The benefits for corporates are clear in terms of price and speed. Corporates will also appreciate the elimination of settlement risk. Further, Ripple uses industry standard ISO and MT messaging, and because participants are both directly and multilaterally connected there is no loss of corporate data in the payment messages. Known fees and complete messages make for much higher auto reconciliation rates.

Unlike some other fintechs, Ripple is bank centric. Banks, rather than their customers, connect to the Ripple network. This has two big benefits. First, customers are used to trusting banks – which is better than having to get comfortable with entrusting your money to some fintech you have never heard of. Second, regulators are comfortable with banks – which means they will not pull the plug on Ripple as they might with non-bank fintechs.

Ripple technology

Although Ripple is also a blockchain company, and has its own currency code XRP, the cross-border payments are using a subset of blockchain technology. Ripple uses the consensual validation of encrypted hashes to secure the messages across the Ripple network, but does not hold the ledger. Ripple calls this Inter Ledger Protocol (ILP) and they have open sourced it to public domain.

ILP allows Ripple to connect existing bank ledgers. This lowers barriers to entry. In effect, banks connect their core systems to the Ripple network – analogous to how they currently connect their core systems to the SWIFT network.

Ripple process

Although it happens within seconds, the Ripple process is holistic, including rich information exchange, liquidity provision and currency conversion. By contrast, the traditional method provides minimal information, liquidity through correspondents, and no conversion (and takes hours or days, and costs more).

Instead of using fixed correspondents, Ripple implements an automated instant auction for liquidity provision and FX, thus assuring best price execution. Banks can restrict their requests for quotation to counterparties matching specific requirements like rating and regulatory standing. KYC and AML compliance is of course covered.

From a corporate treasury perspective, this is analogous to using an eFX platform to get quotes from multiple banks (except that it is purely bank to bank).

There are four key stages:

Get quote: the originating bank sends out a request for quotation across the Ripple network for the payment in question. Quotes received in reply include FX rates and fees as well as compliance requirements. Accept quote: the originating bank accepts the best quote for which they can meet the compliance requirements. The beneficiary bank can then lock the quote. At this point Ripple blocks funds in the two banks’ ledgers – something like a sub second escrow arrangement (without transfer of title at this point). Submit sending payment: the originating bank transfers the funds out of the payer’s account and through ILP to the FX or beneficiary bank. Submit receiving payment: the beneficiary bank confirms that funds have been credited to the beneficiary’s account.

The submit receiving payment signifies that funds have been credited to the beneficiary’s account. All of this happens within one or two seconds. As noted above, this is both more holistic and less complicated than the current process, not to mention much faster and cheaper.

GPII

In response to the challenge from Ripple, SWIFT have launched their Global Payments Innovation Initiative (GPII). Leveraging the current SWIFT messaging and correspondent banking that are the backbone of old cross-border payments, GPII is basically a set of rules to commit banks to behave more reasonably in cross-border payments, supported by payment tracking and data to monitor adherence to these new rules.

The rules are encapsulated in the service level agreement (SLA) that banks must sign to join GPII. This SLA discourages banks from float (theft of value days), opaque charging and delays.

To support this SLA, SWIFT have built an “observer” system so that partner banks can monitor the SLA compliance of their partners across the system.

To entertain the payment originators, SWIFT have developed a payment tracker, on which the payment’s progress can be viewed in near real time. This will be white labelled by banks for their clients.

The SLA is essentially a commercial challenge for banks. The increased transparency will limit their rent extraction (some banks’ internal processes may be so weak that they genuinely have trouble complying with the SLA, but most corporate cash management banks can do same day reasonably priced cross-border payments when they want to).

The tracker is more of a technical problem. First, some banks may have difficulty tracking payments through their systems at all. Second, it requires the creative use of MT199 free format messages to achieve the requisite updates (trade for corporates similarly uses MT798 free format messages to send L/C related messages). Although it is notionally good old-fashioned SWIFT messaging (MT was designed for telex in the 1970s), implementation is akin to a new system.

SWIFT’s 10,000 bank members would appear to give GPII a big head start, it is far from clear how many banks will end up joining GPII. The take up rate amongst banks for SWIFT for Corporates has been agonisingly slow; ditto for trade.

Ripple vs GPII

It should be clear by now that Ripple offers a faster, cheaper and more complete process. The inclusion of FX gets customers away from the exorbitant “board rates” that banks currently apply for cross-border payments. The auction process will result in better rates and fees for both banks and their customers.