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Operational liquidity optimization
Financial institutions require significant liquidity to ensure efficient operations in a regulatory compliant manner. Operational friction such as settlement timing, market fragmentation and other issues require a level of liquidity “working capital” that is expensive to fund. DLT has the potential to significantly reduce these frictions and their associated liquidity requirements.
For example, to facilitate gross intraday settlement activity, treasurers are often required to maintain intraday liquidity and pay for intraday credit lines. This has an impact on the financial institution’s profitability and ability to raise funding during stressed market conditions.
DLT-based intraday liquidity solutions, such as intraday repos, and real-time collateral and FX swaps, offer access to liquidity with transactions that settle instantaneously or within minutes using smart contracts. DLT enables this liquidity to be used for shorter time periods than traditional solutions. For example, using a DLT solution a treasurer may be able to borrow intraday liquidity for 30 minutes if that is all it’s needed for. This allows financial institutions to decrease their reliance on their intraday liquidity buffers and credit lines, minimizing funding costs. These DLT-based solutions also offer additional benefits, such as programmable trade terms that increase control and reduce counterparty risk, real-time transparency of trade lifecycle and collateral ownership, automated settlement and maturity of trades and liquidity for assets previously unavailable to be used as collateral. While in the current regulatory environment most solutions are offered leveraging private blockchains or private versions of public blockchains, the long-term solutions could leverage liquidity over public infrastructure.
For global institutions, the need to hold liquidity in multiple entities and geographic regions may be reduced by using DLT-based solutions. For example, some global banks have tokenized cash and implemented a global centralized intercompany liquidity pool that allows liquidity to be transferred on an intercompany basis instantaneously around the clock, reducing entity level liquidity requirements. This may significantly reduce liquidity costs and allow current processes to be simplified and optimized in a regulatory-friendly manner.
Another key area of opportunity DLT provides to treasurers is in payments. Blockchain-based payments can be made instantly on a global basis, removing costs and friction associated with traditional payment rails. Importantly, while a common area of concern with blockchain or crypto-based payments is anti-money laundering (AML) and fraud, these payments have a built-in audit trail and traceability since all transactions are recorded on the blockchain. In addition, DLT-based payments can be programmed to address other needs. For example, a tokenized bond could be programmed to make its own principal and interest payments. Similarly, a payment for services could be programmed to make a required tax payment.
The launch of stablecoins by established financial institutions and higher adoption of public-permissioned infrastructure opens the door for broad adoption of blockchain-based payment solutions for financial institutions.