mBridge and atomic settlement have the potential to increase efficiency and use of local currencies in cross-border payments

The Bank for International Settlement (BIS) Innovation Hub in its report, Project mBridge: Connecting economies through CBDC, cited a study by JP Morgan of the substantial costs associated with the correspondent banking model, which in 2020 estimated transaction charges of around 0.5%, or approximately $120 billion, of nearly $23.5 trillion in cross-border transactions flows, (excluding foreign exchange (FX) costs), stemming mainly from inefficiencies that introduce settlement risk to the cross-border payment and settlement system.

Cross-border payment and settlement have erstwhile been affected mainly via telegraphic transfers supported by a network of correspondent banks through Swift, the international financial messaging platform. Such transfers remain slow, costly, and opaque due to the number of intermediary banks involved. A transfer could take up days to complete and the World Bank estimates the average cost of a transaction to be about 6% of the transfer value.

The BIS Innovation Hub observed that these inefficiencies introduce settlement risk into the system. In addition, as settlement occurs in commercial bank credit, it carries the associated credit and liquidity risks where settlement funds may not be available in the event of illiquidity or insolvency which can become significant when aggregated over large values and long settlement periods. While settlement in central bank money eliminates this risk, it is typically restricted to interbank domestic payments on access-controlled central bank real-time gross settlement (RTGS) systems. The exception is the Continuous Linked Settlement (CLS) platform that settles FX transactions on a payment versus payment (PvP) basis and maintains an account of each central bank which currency it settles. It however supports only a limited number of currencies.

It also noted that “innovation in the payments space has been concentrated mostly in the domestic arena, with cross-border payments often left on the sidelines. While incumbent payment providers and private sector players have pursued various initiatives to alleviate longstanding challenges in international payments (Swift global payments innovation, Visa business-to-business connect and continuous linked settlement system are some examples), they are limited in scope and high operational costs persist”.

Emerging market and developing economies (EMDEs) face greater challenges when global banks started to rationalise their correspondent networks and services as part of global de-risking in the aftermath of the Great Financial Crisis, leaving them with limited access to the global financial system. As cross-border transactions are settled in a few major currencies and FX trading in non-major currency pairs remains limited. This leaves EMDEs exposed to the collateral effects of the monetary policies of the jurisdictions of these major currencies and attendant financial stability risks, such as credit cycles. In addition, given the limited access to international financial markets and currencies of these economies, they face heightened liquidity risks in times of global financial disruptions. The report also cited rising FX settlement risk in recent years due the declining rate of global settlements using PvP mechanisms, as existing arrangements such as CLS do not support many EMDE currencies which trading volumes have been steadily increasing.

Cross-border payment and settlement using central bank digital currencies (CBDCs) of multiple jurisdictions, or mBridge, as well as atomic settlement involving tokenised digital assets such as commercial bank money in the form of deposits have the potential to reduce such challenges in international payments, and extend PvP protection to currencies not currently covered by existing systems.