When a person in London sends money to a family member in Manila, the funds often arrive on the other side of the world within minutes. This speed seems to violate the laws of traditional finance, where correspondent banking can take days to clear a single payment.
The mechanism that makes this possible is prefunding. This practice, along with net settlement, forms the financial backbone of modern remittance services, allowing them to operate at speeds that traditional banks struggle to match.
The capital-in-place model
Prefunding means depositing money in a destination country before any customer transaction takes place. A remittance company operating in the US-to-India corridor will hold a large balance of Indian Rupees in an Indian bank account.
When a customer in New York pays $500 to send money to their relative in Delhi, the remittance company does not wait for those dollars to physically “move” to India. Instead, it instructs its Indian partner or subsidiary to release the equivalent amount in Rupees from its pre-existing local pool.
From the customer’s perspective, the money has been “transferred” instantly. In reality, no money has crossed any border. The company’s pool in India has decreased, and its pool in the U.S. has increased.
Why prefunding speeds up transfers
Traditional correspondent banking is slow because it involves a chain of message-based instructions between multiple independent banks. Each bank must verify the sender, check for fraud, and update its own internal records before passing the payment on.
Prefunding eliminates this chain entirely for the customer-facing part of the transaction. The payout happens locally, using local rails like UPI in India or Pix in Brazil. These domestic systems can clear payments in seconds.
The only cross-border activity happens “behind the scenes” when the remittance company needs to replenish its foreign pools. This is done in bulk, at times chosen by the company, rather than on a per-transaction basis.
The hidden cost: Trapped capital
The main drawback of prefunding is the capital it requires. A remittance company serving dozens of countries might need millions of dollars sitting idle in bank accounts around the world.
This capital is “trapped.” It cannot be invested or used for other purposes while it sits in a foreign bank, waiting to be disbursed. The cost of this immobilized capital is a significant operational expense that ultimately affects the prices users pay.
Furthermore, the company is exposed to currency risk. If the local currency depreciates sharply, the value of its prefunded pool drops with it. Managing these risks requires sophisticated treasury operations.
Net settlement: Reducing movement
Net settlement is a mechanism that dramatically reduces the number of actual transactions that need to occur between two parties. Instead of settling every payment individually, banks and remittance companies calculate a “net” balance at the end of a defined period.
If a company needs to pay out $1 million in India during a given day but also receives $800,000 from Indian senders going in the other direction, the net amount it needs to move is only $200,000. The rest of the flow cancels itself out.
This process reduces banking fees, minimizes currency conversion costs, and improves cash flow predictability. It is how large-scale payment networks can process billions of dollars with relatively small amounts of actual liquidity.
Netting cycles and timing
Financial institutions typically run “netting cycles” at specific times of the day. All transactions submitted within a cycle are aggregated, and only the net position is exchanged.
The timing of these cycles affects when funds actually become available. If a customer submits a transfer just after a netting cycle closes, the underlying settlement might not occur until the next cycle, even if the payout to the recipient happens instantly via the prefunded model.
This creates a difference between “customer time” (the perceived instant transfer) and “settlement time” (the actual movement of money between institutions), which can range from a few hours to a full business day.
Prefunding vs. Real-Time Gross Settlement
At the opposite end of the spectrum from net settlement lies Real-Time Gross Settlement (RTGS). In an RTGS system, each transaction is settled individually and immediately, without any netting or batching.
RTGS offers certainty and finality. Once a payment is processed, it is irreversible. Central bank systems, like Fedwire in the U.S. or CHAPS in the UK, typically use RTGS for high-value, time-critical payments.
However, RTGS requires significantly more liquidity. If you have to settle every payment instantly, you need the full amount available at all times. This is why net settlement remains the dominant model for high-volume, lower-value payments like remittances.
Emerging models: On-demand liquidity
To reduce the burden of prefunding, some companies are exploring “on-demand liquidity” solutions. These often involve using digital assets, such as stablecoins or cryptocurrencies like XRP, to bridge currencies in real-time.
In this model, instead of holding pools of fiat currency, a company converts the sender’s funds into a digital asset, transfers that asset across borders instantly, and then converts it back to the local fiat currency on the other side. This approach is commonly known as the stablecoin sandwich.
This approach theoretically eliminates the need for prefunded accounts but introduces other risks, including the volatility of the bridging asset and the regulatory complexity of dealing with cryptocurrency in multiple jurisdictions.
