Liquidity bridges have gradually morphed in tandem to the evolution of cross-borderpayments, mainly due to G20’scommitment to establishing a cross-border payment program.
As central banks ponderon whether to establish liquidity bridges, here are some highlights on theirbenefits and their challenges.
Bridges canbenefit participants due to how they are able to reduce their need of:
· Having multiplecollateral buffers in different jurisdictions and/or currencies
· Undertaking FXtransactions
· Having cash buffers
Consequently, this goesa long way in reducing transaction costs, associated settlement risks, and, ingeneral terms, the overall complexity or operations.
Moreover, given theadded flexibility they add, they help banks in terms of managing their intradayliquidity.
Accordingly, it iswithin the industry’s best interest to explore the realm of liquidity bridgesas they can certainly provide many benefits for payment service providers andbanks in terms of liquidity management while effectively lower costs ofcross-border payment services.
Right now, banks areeither forced to invest in liquid assets which can be used as collateral ormust hold foreign currency in either a foreign central bank or in theirrespective correspondent banks accounts.
And while the need tosource this liquidity might be rightfully seen as a serious credit risk, manymiss the opportunity cost it entails.
To further aggravate the problembanks usually overfund their payment obligations as a way ofmanaging their risk towards payments.
A liquidity bridge isable to take down costs while simultaneously releasing the participants’tied-up liquidity, meaning it will also be easier for banks to better allocatetheir collateral and manage their intraday needs.By not havingbridges, banks which operate in multiple different currencies will most likelybe required to hold a substantially larger pools throughout thejurisdictions they are operating in, something which also comes with higherfunding costs and the inevitable passing of costs to the end users and costhike on cross-border payments.
When compared to thealternatives, bridges’ settlement processes are much easier and theneed to counterparties and/or clearing entities is also lower.
Credit and settlementrisks can also be reduced or fully eliminated via liquidity bridges. As such, cross-borderpayments can be faster, cheaper, and, more importantly, see less friction.
Intraday liquidityrelies heavily on central banks provisions to domestic market participants.
With intraday paymentobligations in mind, a higher adoption rate for liquidity bridges can correlatewith a lower intraday settlement risk internationally.
Moreover, sincecollateral demands begin to stabilize so will asset volatility lower, adding tothe overall financial stability.
While there are highoperational costs, central banks which establish and operate liquidity bridgesmust also face other risks.
Risks can be dividedinto at least four distinct categories:
1. Entryrisks
2. Operationalrisks
3. Financialrisks
4. Systemicrisks
First and foremost, abridge can only be established in a place in which the bank is legallyauthorized to operate it.
If that jurisdictiondoes not provide a sound legal framework, the risk is inherently higher.
Moreover, the casebecomes increasingly harder when crafting a multilateral bridge as otherjurisdictions regulatory frameworks, legal agreements, technical costs ofimplementation, operational costs, and even currency volatility come into play.
Whether it’s abilateral or multilateral bridge, as interdependent as participants become, sodoes the systemic risk become higher.
Lastly, there are alsoemerging market risks and developing economy risks which should be accountedfor.
Liquidity bridges canmake banks and PSPs see their costs alleviated while driving down costssurrounding cross-border payments.
Risk management shouldbe a top priority for participants as there are still some challenges whichneed to be addressed.
However, the upside isundeniably massive and with G20 pushing for a unified framework, participantscan certainly see themselves closer to overall financial stability.
Liquidity bridges have gradually morphed in tandem to the evolution of cross-borderpayments, mainly due to G20’scommitment to establishing a cross-border payment program.
As central banks ponderon whether to establish liquidity bridges, here are some highlights on theirbenefits and their challenges.
Bridges canbenefit participants due to how they are able to reduce their need of:
· Having multiplecollateral buffers in different jurisdictions and/or currencies
· Undertaking FXtransactions
· Having cash buffers
Consequently, this goesa long way in reducing transaction costs, associated settlement risks, and, ingeneral terms, the overall complexity or operations.
Moreover, given theadded flexibility they add, they help banks in terms of managing their intradayliquidity.
Accordingly, it iswithin the industry’s best interest to explore the realm of liquidity bridgesas they can certainly provide many benefits for payment service providers andbanks in terms of liquidity management while effectively lower costs ofcross-border payment services.
Right now, banks areeither forced to invest in liquid assets which can be used as collateral ormust hold foreign currency in either a foreign central bank or in theirrespective correspondent banks accounts.
And while the need tosource this liquidity might be rightfully seen as a serious credit risk, manymiss the opportunity cost it entails.
To further aggravate the problembanks usually overfund their payment obligations as a way ofmanaging their risk towards payments.
A liquidity bridge isable to take down costs while simultaneously releasing the participants’tied-up liquidity, meaning it will also be easier for banks to better allocatetheir collateral and manage their intraday needs.By not havingbridges, banks which operate in multiple different currencies will most likelybe required to hold a substantially larger pools throughout thejurisdictions they are operating in, something which also comes with higherfunding costs and the inevitable passing of costs to the end users and costhike on cross-border payments.
When compared to thealternatives, bridges’ settlement processes are much easier and theneed to counterparties and/or clearing entities is also lower.
Credit and settlementrisks can also be reduced or fully eliminated via liquidity bridges. As such, cross-borderpayments can be faster, cheaper, and, more importantly, see less friction.
Intraday liquidityrelies heavily on central banks provisions to domestic market participants.
With intraday paymentobligations in mind, a higher adoption rate for liquidity bridges can correlatewith a lower intraday settlement risk internationally.
Moreover, sincecollateral demands begin to stabilize so will asset volatility lower, adding tothe overall financial stability.
While there are highoperational costs, central banks which establish and operate liquidity bridgesmust also face other risks.
Risks can be dividedinto at least four distinct categories:
1. Entryrisks
2. Operationalrisks
3. Financialrisks
4. Systemicrisks
First and foremost, abridge can only be established in a place in which the bank is legallyauthorized to operate it.
If that jurisdictiondoes not provide a sound legal framework, the risk is inherently higher.
Moreover, the casebecomes increasingly harder when crafting a multilateral bridge as otherjurisdictions regulatory frameworks, legal agreements, technical costs ofimplementation, operational costs, and even currency volatility come into play.
Whether it’s abilateral or multilateral bridge, as interdependent as participants become, sodoes the systemic risk become higher.
Lastly, there are alsoemerging market risks and developing economy risks which should be accountedfor.
Liquidity bridges canmake banks and PSPs see their costs alleviated while driving down costssurrounding cross-border payments.
Risk management shouldbe a top priority for participants as there are still some challenges whichneed to be addressed.
However, the upside isundeniably massive and with G20 pushing for a unified framework, participantscan certainly see themselves closer to overall financial stability.
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