“Isn’t Ripple only for banks? What can it do for our Treasury?”
tl;dr : Not all payments are created equal. Treasurers around the world feel the correspondent banking model inefficiencies, but the ones transacting in less liquid currencies suffer more. The adoption of Ripple’s solutions can result in lower fees and reduced risk, offering tremendous benefits to Corporate Treasuries. Certainty over settlements will also aid key treasury processes (e.g. more accurate cash forecasting) and can contribute to the overall stability of the business environment. The new payments technology landscape can open up new treasury operating models and reinforce the role of Treasury as a strategic partner to the business.
As a treasury & risk technology consultant, I am often asked about Ripple. “What can Ripple do for Corporate Treasury?”. “Is it only for banks? How would it fit in the current system architecture and our Treasury policy?”.
In this post, I will try to answer these questions and give some of my thoughts on the technology.
The (Treasury) world around payments, and Ripple
Even before the blockchain wave of interest (call me “hype”), payments have been in the spotlight for a few years. Technology innovation, new EU (PSD2) and UK (Open Banking) directives, as well as SWIFT’s gpi initiative, are stirring the waters, while some processes remain stuck in the previous century.
Despite the technological advances of the sector, if you are a Treasurer who wants to send a cross-border payment to or from a non-European country and your banking partner is not within the gpi network…you are in bad luck: Your payment will still need 2–3 (or more) business days to settle, the transfer will be costly, and during that time you will have virtually zero visibility of your funds’ tracks.
This happens due to a combination of the process architecture (correspondent banking), the limitations of the technology (unidirectional messaging) and a bad habit of some banks to add various fees along the way.
In a not uncommon scenario, that one payment will need to mobilise the ledgers of three or four banks. Your bank, your bank’s correspondent bank, the beneficiary’s bank and the beneficiary’ bank correspondent bank.
It is becoming clear that a distributed ledger solution would make the most sense here. If these three or four banks shared a common ledger, interbank reconciliation could be almost instant and the payment would settle immediately. In fact, the whole correspondent banking system could be placed into question as the business model would thoroughly change.
But let’s take things from the start:
What is Ripple offering?
Ripple offers three products:
- xVia: A payments interface
- xCurrent: A settlements solution for banks
- xRapid: A liquidity solution
What is xVia doing for the Corporate Treasurer?
Have you used Alliance Lite 2 to track your company’s payments through SWIFT? (often, to find out that you need to pick-up the phone and call your bank to ask about that NACK message). Think of xVia as a connector to a payments network (RippleNet) which comes with an application similar to Alliance Lite 2 or to the new SWIFT gpi Tracker, adding features such as the ability to attach invoices and other rich data.
So, your TMS or ERP payments gateway would interface with xVIA’s API, sending instructions and receiving confirmations through RippleNet.
Ripple’s xVia [source: ripple.com]
Wait, you said “RippleNet”? That means we should connect our Treasury system to RippleNet instead of SWIFT?
It could connect to both, but that would probably be quite costly (paying subscriptions to keep both channels open). Using RippleNet as a Treasurer, you are limited to the network of banks signed with Ripple. While its size (~100 members) cannot be compared to the 11,000-members SWIFTnet, RippleNet has seen a very good growth with some of the world’s biggest banks (MUFG, Mizuho, Credit Agricole, Santander) connected to it. To be fair, RippleNet’s size is actually comparable to that of gpi (~160 banks, according to SWIFT). Moreover, RippleNet members can also be SWIFT members, so if your Treasury’s only or main banking partner is one of them, the migration to Ripple would probably cause no stress to your existing banking relationship.
What does xCurrent do for the Treasurer?
