OF AMERICA’S hired farmhands, about half are undocumented immigrants. Many are unbanked, which makes it hard for them to send money home. Some drive home in trucks laden with gifts, and return with lighter items—high-sugar Mexican Coca-Cola is popular. Even for migrants who use formal channels, cross-border payments are an expensive chore. Remittances to developing countries are set to reach $550bn this year, beating foreign direct investment, the World Bank said on April 8th. Buoyed by e-commerce, cross-border transfers to and from individuals and small businesses come to $10trn a year. A hefty chunk is taken in fees along the way. The middlemen benefit: on April 9th Finablr, a payments and exchange group based in the United Arab Emirates, said it would seek to raise over $200m on the London Stock Exchange, in part to invest in expansion.
Some fintechs are trying to disrupt the cosy status quo. So far they have only nibbled around the edges of the market. But that may be about to change. In a world made smaller by Skype and instant messaging, “why does money still go on a donkey?” asks Taavet Hinrikus of TransferWise, a London-based fintech that typically charges a tenth as much as British banks.
To send money across borders, banks use “correspondent” accounts they open with each other. When Anna at Bank A wants to wire $10 to Boris at Bank B, Bank A takes $10 from Anna’s account. It then sends a message through SWIFT—a system used by some 11,000 banks to communicate—telling Bank B to wire $10 from its correspondent account into Boris’s. And the matter is settled: money transfers are about moving data, not money.
There is a complication that will be familiar to air travellers: when two banks have no direct connection, the chain of requests has to involve stopovers. Each “airport” levies a fee and makes it go through security, creating delays. That problem is getting worse. Afraid of falling foul of stricter anti-money-laundering rules, banks are increasing their oversight by shrinking their sprawling networks. The number of active correspondent relationships fell by 15.5% in the six years to 2018.
Fintechs save time and money by shortening the journey. Some do so at the sender’s end. Last year TransferWise and Ebury, a firm that serves small businesses often neglected by banks, became the first non-banks to join Britain’s Faster Payments scheme, which allows members to send and receive money in seconds. More important, though, is creating direct ties with big banks on the recipient’s side, leaving at most the final leg to third parties.
Fintechs also build their systems from scratch, automating as much as possible. And they seek to reduce the “float”—the currency they must hold offshore to match users’ requests. Many aggregate transfers to net them out against payments going the opposite way. Some use machine-learning to predict how much they will need. Small World Financial, a London-based firm, found that migrants send more money home when it is raining where they are living, says Nick Day, its chief executive.
According to FXCintel, a data provider, the best fintechs keep fees below 2%, and often much lower on many of the routes they serve. They are faster, too: many transfer money in minutes on popular corridors. Azimo, which is based in London, pledges 30-minute transfers to Nigeria, even at the weekend.
Contrast this with American high-street banks, which can charge over 5% for smallish transfers between major currencies. MoneyGram, a long-established money-transfer giant, levies 5% for the hop from Britain (sterling) to Ireland (euros). Fees for minor currencies are swingeing. Wiring $200 from South Africa to Nigeria can take days, and costs over 25%. Cash transfers generally incur much higher costs than those between accounts.
Startups focused on remittances are growing fast. Seattle-based Remitly already processes transfers of $6bn a year. But they are as yet taking slices of an expanding pie rather than gobbling up market share. Most focus on specific corridors and digital channels. That leaves many destinations and cash-only customers to decades-old giants like MoneyGram and Western Union, which runs a global network of 550,000 agents. Western Union is everywhere except in Iran and North Korea, says Hikmet Ersek, its chief executive. The firm, which handles $88bn of consumer-to-consumer transfers a year, is on average 15% dearer than competitors, he admits. But he does not see pricing pressure, “because no one is in the last mile”.
Challengers have made a bigger impact in rich countries. TransferWise, which processes $46bn a year, says it accounts for 15% of British consumers’ outbound transfers, beating banks. These seem unruffled: their pricing has not budged since 2015. “The brand equity of big banks still allows them to charge more,” says Daniel Webber of FXCintel. Opaque pricing makes that easier. Unlike interest rates, which neatly capture the cost of a loan in a single figure, the price of a cross-border transfer consists of two parts: a fixed commission and a margin on the exchange rate. And like plane fares, fees can rise or fall depending on timing and amount.
The incumbents may soon have to mend their ways. Last December the European Commission passed a law that will force banks and firms to disclose markups from 2020. Australia’s regulator is considering a similar move. Startups should benefit: a study in 2018 found that the share of consumers who chose the cheapest provider of transfers rose by a quarter when fees were clearly displayed.
These changes may push fintechs and banks into each other’s arms. In Europe, digital lenders such as N26 and Monzo already use TransferWise to handle transfers. Their brick-and-mortar peers should seek to strike similar deals, says Martin Griffiths of Barclays, a British high-street bank. If they do not, they can expect the market to be disrupted around them.