Over the past few years, a number of international banks have started offering products that enable their clients make cross-currency payments from a single currency nostro. The core theme of these products is to execute foreign exchange (FX) in the payment and deliver local currency to the destination -- enabling a value transfer from the beneficiary bank (which would have executed the FX) to the remitting bank (which actually does).
While lifting fees are worth about $10 to $15 per transaction, executing the FX in a payment can raise the yield to about $75 to $100. The economics of such an “FX conversion” type product are attractive, but the key is to identify and convert the right transactions – those where the beneficiary is not expecting payments in the original currency. Furthermore, the processes surrounding mis-conversions -- those conversions that slip through the cracks where the beneficiaries demand payment in originating currencies, must be designed and managed with the specific client in mind.
There are five key principles that banks can follow in order to ensure that the delivery of converted payments do not adversely impact clients.
1. Use of local knowledge
Many banks recommend FX conversions for a large number of payment corridors, only to find out that there is little client traffic to the majority of those destinations. An absence of knowledge of local practices means that most of these transactions fail, resulting in complaints from the beneficiaries and their banks. There have been instances where local regulators were brought in by local banks to instruct foreign banks to stop conversions. In this instance, a bank’s footprint and presence in the various clearing markets can set it apart from the competition.
Banks should continuously leverage close ties with local stakeholders to assess the acceptability of FX conversion in various markets. Among other factors, they should take into account the relationships and reciprocity arrangements with local banks, and the probability that local beneficiaries will hold an account denominated in one of the offered base currencies (eg US dollar, euro, pounds and Australian dollar). Furthermore, banks should also rely on frequent analyses of payment traffic and continuously update clients as soon as market conditions change.
2. Leveraging relationships with local financial institutions
Maintaining strong relationships with local financial institutions in FX conversion destinations should be another important objective that banks aim for. Some banks leverage their dedicated on-the-ground relationship managers and service officers to foster links to the local banks. Regular communication with these sales and service teams ensures an appreciation of emerging local practices that may impact the banks’ remitting clients. This enables banks to be in a good position to make quick decisions in the best interest of their clients.
3. Operational flexibility
The easiest way to recover from a mis-converted payment is to recall it and then re-effect it. Unfortunately, this is a manually intensive and time consuming process. The returned payment may span a number of correspondent banks and take a few days to execute. Besides, few banks will re-effect the payment before the original funds are returned, leaving the beneficiary out of pocket for a number of days (up to 5-7). A better way to make the beneficiary whole is to top-up to the extent of their loss. This is typically more difficult to do as it involves more than one team within a bank (payments, FX, operations) to coordinate actions. A key value proposition for any bank would be its ability to quickly recover from mis-converts with limited impact on the beneficiaries -- by executing top-ups on the same or next day that the claim is received. The bank should develop comprehensive yet flexible rules governing when payments should be topped up versus when they are re-effected. Operations staff should have pre-authorised approvals to top up legitimate requests.
4. Highly competitive rates and fees
Banks should leverage the strengths of their sales and trading desks and pick destination markets where they are major currency market-makers. Clients will then benefit from the banks’ ability to provide competitive rates for conversion. Often, even the beneficiaries will be better off receiving transactions converted by the intermediary bank at source rather than having the payments converted by the beneficiary bank. If the intermediary bank self-clears in those destinations and can control (and limit) the fees taken end to end, it will be even more compelling to potential clients.
5. Grow with clients
Banks should identify the top 15 to 20 destinations which can support meaningful payment flows. More importantly, they should also identify particularly high-risk destinations for specific currencies, and be upfront with clients on the consequences including these destinations. In general, small thresholds and spreads are recommended at the start, and a gradual increase is preferred to limit risk. As the product matures, banks may increase the currency corridors or the payment thresholds, determining the best combination for clients at each stage of the relationship.
Summary
The above principles have enabled banks to deliver significantly higher payment yields to their clients; and at the same time ensured that beneficiaries’ concerns are addressed. This is especially crucial given the growing number of cross border payments and increased competition among payment providers (banks and non banks). To this end, taking care of both remitters’ and beneficiaries’ interests is essential to the profitability of FX conversion, and will ensure that such gains are sustainable into the future.
Anurag Bajaj is global head of clearing and liquidity management (banks) at Standard Chartered, while Terence Rodriguez is associate director, payments products.