If you are a non-bank Corporate Treasurer interested in Ripple, xCurrent is not your worry. Not that it is a less important component. On the contrary, xCurrent is the solution which enables your banking partner to achieve near-instant settlement of payments, and thus benefiting your business. Let’s see in brief what happens between the banks:
“xCurrent is for banks” [source: ripple.com]
When a payment in xCurrent is initiated, banks exchange KYC/AML information. The screening completes in seconds through xCurrent bidirectional messaging. This eliminates a common bottleneck of the traditional payments system, where correspondent banks would sometimes require additional information as part of KYC/AML processes. Treasurers often find out that after initiating a USD cross-border payment (under the current model), the correspondent bank blocks the transfer, leaving everyone in the dark for at least one business day, until the back office provides assurances that the payment will not benefit sanctioned individuals or countries.
Following these checks in xCurrent, the transaction cost is calculated and the banks settle the payment instantly on ILP Ledger (Interledger Protocol Ledger), which is a subledger of each transacting bank’s general ledger.
xCurrent architecture [source: ripple.com]
Where does XRP (the digital asset) fit in this?
So, let’s imagine your TMS is connected to xVia. Payments along with invoices and other data are sent through the API, your banking partner settles the payment through xCurrent and the payment reaches the beneficiary’s bank.
**However, not all payments are created equal:
As we saw above, along the journey of the payment through xCurrent, there is an FX conversion stop. In case you are in the UK and you want to pay a supplier in a eurozone country, your bank feels comfortable that the market will be providing enough GBPEUR liquidity and that the FX quote they get will always be a very reasonable one. It could also be the case that your bank itself acts as a liquidity provider. As a corporate, you can expect lower fees and shorter processing times. Let’s call this, scenario A.
Now imagine a different scenario, let’s call it scenario B, where you are a Treasurer in the UAE (Group currency: AED) and your supplier is in Morocco. The payment should be made in Moroccan Dirham, MAD. Under the current SWIFT model, the friction would be enough to make any Treasurer..mad (pun intended): Your UAE Bank would send the payment to its correspondent bank, the correspondent bank would send it to the Moroccan Bank’s correspondent Bank and then it would reach the beneficiary’s account. Needless to say that the fees of four banks and the currency conversion spreads (possibly AEDUSD and MADUSD) would add significant cost. Add the likely KYC/AML delays during USD clearing and you have a perfectly inefficient process. Using xCurrent, your banks would alleviate the pain with shorter timeframes and guaranteed best FX execution, but the need to use multiple nostro accounts of illiquid currencies wouldn’t be eliminated.
Sadly enough, scenario B is the norm for many Treasuries around the world which are not in Europe or North America. Treasurers have either decided to swallow the exorbitant fees or have tried to mitigate the cost by maintaining subsidiaries accounts in countries where they have considerable business activity. The latter practice introduces additional FX risk for the Group, operational burden to manage the accounts and it has, of course, an adverse effect on the company’s liquidity.
Ripple’s xRapid enables xCurrent members to use XRP (the cryptocurrency aka digital asset aka native token) as a bridge currency in order to settle payments. Under the scenario B above, this could happen in multiple ways:
The simplest one (shown above) would require your UAE bank and your supplier’s Bank in Morocco to have pre-funded ILP accounts with XRP. As you send the payment, the bank converts your AED into XRP and settles the amount with your supplier’s bank in XRP. The Moroccan bank then converts the XRP into MAD and credits your supplier’s account. Alternatively, one or both banks wouldn’t need to maintain pre-funded XRP accounts but instead, they could request XRP liquidity on-demand from market makers.
In all cases, the need to maintain nostro/vostro accounts is eliminated. Capital is freed from sitting idle in correspondent bank accounts and as XRP transaction costs are minuscule (*), banking fees would be much lower.
To give you an idea about how minuscule the XRP costs are, please take a look at the posted transaction below, from May 24. The fee to transfer over 50 million XRP (> $30 million at that day’s market price) was 0.0000072 USD. Yes, you read well.
source: xrp charts
Where is the caveat?
