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How unlocking the potential of tokenised markets can help banks keep pace with the digital economy

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Giulia Secco is the Strategic Partnership & Ecosystem Manager at Fnality International.

 

In the aftermath of the 2008 financial crisis, a person or group of people operating under the pseudonym Satoshi Nakamoto created the first cryptocurrency, Bitcoin. Unlike government-issued currencies, the creators wanted Bitcoin to be operated peer-to-peer by its users in a decentralised fashion, meaning that no central authority, middleman or group would be needed to authenticate and validate the transactions.

To make this possible, Satoshi Nakamoto created a digital ledger which could distribute the currency: the so-called blockchain, which enabled the creation of an immutable recording of ‘blocks’ of transactions, validated in a distributed way by its own network participants (nodes). In the years since, many believe that this it is this technology that could truly revolutionise the financial sector.

Crypto enthusiasts believe that the decentralised blockchain architecture will help to address many current financial inefficiencies, for example by eliminating intermediaries (i.e., banks, custodians, clearinghouses, etc) which play an essential third-party guarantor role in the current centralised system, where ledgers of records are maintained by a central authority that validates transactions. By removing intermediaries, and so, single points of failure, the system gains in resiliency, whilst associated costs can be massively reduced.

Blockchain, also known as Digital Ledger Technology (DLT) – even if the 2 terms do not mean perfectly the same thing – can indeed revolutionise the way different economic agents cooperate enabling a faster, cheaper, reliable, and more transparent capital market infrastructure, which facilitates the building of a secure and reliable P2P global financial market. This can be achieved essentially thanks to the peer-to-peer nature of DLTs, by moving from the current status where settlements require several days to complete (T+), and where one party of the trade is highly exposed to the risk of the other party not fulfilling its liability, to the near-immediate final settlement of financial transactions (T0).

Today Bitcoin is no longer the only cryptocurrency in circulation. Aside from Ethereum, which is the second-largest cryptocurrency in terms of market capitalisation, there is a specific category known as “stablecoins”. As suggested by the name itself, stablecoins have been created with the intent to mitigate the typical volatility of cryptocurrencies, by linking their value to real assets or fiat currencies. The largest stablecoins’ price is usually designed to be pegged as closely as possible to 1-to-1 to the US dollar.

The speed of market acceptance of stablecoins has been remarkably quick, not only for the promise to reduce volatility and offer a more reliable cash-asset but also for providing a quick, cheap, and programmable payment leg able to support the trade of “tokens”, digital representation of values, good and services, based on blockchain.

Differently from what crypto enthusiasts believe, in our view, the future of Finance will not witness complete disintermediation in accessing capital markets and so, certain intermediaries, such as banks and custodians, won’t be disappearing altogether, but rather their role has to change considerably (if they don’t want to perish or even worst, be replaced by innovators).

Why is this? Why can the finance system not just adopt a stablecoin to pay and transfer money globally and instantly?It is because of customer protection. Many regulators and central banks around the globe have developed a deep understanding of this new technology and the growing demand for tokenised cash and assets, and they now recognise the benefits brought about by innovative technology adoption.

Just as an example, the Bank of England announced in April 2021 the introduction of a new omnibus account model that created an opportunity for innovative financial market infrastructures to access the Bank’s RTGS system in a new way. But they are also concerned about potential threats. The main one is around financial stability: if a very large stablecoin suffers from a loss of confidence leading to a stablecoin run that can have knock-on effects on the entire financial and economic system. Another major concern comes from the anonymity that stablecoins can guarantee, making them the ideal medium to facilitate illicit and criminal activities against anti-money laundering, tax compliance, and sanctions.

While stablecoin arrangements are under regulatory scrutiny and in order to be able to bring new payment solutions at scale they will need to be regulated, their role is now also better defined: based on the latest USA President’s Working Group on Financial Markets’ report, stablecoin issuers will need to be treated as depository institutions (aka, banks).

Most payments in the wholesale financial market between banks and other larger institutions are today conducted via central banks’ RTGS systems (real-time gross settlement) due to their zero-credit risk characteristic. Stablecoins however bear credit risk as funds/assets are usually held by commercial banks or other non-central bank entities. In order to replicate such a zero-credit risk payment facility on DLT, the idea of CBDC (Central Bank Digital Currency) has been brought up where central banks themselves issue tokens backed by central bank money.

Despite several POCs, and unlike in the retail space, no wholesale CBDC has yet gone live. We expect that some CBDCs – which are essentially a digital form of a country’s fiat currency, issued and regulated by the national central bank – will serve the retail domestic financial market bringing all the benefits that we have previously discussed (efficiency, resiliency, auditability, transparency). The reason for narrowing CBDCs to domestic markets only, in our view, is due to the significant collaboration required between jurisdictions for cross-border payments, from a technical, legal, and risk perspective.

We believe that the absence of any wholesale CBDC solution yet live indicates that public sector institutions will take advantage of private-sector innovations, like the ones that Fnality Global Payments aim to offer.

