustainable manner.
The authors are Respectively, fintech lead and former research fellow, Vidhi Centre for Legal Policy
Views are personal
