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Financial Inclusion: Out-Dated Systems and Payment Processors Are Major Obstacles

The African Development Bank report, “Financial Inclusion in Africa,” states that the leading prohibitive factor in more robust financial infrastructure is inadequate access to financial services. Less than one adult out of four in Africa have access to an account at a formal financial institution.

Broadening access to financial services will mobilize greater household savings, marshal capital for investment, expand the class of entrepreneurs, and enable more people to invest in themselves and their families. Financial inclusion is therefore necessary to ensure that economic growth performance is inclusive and sustained. Financial inclusion refers to all initiatives that make formal financial services Available, Accessible and Affordable to all segments of the population.

The pieces to the puzzle for improving access are available. It is precisely where Africa can break free of out-dated systems and payment processors that are replete withtrust issues and high fees.

The emergence of blockchain technology has undoubtedly altered the course of global digital payment development. With the likes of Ripple and Facebook’s Libra challenging the monopoly of banks and other financial institutions, mainstream players like SWIFT, Visa and Mastercard have been forced to seek significant improvements to the legacy system.

Moving forward, the burning issue appears to be relevance. Blockchain systems run on the premise of replacing the legacy system with a more secure and efficient payment infrastructure. The mainstream players seem forced to face the quintessential evolutionary puzzle of “adapt or die out.”

Like in every technological race, competitors have to figure out which parameters will give them an edge over the rest of the playing field. Transaction speed, security and cost-efficiency are a few of the pain points in the modern-day cross-border remittance industry. 

Fast, cheap, good — the three vertices of the project management triangle arguably describe the balancing act faced by companies looking to lead the way in the developing payment sector. The Society for Worldwide Interbank Financial Telecommunications (SWIFT) recently test ran a new instant cross-border payment system that offers significant improvements in throughput time.

The move is part of SWIFT’s plans of enabling instant settlement capabilities through its Global Payments Innovation (GPI) in the wake of imminent competition from the likes of Ripple. SWIFT also promises that the new system will reduce the cost of adoption for financial institutions that use the framework.

Usually, the balancing act for most projects is how to attain two out of the three parameters previously listed. For cross-border remittance, technological innovation arguably takes care of the speed and cost components. Blockchain companies such as Ripple promise transaction settlements in as little as four seconds, costing a few cents to move money from one corner of the globe to another.

The burden of banking

Experts have consistently highlighted a particular aspect of the legacy financial system that creates inefficiencies in international payments — the need for correspondent banking relationships.

Commercial banks around the world tend to hold accounts with correspondent banks overseas to implement cross-border wire transfers, usually over the SWIFT network. Blockchain payment proponents say the Nostro/Vostro account mechanism creates delays and inefficiencies in the system.

For wire transfers via a system like SWIFT, the participating banks need to have correspondent relationships abroad. A correspondent bank makes or receives payments on behalf of another financial institution in a different country.

For example, if Bank A in Country 1 needs to send a wire transfer to Bank B in Country 2, Bank A will contact its correspondent bank in Country 2 to facilitate the payment. Usually, Bank A would maintain an account with this correspondent bank.

To the correspondent bank in this instance, the account is called a Nostro account, while for Bank A — the counterparty — that same account is referred to as a Vostro account.

According to the Bank of International Settlements (BIS), global correspondent banking relationships are declining by the year. Apart from the shrinking nature of the network, BIS reports that it is becoming even more concentrated, thus worsening the lack of access to international payments for historically disenfranchised remittance corridors.

The emergence of new international payment methods is one of the reasons identified by BIS that is responsible for the decline of the correspondent banking network. An excerpt from the report reads:

“The continuing decline in the number of correspondent banking relationships in many countries around the world remains a source of concern. In affected jurisdictions, there may be an impact on the ability to send and receive international payments, which could push people into using unregulated and potentially unsafe ‘shadow payments’ with further consequences for growth, financial inclusion, and international trade.”

Thus, while SWIFT can attempt to match Ripple’s speed, the correspondent banking relationship might mean it is only a faster iteration of the current system. Also, with some corridors already having trouble being served by legacy finance, newer payment portals might constitute a better proposition.

For Ripple, banks do not need to hold correspondent relationships abroad to facilitate wire transfers. Instead, financial institutions acquire Ripple’s xRapid software and use XRP as a bridge currency for instant cross-border remittance.

Blockchain companies, however, have to worry about the regulatory implications of their business model. Where SWIFT can operate from a trusted position as a legacy system, Ripple and the likes need to satisfy regulators in multiple jurisdictions. 

The emergence of Facebook’s Libra project also carries with it the possibility of increased regulatory scrutiny for all things crypto- and blockchain-related. Even Ripple’s CEO has concerns that the company could become caught in the middle of regulatory firestorm ignited by Libra.

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