50. International Payments

Achtung: This is a super lengthy and complicated topic… So if your skill set includes getting bored in lightning speed, then please skip it.

Those who have read Dan Brown’s ‘Da Vinci Code’ or watched the movie with the same name starring Tom Hanks, would be familiar with Knights Templar — a holy military order with the purpose of protecting Jerusalem during Crusades. But here is a little known fact about Knights Templars — they developed the first cross border payment/banking system. There was always risk (theft, loss) in carrying money/gold on a pilgrimage to Jerusalem. A pilgrim could simply deposit the funds in one of Templar Churches in London and get a receipt which can be shown in a Templar Church in Jerusalem and collect the funds.

Today’s world is very different from the one in medieval ages… as the cross border trade and travel increased, the cross border payments also evolved. Today, we do trillions of cross-border payments… And in this article, I will talk about international payments / cross-border remittance with India as the focal point.

Jargons

You will come across new jargons and abbreviations in this article so here is the list for your reference. Here are some important ones

Nostro Account: a foreign currency account maintained in a bank in a foreign country. When Party A (in the U.S.) remits to Party B (in India), the funds flow through a Nostro A/c or an intermediary account or a correspondent bank. E.g. ICICI Bank holding an account with JP Morgan in the USA is called a Nostro Account

Vostro Account: When a bank maintains a local or home currency account of a foreign bank or branch in its own country it is called a Vostro account (E.g. JP Morgan holding an account with ICICI in India would be a Vostro A/C)

SWIFT (Society for Worldwide Interbank Financial Telecommunication) is an organization founded in 1973 with the purpose to standardize messaging and processing for global transactions. The SWIFT network doesn’t actually transfer funds but instead, it sends payment orders between institutions’ accounts, using SWIFT codes. SWIFT standardised IBAN (International Bank Account Numbers) and BIC (Bank Identifier Codes) formats

FIRC (Foreign Inward Remittance Certificate) is issued by a merchant’s beneficiary bank for every inward remittance that is received. Apart from working as a legal proof for international payments, FIRC is required to claim export incentives and GST waiver on products sold overseas.

Forex (or Exchange rate) means how much of a currency of another country (e.g. US $) I can buy using a different currency (E.g. INRs). For various macro economic reasons this rate varies/changes unless a country has pegged it to a currency.

FATF (Financial Action Task Force) is the global money laundering & terrorist financing watchdog who set the international standards to avoid any illegal activities

Sanctioned Country: Sanctioned countries are subject to restrictions on certain types of activities. E.g. Iran has a restriction on imports, exports or financial transactions.

OFAC (The Office of Foreign Assets Control) is a part of the United States Treasury that regulates trade sanctions on countries / individuals who are involved in / promote illegal activities.

Money Conversion: As you know in cross-border payments, the currencies are getting converted. In India, only RBI authorised entities, Authorised Money Changers (AMCs), are allowed to conduct exchange / conversion. Different categories for AMCs:

• Full Fledged Money Changer (FFMC) is a money changer authorised to purchase foreign exchange from non-residents visiting India and residents, and to sell foreign exchange for private and business travel purposes only. (E.g. Department of Post)
• Authorised Dealer (AD) Category-II Banks refers to entities who deal in foreign exchange for specified purposes (E.g. Upgraded FFMCs, Select Regional Rural Banks (RRBs), Select Urban Cooperative Banks (UCBs))
• Authorised Dealer (AD) Category-I Banks are authorised dealers of foreign exchange & securities (E.g. Banks)

Use Cases

There are various use cases from cross-border payments, ranging from simple to complex to super complex… A migrant worker in Dubai sending funds to India, a craftsman based out of Chennapattana receiving proceeds for products sold on Amazon USA site, a vendor based out of Singapore wants to receive funds of items sold on Flipkart or a IT professional based of USA ordering furniture for her parents in India on Pepperfry website or you investing in Apple shares via an intermediary etc.

Three main ones:

I will write about three main cases which covers almost all use cases

• Outward Remittance: Funds that needs to move outside India (e.g. payout to a seller based out of Singapore who sold product on Flipkart)
• Inward Remittance: Funds that needs to move to India from other countries against the sales proceeds
• International Payment Gateway (PG): Customer is outside India and paying on Indian merchant’s website/app using her non-INR credit card

Note: Although the third one is nothing but inward remittance but decided to keep it separate as it is one of the most common payment options used by the merchants.

Outward Remittance

Funds that needs to move outside India and below is simple fund flow (from an aggregator’s standpoint)

Illustration 1

RBI has defined a separate remittance scheme under which funds can move out of the country (Here is the list)

Few of the examples for outward remittance types, use cases and few payment providers who provide these solutions.

Illustration 2

If you wish to deep dive into this then please refer these guideline for OPGSP Import, Miscellaneous Remittances and LRS

Inward Remittance

Funds that needs to move inside India and below is simple fund flow (from an aggregator’s standpoint)

Illustration 3

There are 3 remittance channels in which funds can be accepted from international sources and few of the payment companies that provide those services.

Illustration 4

For RDA, the entity to be licensed as an exchange house in the sending country. These entities (non Indian) enter into a partnership with AD Category I Banks for a Vostro A/c (INR A/c) from where payouts are made to the receivers. The funds should be received from licenced and regulated entities in the sending country for sourcing the funds from the remitters (established exchange houses) (E.g. Transferwise)

For MTSS, money transfer companies abroad (operating as Overseas Principals) should be licensed in the sending country and should get necessary approvals from DPSS, RBI. Funds are sent to an Indian Agent (licensed FFMC i.e. Full Fledged Money Changer) (E.g. Western Union)

Compliance & Commercials Models

As compliance and commercials models are almost the same for both inward and outward remittance so I am clubbing those here.