We believe that the current traditional financial system could be significantly improved through the introduction of a regulated distributed financial market infrastructure (dFMI), and the introduction of a cash-on-ledger solution with the credit risk characteristics of central bank money (in each national Fnality payment system funds are “backed” 1 – 1 with real fiat currency, kept in a bankruptcy-remote central bank account).

Fnality Global Payments will offer that harmonisation between jurisdictions needed to unlock the potential of tokenised financial markets: through the introduction of such a network of interoperable payments systems, a broad range of applications and platforms will be allowed to use balances held on each system, introducing near-instant settlements, effective intraday liquidity management, and a reduction of costly and inefficient intermediaries.

In association with technology analytics company FNA, we have estimated that for banks, this approach has the potential to reduce their intraday liquidity requirements by up to 70% (a recent Oliver Wyman report has suggested a potential annual saving of up to $75m per bank with an intraday liquidity reduction of just 25%. If the top 105 Tier 1 banks reduced their intraday liquidity requirements by this 25%, they could realise potential industry savings of $8 billion).

Such an approach will empower financial market participants to manage the entirety of their cash and collateral portfolio from a “single pool of liquidity”, solving today’s problems around the fragmentation of liquidity.

With tokenised assets and new exchanges being introduced at an increasing rate, the safe, effective, and regulated cash-on-ledger solution represents the third essential ingredient for this infrastructure. It cannot succeed without it.

The introduction of this on-chain payments leg will mean the full benefits of a tokenised marketplace can be realised. Without it, the cost of dealing with an inefficient legacy payment infrastructure simply doesn’t outweigh the benefits of a new approach.

But with it, traditional finance actors and the broader global economy can truly unlock the full potential of tokenised markets.

Banking

Is traditional business banking the best option for SME finance squeezes?

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Airto Vienola, CEO, AREX Markets 

The pressures facing business and personal finances alike have been well documented.

Stories are now starting to emerge about how smaller enterprises around the UK – which make up well over 90% of the companies in the country – are coping with that mounting stress. The picture starting to emerge suggests, not well.

Personal borrowing is bridging gaps in business books

One survey released recently suggested that one in five of the country’s small businesses have taken out personal loans by the business owner to try to cover gaps in their incomes and profit margins. A further 43% said they were considering doing the same. This rush to secure additional funds by any means may be understandable for businesses feeling the pinch, but it’s neither sustainable nor savvy. Many of these enterprises are already burdened with additional debt from the Covid relief scheme, and given rising interest rates, soaring energy costs and rising cost of goods, taking on additional debt is not an attractive prospect. Add to that the fact that rates from traditional business banking providers are proving steep, smaller enterprises could be forgiven for looking to personal means to shore up the balance sheet. A recent study from members of the Federation of Small Businesses found that one in five small businesses are struggling to find business lending rates under 11%. To help these companies to survive, something clearly has to give.

Not all Alt-Fi options are equal

Alternative finance services have been proliferating in recent times, and yet almost half of small business operators have concerns about pursuing this option, despite actively seeking additional funding support. Clarity over terms and conditions is an often-cited reason for this reticence, which is only natural when undertaking proper due diligence on financial lending. This is a wise choice, especially as it has become so easy for business owners to quickly and simply access new services through embedded finance services, just a few clicks away on existing digital accounting and bookkeeping services. Many of these are still not clear about any detailed fine print, lengthy contract terms or potentially high fees, and yet these too can look like accessible and viable options to business owners facing mounting financial issues.So, it can be hard to pick the right provider without a lot of research. Those wary of the long tail of taking on debt should be particularly careful when it comes to business Buy Now Pay Later or BNPL offers, which are currently entering the UK market, though that isn’t to say that other alternative financing services won’t suit their specific needs whilst mitigating fears over risk.

A fresh perspective on an established technique

So, if debt should not be an option, and embedded finance can have downsides, where should SMEs turn if they don’t want to kick the can of cashflow problems just a few months down the road? One area to reevaluate, which has seen a tremendous shift given the fresh thinking from alternative finance is invoice financing or spot factoring. No longer the imbalanced option of last resort it was traditionally perceived to be, the option has become much fairer to the SME, in addition to providing a swifter and more flexible alternative. In years gone by, invoice financing was the purview of the banks, which led to low rates of return for businesses looking to unlock the value in their organisation, and often much better value flowing back instead to the lender taking on the risk. This is no longer the case. Likewise, invoice financing earned a bad reputation among some for tying businesses into lengthy contracts – another area which current services in the market have since addressed. Our service for example allows businesses the flexibility to access cash back on just a single invoice of their choosing – which could be the difference for struggling SMEs between dipping into loss or keeping the lights on.

One answer to the late payments problem?

Perhaps the most important area which services like invoice financing assist is overdue invoices – the bane of the British SME. Barclays claimed earlier this year that over a quarter of SMEs are finding late payments to be on the increase, and this was an already notorious issue for many business owners. Estimates show that SMEs on average have £6500 in unpaid invoices at any given time. Financing these invoices ensures that the cashflow of these strapped SMEs is healthier, gets the money back into the business without the concerns of lengthy payment terms or endless chasing, and certainly in our case, has no impact on the relationship with the other organisation. Our platform acts as a marketplace between SME and likely investors, with extensive insight provided to make sure that those investing in the invoice are matched to the right businesses. We take on the intermediate risk – removing any suggestion or potential concerns around unwanted debt collection, for additional business owner peace of mind.

