The first brick on the road to digital banking, a prerequisite of international interoperability, has been laid with the move to immediate payments. Another brick has been laid now that the industry has reached consensus that ISO 20022 is the right language for us to use to send and receive immediate payments.
The ISO 20022 Real-Time Payments Group has launched its first draft of the data flows or the ‘rule book’ for the standard for real-time payments, and many other parties are working furiously behind the scenes to enable interoperability.
However, along any journey, crossroads of some shape or form will be encountered, where important decisions will need to be made that will determine the direction one takes.
The biggest of these will undoubtedly be “how do we handle settlement for cross-border immediate payments?”
Currently, there are three main models for settlement; Deferred Net Settlement (DNS), pre-funding and real-time (or line-by-line as the Australians call it).
- DNS is simple; payments are sent (funds are available immediately) at one point in time and then netted and settled in another according to the settlement cycle. This has high settlement risk and can choke innovation as the longer the settlement cycles, the greater the risk. Smaller players find this environment particularly difficult in terms of participation.
- Pre-funding requires each party to deposit cash to the expected value of its commitments for the next settlement cycle, so this removes the settlement risk as should a member fail, they have already provided the funds to cover their liabilities. This goes some way to opening up the scheme to the smaller players; however, again if there are long settlement cycles, barriers can still remain due to higher amounts of cash required. This does not suit challenger banks or non-bank payments service providers that have small or no deposits to use for pre-funding.
- Real-time removes the settlement risk, and the barriers to entry, however the central bank has to run a real-time settlement infrastructure that operates at the same time as the immediate payments scheme (usually 24*7*365) to accommodate this.
Further difficulties arise: for example someone in the UK, which is moving to a pre-funding model and has a settlement cycle of 3 hours, and someone in The Netherlands where the cycle could run every 15 minutes, want to pay each other.
Who takes the settlement risk, considering the cash and collateral is held by the central bank in a different country? How to get the two to marry up is going to be the tricky bit.
“Why can’t we all just move to a real-time system?” The Australian New Payments Platform is going to be the first example of a line-by-line settlement model, so the technology is as yet unproven. The technology capability required to process the number of transactions in Australia is achievable, however the volumes are vastly larger in countries such as the U.S. and China.
Would a real-time system be able to cope? Will other countries’ appetites be big enough to foot the bill to invest in such a system?
Only time will tell. For now, those addressing the interoperability challenge will need to come up with an answer to “which direction do we take?” around settlement, before we can truly achieve global interoperability.
I will be discussing the benefits and adoptions challenges surrounding ISO 20022, and the future impact to cross-border payments and correspondent banking during Sibos. Click here to see the full schedule of sessions.