Innovative fintech startups are remedying the pain points that have traditionally affected FX customers and helping those most unfairly disadvantaged by the legacy system
The world is more interconnected than ever. The pandemic may have disrupted most trips for now, but we continue to market goods and services, communicate and collaborate internationally at an unprecedented rate and volume. The standard ways to send money from one country to another, however, have remained bogged down in the past. In a problematic way, traditional electronic funds transfer and currency exchange systems are not only slow and inefficient, but also unnecessarily expensive.
This is not just a pain point for large international companies, professional traders and affluent leisure travelers. The stark truth is that the higher costs of sending money from one country to another are borne by those who can least afford it. Although the average cost of transferring funds internationally is around 6.5 percent, migrant construction and domestic workers from low- and middle-income countries often incur fees of up to 20 percent on the sums they send back to home.
How big is the problem for these vulnerable individuals? According to the World Bank, “If the cost of sending remittances could be reduced by 5 percentage points compared to the amount sent, remittance recipients in developing countries would receive more than $ 16 billion more each year than receive now ”. The scale of theft is profoundly discouraging when you consider the bigger impact. These funds could be used to provide education and medicines and to alleviate poverty and hunger in some of the poorest countries in the world. Making remittances more economical has a very real potential to change and save lives.
“Remittances are a vital source of income for developing countries. The continuing economic downturn caused by COVID-19 is seriously affecting the ability to send money home, ”said World Bank Group President David Malpass last year. “Remittances help families pay for food, health care and basic needs. As the World Bank Group implements rapid and comprehensive actions to support countries, we are working to keep remittance channels open and to safeguard the access of the poorest communities to these most basic needs. “
An unfair exchange
While the situation is most striking for low-income migrant workers, we all suffer to one degree or another under the legacy system, where the costs involved in international foreign exchange (FX) transactions often lack transparency. Perhaps the exchange rate you are offering is unfair or hidden costs have been extracted along the transfer chain: an entry fee, an exit fee, a local bank fee, a bank receiving fee, exchange rate increases everywhere and so on. The end result is a terrible exchange rate, often substantially below what is considered the market rate, with no real explanation as to why various charges and commissions were charged, and an unfair levy on those who can least afford to pay.
Margins in official exchange rates tend to have more impact than rates. In a striking example, during 2017, leaked documents obtained by The Guardian showed that Banco Santander generated 585 million euros in money transfers in the previous year, almost a tenth of its annual global profit. Most of that half billion euros, The Guardian reported, was collected by the bank not with fees, but as a result of a large exchange rate margin.
In its defense, Santander told the newspaper that its charges were clearly explained and in line with those of other banks. There is truth to that statement. Virtually every bank in the world has been cheating customers on foreign exchange transactions for as long as you can remember. So far, it is simply standard practice.
Fortunately, in recent years, technology-oriented financial services companies have made overcoming the problems faced by foreign exchange customers a fundamental mission. Fintechs of this type tend to offer customers the interbank rate: the best rate you can get on the market, essentially the official real-time conversion rate between the currencies that banks negotiate with each other. However, when transferring money from customers abroad, banks often charge a significant margin on the interbank fee. The new generation of fintechs, in turn, offers value to customers by charging little or no increase, fees, commissions or other costs in foreign exchange transactions carried out during business hours. By adding thousands of small transfers, these new fintechs can access the interbank rate and pass the savings on to their customers, while bringing transparency and fairness as additional benefits.
New values, new value
Startups can offer these rates and stay on the market because they are entering new markets, building new low-cost networks on a global scale from scratch that did not exist in the past. These networks offer clarity, full transparency and allow for fair fees and charges that are genuinely related to the real cost of the underlying service.
Traditional banks, on the other hand, continue to charge fees based on how they did business years or even decades ago. It really makes sense. Theoretically, costs behind the scenes of banks should have decreased. But the reality is that, in many cases, banks have failed to automate, they are using obsolete technology with compatibility issues, they suffer from technology and operations silos and simply cannot cut their costs. Thus, with vast overheads, they are unable to offer the enhanced value that their new fintech competitors offer.
Startups vying for bank business are much more agile: they have no legacy issues, backward compatibility or pre-existing heavy costs in terms of costs. The new technology gives the organization, in some cases, an order of magnitude reduction in its underlying cost base, mainly through automation. The cost for banks to migrate to a technological solution and totally change the way they operate is very different from the cost for a fintech company to start and operate in a lean and enhanced way by technology from scratch.
Likewise, banks often operate different platforms from country to country, while a fintech startup will launch a globally enabled platform from the beginning. This gives customers immediate visibility into when funds were transferred from one country to another. And it allows the startup to amortize platform costs across a global customer base.
Instead of trying to implement a new operating model within its rigid legacy architecture, today, we see many traditional banks creating a completely separate organization and trying to build it from scratch. For example, Standard Chartered’s Mox in Hong Kong or UOB’s TMRW in Indonesia and Thailand. Perhaps banks like these have recognized the problems they face, considering that it was not possible to renew their existing technology and existing operating models, and that they needed a new start.
This is exactly what customers deserve. For a long time, banks have overcharged for services that have long been radically simplified by technology. It’s time for legacy players to rethink their approach to FX and a host of other offerings; and for new startups to lead the way.