Analysis Blockchain for Banking Feature News

In depth: Cross border CBDC, mBridge and the coming payments fragmentation

mbridge cbdc cross border

There’s been much talk about the coming fragmentation of payments. A key driver is geopolitics and the use of Swift for sanctions. Countries that fear they could be next have started looking for alternatives. Technology isn’t necessarily the driver of fragmentation but is an enabler. Some envisage the cross border CBDC project mBridge as one of the platforms that could break Swift’s stranglehold over cross border payments. Launching in mid-2024 with a minimum viable product, mBridge involves the Bank for International Settlements (BIS) and the central banks of China, Hong Kong, Thailand and the UAE.

We explore why mBridge’s use of digital currency could help it gain traction. The short answer is it could eventually reduce bank costs for cross border payments.

Greater international use of the RMB has been a Chinese government goal for some time. But the currency’s usage has not matched the growth of its economy. Arguably, there are many reasons, which are not the topic of this piece. 

There have been several cross border CBDC trials, but China’s involvement might be the reason mBridge is the only one currently on a path to production. China doesn’t like being reliant on Swift for payments. 

Currently, renminbi cross border transactions can go via Swift or China’s cross border payments platform CIPS. 

UAE, China and their respective commercial banks have tie-ups for digital currency beyond mBridge. And the first deal to settle foreign oil purchases using the digital yuan was signed last week. Some might argue that if CIPS hasn’t gained traction versus Swift, why would mBridge? Swift has 11,000 banks. CIPS almost 1,500 after eight years.

Every bank that wants to use CIPS must integrate with it, or pay via a settlement bank. With mBridge, banks connect via their central bank. In China, mBridge is connected to the local eCNY CBDC system. So there’s relatively little friction.

Digital currency benefits

But that’s not the major benefit. Today payments are made via messages which involve two steps, the message and the movement of money. In contrast, with digital currency, there is no separation of message and money. They are one. That means there’s atomic settlement. The transaction works or it doesn’t, removing the need for reconciliation. The money is never in limbo.

Most (89%) Swift messages reach the recipient bank within an hour. Only 54% of payments arrive at the payee within an hour because of delays in the second step. So digital currency payments can be faster. But that’s still not the major advantage.

Doing away with messages means banks no longer need to hold foreign bank accounts (nostro accounts) in all the major jurisdictions. These bank accounts tie up capital which can now be used for other purposes. That significantly lowers cross border payment costs.

Let’s look at how it works currently. If I want to pay someone in China, my bank will send a message via Swift to a bank in China asking it to use my bank’s Nostro account to pay the recipient. On receipt of the message, the Chinese bank will transfer the money to the recipient, who may be at a different bank. If so, that would involve a domestic Chinese transfer, a third step. If my bank doesn’t have a Nostro account at a Chinese bank, it will need to send the payment via a correspondent bank with a Chinese account, costing extra.

How digital currency works differently

With digital currency, my bank needs neither a Chinese bank account nor a correspondent bank. Nor is there a need for a domestic bank-to-bank payment in China. My bank could go onto mBridge, buy renminbi CBDC on the platform, and transfer the digital currency to the Chinese recipient’s bank directly. The recipient bank still has to credit its client, but the mBridge wholesale CBDC connects directly to the domestic eCNY digital currency, so it will be a straight through process (STP). 


Hence, for foreign commercial banks, the biggest incentive to use mBridge will be to reduce the need for Nostro accounts.

To realize these money savings, several things need to work. FX rates on the platform must be very competitive. If they aren’t, this will partly neutralize the savings on Nostro accounts. Plus there are integration costs for banks, so the frictions need to be small. 

For banks to be willing to incur those integration costs, mBridge needs to be operational in sufficient jurisdictions. During the build phase, it was necessary to keep the number of participants small to move quickly. Many other central banks were observers at trials. Some were interested as a learning experience. Others are regional central banks such as the Philippines, Malaysia, Indonesia and Korea. 

China is hedging its bets by also connecting its domestic eCNY system directly, such as the recent UAE deal. Alternatively one can view these deals as getting ready for mBridge.

There will be additional incentives for Chinese banks who will be strongly encouraged to use the system.

Banks are allowed to hold foreign CBDCs

A key takeaway from another cross border CBDC experiment, Project Dunbar, is the challenge of central banks allowing foreign banks to hold CBDC. After all, most central banks don’t allow foreign banks to hold reserves. mBridge allows them to hold CBDC.

However, there are two sets of restrictions which address central bank concerns. Firstly, commercial banks can access foreign CBDCs but they are only usable on the platform. Conversions between the CBDC and central bank reserves can only happen for domestic banks. So there is still no foreign bank access to reserves. Secondly, banks can’t hold foreign CBDCs overnight.  

During the trials, the overnight restriction proved a challenge, particularly because of the mismatch in central bank operating hours. However, with greater automation it may be less of an issue, but it remains to be seen. 

Governance challenges

Last week, one of the Governors of the U.S. Federal Reserve observed that central banks are reluctant to allow central bank money to circulate on platforms they do not control.

That’s a key challenge for mBridge. While governance can potentially be democratic, it will be hard to break the view that this is a Chinese driven platform. In fact, it was initiated by the Bank of Thailand which collaborated with Hong Kong on Project Inthanon-Lion Rock for cross border payments. The central banks of China and UAE joined later.

China has a strong influence over Hong Kong, which gives it a 50% influence over the platform. Plus China has very strong commercial ties with the UAE. The UAE’s digital currency advisor spent 17 years at the Hong Kong Monetary Authority. However, as more central banks join, potentially China’s influence will be diluted.

Or maybe not.

During the development process, each of the four banks took on different roles. The People’s Bank of China’s Digital Currency Research Institute was responsible for the technical development. Even if it doesn’t formally operate the production platform, as the developer it will be heavily involved in operations.

The blockchain solution is only one part of the platform but is custom-built. Initially, it relied on widely used components. More recently it switched the blockchain consensus mechanism to a Chinese one, co-developed by the central bank.

China’s influence could be even broader. The trials to date were for cross border payments. However, last year’s mBridge paper said “mBridge can be further developed to become an infrastructure for domestic CBDC, if desirable.”

mBridge’s impact on settlement banks

Assuming mBridge takes off, how will this impact settlement banks? On the one hand, a decline in the usage of correspondent banks is bad news. That’s something settlement banks are already getting ahead of with private digital currency solutions such as Partior.

On the other hand, how many mBridge-type platforms might there be? For geopolitical reasons, it’s likely to be more than one. There are already several private ones in the works beyond Partior. As the number of payment platforms proliferate, smaller banks won’t be able to afford to integrate with all of them. Hence the role of settlement banks will persist, but with different global payments plumbing.

Sign up to be notified of the launch of our upcoming research paper: Tokenized deposits, bank stablecoins and DLT payments including a map of the private projects.

Image Copyright: Ledger Insights