International payments are a core concern for any business with clients, suppliers or subsidiaries abroad. We take a look at the factors to consider when transferring funds internationally, from the chosen payment method to the solutions available to make the process faster, cheaper and more transparent. We also examine which type of financial institution has the upper hand, banks or fintechs.
For any business operating internationally, cross-border payments are a key issue. CFOs, treasurers and accounting professionals must identify the service providers and payment options most suited to their business activity and trade environment. From a sluggish payment journey with limited visibility to opaque rates and fees, the pitfalls of international payments can prove substantial.
Traditional banks have recently come under greater scrutiny, losing the confidence of both regulators and the public following the 2008 financial crisis. Since then, compliance budgets in traditional financial institutions have ballooned, while research and development (R&D) efforts have trailed those of fintechs. This is in part due to favourable legislation and a market appetite for greater competition and better services.
Where banks’ cross-border payment services lack speed, transparency and traceability, new payment service providers (such as the PISPs and AISPs enabled by EU Directives PSD1 and PSD2) have sought to innovate. Aimed squarely at businesses and consumers, they offer an alternative to legacy players. With new and growing competition constantly vying for market share, however, it begs the question, what international payment methods and services are actually out there for SMEs and mid-caps? And which market players are the better bet overall?
5 ways to make international payments
When sending funds to a stakeholder abroad, it is important for businesses to select the most suitable payment method, be they an importer or an exporter, a client or a supplier. These methods are also referred to as documentary transactions, each presenting distinct characteristics. The most common include bank transfers, cheques, clean drafts, documentary credit and SEPA Direct Debit (SDD).
1. Bank transfers
These represent a simple transfer of funds from the debtor’s bank account to the creditor’s. When an importer pays a supplier by bank transfer, they have the option of making an advance payment, which consists of paying for goods before receiving them. This carries the risk that the goods may ultimately not be sent or may not be delivered as expected.
On the flipside, when a supplier ships goods before receiving payment, it is referred to as open account trading. Here, the exporter runs the risk of not being paid. Bank transfers are flexible, fast and universal, but require a trusting relationship between both parties, as the debtor must initiate payment.
2. Direct Debit
A direct debit enables creditors to immediately collect funds for one-off or recurring invoices. With the debtor’s prior agreement, expenses and invoices are paid automatically. Though practical, businesses must remain vigilant, ensuring awareness of all funds deducted and the reasons for it.
Europe-based direct debits rely on the intervention of four parties: the debtor, the creditor and each party’s bank. There are two distinct schemes, SEPA Core Direct Debit and SEPA B2B Direct Debit.
Core Direct Debit allows you to collect from both private and corporate debtors. Accepting SDD Core Direct Debit is mandatory for banks in the SEPA zone.
B2B Direct Debit (SDD B2B) can only be used for corporate debtors. Though irrevocable, it requires that the debtor inform their bank in advance.
Less common nowadays, cheques are a mandate given by the drawer, or initiator of the transaction (in this case, the debtor), who instructs the drawee (their bank) to pay a particular beneficiary. Upon receipt of the cheque, the beneficiary cashes it through their bank, eliminating the drawer's debt. While inexpensive, cheques are impractical and slow. The debtor initiates the transaction and can enact a payment reversal at will, with beneficiaries maintaining few regulatory protections.
4. Documentary credit
With documentary credit, a debtor’s bank makes a commitment to pay the amount due to the relevant creditor. The latter must submit a series of documents, justifying the transaction. Documentary credit may be either revocable or irrevocable, subject to the agreement of all parties. As the only payment method combining a means of payment with a payment guarantee, it can compensate for a lack of trust at the beginning of a new client-supplier relationship.
5. Clean drafts
In this case, the beneficiary initiates the transaction, affording them greater control. Clean drafts are divided into two separate negotiable instruments:
- The bill of exchange is a document issued by the drawer (in this case, the creditor or beneficiary), ordering the drawee (debtor) to pay the amount due on a specific date.
- The promissory note is a document issued by the debtor, whereby they undertake to pay the creditor the amount due on a specified date.
The beneficiary submits both documents to their bank, which handles the collection. Clean drafts are, however, little known in many countries and still do not guarantee final payment.
Who bears the additional costs?
When a business initiates an international payment, it has three invoicing options to choose from. It can either take on all potential fees itself, charge these to the beneficiary or divide them evenly between both parties. But how does this work? And is it always an option?
An international payment is usually processed by several banks. Those of the debtor and creditor, as well as any intermediary banks. For example, to transfer funds in dollars to China, the payment must be made through a US bank, in conjunction with the US central bank. This generates transaction costs that the payment issuer may have the option of assuming, sharing or invoicing to the beneficiary. Let’s take a closer look:
1. "Ben" (BEN)
The transaction costs are invoiced to the creditor, or beneficiary, as a deduction from the paid amount. About 10% of market transactions are conducted this way.
