There are several ways by which international payment transactions are done around the globe.
Main mechanisms for payment and settlements are as follows:
- Correspondent Banks Network – loosely coupled network of private banks.
- Clearing Bank Model -using international clearing banks – China’s RMB Clearing Banks
- Cross border RTGS – used mainly in regional economic and monetary blocs such as EMU – TARGET2.
- Clearing House model – Offshore Payment,
- Clearing, and settlements through systems such CHIPS in USA and CIPS in China.
What Is Cross-Border Settlement?
Cross-border settlement refers to any financing arrangement that occurs outside a country’s borders. Any settlement that takes place in a country (or currency area) in which one or both parties to the transaction are not located can be called cross-border settlement. It helps businesses participate in international trade by providing a source of funding that enables them to compete globally and conduct business beyond their domestic borders.
Advantages and Disadvantages of Cross-Border Settlement
When a company has global subsidiaries, it is common for them to use cross-border financing services. By choosing cross-border financing, these companies can increase their borrowing capacity and gain access to the resources they need to compete on a global scale.
Factoring is a type of cross-border financing that provides businesses with immediate cash flow that can be used for a variety of purposes.
The third-party firm, also known as a factoring company, gets transactions from clients and sends them to the original business owner after deducting service fees. The benefit to the business owner is that they get their money right away instead of waiting 30 to 120 days for payment from their clients.
Currency risk and diplomatic risk are two possible pitfalls of cross-border settlement. Currency risk refers to the probability that businesses will lose revenue as a result of variations in currency prices arising from foreign trading. Companies can find it difficult to obtain a favourable exchange rate while structuring loan terms across nations and currencies.
Political risk is the risk that an organisation faces when doing business in a foreign country that is undergoing political turmoil. Changes in political climates, such as elections, civil strife, or coups, may stymie the execution of a contract or transform a lucrative venture into a losing one. As a result, some cross-border financing companies could impose restrictions on doing business in specific regions of the world.
Particular Points to Consider
Most companies, as well as sponsors, have opted for loan funding over debt financing in recent years. This has had an effect on the nature of many cross-border loan financing agreements, particularly because covenant-lite (cov-lite) loans offer borrowers much more flexibility than conventional loan terms.