Blockchain On The Cusp of Disrupting Cross Border Payments

The blockchain technology now has a real shot at transforming cross border payments as well as trade finance than any-time before. There is now not just anecdotal supporting this but empirical evidence too.

This is a conclusion that can be gleaned from a study jointly conducted by Official Monetary and Financial Institutions Forum (OMFIF) and CCB University, a Chinese learning institution that was established by China Construction Bank in 2018. The study was titled; ‘The role of blockchain in banking: Future prospects for cross-border payments.’ 

In the study, the OMFIF and CCBU investigated the effects of blockchain and distributed ledger technology on financial institutions’ business models and the results validate what blockchain enthusiasts have known for some time.

Millions Invested in Blockchain Already

In fact, the results of the study reveal that some financial institutions are already channelling resources towards a realization of this objective. It seems financial institutions are now fully aware that the blockchain could be the missing link.

For example, the study points to a 2019 Institutional Deposits Corporation survey on blockchain spending which found that cross-border payments were the use case receiving the most annual investment at $453m, equivalent to 16% of market share. Trade finance and post-trade or transaction settlements are next with a 10% market share or approximately $283m.

Based on this survey alone, it is easy to conclude that financial institutions now understand the blockchain has advantages over current payments technology when it comes to cross border payments and trade finance. 

Some of the advantages observed include facilitating near-frictionless settlement at any time, global interoperability, high security, and ultimately quicker and lower-cost transactions.

The current cross-border payments system relies heavily on correspondent banking networks facilitated by financial intermediaries at multiple levels. Such an army of intermediaries usually drives up the transacting costs or the speed of finalizing these. There is no better depiction of this than the correspondent bank network system. 

A correspondent bank will have either a Nostro or Vostro account with a counterpart bank in another country. A Nostro is the account of a local bank held by a correspondent bank in another country, in its foreign currency. A Vostro is the account of a foreign correspondent bank, held by a local bank in its domestic currency. This reciprocal system of accounts facilitates foreign exchange transactions and the flow of funds between countries.

In addition to this, financial institutions also use the Society for Worldwide Interbank Financial Telecommunications (SWIFT), a messaging network, to securely exchange electronic transaction messages detailing instructions for cross-border payments via a standardized system of codes.

Now as the report by OMFIF notes, SWIFT provides neither clearing nor settlement.  Correspondent banks participating in a transaction must still process the messages individually on their back-end and subsequently settle any transactions through foreign exchange markets.

High Costs Associated with Intermediaries

A recent McKinsey Global Institute study on cross border payments, which found that the bulk of costs (nearly 35%) in existing international transactions methods are related to Nostro-Vostro liquidity and reconciliation due to a lack of real-time data and differences in end-to-end payment processes.

On the other hand, Blockchain-based transactions diminish the role of any intermediaries, centralized institutions, and/or correspondents in the cross-border payment process.

Transactions can be executed directly between the parties who have entered into a bilateral agreement on the platform, thereby reducing the need for interpersonal trust between transacting parties. This lack of centralization, as well as the secure and immutable nature of the transactions, often translates into a high efficiency, transparency, security and lower costs.

The reduction of intermediaries such as correspondent banks or central agencies can help minimise charges incurred along the payment chain. Currently, transaction settlement relies on financial intermediaries and service providers.

Increased Investment Further Reduces Costs

Also, a peer-to-peer model reduces the need to update and reconcile multiple accounts in the post-trade cycle. Before the emergence of blockchain-based solutions, post-trade processes required a considerable amount of reconciliation. The blockchain almost eliminates this!

However, there is even a better outcome if financial institutions decide to go for full-scale adoption rather than the current piecemeal approach.

For example, a 2017 Accenture study estimated that full-scale blockchain adoption among global investment banks could reduce reconciliation and other infrastructure costs by 30% on average, an amount ranging from $8bn-$12bn.

Full-scale adoption means a shift from account-based to token-based payments systems. The lengthy and costly infrastructure for intermediaries, compliance and verification procedures are essential to conducting transfers of claims upon payments recorded within an account.

Blockchain-based transactions could allow for the authenticity and value of exchanged payment objects (tokens) to be verified independently, precluding the need for messaging, clearing and settlement systems.

It stands to reason therefore that financial institutions, particularly those from Africa, must take heed and lead in the adoption of blockchain. The blockchain potentially levels the playing field thus allowing smaller financial institutions to offer cross border payment services or trade finance at costs similar to those offered by their larger peers.

 Now is the Time

Furthermore, financial institutions must be aware, if they decide to ignore or delay adopting this technology, tech firms will simply seize the initiative as they have done elsewhere. History already showed how the reluctance to embrace emerging technologies usually comes back to haunt those ignoring this. 

Results of the OMFIF/CCB University study must persuade obstinate financial institutions from Africa to change tact.  In Africa, where the use cases of the blockchain are more amplified, privately issued cryptocurrencies are already replacing fiat money as the preferred means of remitting funds by the migrant population. 

Established and registered money transfer organizations are feeling the heat.

The same will potentially happen to cross border payments and trade finance. Established financial institutions on the continent will be robbed of a vital source of revenue unless they embrace this innovation.



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