Blockchain or distributed ledger technology (DLT) has yet to achieve widespread use, but it is mature enough to begin commercial use. Ripple, a DLT technology provider, believes the time is ripe for banks to work together to initiate a network for more efficient inter-bank and cross-border payments, according to a white paper [PDF] by Ripple and Accenture.
The paper, titled, “The Journey to Real-Time Cross Border Commercial Payments using Distributed Ledger Technology,” noted that more than 600 alternative distributed networks have emerged since bitcoin began in 2009, including Ripple, which came in 2012. Nevertheless, there is no widespread use of DLT in inter-bank commercial payments, an area with great opportunity.
Numerous banks have tested the technology, but not many have used it to support customer business.
Ripple Seizes An Opportunity
Ripple has focused on inter-bank commercial payments and cross-border transfers since these payments usually use a network of banks without a central clearing house or authority. DLT brings an opportunity to make improvements over existing systems.
Cross-border payments currently have certain restraints. They usualy take more than a day and are restricted to business hours. At the point of initiation, the exchange rate and transaction fees can be unknown. The funds can move through many banks before reaching their destination, oftentimes incurring delays and additional fees. Customers often experience delays, high costs and uncertainties in managing these payments.
Banks have to allocate resources to manage liquidity and transactions, respond to inquiries, repair payment details, track status and fix errors.
Ripple, in contrast, offers a real-time, 24/7, synchronous, transparent and information rich transactions. Payments are immediate with real-time confirmation, certainty, and transparency of rates and fees prior to the transaction.
The Ripple solution joins payment messaging with fund settlement, which has proven itself with domestic payment schemes and card systems like MasterCard and Visa. Such as system is not available for cross-border, inter-bank payments where messaging is isolated from the operation of vostro and nostro accounts used for settlement.
The Opportunity Is Now
The opportunity to initiate a Ripple-based network currently exists, as thousands of banks can be reached via correspondent banking that engages in cross-border payments, representing 10 to 15 billion payments with a yearly value of $25 to $30 trillion.
But the process will take careful planning, as these banks cannot link immediately into a new DLT network. Nor is it practical to expect fast migration to full-scale volume, as it would invite risk since there are too many uncertainties of how the network would operate.
What is practical is to begin creating such a network from the bottom up, beginning with a small number of banks and transactions. The technology is available, and customer demand is strong. Deploying DLT technology iteratively permits learning by doing and a slow rollout that can scale gradually in a controlled manner.
This approach has its unknowns, but the unknowns can be quickly discovered and addressed. Initial adopters will learn things that will allow them to change and influence existing and new products, operating models and services needed to meet an increasingly dynamic payments industry.
A small number of banks must agree on the infrastructure. Each bank can make the necessary preparations to IT systems, priority payment flows, business processes, customers, regulatory obligations, all of which are “known knowns.” Banks can determine how these things will be affected and the changes that have to be made. They can decide on things like how many countries and customers to involve in the beginning.
Banks may have to work with integration partners to determine the degree of integration that can be controlled so they can move from light integration to deeper integration as volume increases.
What’s Needed Now
A system of governance and a payment scheme will be needed to define participant requirements. These are the “known unknowns.” Forming a permissioned DLT network can determine who participates and how the network will operate. They have to work together to define controls and operating rules, but only to the degree needed to begin the network. The controls can be refined as the network expands.
The types of intermediaries and correspondents will change over time. Different scenarios exist for network adoption speed. These are “unknown knowns” that require a strategy for determining choice of payment flows, customers, products, services, new revenue streams, transaction growth rates, and the impact on correspondent banking.
The strategy can only be refined once the network launches and expands.
There are also “unknown unknowns” that cannot be predicted. Data controls, governance, confidentiality, security and confidentiality can be refined through experience in relation to growth. Banks, by being agile, can adapt and respond quickly to these unknowns as the network expands. It is a reason the network must begin small and scale steadily.
Correspondent banking is already established in global banking. Because banks have no wish to bring risks to cross-border payments, starting small and scaling makes sense as it allows banks to prepare internally to avoid disruptions and risks to their existing cross-border payments while introducing new capabilities.
Banks have taken this approach in the past. The EBA Clearing established the Euro high-value payment system in 1999, launching with 44 banks in 21 countries. It was based on a design for settlement and clearing to meet its participants’ needs. Some banks committed all commercial payments to the Euro right away while others joined gradually.
