Dr Ruth Wandhöfer

The great settlement reset

November 2022 in Payments

By Dr. Ruth Wandhöfer, independent Non-Executive Director at RTGS.global

It is no secret that there are issues within the cross-border payments industry. Up until recent years, the whole system was left in its current state – unresponsive, slow and archaic. The technology that was modern and innovative in the 90s, is now outdated and unable to cope with the needs of the digital world. Despite this, the industry has been too scared to face the preverbal monster of a task, that is modernising the cross-border settlement systems. Businesses may be talking about ‘the great resignation’, but the thought on the minds of members of the payments industry, is ‘The great settlements reset’.

The need for this reset has been bubbling for quite some time. In recent years, industry leaders have made moves towards it. The Bank of England and other central banks have been preparing to face the terrifying prospect of modernising the system. In doing this, they are lowering costs, increasing efficiency and beginning to enable transparency in payments.

While CBDCs could offer many benefits to efficient settlements, they on their own are not the silver bullet to solve all the issues present in the payments industry

In a society accustomed to immediate results, we expect effective measures to resolve the current issues immediately. It is easy to forget that there is not just one hurdle to overcome when trying to solve the issues within the present ecosystem, as it’s not just one element that is out of date.

In other words, by focusing on improving one element of payments, the underlying system which affects the speed of transactions, often tends to be overlooked. The great reset then, is about resetting the way we go about fixing the issues, moving toward replacing the existing systems and scrapping those which do not work. By tackling issues one by one, using a divide and conquer approach, we will succeed in overcoming obstacles.

$9 trillion globally is, on any given day, are exposed to settlement risk in cross-border transactions. A reset is needed in order to significantly reduce this risk and to help the industry not just survive but match the needs of today’s market.

The need to rethink and reset

Legacy technology and systems are the reason why cross-border settlements are still archaic. Much like using a blunt sword in a duel can hurt the wielder rather than the opponent, inefficient technology can put a bank at risk, especially in an era when cybersecurity is becoming a grave issue at hand.

The Consolidate Progress Report on the G20 Roadmap for Enhancing Cross-Border Payments of 2021, triggered an attempt at the ‘reset’. It outlined the weaknesses and where we can target our innovative efforts, helping to motivate and drive the industry forward. The report highlights three major weaknesses that need to be targeted: speed, infrastructure and innovation. 
The current cross-border payments ecosystem is incredibly slow. Transactions can take up to 48 hours and longer, leading to banks working in credit, which greatly increases settlement risk. The aim outlined in the report is to ensure that 75% of cross-border payments to complete within one hour of the payment initiation and all other payments to ensue within 24 hours at the most. This is a big challenge to undertake and is reliant on new settlement fabrics being put into place effectively, but once achieved this will revolutionise payments.

The report also suggested the need to reduce the number of intermediaries in payments. Now this isn’t to say that tackling the issue from all sides isn’t important, but it is important that we ensure platforms are cohesive. This means we need payment infrastructures that are multilateral platforms that can reduce friction in payments. This will lead to a reduction in risk as we tackle the issue and allow for a larger amount of currency to be exchanged more efficiently.

There is no debate surrounding whether or not our current system works; the technology, at present, is frozen in a space between digital and printed documents. This outdated system has maintained dominance for decades, international payments have stalled. Potential for progress could be introduced through the use of wholesale Central Bank Digital Currencies (CBDCs) in payments or by other innovations enabled by those embracing a reset in our industry. However, this potential is snuffed out by inefficiencies, including the number of intermediaries, security and liquidity, that are yet to be solved.

Better innovation will help overcome hurdles faster. It means innovation in mindset as well as technology, as well as trust and collaboration between public and private bodies.

The way to achieve a ‘great reset’ is by ensuring that your technology is capable of supporting innovation

The great steps to take

The great settlement reset will take innovative and original ideas and technologies. Transferring currency around the world needs to be reimagined, streamlined and made cost effective. To achieve a great reset, there are great steps that must be taken.

While CBDCs could offer many benefits to efficient settlements, they on their own are not the silver bullet to solve all the issues present in the payments industry. There are many aspects that need to be put in place before they can be used – namely the infrastructure used to deliver CBDCs cross-border between institutions. At the moment the infrastructure hasn’t been innovated enough to account for this new way of transacting. We need to take a step back and look at how we can design the right FMI to cope with CBDCs and the future of transacting in the digital financial system.

Firstly, there needs to be a decision surrounding regulation of CBDCs. There is also a level of exclusivity as those without digital devices cannot access and use them. 97% of money comprises commercial bank deposits and 3% cash is physical cash. Considering the growing cashless society that now exists in payments, embracing new technology that supports this is imperative.

Using a cloud-based alternative to the systems in place now, an alternative that can be used in the market today as well as support the innovation of the future, is one way to do this. Embedding technology within the system that enables movement of funds and atomic settlement, not only reduces risk but also provides transparency.

As well as these elements, the cloud-based technology from RTGS.global will enable the trade of digital currencies to take place in seconds rather than hours. Meaning that this settlement fabric will help with the reset by tackling all the weaknesses at once – speed and risk, infrastructure and innovation.

The great solution

The way to achieve a ‘great reset’ is by ensuring that your technology is capable of supporting innovation. One innovation that is necessary is giving banks the ability to see liquidity in cross-border transactions. This is important as it protects them in payments and changes the way they work. For example, where checking for liquidity used to involve manual processing, this would enable checks to be done automatically, reducing costs as well as settlement risk.

This settlement fabric must enable atomic settlement across banks. Using an atomic settlement Lock technology, liquidity shortfalls are prevented. Before funds can be transferred, the technology ensures that both banks are liquid. With this simple process, real-time, bilateral settlements of funds would help secure payments in real-time.

In addition, the technology works 24/7/365, which has the potential to significantly reduce costs and increase efficiency.

If the aim of the payment industry is to ‘reset’; the mindset of its members and all the weaknesses of the system need to be targeted. The implementation of bilateral atomic settlement can enable this as soon as today – something that couldn’t have been said ten years ago. It is only through universal adoption of this technology that payments will be able to fully transform for today and the future.