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Any business participating in international commerce normally needs to make payments in foreign currencies to suppliers/sellers overseas for goods and/or services sourced from other countries.
There are many different methods of sending money globally. Transferring money electronically is by far the dominant method, although some paper-based cash ways to pay still exist (e.g. cheque, bank draft, money order).
International wire transfers
An international wire transfer (hereinafter, “international wire”) is a cross-border service offered by banks for transferring funds over an electronic network from a bank account in one country to another bank account in a different country.
International wires are practically synonymous with SWIFT transfers due to the pivotal role the SWIFT network (Society for Worldwide Interbank Financial Telecommunications) plays in facilitating such transactions.
Headquartered in Belgium, SWIFT is a global member-owned cooperative of c. 11,000 financial institutions spanning over 200 countries and territories, and is the world’s leading provider of secure financial messaging services.
International wires using the SWIFT network are the most common method worldwide to transfer funds from one bank or financial institution (FI) to another.
There is a common misunderstanding about what SWIFT does. It is neither a clearing nor a settlement network. SWIFT is a financial messaging system which sends global payment orders initiated by financial institutions to be processed by a clearing or settlement system.
Sending an international wire involves two different processes – clearing and settlement.
International wires are initiated in one country and settle in another. When a bank’s personal or business customer initiates an international wire – via online banking, an app, by phone or in-person at a branch – they need to provide information about the payment destination and recipient based on SWIFT messaging standards, i.e. a common language for payment data across the globe.
The sender’s bank ensures sufficient funds are available in the sender’s account to cover the payment and applicable fees, debits the corresponding amount from that account and initiates the funds transfer by messaging a payment instruction/order to the recipient’s bank via the SWIFT network.
Clearing covers the transfer and confirmation of payment information between the sending and receiving banks.
When the receiving bank receives the SWIFT message with all the required information, it deposits the payment amount into the recipient’s account using its reserve funds. At this point, the payment has been cleared, and the clearing phase is completed.
No physical money is transferred between the two banks when conducting an international wire. Only the payment information included in the SWIFT message is passed between the banks.
Settlement: Net vs gross
Settlement is the final step in making a payment and involves collecting the funds for the payment order processed during the clearing phase. Banks can begin the exchange of funds to settle a payment right after clearing has taken place (funds deposited in the recipient’s account) or later. Once the settlement has occurred, the payment is complete.
Payments can be settled either on a net or gross basis.
Net settlement: When banks aggregate transactions (debits and credits) throughout the day and settle in bulk, by sending a final settlement wire at the end of the day.
Gross settlement: When individual payments are processed and settled instantly based on individual transaction data received in real-time.
Unlike clearing, only a settlement network can facilitate settlement. The clearing system that has handled a transaction, e.g. CHIPS, will send the payment information to a settlement network to settle it, e.g. Fedwire.
Interbank settlement systems are run by central banks. If both transacting banks have a settlement account with the central bank in the country, the central bank directly debits the sending bank’s account and credits the receiving bank’s account (both in central bank money).
Once the funds have been transferred to the receiving bank’s account, the settlement phase has been executed and the international wire completed.
Differences between clearing and settlement
A key difference is that clearing determines the commitment of the funds and settlement is how banks do the funds reconciliation with each other.
Settlement involves the exchanging of funds between the sending and receiving banks, while clearing normally ends without movement of funds between the banks.
Timing is another difference.
The clearing process takes place fast, and is typically finished within minutes, whereas the timing of settlement is more flexible, as the payment recipient can already access the funds in their account by the end of the clearing phase.
International wires are a secure and relatively simple way to send large-value transactions internationally, as SWIFT does not limit the payment amount. However, wires take time to clear and settle, and there are fees involved.
Should the bank of the sender not provide the currency for payment, or if it lacks a direct account connection with the recipient’s bank, the use of intermediary banks in correspondent banking will be necessary.
This lengthens the payment chain and adds time and cost. An international SWIFT wire can touch 2 to 5 banks on route to the recipient, and may take up to 5 business days to clear and settle for low-volume payments in exotic currencies involving additional intermediaries along the way.
International wires can be expensive. Sending banks typically charge a flat service fee for issuing wires, usually $10 to $50 per transaction.
When intermediary banks are involved, each can also lift their own fees, unknown to the sender in advance.
Moreover, the recipient’s bank may deduct a fee for receiving the incoming transfer (“bene-deduct”), usually between $10 and $20 but as high as $40 in some markets. Higher cost makes international wires suitable mostly for larger value cross-border transfers but uneconomical for lower value, mass payments.
Nowadays, there are alternatives to international SWIFT transfers for sending commercial payments cross-border.
New, innovative financial market infrastructures (FMI) are emerging that reimagine the business of moving value across borders, which can enable low-cost real-time payments with instant settlement on a global scale.