Introduction
Despite repeated narratives about globalization and a connected world, there is no effectively functioning global payment system to enable the frictionless flow of money across borders. Money is far more than just data – it is a complex bundle of rights and expectations closely tied to nation-states and their institutions.
In the absence of reliable financial infrastructure linking payments to the guarantees and stability provided by nation-states, intermediaries have been forced to create trust and facilitate movements of money in very different ways.This blog post will examine the three main models of payment infrastructure provision that have emerged over recent decades:
traditional bank-based systems, global companies acting as intermediaries, and the newer entrance of tech-driven companies seeking to disrupt existing frameworks. It will assess whether the latest wave of digitization can solve the problems of exclusivity and high costs that have plagued cross-border transfers, or if they will simply exacerbate existing challenges.
Bank-Based Payment Systems
Clearing Houses Handle Calculations Between Banks
Clearing houses play a critical role in bank-based systems by efficiently calculating the amounts owed between banks for payments sent and received. They greatly reduce transaction costs by establishing set procedures and netting payments rather than requiring constant renegotiation for each transaction.Settlement then involves the actual transfer of funds between banks, often using central bank money considered the most stable and secure asset.
Close Collaboration in Domestic Payment Systems
Within countries, domestic payment systems depend on close collaboration between the interconnected infrastructure of commercial bank networks and central banks’ clearing and settlement systems. This links day-to-day payments to the stability and guarantees provided by the nation-state’s institutions.
Global Payments Involve Higher Risks
Global payments have inherently higher risks and complexities than domestic transfers because no uniform global currency exists. Transforming one national or regional currency into another inevitably introduces frictions and inefficiencies.The bundles of rights and expectations tied to individual national monies also cannot simply or directly be exchanged across borders. Something is lost in translation.
Global Companies as Intermediaries
Companies Bridge Gaps Between Countries
Given the lack of unified global payment rails, a handful of powerful intermediaries like credit card companies and elite settlement banks have emerged to facilitate cross-border financial flows.These global companies bridge the gap between the fragmented infrastructures and currencies of nation-states to power global business.
But Rely Heavily on Traditional Bank Networks
However, it is important to note these global intermediaries rely heavily on long-established bank-based systems underpinning domestic economies. They extend access and provide infrastructure for transmitting payment information worldwide, but are not replacing existing localized banking infrastructure.
Settlement Banks Handle Currency Exchanges
Within this global web, a very small number of major settlement banks, literally something you can count on one hand, handle the actual settlement of currency exchanges and cross-border transactions. This exposes them to substantial liquidity and credit risks.
Power Concentrates from Network Effects
The need to create trust and minimize risks in the absence of coordinated global rails leads to the inherent concentration of power in a handful of players. Network effects and economies of scale reinforce this tendency towards an oligopolistic provision of financial infrastructure.
A small elite number of banks and global companies can effectively dictate the conditions of global payments.
Entrance of Tech-Driven Companies
New Startups and Technologies
Since the 2000s, a second wave of digital innovation has shaken up finance, enabled by blockchain and related technologies. This has been actively promoted through industry regulation seeking to foster competition.
A whole generation of fintech payment startups has emerged, claiming to transform traditional models.
But Most Only Disrupt Front-End Services
However, a deeper analysis finds the majority of these new tech-driven companies have only disrupted the customer-facing front end of banking and payments. Back-end clearing and settlement largely remain unchanged in most countries, still reliant on existing rails.
Closed-Loop Systems Seek Greater Autonomy
More radical experiments like cryptocurrencies and proposed “closed-loop” payment systems aim to completely detach from the traditional banking system. But their success has been limited to date.The risks of fragmenting payment rails and letting private networks dominate through proprietary digital currencies are becoming apparent.
Big Tech’s Mixed Results
Big tech firms like Google, Amazon, and Facebook attracted by the riches of payment data have also dipped their toes into finance. But even their vast resources have not enabled them to easily establish financial infrastructure, so many have shifted to partnering with banks.
Conclusion
In conclusion, no seamless, frictionless global payment infrastructure exists today, despite perceptions of a highly financially integrated world. The movement of money internationally still relies on a small number of correspondent banks making risky currency exchanges.
This gives them disproportionate power to dictate the terms and costs of cross-border transactions. So far, new technologies have mainly reinforced these intermediaries rather than disrupting them.
It remains an open question whether private tech firms or public banks will solve the exclusivity and high costs of the current system. More coordinated central bank infrastructure linking national payment systems may prove essential for the future.
