An animated guide to the sticking points behind cross-border payments.
$8 trillion moves between different currencies every single day. It’s the biggest market in the world. It’s about 30 times daily global GDP.
If you’re new to foreign exchange, but you’ve experienced the pain of it taking a long time and you’re in agony wondering if the money that you sent is ever going to reach the recipient, and how much money they’re going to get, and who’s taking fees and what those fees are…that’s what I’m here to explain.
Why is it expensive? Why is it complicated? Why are people trying to disrupt it or not disrupt it? How does this work?
It’s a very, very complicated process because this stuff only exists in digital form. You’re not sending paper currency somewhere. You’re not sending gold and guts to Japan via FedEx. You’re basically shuffling ones and zeros around, but you need to make sure that they’re accounted for correctly.
How does money move from one country to another?
I’ll give you a great example from my personal life: I’m American, my wife is Japanese. We go to Japan a lot. We send money to Japan sometimes. How does it work for me and my wife, sending U.S. dollars to yen in Japan?
The way that this typically works is there are two banks. We bank with Chase, her family banks with one of the biggest banks in Japan called MUFJ.
How does the money get from Chase to MUFJ in Japan? A lot of banks have relationships with each other. So Chase will keep some Japanese yen in what’s called a “nostro” account. It’s a Latin word, it means “our.” They’ll have yen that they keep on deposit, on-demand in a Japanese bank.
Likewise, people in Japan might want tto send money to the U.S. So a Japanese bank will keep a “vostro” account (“your”)—they’ll keep money in U.S. dollars at a U.S. bank.
I go to Chase and say, “Please send money to this Japanese recipient at this Japanese bank.”
And they’re like, “Oh yeah, we know that bank.” They use a messaging service called Swift. Just like you can send an iMessage or an email, a Swift message is a network by which one bank tells another bank: Here’s what money needs to move, here’s how much, and whether to debit the sender or the recipient.
The money gets moved because Chase will tell MUFJ: “Take money from our nostro account in yen, and then move it into this account that you control,” which is pretty basic. MUFJ is just taking money from one account that they control and moving it into another account that they control. And that’s how the whole process works.
However, that assumes that those two banks have a relationship with each other. In general, it tends to be hard to move money because there sometimes has to be one, two, or three banks involved in the middle.
Most banks don’t have relationships with every other bank in the world. And this is where it gets a bit more complicated and introduces the concept of correspondent banking.
What is a correspondent bank and how does it work?
To move money from one bank to another actually requires a third bank to be involved, which is called a correspondent bank.
So imagine that I live in Iowa and I bank with Bank Iowa. Bank Iowa almost certainly does not have a nostro account with MUFJ. So they find a correspondent bank that does—that already has nostro and vostro accounts with the recipient.
Then the correspondent bank will look up what’s the right fee to charge. (And normally the right fee to charge is whatever makes them a lot of money…)
They’ll say: One U.S. dollar is 140 Japanese yen. But you know what? We’ll say that one U.S. dollar is 137 Japanese yen and we’ll take 3 yen as our fee. The correspondent bank will then just shuffle money between these accounts.
Why does sending money overseas take so long?
What is often frustrating for people is that when you send an iMessage from your iPhone to an iPhone in Japan, they’re using the same protocol. They have the same hardware and software. And with messages, you just send them back and forth. It’s a piece of cake. There are no intermediaries involved.
For traditional banking, on the other hand, what makes them slow is that—even though money is effectively all digital, it’s just a message—that’s always going through not just one centralized party, but maybe multiple centralized parties.
The main way to move money between banks in the United States is the Federal Reserve has a wire system called Fedwire. It closes every day at 7:00 PM Eastern Standard Time.
So if I wanted to send money from this country to Japan, but it happens to be 8:00 PM on Friday, that might not work because there’s no way for my local bank to then wire money to the correspondent bank. And by the way, it might be a Japanese holiday, so they can’t even receive the money.
So there are all sorts of different reasons why it can take a long time, from national holidays to slow systems to currencies that aren’t traded that often.
There are also all sorts of laws that have to be complied with. So if I go to send money from my little house in Iowa to Japan, my local bank wants to make sure that this is on the up and up. What if I’m laundering money? If it’s a transaction more than $9,999.99, that automatically has a higher set of checks and balances than if it’s under that dollar amount.
Then the recipient bank will often do the same thing. Some recipient banks in some countries have very, very strong currency controls. They might say, “Why is this money coming in? What is the purpose?” Or: “Why are you sending money out of the country?”
There are lots and lots of different layers involved. It is a complicated process, but once you break it down, it kind of makes sense and you can understand a lot of different ways where it will hopefully be more effective in the future.
See a16z.com/global-payments for more.