Cross-border transactions are generally more costly and slower, with less access and transparency than domestic payments. They can take a few weeks to reconcile and cost up to 10 times more than a domestic transaction. Here are a few more challenges with cross-border transactions.
1. High funding costs
Depending on the transaction type and currencies involved, payee entities must provide funding in advance. They may need to access the relevant currencies or foreign currency markets to even initiate the transaction. That means putting aside capital to cover expected transactions, and those funds can’t be used for anything else.
2. Transaction fees
The more entities involved in a cross-border transaction, the higher the cost due to bank fees at each stage. Many of these fees are absorbed into the merchant bank fees and accounts, but they’re sometimes passed along to consumers or the originating payee. For example, credit card companies often charge card holders a foreign currency transaction fee for purchases made in currencies other than the card’s currency. This rate can vary between cards, issuers, and currency types, so it’s hard to know the fee for the transaction.
3. Currency exchange rates
Exchange rates fluctuate all the time, affecting both payee and recipient entities. Recipients could end up with a deficit if the rate decreased between the time the transaction was begun, processed, and settled. Likewise, payees may spend more on their end if the rate was higher when they started the process. To avoid this, many merchants offer the ability to purchase in a local currency and use a payment gateway or processor to find the best exchange rate for the merchant automatically. Consumers save money when spending, and merchants save during the transaction and settlement processes.
4. Long transaction chains
A transaction chain is the number of entities involved in a payment transaction. Domestic transactions or in-network single currency cross-border transactions tend to have shorter chains. Multi-currency cross-border transactions tend to have longer ones. The correspondent bank model allows entities to offer cross-border transactions, but it can lengthen the transaction chain at the same time. Each “link” in the chain increases the timeline, funding needs, fees, validation checks, and the potential for data to be corrupted as it is transmitted.
5. Complex compliance checks
Cross-border transactions tend to face broader and more stringent compliance checks against fraud, sanctions, and financial crime. Each check takes time and may happen multiple times during the transaction’s journey. Each bank or payment gateway may use different rules and guidelines when checking transactions, leading to incorrect flagging or declines. For example, if a customer has a similar name to one in financial crime databases, they may be declined automatically.
Domestic compliance checks may complicate these transactions if they move through different domestic banking networks or systems and trigger domestic compliance rules. For example, in the US and Canada, transactions that move across states and provinces may trigger unique checks that other transactions may not.—And that’s even before the transaction gets to an international border.
6. Tax and legal implications
Taxes and local laws are another complication for cross-border transactions. There are implications for individual countries involved in the transaction and any tax-related treaties between their governments. Sales tax is the most obvious example of tax implications for cross-border transactions and how it’s applied to different transaction types depends on the countries involved. For example, it may apply to goods over a certain threshold in one country, and under that threshold in another. It may not apply to services at all in most countries and apply to all services in another, but at different rates depending on the recipient entity’s location.
7. Limited operating hours
Digital transactions can happen at any hour of the day, but balances and settlements often depend on bankers’ hours of operation for updates. That means that reconciliation and settlements can only happen during the hours banks are open in the payee and recipient entity’s location. This can create long delays and bottlenecks in clearing and settling cross-border transactions, especially across large time differences.
The impact is that transaction fees may fluctuate since foreign exchange rates may change during this time. Banks, entities, and recipients often must hold enough balance to cover unknown costs of the eventual foreign exchange rate, driving up overall transaction costs.
8. Fragmented and truncated data formats
Financial transactions contain sufficient information to confirm the identity of the those involved in the transaction and confirm its legitimacy. However, data standards and formats can vary significantly across countries, systems, message networks, and financial jurisdictions. This variation results in data fragmentation or loss as systems are not set up to handle unfamiliar data. Data may need to be translated and could lead to slight changes in spellings or formats, making it difficult to set up automated processes and increasing delays and decreasing transaction success rates.
9. Legacy technology platforms
Traditional financial institutions are notorious for using legacy technologies that may not interface well with newer technologies. These legacy processes and technologies may have fundamental limitations that cause settlement delays and create processing bottlenecks, such as relying on batch processing, no real-time monitoring, and low data processing capacity. These systems may not be able to handle the ebb and flow of financial transactions in real-time. Legacy technology may be a significant barrier for emerging business models and cross-border transaction technologies who want to enter a new market.