An untapped opportunity for fintechs?

A retreat by global banks from providing correspondent banking services in the South Pacific region could provide an opportunity for non-bank players such as fintechs to provide remittance payments to the region, according to a recent paper by the Reserve Bank of Australia.

The paper, Developments in Correspondent Banking in the South Pacific, explored the implications of this scale-back as well as the potential for low-cost technology solutions such as fintechs.

Correspondent banking involves a financial institution (the correspondent) providing a deposit account or other service to another financial institution (the respondent) for the purposes of currency exchange, handling trade-related documentation and cross-border money transfers.

“This issue is not specific to South Pacific countries.  A number of developing countries and regions in the world are concerned about the withdrawal of correspondent banking services by large international banks and what impact that may have on their economies and social wellbeing,” the report’s co-author and Assistant Governor (Business Services) Lindsay Boulton said.

“Given that South Pacific nations are small they are obviously concerned about the withdrawal of these services.”

According to the paper, a retreat by some big banks emerged 10 years ago, as part of a strategy to de-risk their businesses in light of the Anti-Money Laundering and Combatting the Financing of Terrorism (AML/CTF) laws.

In particular, the paper acknowledged the operation of money transfer operators (MTOs) in the region. While global companies such as Western Union and MoneyGram are present so too are smaller family-owned operators.

Banks have been concerned about the lack of transparency in the activities of some of these smaller operators making it difficult to comply with AML/CTF requirements.

“Regulation is seen to have increased compliance costs. "In response, a number of global financial institutions have scaled back their correspondent banking services in developing regions around the world, including in the South Pacific,” Boulton said.

Despite this scale back, the paper did reveal that remittances in the South Pacific have in fact continued to increase. In Tonga, for example, the value of remittances in local currency terms is now at record levels, while those to Fiji and Samoa also remain at high levels.

Challenges for fintechs

According to Boulton, while the retreat by correspondent banks had an initial impact on remittance services in the South Pacific, the overall level of service has since recovered.  

“Arguably, you could say that while large correspondent banks have scaled back their service as a result of the changes from the AML/CTF laws, other organisations have stepped in to fill void that they have left. At the same time, there has also been an improvement in the quality of the services coming from smaller remittance service providers.

Technology-based solutions were highlighted as one way to improve cross-border payments. Indeed, the paper highlighted the issue of servicing the unbanked given the “geographical dispersion of populations among the small island nations of the South Pacific and the relatively small size of these populations, a proportion of which are outside the formal banking system”.

This, according to Boulton does provide the ideal conditions for low-cost technology-based money transfer solutions.

In fact, the paper did acknowledge that this is already occurring in other low-income regions of the world, such as in Africa, where mobile money facilities that use local mobile phone networks are providing inexpensive and accessible alternatives to conventional cross-border money transfers.  

While not noted in the paper, one successful player for example is M-Pesa, a mobile bank in Kenya which has been pivotal in driving financial inclusion where banks have not.

Online brokers, like TransferWise, who charge really low fees for remittances, could also eye similar opportunities.

Boulton did not comment on specific businesses like TransferWise but did highlight a caveat – also noted in the paper, that a number of developing countries are still in developing phase and lack appropriate and reliable infrastructure.

“There are opportunities for fintechs that have a solution that is low cost. However, at some point, these fintechs will need to interface with the traditional banking system and that is where the development of infrastructure can restrict the opportunities available to them.”

A role for big players

Boulton added that innovative solutions do not necessarily have to come from fintechs, the traditional players also have a role. For example, the Tongan Development Bank in partnership with the World Bank Group has developed a remittance facility, the ‘Ave Pa’anga Pau voucher, for use in the New Zealand–Tonga corridor.

This product is purchased online in New Zealand and redeemed or remitted to a bank account in Tonga. The Tonga Development Bank receives the funds only via electronic payments in New Zealand before disbursing them in Tonga using the liquidity obtained by importers.

It’s still a pilot program but the RBA Assistant Governor does acknowledge that is it a “good initiative and a potential solution”.

Ultimately, however, Boulton noted that the issue of unbanked must also be addressed by the countries respective governments.

“The unbanked population is up to their authorities to tackle. Encouraging their people to use the banking system is a matter for them,” he said.

In terms of devising specific solutions for the region, from RBA’s point of view, the central bank will remain focused on ensuring a robust Australian economy.

“Together with New Zealand, we are the economic power in the region. When our economies are doing well, there is a spin off to the economies in the South Pacific.  

Lindsay Boulton will be speaking at RFi Group’s Global Business Banking Summit in Sydney next week.

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