While the pressures may be mounting on the SMEs around the country, one thing is clear. No business should rush into making long term financial decisions simply as the cashflow is drying up. Any savvy business would be well advised to make sure they understand the implications, short and long term, of any lending solution they look to employ. However, knowing that there are options and the business’ bottom line does not simply have to rely on traditional banking services, should provide business owners with a lot more options at their disposal to help them to face the coming months with greater cash liquidity confidence.

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Banking

BANKING FOR BETTER 

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By Alex Kwiatkowski, Director of Global Financial Services, SAS.

From shifting market dynamics and mounting geopolitical tensions, to skyrocketing cyber threats and a worsening climate crisis, the world faces risk and uncertainty on many fronts.
But how are these and other prevailing trends reshaping the financial services sector?
A volatile landscape  
Describing the past few years as ‘volatile’ could be seen as a slight understatement, akin to saying the Titanic had a minor mishap at sea or that Liz Truss’s economic policy was mildly unorthodox. From the COVID-19 pandemic, Russia’s despicable invasion of Ukraine and the increasingly intense impacts of climate change, the resilience of not only businesses but whole nations has been pushed to breaking point.
In many ways, the banking sector has proven remarkably resilient to such challenges and risks. In the face of prolonged disruption, profitability remained higher than many had anticipated. However, the deeper structural challenges, such as digitalisation, the emergence of fintech disruptors, the brouhaha over crypto, and the growing threats associated with cyber attacks, are continuing to gather force as we head into a new year.
A recent Economist Impact survey, sponsored by SAS, found that while banking leaders are conscious of the imminent risks and those on the horizon, many are generally optimistic about how their organisations could be reshaped over the next decade, and beyond. I believe this optimism is well-founded rather than misguided, although pragmatism is required.

Alex Kwiatkowski

Digital transformation

For some years leading up to the COVID-19 pandemic, banks had been wrestling with exactly when and how to digitally transform. Like so many other industries, the chief legacy of the pandemic was to force rapid and wholesale change on a sector not always eager to embrace new ways of operating.
Traditional banks are now on track to be digitally transformed by the end of this decade, with technologies such as cloud computing and AI becoming industry norms. When considering the next three to five years, 57% agreed that digital transformation is among their top strategic priority. Cybersecurity and data protection (55%) are not far behind.
This focus on digital transformation is understandable, given the opportunities it may bring. Respondents from the Asia-Pacific region were the most excited, with 64% selecting it as among the greatest opportunities for their organisation. This was much higher than their counterparts in North America (52%), Latin America (50%) and Europe (50%). In fact, the tech-savviness among Asian consumers has created an opportunity for banks to leap ahead in delivering innovations compared with other regions.
When asked about the role of advanced data analytics in a successful digital transformation, just under half (48%) of executives selected this as the most important digital capability that their organisation must harness. It was the clear overall favourite, followed by blockchain (35%), AI/machine learning (34%), IoT/5G (33%) and robotic process automation (29%).
However, the survey also revealed a number of hurdles that may prevent the full uptake of data analytics, such as the increased risk of cyber attacks and a reliance on legacy technology systems. In addition, functions and departments working in silos was viewed as a potentially significant barrier, with 48% noting this as a “significant barrier” to change.
Purpose-driven banking
Alongside this goal of digital transformation, a growing consensus has emerged among banking leaders that the wellbeing of customers, communities, employees and the environment ought to be at the forefront of strategy.
Termed ‘purpose-driven banking’, this shift often encompasses ESG-related activities as well as a broader commitment to customer relationships over profits.
Purpose-driven banking has broad support among the industry’s leaders, with 82% of executives agreeing that financial services organisations can pursue profit and a better society at the same time. That sentiment is even more common among C-level executives, with 91% in agreement.
Arguably one of the most interesting results of the survey is the fact that 76% of respondents believe that the banking sector has an obligation to engage with and address societal issues. An even larger portion (81%) said that their bank takes responsibility for the social impacts of its activities.
Interestingly, a clear majority felt that the financial services industry is behind other sectors in terms of progress on ESG commitments. About three-quarters (76%) of C-level respondents said this, compared with 61% of all other executives.
Establishing transparent and measurable ESG goals aligned with corporate strategy is one area where leaders feel behind, with just 38% feeling that their organisation had achieved this. Another important aspect of the purpose-driven mindset is recognising how banks are fundamentally linked to other stakeholders in society. When asked which were the “most important groups for financial services organisations to engage with in order to have the most positive impact”, the technology industry, investors and customers were the top three choices. They were followed by consumers and government or policymakers.
Growing pressure from customers, communities and other external stakeholders are likely to influence the extent to which the banking sector embraces ESG practices, however it’s clear that the banking sector looks set to transform over the next decade. And transform it must.

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