Future of Payments

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How Central Banks Drive Innovation

  • Payments are the foundation of global trade and the digital economy, with much of the innovation coming from the private sector. 
  • However, central banks are now creating their own payment infrastructure and attempting to shape its future. 
  • Digital currencies, instant payments, and the artificial intelligence of central banks will become the key to revolutionizing the future of banking and business.

Payments form the cornerstone of global trade and the digital economy, with a significant portion of innovations originating from the private sector. Payments hold a central position in international trade and the global digital economy, which is undergoing rapid transformation. While much of the recent innovation in the payment sphere has emerged from the private sector, particularly in the form of cryptocurrencies, central banks are also developing their own versions of future payment infrastructure.Should these new infrastructures prove successful, they have the potential to profoundly alter the global economy, the state of trade, and the dynamics between the public and private sectors in the realm of payments. Below are three primary trends in central bank innovations that could exert the greatest influence on the payment sector.

1. Central Bank Digital Currencies

While the cryptocurrency industry undergoes a bearish period, central bank digital currencies (CBDCs) are starting to evolve – these are digital equivalents of paper money issued by a country's central bank. It is estimated that at least 65 countries are developing CBDCs.

China, the world's largest economy, has launched its own central bank digital currency. Since the People's Bank of China (PBOC) introduced the electronic or digital yuan in 2020, the volume of transactions using the digital yuan exceeded $13.9 billion as of August 31, 2022.More cities have begun paying government employees in digital yuan, and major Chinese banks and fintech companies have integrated the digital yuan into their platforms.

In addition to promoting domestic adoption, the People's Bank of China has established the BISIH (Bank for International Settlements Innovation Hub) Hong Kong Centre, collaborating with the Hong Kong Monetary Authority, the Bank of Thailand, and the Central Bank of the United Arab Emirates (UAE) to launch the mBridge project for cross-border operations using CBDCs. Within the mBridge project, actual transactions totaling $46 million have been processed, and the BIS Innovation Hub is also working with several other central banks on pilot projects related to CBDCs.

2. Instant Integration with Payment Systems

One of the major advantages of cryptocurrencies over existing payment systems is the ability to conduct instant transactions, especially for cross-border payments.

Central banks are keeping pace by not only experimenting with CBDCs but also creating and integrating instant and fast payment systems.

As of January 2023, 79 countries have instant payment systems in place. Singapore, Thailand, Malaysia, the Philippines, and Indonesia began establishing bilateral links for instant payment systems in April 2021.

In the Middle East, the Gulf Cooperation Council (GCC) countries established the Gulf Payments system in December 2016 to facilitate regional trade by linking the payment systems of GCC countries.

In Africa, the Pan-African Payment and Settlement System (PAPSS) was established in January 2022, unifying real-time settlement systems and gross settlement systems of African central banks, enabling intracontinental settlements in local currencies.

The BISIH Singapore launched the Nexus project in 2021 to connect multiple instant payment systems across different regions into a decentralized network with a standardized multilateral approach compared to bilateral connections.

Recently, India has been actively linking its Unified Payments Interface with major trading partners to enhance cross-border payments.

3. Artificial Intelligence in Central Bank Governance

Thanks to ChatGPT, artificial intelligence regularly makes headlines. Central banks also utilize AI for data collection and analysis.

AI proves particularly beneficial in combating financial crimes, as it can process vast amounts of information, reduce human errors, and operate around the clock.

Annual estimates suggest that money laundering accounts for 2 to 5% of the global Gross Domestic Product (GDP), and many money laundering-related crimes transcend borders.

Currently, financial institutions and in some countries, fintech companies bear the regulatory burden of identifying fraudulent transactions. Such an approach might lead to increased reporting and a higher number of false positives, slowing down transaction speeds and hindering legitimate operations.

Moreover, if compliance costs outweigh the benefits, regulated financial institutions might decide to withdraw from a country, resulting in 'de-risking,' consequently excluding specific groups from global trade.

How can central banks drive payment sector innovations?

Throughout its extensive history, payments have been an area where the public and private sectors closely collaborate, offering services that facilitate trade and ensure the health of the financial system.

The emergence of Bitcoin and other cryptocurrencies threatens to shift this balance towards the private sector. However, recent central bank innovations, such as CBDCs, could help reduce costs and increase the efficiency of cross-border payments if implemented across various countries. Such innovations have the potential to make fiat currencies comparable to cryptocurrencies in terms of transaction simplification.

Given the growing concern over global digital inequality and financial exclusion, there's a movement towards providing digital payments for free or at very low costs as a critical public infrastructure.

In this context, what services should central banks provide? Can central banks replace some players in the private sector in the payment sector? These questions warrant discussion as the industry continues to evolve rapidly.

For us as consumers, it's undeniable that innovations and competition often bring benefits, especially concerning payments.

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