In a time where a cashless society is ever looming and online payments are becoming dominant, online banking is actually declining whilst bank deposits also shrink, the reason for this is a fragmentation and decentralisation of how we handle our money. Not necessarily decentralisation in the blockchain sense, though DeFi is on the rise, but merely a rising competitiveness among startups that specialise in specific areas of finance.

The rise of accessible currency exchange

One area in which banks are being outcompeted is with foreign exchange. Traditionally, currency shops were used to exchange physical currency for a holiday, but ever since bank cards became standardised and commonplace, using our bank cards for payments was the norm.

Likewise, transferring money to an overseas landlord or business partner may have been done through a bank transfer for sheer convenience. Or rather, it was the only mainstream option. The issue with this is the high costs that high street banks charge around the world. $/£/€ 30 is common for a flat transfer fee overseas, whilst you commonly lose around 3%-5% in the exchange rate spread. Perhaps unnoticed by your average holidaymaker, but a significant threat to the bottom line of an international business when frequently used for international bank payments.

If we look at Lloyd’s international payments rates as an example, we can see fixed fees alone going up to £29.50, without even factoring in the large markup. Perhaps unnoticed by your average holidaymaker, but a significant threat to the bottom line of an international business when frequently used for international bank payments.

Whilst FX specialists have existed for decades, they were mostly reserved for larger businesses that built relationships with their broker. This would not be a place that a holidaymaker or expat would consider for a few exchanges of several hundreds of dollars, or even to transfer money to a bank abroad infrequently.

The relevance of using expats and holidaymakers as a yardstick for activity is because small businesses arguably have more in common with them than larger corporations. Around 5% of the UK population are sole traders, whilst there are undoubtedly increasing amounts of remote workers since the pandemic too. These tend to have more in common with holidaymakers than large corporations, as convenience tends to prevail.

This is why money transfer companies have made such a large impact. They have taken the infrastructure and capabilities of traditional FX specialists but refined them into simple mobile apps.

The money transfer companies that offer a borderless spending card, essentially like a debit card, tend to be leading the way in terms of customer base. This is because they are popular among any customer who is looking to retain that card-spending activity overseas, but with the exchange rate of an FX specialist.

The exchange rate of an FX specialist is often under 1% in their margin and/or fee put together, a significant improvement upon banks. But, before this was convenient, even many small businesses would still rely on PayPal and banks’ terrible rates. Paying a bank account abroad through PayPal can’t be done in a direct way and can be costly to send to a PayPal wallet.

The experience of using a typical money transfer company now is to open an app, and within a couple of seconds the users can open many different virtual bank accounts around the world. So, setting up a new client who lives overseas as a freelancer becomes a matter of opening an account in their currency, so that a “local” transfer can occur, which gives power to the recipient, who can then exchange the funds on their own terms. This deviation away from central financial intermediaries is what is meant by decentralisation, as it empowers the individual over their choices and capabilities with currency.

Roboadvisors, investing, and storing money

Of course, banks are supposed to be a safe place to store money. But, given that your funds are not kept in reserve for you, but instead are allocated into various investments by the bank, you’re supposed to receive a reward for “lending” them such capital. For years, this reward has been at best 0.5%, roughly 8% less than inflation, meaning there is no reward but instead a vast real cost to handing over your money.

Again, winding back the years and investing was something reserved for the upper class and businesses – possibly some middle-class involvement too depending on the country. However, the pandemic really changed this, in which retail investors now make up such a significant number of total investors that they’re even influencing markets in strange ways.

Whilst some have taken to reading up about investing in their spare time during lockdown, many others have become aware of the power of passive investing. Namely, index funds. Between Vanguard global trackers and easy-to-use roboadvisors (essential AI driven apps that invest your money for you, but mostly into index funds anyway), more and more of the middle class are pouring their money into these long-term investments because of how accessible the apps are.

Again, decentralisation is occurring, in which banks are no longer seen as the only place to store your money. Instead, they’re merely where we get paid into, and where our emergency fund is, whilst anything beyond this is commonly invested through apps like Robinhood, Betterment, and Vanguard.

Furthermore, even for money that is not for investing, the money transfer apps are a commonplace to keep some deposited funds if they’re frequently being exchanged, spent, and sent. Whilst they’re often not covered by deposit insurance due to not officially being a bank, it is still directly taking from the deposits of banks.

And, for those investments that are overseas, banks are even further at the back of the queue. Investments are of course behaviour in which costs are most closely considered, thus making the typical 3%-5% loss in exchange spread from banks out of the question. This is where FX specialists and money transfer firms do differ between themselves, as some are focused on larger, one-off transfers and others are targeted towards the daily use of small, frequent transfers.

The reason why they’re not homogenous in their service, beyond the obvious need for differentiation to gain a competitive advantage, is because we can quite easily think of two categories of service: App-based and customer service-based.

App-based services, like Revolut, are all about speed, convenience, and somewhat replacing the need for a high street bank. This is great for those remote workers looking to receive their overseas salary, exchange it swiftly, and begin spending on their Visa card. However, this is not the provider to go to for an overseas investment.

Instead, buying a property abroad or similar requires more vigilance and perhaps advice. The FX specialist will provide a dedicated dealer over the phone for free, in which they may be experts on buying overseas property, and can offer more sophisticated services – forward contracts, for example. This is more secure when handling hundreds of thousands of dollars, plus the fees tend to fall as the value of transfer becomes larger.

This isn’t to say that there is no way back for highstreet banks. They still retain a certain gravity when it comes to securely storing savings, as well as being the main source of mortgages and loans (although, loans are becoming decentralised too). The vast size of their infrastructure could be behind some of their slowness in development, but complacency is also at play here. As deposits are dropping, though, it may be the wake-up call needed to better cater to the world of international transactions.

Brought to you by Andreas Nilsson