What is the underlying mechanics of international wires/payments? What is the similarity between International Wire Transfers and Icebergs? For both, you only see a minor part compared to what is below the surface. Whenever you want to send money abroad, you basically either make an order with your bank (or better yet with a money transfer company), indicating where you want the money sent to and wait for it to arrive.
In this article, we will first explain how international wire transfers work. However, as international payments also depend on local settlement in both the remitting and beneficiary countries we will also take a detailed look at some of the different clearing systems specific to the UK, EU and USA. Read to the bottom if you would like to learn more about domestic payment clearing too.
SWIFT: The King of International Transfers Protocols
And how money transfer companies bypass it to lower fees
SWIFT, standing for the Society for Worldwide Interbank Financial Telecommunication, is a system that enables banks to securely send international messages to each other, implement transfer instructions (MT202) and process the fund transfer (MT103). SWIFT has been an integrated component of any international wire transfer operation for the last 30 years allowing banks to effectively communicate. One main drawback of this system is that it is not free of charge and it usually embeds fixed fees (around $10 per transfer).
Now if banks were to pay $10 for each and every debit/credit operation they make – this would amount to billions of dollars per year. Having had total domination of the market, the lack of competition has potentially lead to inefficiencies too – with payment delivery times of almost all currency pairs remaining the same for many years.
Like any technological system, it can still be prone to attacks. The SWIFT system of Bangladesh was hacked in 2015. It appears the country was using second-hand switches with no firewall in place. The theft yielded the hackers with a billion dollars.
Are There New Alternatives for International Wires?
The rise of blockchain is showing us that international transfers can be completed in a matter of minutes, if not seconds. One of the most recognised blockchain technology firms to have launched is Ripple. Banks and international payment companies can link directly with the RippleNet platform – API connectivity through a common communication system that can instantly transfer data. Helping firms to work much like they can with distributed ledger technology – a network of replicated, shared, and synchronized digital data geographically spread across multiple sites, countries, or institutions.
International payment companies are leading the way in trying to adopt these technologies or indeed build their own adaptive ledgers. Providing you are making payments within WorldFirst’s World Account platform from one World Account to another or similarly with TransferWise’s Borderless Account then these transfers can happen with an instant net off of each client account. The issue is most payments are to different payment firms – often meaning a bank instruction is required, including possible cumbersome local domestic payments before a slow SWIFT payment, only have a slow domestic payment on the other end too.
There can also be scenarios, for example, where one institution has linked to RippleNet for instant local settlement on one end of the international payment but it is then required to go to an intermediary bank not on the RippleNet platform so the next stage of the payment has to be sent via SWIFT.
At MoneyTransferComparison.com, we have tested many companies and we highly encourage you to send your international wire transfer via the following houses who take benefit from the different systems in place in order to minimize time and cost.
The Basics of Wire Transfers
When it comes to wire transfers, there are different setups depending on whether the transactions are intra-bank, national or international. Moreover, several other elements impact the flow of money including the currency, the local regulation and the agreements between the banks.
Basically, if you are a client of bank ABC and you want to send $10 to a client (your friend Joe) of the same bank, things will be very straightforward. Bank ABC will just debit your account by $10 and credit Joe’s account by $10. There will be actually no physical movement of money and in most cases, fees will be quasi-null.
Now, in case Joe is not a client of bank ABC. Let’s assume that Joe is a client of bank XYZ. In case there is an existing relationship and agreement between your banks, the flow will work in the following way:
- Bank ABC will debit your account by $10
- Bank ABC will credit bank XYZ account by $10
- Bank XYZ will credit Joe’s account by $10
Obviously, there being an existing agreement means that Bank ABC has an account in bank XYZ and vice versa. In this particular case, there will be fees applied anytime there is a new credit or debit operation.
Now, in case of banks ABC and XYZ have no direct relationship, or it is an international payment and your bank doesn’t have the capabilities to clear the destination currency of your choice, there will be a need for a third party or fourth party correspondent bank. Let’s assume that Bank ABC and XYZ each have a direct relationship with bank TUV. The process will get more complex and will involve more fees and transactions as follows:
- Bank ABC will debit your account by $10
- Bank ABC will credit bank TUV’s account by $10
- Bank TUV will credit bank XYZ’s account by $10
- Bank XYZ will credit Joe’s account by $10
So this process can get more complex, particularly in more exotic countries. For this reason, transfers between major banks can usually be done at minor costs, while transfers to remotely located smaller banks involve more fees.
