Interbank Communication: a Ripple in the ocean?

Mees Vlasveld, Jeroen van Leeuwen, Jesse Koster

November 2018

Since the 1970’s there has been one dominant player in the world of interbank telecommunication: the Society for Worldwide Interbank Financial Telecommunications (SWIFT). The general public, however, is not familiar with this organization: simply searching for ‘SWIFT’ on Google gives more hits for the ‘Queen of Pop’ Taylor Swift and Suzuki’s subcompact automobile, than for SWIFT’s interbank messaging system. In our eyes unjustified, as SWIFT directs the transfer of nearly $5 trillion in worldwide payments per day according to the (US Department of the Treasury, 2006). We hear you thinking: how many zeros are that? In numbers: $5,000,000,000,000 or roughly the equivalent of 280 million Suzuki Swifts. SWIFT’s main task comprises the processing of global financial messaging, which is used by banks to carry out payments worldwide. Its current dominant market position is, however, under siege because new technological innovations make their network seem slow, expensive and opaque. The resulting shifts in customer demand (McKinsey, 2018) makes for a present-day challenge: will SWIFT be able to successfully transform itself and absorb these technological developments, to maintain its leading position in international payments? This blog provides an overview of how the current interbank communication network works, the challenges that it faces and whether the blockchain alternative poses a serious threat.

The Society for Worldwide Interbank Financial Telecommunications

SWIFT provides a secured exchange of financial information through messaging between international banks. Besides messaging, SWIFT provides other products and services such as anti-money laundering tools, which facilitate transactions and their integrity (Scott & Zachariadis, 2012). Banks are responsible for settling international payments via a clearinghouse, whereas SWIFT provides the network through which banks communicate (Kozolchyk, 1992). This communication system was introduced in 1973 replacing the telex (teleprinter communication) and it has since been the industry’s technological standard. SWIFT’s dominance can partly be attributed to the economies of scale (network effects) created by the widespread adoption, as currently, almost all banks utilize their product (Scott & Zachariadis, 2012).

Despite SWIFT’s dominant market position, there is a present-day debate that questions the capabilities of the organization. Not surprisingly, the decades-old "secure" messaging system has been a target for hacking attempts as it handles most of the world's payment messages. Criminals have long since attempted to interfere with SWIFT messages, to direct money transfers into their bank accounts. Recent examples are the $81 million cyber-heist in Bangladesh (Rodrigues & Shrivastava, 2018), the theft of $6 million from a Russian bank by unknown hackers (Stubbs, 2018) and a $12 million loot from an Ecuadorian bank (Bergin & Layne, 2016). Additionally, questions have arisen whether the current network of SWIFT is meeting the requirements of all stakeholders in the financial supply chain. Major corporations have repeatedly criticized SWIFT for the fact that their position in the system is disproportionate to their importance in the network (Scott & Zachariadis, 2012).

Apart from the issues regarding security and governance, SWIFT needs to keep up with technological change to maintain its dominant position. There is a constant pressure for innovation and a demand for state-of-the-art services from its large member base (Scott & Zachariadis, 2012). In order to meet its members’ requirements, SWIFT recently introduced a new telecommunication tool for global payments named Global Payment Initiative (GPI). This technology was introduced mainly to improve four aspects of its system: speed in global payments, traceability (payments can be traced real-time, as with parcel delivery), transparency (all fees and foreign exchange rates are transparently presented), and security regarding the information sent over the network (SWIFT, 2018).

Blockchain disruption

Although SWIFT attempts to improve its current system with GPI, it still lacks the transformational change compared with other recent technological innovations. One of these innovations is the blockchain technology. Telecommunication messages via SWIFT’s GPI generally still have to pass through multiple banks before reaching their final destination. This makes SWIFT payments relatively time-consuming, costly and causes a lack of transparency on how much money will arrive at the other end (McKinsey, 2016).

But how can the blockchain technology enhance the payments by banks and messaging between banks? The main advantages of blockchain for the financial sector are more transparency, enhanced security, and reduced costs. Blockchain makes transaction histories more transparent and easier to trace because of the single ledger that is used by all participants. Enhanced security is accomplished by the fact that transactions must be approved by all parties before they are recorded on the ledger, minimizing the risk of fraudulent transactions. Additionally, all information that is stored on one blockchain runs on a network of computers instead of one single server (e.g. of a specific bank). The combination of both characteristics makes the system itself unhackable. Ultimately, costs are reduced due to the speed of the transactions and by reducing the involvement of third parties, i.e. other banks. Transactions take place in seconds instead of hours or days (Ripple, 2018).

