Yesterday the Bank of International Settlements (BIS) which is owned by sixty central banks, published a report into correspondent banking relationships used for cross border payments. Over the past seven years, correspondent banking relationships have declined by almost 20%. Benoît Cœuré, chairman of the Committee on Payments and Market Infrastructures, noted that this “may push people to use ‘shadow’ payment services such as cryptocurrencies”.
Typically in correspondent banking, to make cross border payments, a bank will establish accounts at other banks in numerous jurisdictions. The downside is it ties up funds and is an administrative burden. For those jurisdictions where it doesn’t have a banking relationship, payments will be routed via another bank.
Despite the decline in the number of banking relationships, over the same seven year period transaction volumes have increased by close to 40%. Hence there’s been a concentration of transactions across fewer channels. One possible explanation for this is the rise of companies such as Earthport and Transfast, both recently acquired by Visa and Mastercard respectively.
Earthport, Transfast and others like them establish banking relationships with many banks around the world. So instead of a bank or fintech having to set up fifty or a hundred foreign bank accounts, it simply connects to one of these companies to route payments.
With cryptocurrencies such as Ripple or Stellar a cross border payment becomes a specialized foreign exchange transaction without the need to tie up money in numerous foreign bank accounts. A few remittance companies have signed up to Ripple.
So when a dollar payment is sent to India, there will be a conversion from dollars to Ripple’s XRP cryptocurrency. And on the Indian end, the XRP will be converted to Rupees. This means the sender doesn’t need to have numerous bank accounts in different currencies. Instead, they need the ability to send and receive XRP. However, unless they convert the XRP immediately, they will be vulnerable to fluctuations in XRP’s value.
The intermediate currency doesn’t need to be XRP, but it should have liquid exchange rate markets. This is part of the logic behind IBM’s World Wire network powered by Stellar.
For now, the volumes in conventional foreign exchange markets are exponentially greater than throughput in any cryptocurrency whether that’s XRP, Stellar Lumens or Bitcoin. In general, the greater the volume the narrower the margin or cost.