Challenges and Limitations of the Correspondent Banking System in Cross-Border Payments and the Potential of Intrasettle's mCBDC Models.
The global economy has experienced tremendous growth in the past few decades, leading to a rapid increase in international economic integration. However, the cross-border financial flows underpinning this integration have not kept up with the pace of change, causing many inefficiencies in the cross-border payments system. Correspondent banks play a critical role in cross-border payments. Still, cross-border payments are typically made through a global network of correspondent banks that involves multiple intermediaries that are fragmented across different time zones and operating hours. Due to the duplicated processes and steps in the correspondent banking chain, cross-border payments exhibit high costs, low speed, operational complexities, limited access, and low transparency. As a result, settlement risk is introduced into the system, which is detrimental to both financial intermediaries and end users.
Moreover, the bulk of settlement in correspondent banking occurs in commercial bank credit, which carries the associated credit and liquidity risks where settlement funds may not be available in the event of illiquidity or insolvency. Settlement in central bank money, the safest settlement asset, eliminates this risk. However, it is typically restricted to domestic interbank payments on access-controlled central bank real-time gross settlement (RTGS) systems.
The costs associated with the correspondent banking model are substantial, with private sector estimates suggesting that in 2020, for nearly $23.5 trillion in cross-border transaction flows, transaction charges amounted to around 0.5%, or approximately $120 billion (excluding FX costs). With adverse secondary effects not captured in this figure, such as settlement delays and risks, likely amounting to far greater costs.
The correspondent banking model presents even more challenges for emerging markets and developing economies (EMDEs). Banks have started paring back their correspondent networks and services after the Great Financial Crisis, with smaller economies likely experiencing a greater decline. This has left many needing more affordable access to the global financial system. Additionally, cross-border transactions are often settled in a handful of dominant currencies, and FX trading involving non-dominant currency pairs remains limited. This exposes EMDEs to spillover effects from the monetary policies of jurisdictions from which the foreign currency originates and associated financial stability risks, such as credit cycles.
In contrast to the traditional correspondent banking system, IntraSettle's MCBDC models have the potential to alleviate many of thechallenges aboves in international payments. By providing a shared platform on which participants can conduct peer-to-peer payments directly in the safety of the CBDCs of multiple jurisdictions, IntraSettle has the potential to extend PvP protection to currencies beyond those covered by existing systems and support the use of local currencies in cross-border settlement.
Kumaraguru Ramanujam | Ramesh B. | Antonino Sardegno | Alexander Ball | Mohammed Ibrahim Jega | Sol Enenmoh
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