..But hang on, how do these banks communicate and send instructions to each other?
How to wire money to a bank account DOMESTICALLY?
SWIFT is the international protocol. What about others?
BACS which stands for Banker’s Automated Clearing Services is a UK “netting system” aimed at optimizing flows between banks. It actually acts like a central clearinghouse that keeps track of all debit/credit operations between banks and only settles the difference at the end of the day. Look at this possible scenario to understand how it works:
Let’s assume that during a given day, Bank ABC’s clients sent £100 million to Bank XYZ’s clients. Within the same day, Bank XYZ’s clients sent the equivalent of £80 million to Bank ABC’s clients.
Basically, the system will net out all these flows and logically instruct to credit £20 million into Bank XYZ’s account held at Bank ABC. By doing so, the fees will be limited and split among all the clients having made transfers. In fact, fees will be quasi null if you opt for BACS processing of your wire transfers – though the transfer will take more time (around 3 days). Or can be almost instant in the case of faster payments which go over the BACS network for same-day delivery – maximum payment size of £250,000 (more on this below).
For those in a hurry and in need to quickly move funds, there are adapted systems that can help you achieve your objective.
Moreover, BACS does not guarantee that banks will actually commit to make the payments. Imagine that bank ABC goes bust before settlement… it would have dramatic consequences and Joe would never receive his money.
For this reason, central banks get into the picture.
New On BACS: Customer protection in the UK. If you send a payment via BACS by mistake you can reclaim your money through noticing the bank; If there were no reclaims, you should be refunded within up to 20 days.
Target2, Fedwire & Chaps
As seen above, central banks exist to help minimise risks (liquidity, counterparty). Each time a transfer is required, banks must instruct the central bank to move money from its account into a different entity. So this is exactly the role of entities such as Target2 in Europe (Euro), Fedwire in the US ($) and Chaps in the UK (Pound). They allow gross and real-time transfer of funds between entities and by doing so, dramatically decrease the time it takes to process a transfer and make it on a real-time basis.
On the fees side, it is more expensive than the netting systems, though incentives are provided as transaction sizes increase. While Fedwire and Target2 seem to be competitive, CHAPS charge tremendous fees (up to £35) for each transaction.
Target2 Fee System
Fedwire Fee System
One Edge – FPS
Introduced in 2008, Faster Payment Services is the latest clearing infrastructure in the UK payment space. It completely changed the face of wire transfers by operating on a 24/7 basis and enabling transactions to be made within a couple of hours (and even less at times), and providing flexibility to clients (online, phone banking, branch).
Basically, FPS works pretty much similar to CHAPS, except that the central bank does not get involved and charges are non-existent (initially, there was an intent to charge anywhere between £1 and 5 by transaction – though none of the banks using this system has been charging customers).
What is important to keep in mind is that FPS only works between member UK banks (as below). So any payment made to a bank account that is not part of the system will take more time and would potentially be subject to charges.
- Member Banks
- Barclays Bank PLC
- Citibank N.A
- Clydesdale Bank PLC
- Co-operative Bank PLC
- Northern Bank Ltd T/A Danske Bank
- HSBC Bank PLC
- Lloyds Bank
- Nationwide Building Society
- Royal Bank of Scotland Group
- Santander UK PLC
Very interestingly, transaction limits are quite high and can enable both retail and corporate customers to make important transfers on a daily basis. The limits are detailed below for each bank:
Bottom Line on International Wire Transfers:
Put simply, international wire transfers are becoming cheaper and quicker thanks to regulators efforts towards decreasing processing times and costs. And of course, new technology and FinTech firms who continue to challenge the traditional banking model. It remains clear that international wire transfer companies benefit from these efforts while boosting their business. International Payments are still yet to be truly disrupted as most payment routes are still reliant on the cumbersome local domestic settlement we have explained above and often SWIFT when sending funds overseas.
For all these reasons, yes it is still possible to send money cheaper and quicker & yes, you need to choose the right FX company that will enable you to benefit from all the upsides resulting from technology, innovation and regulators’ efforts.
All in all, there is a lot of movement happening within the fund transfer industry and one can only expect things to get quicker and cheaper thanks to the different actor’s efforts towards liberalizing, opening and becoming smoother. Perhaps the only thing holding it back is the reluctance of banks – aware that the adoption of new technologies can reduce the reliance on their part in the payment cycle. Finding a way to continue giving banks their slice of the pie may be the only way to see true change quickly.