2. "Share" (SHA)
For each transaction, the costs are shared between the beneficiary and the payment issuer. The costs of the issuing bank are borne by the debtor, while the costs of the intermediary and creditor’s banks are deducted from the amount sent, therefore borne by the beneficiary. This process represents about 60% of market transactions.
3. "Our" (OUR)
The debtor chooses to cover all costs. This ensures that the beneficiary receives full payment, without fees or deductions. This represents about 30% of market transactions.
In the European Economic Area (i.e. when the issuing and recipient banks are both located within the EEA), the law requires that the “Share” option be adopted for any payment in an official EEA currency. A BEN or OUR transfer cannot be made. That said, even outside the EEA, the SHA option is the most widespread.
Banks or fintechs, which has the edge?
When it comes to international payments, fintechs represent an increasingly compelling option for businesses. Less burdened by barriers to innovation, outmoded management silos and legacy costs, they strive to offer customers the latest developments in financial technology, while improving speed, value, transparency and user experience. But what makes them a better option for payments?
In 2012, roughly $3 billion was invested in fintechs globally. In 2019, this figure exceeded $69 billion. Testament to their growing market share and influence, traditional banking and payments players have been increasingly acquiring fintechs to bolster their innovation efforts. With seemingly boundless resources at their disposal however, why do large multinational banks not simply innovate for themselves? How have fintechs been able to carve out a decisive niche in a previously impenetrable market? The reasons are manifold, but let’s look at some noteworthy examples.
1. Competition-friendly legislation
In 2015, the European Union revised its Payment Services Directive with PSD2, further opening the market up to AISPs (Account Information Service Providers) and PISPs (Payment Initiation Service Providers). While many of the payment services provisions were due to enter into force on 14 September 2019, some were beset by implementation delays, notably in the areas of open banking and SCA (Strong Customer Auhtentication). Regardless of setbacks, however, the new payments landscape the Directive has enabled is increasingly occupied by fintechs, which frequently offer a service similar to that of traditional banks, but with improved speed, better rates and greater transparency.
2. Cultural issues
Traditional banking players are underpinned by outmoded management structures, with heavily siloed departments, minimal innovation and considerable legacy costs. For B2B and retail banking, the sector has traditionally been one of stability, preventing radical change. New payment service providers pride themselves on precisely the contrary, disrupting the previous payments landscape with features and characteristics adapted to modern business needs.
Rather than covering all business or consumer needs, fintechs identify specific areas where services may be optimised using intuitive modern platforms. In areas like cross-border or multicurrency payments, they target their technological initiatives, providing a more tailored and satisfactory product. Banks struggle to respond to customer needs in the same way, notably due to budget allocation. To alleviate reputational damage following the 2008 financial crisis, banks made significant investments in strengthening security and tackling abusive practices, often resulting in burgeoning compliance budgets and neglected R&D efforts. In 2018, American banks spent just 5% of their net banking income on “renewal” initiatives.
These three factors, among others, often see banks offering sluggish, out-of-date or ill-adapted products and services in comparison with digitally focused fintech competitors. According to the figures of PwC’s Global FinTech Survey 2016, which studied the responses of 544 top-tier financial sector professionals, only 53% of banking sector participants identified as “customer-centric”, while this figure exceeded 80% for fintech respondents. If traditional institutions themselves acknowledge that the customer is not their core concern, where does that leave businesses looking for the best payment solutions?
Businesses operating internationally are acutely aware of the costs and challenges presented by international payments. Opaque rates and fees, slow transactions, minimal payment journey transparency, the lists goes on. The need to mitigate such constraints and limit margin erosion is critical, making the choice of payment method, invoicing procedure and service provider absolutely vital.
From bank transfers to direct debit, businesses need to evaluate the payment methods available according to speed, operational ease and cost, while taking into account their relationships with stakeholders. When invoicing too, it is important to examine the proportion of fees paid by each party, ensuring the most favourable arrangement is attained. Above all, there is the question of service provider. From traditional financial institutions to fintechs, businesses must seek out the most suitable provider for their cross-border payments, multicurrency transactions or otherwise. Fintechs’ unique ability to address specific pain points and business needs often makes them a convincing option.
The payment services market has never been so open. Legislative developments and tech-driven innovations mean that SMEs and mid-caps now benefit from a wealth of choice. No longer constrained by the one-size-fits-all banking monopoly, they can pick and choose the services most adapted to their daily payment concerns. They merely need to ask themselves which specific payment issues rank highest in their priorities and which mix of service providers is best suited to their business.