EBA Clearing has since expanded and the network reaches 4,806 banks. It is now launching an instant payment scheme involving 40 banks.
The Faster Payment (FPSL) began in 2008 with 13 member institutions in the U.K. and has expanded from 227,000 daily transactions to more than 3 million. FPSL is opening access to its infrastructure.
Both FPSL and EBA Clearing began small and scaled steadily, creating controls, services and governance as volume grew. The difference between these examples and DLT is that with the latter, no new major infrastructure has to be tested. Ripple is designed specifically for inter-bank and cross-border payments.
Fiat Settlement Mechanism Needed
A settlement mechanism in fiat currency is required for cross-border payments. This cannot be avoided in a DLT payments network that does not operate solely with its own cryptocurrency to make payments. A DLT network can issue fiat currency, but such initiatives would have to be driven by central banks to issue the cryptocurrency.
Ripple has a native digital asset, XRP, that can provide settlement to reduce liquidity cost, but it has a flexible architecture that uses the Interledger Protocol that does not require using a cryptocurrency. Hence, a fiat currency settlement mechanism is required. This calls for creating a cross-border settlement scheme in the case of a DLT network for cross-border payments.
The rules, governance and planning component covers regulatory compliance, network participation rules, governance structure, payment settlement and processing, best practices like CPMI-IOSCO principles of financial market infrastructure, and validating and approving transactions through a consensus mechanism.
Core scheme functions cover settlement, market maker management, risk management and assurance, scheme development participant management and communication, and on-boarding.
Products and services cover real-time payments, foreign exchange, and trade finance.
Operations, data management and technology cover security, data access, consensus validation, access management and scheme management.
Support functions cover IT, finance, legal and billing.
Infrastructure covers the DLT network that Ripple provides and the integration needed for banks to link to the network, such as message translation. Software providers such as D+H give standard Ripple integration to payment engine platforms.
Centralization Still Needed
The operating model resembles a centralized function, which contradicts the distributed nature of a DLT network. But this cross-border settlement scheme is needed for a permissioned network and for settlement to operate cross-border in fiat currencies.
MasterCard and Visa use distributed networks for their banks, enforcing rules under their respective payment schemes. Hence, it is important to have a scheme for settling cross-border payments running on a DLT network.
The overhead of operating a DLT scheme for cross-border settlement is expected to be low and manageable.
Ripple offers a DLT solution for cross-border payments that integrates the messaging needed to clear payments among the sending bank with the settlement process that is needed to settle fiat funds among the banks. The solution reduces the cost of settlement by allowing banks to transfer and settle funds instantly and creates revenue opportunities by allowing access to new markets such as micropayments.
Ripple operates with banks like Fidor and Santander already. Central banks and governments support the technology. There is a strong desire among commercial banks to test the technology with real transactions. Several banks have done proof of concepts that include real money transfer. Thirty banks have done pilots and are moving to live operation.
Banks Form An Alliance
A group of banks have already formed an alliance to create a cross-border network and are preparing their strategy to define the cross-border settlement scheme. They are using an agile approach.
The pace of change is increasing with digital business models, smartphones, autonomous payments, APIs, real-time payments, and regulations such as PSD2 in Europe. Real-time, 24/7, domestic payments exist in the U.K. and Nordic countries and will extend to the rest of Europe, Australia and the U.S.
Nevertheless, a gap exists in the global payments landscape for real-time, 24/7 cross-border payments. To address the needs of the digital economy, this gap has to be filled.
DLT offers a solution as banks are already upgrading business processes and IT systems for real-time domestic payments that can be used for real-time, cross-border payments.
Ripple stands ready to launch and scale a cross-border payments network. A group of banks has formed to use Ripple and stay ahead of the competition.
The $24 trillion annual global trade industry will not migrate to a new commercial payment network in five years. The level of migration will depend on competition from alternatives. A new network has to be created and be ready to scale steadily before full participation can begin.
The network cannot be designed in full prior to its launch. Certain unknowns can only be discovered through live experience, which is the fintech approach of agile development as opposed to the monolithic approach for big infrastructure systems.
Ripple calls on banks to collaborate to initiate the foundation of a 24/7, real-time, efficient, transparent cross-border payments network.
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