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    The evolution of payments: Multiple paths, one destination

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    By Saket Sharma, Chief Digital and Information Officer, and Michael Bellacosa, Head of Global Payments Product Management, BNY Mellon Treasury Services

     

     

     

    An innovation boom is taking place in the payment space. Following decades in which the industry saw little in the way of significant change, a host of industry initiatives and digital capabilities have emerged—with the potential to irrevocably change the way payments are processed globally.

    So far, the introduction of real-time payment systems in countries around the world alongside transformative developments from SWIFT (Society for Worldwide Interbank Financial Telecommunication) have already begun making payments—both domestic and cross-border—more frictionless, speedy, efficient, transparent and cost-effective.

    Yet, while this payment journey is well underway, in many ways it is only just beginning. The implementation of new technologies, such as distributed ledger technology (DLT) and artificial intelligence (AI), looks likely to unlock a host of benefits, including greater transparency and more automated processes. The development of digital currencies is also ramping up—a trend that could one day change the way we look at settlement speed, liquidity, reconciliation, risk and even the traditional role of correspondent banks as intermediaries.

    As we advance along this journey, the future of payments looks bright: a world in which all have the expectation and ability to move money instantaneously 24/7/365 with full transparency. While the endpoint seems clear, there is no single, fixed route for the industry to take. To reach the desired destination, banks need to embrace a wide array of industry trends—building a comprehensive toolbox of payment solutions that will enable them to meet their clients’ needs for years to come.

    New initiatives

    In the past few years, the industry has come together to implement and advance a series of initiatives designed to deliver faster, smarter, more transparent and more convenient transactions.

    More than 50 countries are now live with their own domestic real-time payment capabilities—allowing payments to be cleared and settled around the clock in real-time and with improved messaging capabilities, such as immediate confirmation of payment and notification of receipt. The improved flexibility and convenience afforded by real-time payments are changing how and when consumers and businesses choose to transact, while enhanced transparency and reliable, up-to-the-second liquidity are helping businesses improve their cash management and reconciliation processes.

    Elsewhere, SWIFT’s global payments innovation (gpi) initiative, developed in collaboration with participants from across the industry, is one of the most powerful developments in recent years. SWIFT gpi addresses a host of the pain points traditionally associated with cross-border payments, such as slow processing times and a lack of transparency. Today, the scope of gpi is also expanding, with new capabilities—including gpi Case Resolution (gCASE), gpi Stop and Recall Payment (gSRP) service and a new pre-validation service—being introduced to drive efficiency and remove friction in the pre- and post-payment processing stages.

    Recently, SWIFT has also worked with a number of banks, including BNY Mellon, to propose a new platform that will help reduce the remaining friction in the cross-border payment space. Known as the Transaction Manager, SWIFT’s new platform will enable account-to-account transfers with transparency and predictability as well as increased resilience and security.

    New technologies

    The growth and evolution of a range of sophisticated, emerging technologies are creating unique opportunities for banks to enhance their existing processes. These efforts to modernize and strengthen payment capabilities are being driven by fast-changing client expectations—which are shifting to better match the levels of service available in the consumer space—and various collaborative industry initiatives involving both banks and fintechs (financial-technology firms). But with many of these technologies still emerging, what inroads have been made so far?

    Today, artificial intelligence (AI) is being used across the banking industry to leverage data, detect patterns, gather insights and, in turn, recommend actions. How these recommendations are used is then often tracked by the AI technology, allowing the applications to “learn” and improve over time. AI is currently proving most effective in bringing improved client experiences and operational efficiencies to specific use cases, including fraud monitoring, compliance and simple customer inquiries. Banks are also exploring the potential to apply AI to higher-value activities, including treasury management functions such as liquidity management and payment channel optimization—although such capabilities remain several years away.

    Another key emerging technology is distributed ledger technology (DLT), a decentralized ledger that transparently records and stores the details of every transaction on a shared network. An example of a distributed ledger is blockchain, which stores data sequentially in a series of “blocks”. Each block in the chain draws upon the previous one to ensure that the data in the overall blockchain remains unchanged. This removes the need for multiple copies of the same information to be stored in separate silos, thereby enhancing security and significantly improving reconciliation processes, for example.

