Exchange start-ups challenge banks

Taavet Hinrikus, an Estonian-born technology professional, was employed by Luxembourg-based Skype but living in London, which meant he was losing hundreds, if not thousands, of pounds in currency-exchange fees every year.

So Mr Hinrikus, one of the first employees at Skype, began an informal currency exchange with a friend, Kristo Käärmann, who was paid in pounds but had a mortgage to pay in euros back in his native Estonia. Soon the pair realised their arrangement could be broadened into a business open to others, and TransferWise was born.

TransferWise is one of a number of start-ups that have sprung up over the past few years looking to use the internet to spark a digital revolution in financial services, much as Amazon has upended the retail sector, or Skype has changed telephony.

"Everyone has this sinking feeling that you are being ripped off but you don't know how much. The banks do everything they can to hide it," Mr Hinrikus said. "Kristo and I calculated that we were saving each other thousands of pounds and we realised we could turn it into a business."

Their idea is to use the internet to transfer money across borders at lower prices than banks can offer. With TransferWise, transferring £1000 into a euro account costs just £4.50 compared to more than £120 with Western Union and between £40 and £50 with many of the main consumer banks.

Meanwhile, the Currency Cloud, based in the UK, is a platform that other businesses can link to in order to transfer money across borders at a smaller cost than through the banks. Charges are typically 1 per cent of the transaction, compared with around 4 per cent charged by banks, said Mike Laven, chief executive. A similar venture, CurrencyFair, was started in Ireland in 2010 by four friends, three of whom were expats feeling jaded by high exchange fees.

"I think it's almost a perfect storm; you have a time where the internet is cutting the middle-man out of almost every industry, marketing is being reinvented around social channels, and consumer trust in banks is at possibly an all-time low," said Brett Meyers, an Australian and one of the company's four co-founders.

The sums that currency start-ups move are a tiny part of the overall foreign exchange market, which, according to the Bank for International Settlements, averaged nearly $4tn a day in 2010. However, they are growing fast. CurrencyFair handled €20.5m worth of transactions in July, more than double the €10m it handled in April.

Western Union, which handles about 20 per cent of the world's money transfers, makes quarterly profits of more than $270m, and still holds many advantages over is tiny internet rivals, including a famous brand and a vast network of agents in hard-to-reach areas who can deliver cash to recipients. The internet currency exchanges are limited by transfers being able only to be made between bank accounts. Customers need a bank account in each country or at least a trusted friend to whose account the money can be sent. It is not as simple as walking to a counter and picking up holiday cash.

Still, the services will in particular benefit smaller companies that have been unable in the past to negotiate beneficial rates with banks.

"Large multinationals with large transactions get very good prices from banks but small companies have never had that access. This is democratising access to financial services," said Nasir Zubairi, head of product marketing at The Currency Cloud.

All the companies are licenced by financial services regulators in the countries in which they operate, a process that takes months and is often the hardest part of starting the business.

Now that they are officially established, however, TransferWise, The Currency Cloud, and CurrencyFair are all starting to attract interest from venture capital companies.

Notion Capital last month announced a £2m investment in The Currency Cloud. "We are looking to invest in start-ups that will shake up large but sleepy markets. Cross-border payments are a classic area where the internet can innovate. It is a multi-trillion dollar market which is very opaque, with lots of layers of costs. The internet can bring a lot more transparency to it," said Jos White, co-founder of Notion.

The venture capital investors believe the currency start-ups are just one part of a much wider assault by start-ups on all elements of the banking industry. "Different slivers of the finance world are starting to be broken down," Mr White said.

"In 2008 we started looking at financial services as a sector that was ripe for taking a swing at," said Saul Klein, partner at Index Ventures. "The credibility of banks is being chipped away and every month it is becoming clearer that banks have been making too much money on many of their services." Index has put money into Funding Circle which offers small business loans, Adyen, which offers cross-border internet payments to small businesses, and Boku, a mobile phone payments service.

Tradeshift, an Anglo-Danish company that allows businesses to invoice each other over the internet, raised $7m in financing from Notion Capital last year. "The whole banking system is being disrupted. Start-ups like the Currency Cloud and Wonga are showing what is possible," said Christian Lanng, chief executive of Tradeshift.

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