In interviews with more than 50 banking and finance executives, Bain & Company found that in theory banks are well positioned to confront digital currency challenges, but the reality is more complicated
New York – July 15, 2016 – Compared with current payment systems, distributed ledgers offer distinct advantages that meet customer demands for a faster, cost effective and more reliable cross-border payment option. While the technology is still in its infancy, distributed ledgers offer the potential for profound improvements in the operation of the complex pipelines that make international payments possible. And, in the long-run, distributed ledgers may impact all forms of payments including domestic cards and automated clearing houses (bank-to-bank).
In interviews with more than 50 senior bankers, venture capitalists, technologists, international payment association executives and start-up CEOs, Bain & Company found most banks are not prepared to retain control of international payments – a battle for a market worth $150-200 billion today.
Bain’s research shows that in theory banks are well positioned to confront the changes triggered by the rise of distributed ledgers. In practice, however, the situation is more complicated. Regulatory and other hurdles may have forced most digital currency start-ups to partner with, rather than compete directly against, incumbent banks. Yet, most financial institutions remain in ‘experimentation mode,’ wary about the scalability of the technology, privacy issues associated with broadcasting commercially sensitive information about money flows, and the volatility and governance of non-fiat digital currencies. With such a large prize available, faster-moving, more committed banks stand to gain significant share.
“Change will not come easily for banks,” said Glen Williams, who leads Bain’s global payments sector and co-authored the report. “They recognize that distributed ledger technology has the potential to improve the speed, transparency and efficiency with which payments are made, but the current market structure gives them a powerful incentive to stay the course. About $300 trillion of transactions flow through these networks each year, creating significant revenues for banks. Further, network dynamics make it hard for alternatives to scale up: participants will not join a network until it has sufficient reach, but reach comes only from widespread participation.”
Banks’ initial responses to fast-moving developments in digital currency – appointing mid-level technology executives to industry consortia, participating in the conference circuit and running limited distributed ledger simulations – have left them flat-footed.
Lack of a clear path forward is particularly problematic for international payments and trade finance, where distributed ledgers have the greatest near-term potential for disruption.
By cutting the number of middlemen and enabling direct transactions between counterparties in international correspondent banking, distributed ledger solutions speed up transaction times. They also ensure that each participant has a complete view of its customer accounts and balances – the key building blocks of automated payment-tracking and notification tools. Finally, distributed ledgers may also significantly reduce costs, including the capital tied up in the correspondent banking network, and error rates.
Trade finance, although a smaller sector than international correspondent banking, exhibits many of the same characteristics. It generates roughly $23 billion of direct banking revenues worldwide, supports many broader transaction banking relationships and suffers from extensive friction points. For example, about 50 percent of banks’ costs for a letter of credit arises from manual document handling and checking, which creates delays, errors and expense. That opens the door to huge potential improvements from distributed ledgers, though commercial offerings capitalizing on that possibility are still in early stages.
“Despite hesitancy among many banks, we see evidence that companies are finding ways to overcome technical and adoption hurdles to avoid getting left behind,” said David Gunn, head of Bain’s payments team in Europe, the Middle East and Africa and the report’s co-author. “The wave of investment in digital currency start-ups clearly signals that payments channels are attracting a new degree of interest, and new competitors are changing customer expectations. Innovation is upon us, and doing nothing is not a viable option. Now is the time for banks to move from experimentation to action.”
In the longer term, as central banks gain comfort with the technologies, the impact zones will shift towards domestic payment systems – including cards and automated clearing houses (i.e. the ‘rails’ over which domestic banks exchange money today). This will impact all banks profoundly, not just those with significant cross-border business.
Editor’s Note: To schedule an interview with Mr. Gunn, please contact: Dan Pinkney at email@example.com or +1 646 562 8102
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