A Promising Path to Interoperable Cross-Border Payments

New digital technologies have made a significant impact on payments and financial services in the last three decades. We can now access our bank accounts from our smartphones, shop online, make instant money transfers, and have immediate access to funds. These new consumption habits and growing globalization have only increased the demand for seamless and inexpensive cross-border payments. In the meantime, digitalization and innovations have made payment systems particularly efficient, affordable, and more inclusive.

Instant payment systems (IPS) have been at the forefront of this financial revolution, delivering significant benefits to end users and regulatory bodies alike, with significant growth in adoption across the world boosting digital economies, from developing to developed nations.

Challenges of Cross-Border Instant Payments

Despite the widespread adoption of IPS in more than 60 countries, cross-border instant payments have not kept pace with this progress. Moving money across borders can still be challenging for different reasons:

1. There is heavy reliance on correspondent banking. Competition in these services is decreasing, with the number of correspondent banks globally decreasing by nearly 30% in the last decade.
   
   
2. It is expensive. Customers pay high exchange rates due to many intermediaries with each getting a cut.
   
   
3. The process takes time, sometimes a lot of time, which has unfavorable consequences for end-users and businesses.
   
   
4. Interoperability between different IPS systems is very low.
   
   
5. Slow access to funds and high fees affect businesses, and migrant workers.

Promising Initiatives for Cross-Border Payments

Despite these obstacles, progress is being made. Firstly, the G20, with the support of the International Monetary Fund (IMF), has made improving cross-border payments a priority and we are seeing some promising initiatives that include:

• The Central Banks of Indonesia, Malaysia, Philippines, Singapore, and Thailand are collaborating to establish regional interoperability of fast payments by connecting their respective IPS systems. This initiative aims to achieve several significant outcomes, such as reducing transaction costs for cross-border payments in the region. Moreover, it has broader objectives encompassing the promotion of inclusive growth, facilitation of cross-border trade, investment, financial deepening, remittance, tourism, and other economic activities. Additionally, it aims to foster a more inclusive financial ecosystem in the region.
  
  
• The implementation of this initiative will bring numerous advantages, particularly for micro, small, and medium enterprises, by enabling their seamless participation in international markets. The cooperative efforts will encompass various modalities, including the utilization of QR codes and fast payment technologies, as stated by the Monetary Authority of Singapore.
  
  
• Buna, led by the Arab Monetary Fund, serves as an instant payment hub connecting central banks across the Arab region. This interoperable platform has the primary objective of facilitating secure, cost-effective, risk-controlled, and transparent transactions for financial institutions and central banks. It enables the seamless sending and receiving of payments in both local currencies and major international currencies.
  
  
• As highlighted by the Arab Monetary Fund, the establishment of this initiative plays a vital role in exploring and enhancing opportunities for economic and financial integration within the Arab region. Additionally, it aims to strengthen investment ties with global trading partners, thereby contributing to fostering a more interconnected and prosperous economic landscape.
  
  
• The BIS Innovation Hub’s Project Nexus serves as a centralized platform that enhances the efficiency of connecting fast payment systems across countries. Its goal is to significantly enhance the speed, cost-effectiveness, transparency, and accessibility of cross-border payments on a global scale.

As the number of interoperable IPS projects continues to grow, various challenges arise, including complex technical integration and multi-party legal negotiations, among others. Nexus effectively tackles these challenges by streamlining the integration of multiple IPS on a distributed network through a standardized and multilateral approach. By adopting this unified framework, the project eliminates the need for repetitive integration efforts each time a new connection with a different country is established. This simplifies the process and enhances efficiency for all participating parties, ultimately promoting seamless cross-border transactions.

CBDC for Cross-Border Payments

Central bank digital currency (CBDC) is also a promising solution to address the current challenges of cross-border payments, with high-potential work underway to create cross-border and interoperable CBDCs. The IMF and World Bank, as examples, suggest and highlight the need and benefits of CBDCs for cross-border payments.

Concrete initiatives that are advancing in this direction include:

BOC-BOE-MAS Models

The Bank of Canada, Bank of England, and Monetary Authority of Singapore joined forces to review the existing challenges of cross-border payments and issued a report that explores more efficient models for processing cross-border transactions through a wholesale CBDC.

The report identifies several challenges for end-users, commercial banks, and central banks, including lack of payment status transparency, visibility and certainty of outcome, limited availability of cross-border payment services, prolonged time for payment processing, and high costs associated with the correspondent banking model, in addition to challenges associated with legacy payments infrastructure across networks, central banks, and commercial banks.

The project proposes three broad conceptual design options for cross-border payments. The first option involves using intermediaries, and the second and third involve granting transacting parties access to the central bank’s liabilities. Access to the central bank’s liabilities can be achieved through two different designs:

1. The first design grants transacting parties with direct access to accounts or wallets on the network. i.e., allowing a financial institution to hold the currency issued by the foreign central bank.
   
   
2. The second design allows the local currency to flow into foreign currency networks where it can be transacted directly. This arrangement can be viewed as a multi-currency settlement system.

Project Inthanon-Lionrock

This joint initiative by the Bank of Thailand and Hong Kong Monetary Authority explores the application of CBDC to cross-border payments between the two countries. The cross-border corridor network prototype was developed, allowing participant banks in Hong Kong and Thailand to conduct funds transfers and foreign exchange (FX) transactions on a peer-to-peer basis, which helps reduce settlement layers.

Leveraging on smart contracts, the cross-border funds transfer process was enhanced to become real-time. The project was completed in December 2019 and a DLT-based proof of concept prototype was developed successfully together with ten participant banks from both places. The two authorities agreed to proceed with further joint research work in relevant areas, including exploring business cases and connections to other platforms, involving participation of banks and other relevant parties in cross-border funds transfer trials.

Project Aber

The Saudi Central Bank and the Central Bank of the United Arab Emirates announced the launch of their pilot Project Aber to create a CBDC that can be used for settlement of cross-border payments between commercial banks in the two countries. The initiative aimed to implement a proof of concept for studying, understanding, and evaluating the feasibility of issuing wholesale CBDC, with the objective of reducing transfer times and costs between banks, in addition to experimenting with the direct use and actual application of technologies such as distributed ledgers.

Initially, the joint venture for digital currency was restricted to banking institutions and not open for public use. Six commercial banks in Saudi Arabia and the UAE were selected to participate in the development of the currency. In November 2020, the two central banks issued a report on the status and results of the project, acknowledging several technical and business challenges faced, but also the overall success of the experimentation by achieving the project’s main objective: using a new DLT-based solution for real-time cross-border interbank payments between commercial banks without the need to maintain and reconcile nostro accounts with each other and all the advantages that this brings.

Final Thoughts

It is important to recognize the results of such ongoing work. While these initiatives show promise, achieving widespread interoperability and addressing the concerns of high costs, slow processing times, and limited access to funds requires collective efforts and collaboration across borders between financial leaders and technology providers.

By leveraging emerging technologies, and availing infrastructure to seamlessly integrate with those technologies both at a bi-currency level (country-to-country) and at a multi-CBDC level or consortium of multiple countries, a foundation for a truly global and interconnected payment ecosystem can be created. This will not only benefit businesses and financial institutions, but also enable migrant workers, micro, small, and medium enterprises, and individuals around the world, to participate more effectively in the global economy.