June 28, 2018 Reading Time: 4 minutes

Cross-border payments have always been notoriously slow, sometimes taking up to a week to settle. This sluggishness can be blamed in part on lack of choice. Wire transfers are pretty much the only way for individuals and corporations to make large cross-border payments, and these are conducted through the correspondent-banking system underpinned by a single communications network: SWIFT. Thanks to the fintech challenge posed by blockchain-based tokens Ripple and Bitcoin, however, the quality of service is finally being upgraded.

We should probably start by reviewing how a cross-border payment works. Say a grocer in Philadelphia needs to wire €100,000 to a mustard supplier in Cologne, Germany. The grocer asks their local bank in Philadelphia to effect the payment. The local bank probably won’t have the capabilities to do this, however, and will turn to a large multinational that provides correspondent-banking services, say Bank of America. Bank of America now debits the local bank’s correspondent account $117,000 (the EUR/USD exchange rate is 1:1.17), the local bank in turn debiting the grocer’s account for that amount. 

Bank of America maintains a foreign correspondent-bank account with a large German bank that has a large balance of euros. It instructs its German correspondent to send €100,000 to the account of the mustard supplier. Voila, the payment has been made. Bank of America has been used as a straddle between the United States and Germany. 

To coordinate this chain of account transfers, bankers need to communicate with each other. They could rely on phone calls or faxes, but this would be inefficient. Instead, they use a proprietary digital-communications network maintained by the Society for Worldwide Interbank Financial Telecommunication, or SWIFT, a bank-owned cooperative based in Belgium. SWIFT provides both the syntax — a standard set of codes — and the hardware underpinning this communications network. 

SWIFT payment requests are instantaneous, but banks do not act on these messages promptly, in part due to time zone differences or errors made in the original payment instructions. Penny-pinching is another reason for not immediately settling a payment. The longer a bank waits to effect a client’s payment order, the higher the odds that other clients will request to make payments along the same corridor. By batching multiple payments orders together into one payment, a correspondent bank can save money, these savings being passed on to its customers. 

Inefficiency also deserves some of the blame for the slowness of cross-border payments. Aside from carrying physical cash across the border, the SWIFT-mediated correspondent-banking system has for many years been the only way to make large cross-border payments. So there has been little competitive pressure to provide a better quality product.

With the rise of Bitcoin, in 2009, and other blockchain-based tokens, in particular Ripple in 2013, the SWIFT-mediated cross-border payments monopoly has finally been confronted with a potential competitor. In the case of Bitcoin, advocates have proposed using the cryptocurrency as an alternative payments rail. Rather than requiring a correspondent bank to facilitate the payment to its German supplier, our Philadelphia-based grocer could buy bitcoins with dollars and send them to the supplier, who would then sell them for euros. 

Ripple takes a different approach. Whereas SWIFT is just a communications network — it doesn’t actually move account balances — Ripple unites the communicating function with the actual transfer of value. Participating banks plug into a blockchain-based environment where they can exchange digital IOUs denominated in national units of account. To effect the grocer’s payment, the grocer’s Philadelphia bank creates a $117,000 digital IOU and then communicates its desire to buy a €100,000 (euro-denominated) IOU. Both IOUs reside on the Ripple blockchain. Once the swap is made, the Philadelphia bank can “ripple” these digital euro IOUs to the German bank. Voila, value has been transferred. The mustard supplier’s bank account can now be topped up with €100,000. Notice that Ripple has cut out both SWIFT and the traditional correspondent banks from the payments circuit. 

SWIFT was originally created back in the early 1970s to replace telex systems owned and run by post, telegraph, and telecom companies. At the time, the banks that created SWIFT were worried that these telex systems, which they did not control, would suffer capacity failures and security problems. 

Now the tables have turned. SWIFT is no longer the gate crasher but the gate crashed. In early 2017, it reacted to the competitive threat posed by Ripple and Bitcoin by introducing SWIFT gpi. The underlying idea behind gpi was to remove some of the fat accumulated by the SWIFT-mediated cross-border payments system because of many years of complacence. Banks that join gpi commit themselves to offering customers same-day settlement (or better) between banks, a big improvement from the existing settlement process, which can at times take several days to complete. 

Another goal of gpi is to improve the tracking of payments. Oddly enough, SWIFT has never provided a way to track a payment as it hopped from one correspondent to another. Customers who wanted to know the status of their payment were out of luck. With Ripple offering its own blockchain-based tracking system, SWIFT was pressured to come up with its own solution. Each gpi payment is provided with a unique end-to-end tracking number enabling it to be monitored by a SWIFT-hosted database. 

The preliminary results are in. After just a year and a half of operations, more than $100 billion a day in payments is being conducted using gpi. That represents 25 percent of SWIFT’s cross-border payments traffic. In the United States–China corridor, gpi accounts for more than 40 percent of traffic. Most importantly, payments have become much faster. Nearly 50 percent of gpi payments are settled in less than 30 minutes, with Citi US reporting that its gpi transactions are taking an average of just 18 minutes. Some transactions are being completed in just seconds. 

Meanwhile Ripple’s cross-border payments platform is not yet being used. A number of trials are being conducted, however, and an app is set to be released later this year. But even if Ripple and Bitcoin are never adopted for cross-border payments, credit goes to these networks for forcing SWIFT to make significant upgrades we all benefit from. Sometimes it is the threat of a new product, and not the product itself, that forces the incumbents to change. 

J.P. Koning


J.P. Koning is a financial writer and blogger with interests in monetary economics, economic history, finance, and fintech. He has worked as an equity researcher at a Canadian brokerage firm and a financial writer and publisher at a large Canadian bank. More recently, he has written several papers for R3, a distributed ledger company, on the topics of central bank cryptocurrency and cross border payments. He founded the popular blog Moneyness in 2012. He designs economics and financial wallcharts at Financial Graph & Art.

Koning earned his B.A. in Economics from McGill University.

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