Payments can be a complicated, even nerve-wracking, affair. It’s not just when one party to a transaction, for one reason or another, is unable to pay on time. Consider banks’ cut-off time, business-hour restrictions and a multitude of charges, for example.

Then think of an enterprise that operates internationally, moving millions or billions of funds in different currencies and across multiple jurisdictions, borrowing here and paying there, dealing with various customers, suppliers, and financial intermediaries, and the pain points multiply.

Now, with the rapid development of digital technology, industries can look forward to a world “where all have the expectation and ability to move money instantaneously, 24/7/365 and with full transparency”, according to BNY Mellon in its recently released twin white papers on innovation in payments.

The use of digital currencies, in particular, could transform the traditional role of banks and other financial intermediaries in the field of payments.

Of the various digital currencies, the US investment bank thinks stablecoins hold the most immediate potential to modernize the interbank payments space. Cryptocurrencies are “unproven, unstable and largely unaccepted” while the broad use of central bank digital currencies, which are essentially the digital form of a fiat currency, is still a long way off. On the other hand, the value of stablecoins is linked to a pool of assets, which serves as a stabilizing factor.

Stablecoins may deliver benefits in three key areas: cross-currency foreign exchange swaps, securities settlement and, if the model proves successful, even cross-border payments.

Cross-currency FX swaps

Under the current system, if a bank needs to perform a same-day cross-currency FX swap, it needs to factor in cut-off times.  But with a tokenized model, a bank could execute the same swap using a digital currency, and the funds would be transferred and exchanged almost instantly.

“By settling the transaction on the same day, the bank could avoid having an unsettled trade on its books overnight. This would free up capital for the bank that would have previously sat as an assurance against the unsettled trade,” the study says.  

At the same time, various charges and fluctuating rates, as well as the lack of transparency due to the involvement of multiple banks, are eliminated as the transaction is P2P (peer to peer) and conducted in real time. Risk would also be reduced as the transfer in two currencies takes place at the same time and with finality.

In securities settlement, stablecoins could enable more efficient and faster payment. With both the asset and cash tokenized, the transaction could be completed instantly, with the buyer and seller simultaneously receiving their respective asset and payment on the same ledger or via interoperable ledgers. The transaction, being P2P, also removes the need for third parties. It could lead to a reduction in settlement risk, counterparty credit risk, capital costs and reconciliation efforts, according to the study.

Cross-border transactions

Stablecoins could also have an impact on the way cross-border transactions are processed. Under the current system, these transactions – whether wholesale, retail or consumer – involve numerous parties that can lead to multiple costs, multiple risks and a process that can take multiple days.

By leveraging tokenized cash for payments, transactions could be performed instantly and securely on a P2P basis, while also creating a system in which payments could be made anytime.

“This has the potential to radically alter the traditional correspondent banking model, with the immediate settlement reducing counterparty and institutional risk, as well as providing additional risk mitigation due to there being no credit lines or locked capital held in accounts,” the study says.

All this has huge implications to liquidity management. Through the use of digital tokens, transactions in cash, securities and FX markets, which are typically settled on a T+2 basis, could eventually be done on a “T-instant”, real-time basis.

“Beneficiaries will receive the cash straightaway, but the originator, used to having the cash available for an additional period due to longer settlement times, will need to factor in the need for the money to be available there and then,” BNY Mellon says.

Rising to the challenge

The rapid adoption of digital technologies, driven by the Covid-19 pandemic, has heightened the expectations of bank clients when it comes to payments processing. This will require banks to deliver faster and more transparent transactions.

At the same time, banks are increasingly using these digital technologies to rise to the challenge and improve their services.

More than 50 countries now have their own domestic real-time payment capabilities, such as the Real-Time Payments (RTP) Network in the United States, which enable payments to be cleared and settled faster than traditional systems do, although they are restricted in terms of the value that can be transferred.

There’s also the SWIFT global payment initiative (gpi), which uses cloud-based tools to accelerate the processing and increase the transparency of cross-border payments.

As of September 2020, 41% of SWIFT gpi payments are credited to end- beneficiaries within five minutes, over 56% within 30 minutes, 78% within six hours and almost 100% within 24 hours, according to the financial messaging service provider.

API-enabled platform

SWIFT is also working with global banks on a new platform to reduce duplicate processes, streamline execution and enhance the security of cross-border payments.  The platform, based on application programming interface (API, a software that acts as an interpreter between different applications), is expected to be up and running in two years.

“No one initiative or technology is a silver bullet for delivering optimized payments – nor is there one path that will take us there. It is a combination of capabilities that will enable payments and settlements to be truly optimized. Going forward, the industry will see coexistence and interaction between traditional rails, the more established emerging technologies and the new landscape of digital currencies. Digital tokens and fiat money will coexist, with different rails and channels remaining relevant, supporting different payment needs and delivering value,” BNY Mellon says.