Speed and cost is an important factor in any payment system. In traditional banking, system money needs to move through several intermediaries before it reaches its destination. Each of these intermediaries adds to the transaction fees. Settlement happens slowly, since manual work is involved.
Consider John, who's a US account holder and wants to send money to his friend, Peter, in Germany. Here's how the money would flow from John's bank account to Peter's account:
Here is how the transfer happens:
- John places a request to transfer money.
- John's bank is a small bank and doesn't have an EU banking license. Hence, it needs the help of a large US bank to make the transfer. It sends money to the bank, which possesses an EU banking license.
- However, the small bank cannot transfer funds directly to the large bank; it has to route funds through a federal reserve.
- Once the money reaches the large bank, it transfers money from its nostro account to Peter's bank.
- However, the transfer doesn't happen directly, since the funds need to be routed through the European Central Bank.
Each of these intermediates adds to the transaction fee. If $5,000 needs to be transferred, around $250 is charged as transaction fees.
