Blockchain proponents say the disruptive technology is worth the onboarding process. Among one of the loudest of these blockchain champions is Ripple, a FinTech firm that has recently secured millions of dollars in investments and strategic partnerships aimed at promoting blockchain technology’s use for traditionally friction-rich areas, like cross-border payments and real-time payments.
Last week, Ripple published a report outlining some of its boldest claims about the potential of distributed ledger technology, including that it could save banks money.
A lot of money, in fact, according to Ripple’s calculations.
We break down the company’s argument as presented in "The Cost-Cutting Case for Banks: The ROI of Using Ripple and XRP for Global Interbank Settlements."
A Bit Of Background
Ripple provides the infrastructure for blockchain-fueled cross-border payments in an effort to progress towards what the company calls the Internet of Value — a market in which money moves across borders securely and quickly, just like information moves throughout the Internet.
To achieve this, Ripple is placing its bets on XRP, a digital currency that the firm argues will be instrumental as a bridge asset to facilitate interbank transactions.
Collectively, Ripple’s solution surpasses a major portion of the bumpiness around contemporary cross-border payments: money moving between banks, each using their own, legacy systems, and each tacking on fees at each stop.
The company also pointed to the recent rise of the nostro account, an account owned by a financial institution in another country with funds held in local currency, used to facilitate cross-border settlement. While this can be a solution to some of the costs associated with cross-border payments, Ripple noted that many FIs cannot afford to maintain these accounts. It’s an error-prone process, the report added, with banks still handling the cost of compliance, payment processing and FX.
The Case For XRP
“For the first time, digital assets can enable real-time value exchange anywhere in the world, providing liquidity on demand and significantly reducing costs associated with treasury and payments operations, liquidity and Basel III compliance,” Ripple wrote.
For Ripple, XRP is the digital asset that operates on its infrastructure. It’s a currency that allows financial institutions to ditch the nostro account and instead keep XRP on their own balance sheets.
There are several cost-savings benefits to this, argued Ripple.
First, it means banks no longer have to keep a chunk of capital tied up in overseas accounts that require minimum balances. Banks can hold their local currency and keep just one account. Further, FIs need only enough XRP to facilitate a payment. Finally, this process cuts down the number of intermediaries at play when completing a cross-border payment.
And while other currencies, like USD and EUR, have also served as intermediary currencies, Ripple explained that not every bank has enough capital to pool their liquidity in these currencies.
Ripple outlines the various points at which FIs incur costs associated with conducting a cross-border payment.
The most obvious is foreign exchange, the cost to sell and buy another currency. But additional cost burdens can stem from currency hedging, treasury operations, liquidity, the cost of manual intervention in case of error and compliance, especially when it comes to Basel III.
The highest of these costs are treasury operations (what it costs to maintain account minimums and the overhead of managing currencies across accounts) and liquidity (“the cost of funds applies to the time-weighted average amount of capital lockup,” Ripple explained).
Across these areas, Ripple argues that banks can realize cost savings of up to 33 percent by using its technology.
When it comes to liquidity, the time that funds are stuck in transit is eliminated, leading to 65 percent less in liquidity costs.
Regarding payment operations, while banks will still continue to manage their local payment rails, using its technology can lead to a reduction in required staff traditionally needed for trade failures, leading to a 48 percent reduction in this area.
Finally, Ripple explained, Basel III rules designate sending-side banks to hold liquid assets against credit risk exposure while a payment is in transit (in flight). With Ripple, this cost is all but eliminated, cutting costs in this area by 99 percent.
For banks that process $12 billion worth of cross-border transactions every year, they can obtain a full return on investment in less than 15 months if they implement Ripple technology, the company said, estimating that the bank would spend $10 million to deploy the tool.
“Deployment costs for Ripple will vary depending on the bank size and infrastructure, but a bank’s associated savings accrue faster for a larger bank due to higher payment volumes, resulting in a comparable payback period to the model,” the company noted.
When it comes to using XRP as a bridge asset, FIs can save up to 99 percent on liquidity costs, considering they no longer have to maintain multiple nostro accounts. This also means that cash management and account maintenance can save FIs up to 74 percent, the company calculated.
There are some aspects that won’t change for banks, however. For instance, banks won’t see a change in payment operations cost by using XRP. But Ripple argued that its model accounts for FX volatility and hedging costs associated with hedging a volatile asset (XRP).
The Price Tag
What all of this amounts to is billions of dollars saved among financial institutions, Ripple argued. Liquidity and payment operations costs can drop by as much as $18 billion, and by using XRP, total savings can jump to $23 billion every year.
“As banks globally adopt Ripple and as liquidity costs are eliminated, there is a real possibility that the marginal cost of international transactions approaches zero,” the company concluded. “In the end, the exciting potential of the new technology lies not just in the cost savings banks can extract from the old system but the possibility to enable new models and businesses entirely.
“In the world of payments,” Ripple continued, “a technology solution like Ripple and XRP that creates unprecedented cost efficiency and global reach makes use cases, like global disbursements, international cash pooling, low-value remittances and even micropayments, not just possible but profitable.”