Ripple

Currently, the biggest challenger of the SWIFT network is the San Francisco-based company called Ripple. The goal of Ripple is not to replace the existing financial system or banks, but rather to offer a superior alternative for the current financial infrastructure (Arnold, 2018). As the CEO of Ripple Brad Garlinghouse (Bloomberg Markets, 2018) has stated: “We certainly want to see banks succeed in this new world order, and take advantage of these technologies.” Ripple has introduced three innovative products: xCurrent, xVia and xRapid, that will be described briefly below to illustrate the underlying technology of SWIFT’s competition.

xCurrent is a blockchain-based software program that enables banks to instantly settle cross-border payments with end-to-end tracking. Banks can message each other in real-time (back and forth) to confirm payment details before executing the transaction and confirm delivery once the payment settles (Ripple, 2018).

xVia is a visual payment interface designed to make the user experience xCurrent intuitively. This can be compared to the messaging system WhatsApp. WhatsApp provides the user a slick looking interface, although the app uses complex algorithms that bring messages from A to B.

Finally, xRapid is a liquidity solution for companies and financial institutions that conduct cross-border payments. Companies and financial institutions can swap assets, say currencies, in and out of the cryptocurrency XRP in order to move transactions faster through the xCurrent payment protocol. Another important advantage of this product is that it makes nostro accounts redundant. Nostro accounts are pre-funded foreign accounts of international banks that hold the local currency. Currently, these accounts are used to improve liquidity by lowering the risk for the transacting parties (McKinsey, 2016). Maintaining these accounts comes at a cost in terms of currency risk and the need for active treasury management as the accounts are dependent on trading volume. The balances in these accounts add up to around $5 trillion worldwide; money that is just sitting idle. xRapid takes away the need for these nostro accounts, thereby eliminating the associated costs. The potential cost reduction associated with Ripple’s products can be seen in figure 1 below. Banks that use xCurrent (Ripple) save on average 33% of their costs, while banks that use the combination of xCurrent and xRapid (Ripple + XRP) are expected to save between 42% -60% on average.

Figure 1. Long, M. (2016). Ripple and XRP Can Cut Banks’ Global Settlement Costs Up to 60 Percent.

In summary, the Ripple products offer a promising alternative to the existing financial infrastructure plus additional features. xCurrent constitutes a ‘direct attack’ on the current interbank communication network, while xVia and xRapid offer unique advantages in their own right. xVia makes products more user-friendly whereas xRapid enables faster, cheaper and more efficient cross-border payments.

SWIFT has acknowledged that its role in the payment system is under attack and its network has to adapt to modern age standards. Harry Newman, head of banking at SWIFT: “It is no secret that correspondent banking is a 1998 model and we are busy addressing that, bringing it to a 2018 model.”(Arnold, 2018). However, in terms of testing blockchain tools, SWIFT does not conceal its skepticism. Last year, SWIFT carried out a test with multiple banks that led to the conclusion that it would be difficult to achieve the required scale with a blockchain system.

SWIFT argues that blockchain solutions are far from mature in terms of scalability, compliance, and standardization (SWIFT, 2016). These new technologies are indeed still in an early stage of implementation and complications are to a large extent not yet addressed. SWIFT, however, should not underestimate the potential disruptiveness of the blockchain technology which is offered by companies like Ripple, as it could threaten SWIFT’s current market leader position. There are many examples of companies which were once market leaders that lost their dominant position because of the introduction of a breakthrough technology. Kodak is a salient example, as the company underestimated the disruptiveness of digital photography. Likewise, Nokia missed the introduction of the Smartphone technology. Simply ignoring or remaining skeptical regarding blockchain technology makes SWIFT vulnerable to a technology that may end its market leader position. Blockchain may be more than just a Ripple in the ocean.

Conclusion

“You don’t stop playing because you grow old, you get old because you stop playing.”
-- George Bernard Shaw.

Throughout the last decades, SWIFT has built an extensive telecommunication network in which all major international banks participate. With this network, it is the dominant player in the cross-border payment business and will it remain so for at least some years. Nonetheless, SWIFT’s existing cross-border payment infrastructure is far from perfect and it can be improved in terms of speed, costs, and security. Compared with the more streamlined and cost-efficient products of Ripple, SWIFT’s network seems fragile and outdated. If SWIFT fails to keep up with promising technological developments, it may lose its competitive edge and banks may replace SWIFT with the alternative blockchain technology. In this scenario, Ripple may establish a position in the cross-border payment business that is comparable to the one that SWIFT holds today.


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