Ripple has taken the lead in payments innovation. But it has also received some criticism, mainly because of XRP. Criticicm has come from inside the crypto-world, as a number of enthusiasts have claimed that the design of the XRP ledger is not doing a good service to the decentralized vision or the community; but criticicm has also come from the business world, with some commentators arguing that XRP will not serve its purpose and xRapid will not be used by banks.
Ripple’s vision with XRP is indeed a bold one. One can endlessly debate on the crypto-community’s decentralization concerns, but, on the business world, Ripple will have to overcome a number of regulatory obstacles. Is XRP a security or a commodity? Will banks hold XRP in order to use it for settlement of cross-border payments? If not, meaning that they will rely on liquidity providers, what will ensure the availability of the providers in times of stress? If banks fund own accounts with XRP, how will these assets be defined in the books and how risk will be measured in order to meet capital regulations?
This is a very interesting discussion but the analysis is beyond the scope of this post. Ripple has been engaging with regulators globally and has provided answers to the above questions. Regulators might also find out that Ripple’s solutions can make their task easier.
Nevertheless, a transparent cross-border payments solution which settles within a few seconds and which is ready to be deployed today, offering tremendous benefits to Corporate Treasuries, is very hard to be ignored.
Where are we now in terms of market adoption?
- Santander launched a mobile app for cross-border payments which uses Ripple’s distributed ledger technology.
- Western Union and Moneygram are testing Ripple’s technology for payments.
The above is just a sample. There is a growing number of companies who have disclosed that they are testing or even deploying Ripple’s solutions into production.
Is SWIFT doomed?
SWIFT has announced that it is testing blockchain for payments with mixed feelings. The gpi launch, which promises intraday settlements and transparency over fees and FX rates, has been a great success for a number of banks and their customers, but it remains a distant reality for the majority of financial institutions and Corporate Treasuries.
SWIFT is enjoying a dominant market position and, although quite costly at times, the current process is a far too familiar one for Treasurers to replace it with a new one. Ripple’s suite is ready and robust, but it needs the network effect to speed up market adoption and to establish itself. Until then, SWIFT has a — limited in my opinion — time window to reassess its strategy.
What should the Corporate Treasurer do?
As with every period of rapid innovation advancements, there are only two choices: Treasurers can either adopt a wait-and-see stance or take an active approach and dip a toe in the blockchain ocean.
In case they choose to be actively involved, Corporate Treasuries can connect their TMS or ERP payments gateways with xVia and start processing payments through RippleNet. If your main banking partner is a member of RippleNet, it is definitely worth discussing with them on the viability of switching. As shown in the below diagram, a case study should take into consideration a number of factors such the destination of your usual/regular vendor payments, the appetite to disrupt existing banking relationships, etc. After all, when the disruption game is over, Corporate Treasuries will be the ultimate winners, enjoying lower payments costs and better visibility of their funds.
Conclusion or…“Do we really need instant payments?”
This is something that comes up quite a lot: “Treasuries will be more than fine with end-of-day settlements. Instant payments will not add any real advantage to the current processes and policies of many Corporate Treasuries”.
Despite being a legitimate argument, it can easily be contested:
First, we are still very far from even considering end-of-day settlements as the norm.
Second, the eliminated settlement risk and the certainty over fees and processing times, will contribute to a more stable business environment. Treasuries will be able to allocate freed liquidity in more efficient ways and cash forecasting will become more accurate.
But, the noteworthy keyword in the above question is “current”. As technology evolves, Treasury processes adapt in order to make the most of the advancements. How much easier was Hedge Management made since robust TMS’s included this functionality? And on the other side, how many TMS projects have disappointed because of the fact that the business processes were not properly redesigned or evaluated before the implementation?
Having the ability to settle cross-border payments instantly, with much lower risk and significantly reduced cost will open up the potential of new business processes and operating models and will reinforce the role of modern Treasury as a strategic partner to the business.
Could that lead to a new in-house bank operating model in the future? Possibly, but this is for the next post.
Thank you for reading 😊
For any questions or suggestions, get in touch: linkedin.com/in/ikarosmatsoukas