    While DLT is in use today to some degree, its true potential remains untapped, with many believing that the added transparency, speed and risk mitigation could bring huge advances to financial and business processes—including facilitating instant payment settlements in the years to come.

    Digital currencies

    As we continue to look to the future, one development with the potential to revolutionize not only payment but their entire business model is digital currencies. Digital currencies, which are centered on DLT, can be divided into three different categories: cryptocurrencies, stablecoins and central bank digital currencies (CBDCs).

    Cryptocurrencies are a type of digital currency that use encryption techniques to control the creation of monetary units and verify the transfer of funds. They have no intrinsic value or physical form, are not determined by a central bank and have, for the most part, suffered from volatility since their inception. The key distinction of stablecoins, is that while they share many features of cryptocurrencies, the coin’s value is linked to a pool of assets, thereby stabilizing the coin and helping to avoid high levels of volatility.

    Finally, CBDCs are the digital form of a fiat currency issued and regulated by the monetary authority of a country or region. Developments for CBDCs are underway in Thailand, Canada, Japan, Singapore, Europe and, most notably, China, which expanded a trial run of its prototype digital renminbi to urban areas housing some 400 million people in August 2020. Yet, despite these efforts, there are a number of fundamental questions—such as what their impacts on monetary policy and traditional banking models will be and how they will be regulated—that must be answered before CBDCs can become mainstream.

    With the introduction of most CBDCs still a long way off and cryptocurrencies still a largely unaccepted and unstable form of payment, stablecoins would seem to have the most immediate potential to transform and modernize payments.

    For example, stablecoins, when used as digital tokens, can be applied to payment-versus-payment (PvP) transactions—allowing cross-border FX (foreign-exchange) payments to be made in real-time 24/7/365. Under the current model, if a bank needs to perform a same-day cross-currency FX swap, it needs to factor in cut-off times. With a tokenized model, provided the bank can find a counterparty and agree to a rate in the marketplace, the bank could execute the same swap later in the day using a digital currency, with the funds transferred and exchanged almost instantly. This alters the notion of cut-off times and provides banks with longer windows during which to transact while also freeing up capital that would have previously sat as an assurance against the unsettled trade.

    Stablecoins could also be applied to the payment leg in a delivery-versus-payment (DvP) digital asset settlement. Currently, settling these transactions requires multiple parties as well as two distinct platforms: one that processes the settlement leg for the transfer of securities and one that processes the payment leg for the transfer of funds. In tomorrow’s world, stablecoins could be the enabler of more efficient and faster payment legs. With assets and cash tokenized, both legs of the transaction can be completed instantly, with the buyer and seller simultaneously receiving their respective asset and payment on the same ledger without the need for third-party support.

    Further down the road, stablecoins could also ultimately impact the way cross-border transactions are processed. Under the current system, cross-border transactions use a correspondent-banking model that involves numerous parties, with added costs and where multi-bank processing can slow payment execution. With stablecoins, however, cross-border payments could one day be performed instantly and securely on a person-to-person (P2P basis) while also creating a system in which they can be made at any time around the clock. This has the potential to radically alter the traditional correspondent banking model, with immediate settlement reducing counterparty and institutional risks.

    The nature of immediate settlement will also have implications for liquidity management and optimization. In a world in which beneficiaries instantly receive their payments, the originator, which traditionally has had around two days to make the funds available, will now need to send the money there and then. As a result, as digital currencies come of age, it will be increasingly important for banks to pivot their offerings—acting not only as gateways to digital payments but also as effective, instant liquidity providers for the new real-time world.

    Destination in sight

    With several different initiatives and technologies rapidly advancing in tandem, it is clear that no single solution will be the silver bullet for delivering optimized payments. Instead, as we look to the future, it is likely that the industry will see coexistence and interaction between traditional rails, more established emerging technologies and the new landscape of digital currencies. Banks will need to adapt to this evolving landscape—preparing to serve their clients’ needs through a comprehensive toolkit of solutions and services. This will mean investing in the advancement of payments through industry initiatives and emerging technologies as well as taking steps to become the gateway provider of choice for tokenized payments and effective liquidity options. Once equipped with this full suite of capabilities, banks will be ready to support their clients fully as the new era of payments unfolds.

    Read BNY Mellon’s new whitepapers onInnovation in Payments to find out more.

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