I. Compliance & limitations:

PART A: While on boarding a recipient (foreign vendor), it is essential to ensure that the client does not belong to Non-FATF Compliant geographies/Sanctioned Countries. OFAC rules prohibit transactions with certain foreign countries or their nationals and hence are to be complied with.

India abides by the OFAC regulations because:

• US dollar is the most traded currency globally
• Most correspondent banks are based out of the US or associated with US
• Cross-border payments could directly or indirectly involve US banks

PART B: Transaction Limits to be inline with the regulation.

E.g. The OPGSP Import guideline defines a USD 2,000 cap on every purchase. LRS transactions have a cap of USD 2,50,000 annually at a user-level.

PART C: When funds are being moved cross border, it is essential to establish an end-to-end transaction trail. In order to do so, the below information is to be gathered:

• Buyer Information — Name, Email, Mobile No.
• Seller Information — Name, Address, Bank Account Details
• Invoice Specific Details — Invoice No., Invoice Date, Invoice Amount, Description
• AWB (Airway Bill) — where physical goods are moved
• Remittance Scheme Declarations e.g. LRS declaration
• Purpose Code specifying purpose of transaction (Purpose Code specifies the reason for fund movement — Here is the list)

Compliance is relatively easier when it comes to inward remittances since forex is coming into the country. However, the checks remain constant as above

II. Commercial Model:

Commercial models (line items) remains same for both inward and outward remittance

1. GST on Currency Conversion (Read details here)
2. SWIFT Cost (to sender)
3. Correspondent Bank Charges (can be borne either by sender or receiver)
4. FX Margin — Calculations will vary as funds are converted from INR to USD in case of outward remittance and USD to INR in case of inward remittance. (Below is the calculations)

Illustration 5

International Payment Gateway

Here is the use case: An eCommerce merchant wants customers based outside India to make payment on its website.

This is quite a common requirement for the travel (NRI who is coming to India wants to book flight for her domestic journey), education (parents who are in Dubai want to pay their kid’s college fees) and IT Service/SaaS sectors (a US based entity pays small monthly fees to Indian website development company)

Solution for this requirement: the Indian merchant enables international PG via any of the payment aggregators or acquiring banks.

Coverage of this solution: (a) Non-INR Visa and MasterCard credit/debit cards (b) Amex — With direct integration

Working Models:

1. Dynamic Currency Convertor (DCC):

• Merchant shows the amount in INR
• Customer will make the payment in base currency of the card (e.g. US $)
• Settlement will be done to merchant in India in INR

2. Multi Currency convertor (MCC)

• Merchant shows the amount base currency (e.g. US $)
• Customer will make the payment in base currency of the card (e.g. US $)
• Merchant will get the settlement in India in INR

Commercials: Unlike domestic PG, international PG is expensive and there won’t be any sector specific pricing — there will be one standard pricing and that will be always in % (percentage).

Typical settlement time is T+2 days and for every transaction, the merchant has to get FIRC from its acquiring bank (or payment aggregator) and that is a manual process.

Major Concerns with International PG:

• 2nd Factor Authentication (2FA) is not-mandatory outside India except for high risk transactions (or sort of step-up authentication leg). So when the customer is posed with 2FA (OTP), then they may simply drop off and thus the success rate will tank
• Additional Charges: as the base currency and transaction currency are different, a cross-currency mark-up fee (range of 3.50%) will be applied. As customers may not be aware of this, they will assume that merchant has over deducted the card and raise dispute or chargeback
• Refunds: Exchange rate may change from the time of transaction and when the refund is marked. So it is possible that when refund is given the amount will be lesser than the transaction amount

Enabling International PG

The acquiring banks consider International PG as high risk. So the approval is not that simple and bank(s) will have various limitations & conditions for enabling this PG

• Sector restrictions (easy to get approval for eCommerce but not for gaming or NGOs)
• Merchant Restriction based on vintage and reputation (a good brand eCommerce can get approval but a new unknown eCommerce merchant may not)
• Additional documentation — Bank may ask for additional documents such as audited financial reports
• Security Deposit — Bank may ask for security deposit to cover chargeback risk

Closing Points

Payments are complex and International/Cross-border payments are much more complex… There are complex processes, stringent compliances, fluctuating currencies and commercial models. The ecosystem is regulated, managed and governed by central banks, governments and large financial institutes.

If you are a Crypto currency enthusiast then you may say “See? So many inefficiencies — our bitcoin / Dogecoin / MyOwnCoin will fix these problems”. You may or may not be right about it. But before I nip your enthusiasm, let me complete the story about Knights Templars.

As Knights Templars controlled the holy land, pilgrim routes and also managed a private bank (sort of), they became super rich and thus super powerful even beyond the Vatican and the kings of Europe. But the very same wealth and power triggered their downfall as the Church and Kings came heavily on them

Hope you see the parallel here… Governments, Regulators and financial institutions won’t allow Crypto currencies to become a common global currency. Yeah sure, ‘they will explore block chain technology to fix cross-border payment problems… ’ — win-win :)

India receives 15% of global inbound remittances — $83B in 2019 and $27.4B in 1st half of 2020. No need to explain but surely COVID has dampened 2020 numbers. And RBI very well knows the problems and that is why the cross border payments is theme for its 2nd cohort under regulatory sandboxes with the aim ‘to spur innovations capable of recasting the cross-border payments landscape by leveraging new technologies to meet the needs of a low cost, secure, convenient and transparent system in a faster manner’… I will write more about it when the cohort participants come up with new innovations till then let’s continue with the normal.

Thank you Shweta Mohan for helping me completing this article