How to save $120 billion in cross-border payment

Global corporates move nearly $23.5 trillion across countries annually, equivalent to about 25% of global GDP. To do this, they have to rely on wholesale cross-border payment processes which remain sub-optimal from a cost, speed, and transparency standpoint.

As well as resulting in significant transaction costs of $120 billion per annum, these processes also result in additional costs from FX conversion, trapped liquidity and delayed settlements.

While numerous private sector players, from the CLS Group and Banking Circle to SWIFT, and central banks (such as the Hong Kong Monetary Authority and Bank of Thailand) have initiated various projects to resolve the existing pain points, we are yet to see a scalable and seamless solution that can work across countries, currencies, and payment systems.

JP Morgan believe that a multi-currency central bank digital currency (mCBDC) network could provide an effective blueprint to tackle many of these problems simultaneously, thereby making 24/7 and real-time, cross-border, cross-currency payments a real possibility.

In a paper written by Oliver Wyman, it builds on all the previous literature on CBDCs and aims to outline the implementation considerations for central banks to partner with commercial banks to develop, operate, and govern an mCBDC network.

Specifically, the paper outlines four critical elements required for implementation:

1. Target design principles
2. Key building blocks (minting and redeeming CBDCs, liquidity provisioning, market making, and foreign exchange payment-versus-payment settlements)
3. Roles and responsibilities of central banks, commercial banks, and other service providers (e.g. technology companies); and
4. Governance framework for managing network access and resolving disputes. It also details an alternative and complementary model of multi-currency digital corridor network.

While the implementation considerations could apply to participants globally, the paper uses the ASEAN region as an example, given it contributes approximately 7% of global cross- border trade and is home to thousands of European, Asian, and North American MNCs.

The Business Case for mCBDC

Almost all the multinational corporations (MNCs) interviewed, especially those with frequent cross-border trades, have expressed issues with the current cross-border payment system.

Namely, high transaction costs ($27 average cross border fee per transaction, excluding FX), long settlement times (not uncommon for payments to take 2-3 days to reach end beneficiary), and the lack of transparency (limited visibility of payment status).

As an example, the paper examines two MNCs operating in the ASEAN region using local small banks with no direct-dollar correspondent network.

For a $2,950 payment (or THB100,000) from Alpha Corp in Thailand to Beta Corp in Indonesia, Alpha Corp incurs a transaction cost of $40 excluding FX costs by going through multiple intermediaries and facing high foreign exchange (FX) spreads, all while incurring liquidity costs along the payment chain.

Additionally, different cut-off times, processing speeds, and compliance standards across the intermediary banks in the various jurisdictions can incur further delays in the settlement process.

Alpha Corp and the banks upstream are also exposed to settlement risks if the banks downstream fail to execute their obligations.

Alpha Corp does not have full control over the correspondent banking structure, the validation processes, nor complete visibility of the payment status once the transaction is initiated, incurring an additional layer of uncertainty.

The current pain points corporates experience in cross-border transactions are primarily on account of the gaps in the existing correspondent infrastructure setup, and the lack of legal, regulatory, and operational consistency across multiple jurisdictions:

Correspondent banking system: Given the lack of interoperability across the payment infrastructures of different countries, cross-border payments are settled using correspondent banking.

The current setup involves sequential payment processing across multiple intermediaries, each with differing operating hours, messaging standards, and pre-funding requirements. This leads to uncertainty and a lack of transparency in payment processing, in addition to trapped balances in nostro/vostro accounts.

Furthermore, additional settlement and credit risks are introduced in the system.

Legal, regulatory, and operational consistency: Varied legal and regulatory requirements around Anti-money laundering/combatting the financing for terrorism (AML/CFT), and the differing operational windows of domestic payment infrastructures further add to transaction costs and time delays.

Numerous private sector players have taken initiatives to resolve such pain points. While these initiatives have achieved partial success, the paper identifies that we are yet to realise a truly scalable, seamless interoperable solution.

The paper goes on to state that it believes an mCBDC infrastructure could be well positioned to achieve such a solution despite the effort needed by central banks to integrate and collaborate across jurisdictions.

The end result: A full-scale mCBDC network which facilitates 24/7 real-time, cross-border payments and FX PvP settlements could save global corporates nearly $100 billion annually.

Naturally, an mCBDC solution would trigger a rethink on how commercial banks and other foreign exchange providers may deliver their current offerings, however, the paper notes, “we are encouraged by the potential for new business and operating models, which could yield long-term benefits for all participants.”