## Privacy Provision, Payment Latency, and Role of Collateral (WP/20/148)

## Source details

**Canonical URL:** [Privacy Provision, Payment Latency, and Role of Collateral (WP/20/148)](https://www.imf.org/-/media/files/publications/wp/2020/english/wpiea2020148-print-pdf.pdf)

## Other formats

- [Markdown version](/-/media/files/publications/wp/2020/english/wpiea2020148-print-pdf.pdf.md)
- [Structured JSON version](/-/media/files/publications/wp/2020/english/wpiea2020148-print-pdf.pdf.json)

---

### I. Introduction
- Fintech defined as the convergence of artificial intelligence and big data, distributed computing, cryptography, the internet and mobile access.
- Two focal concepts:
  - Privacy provision: increased awareness of privacy problems in payment systems.
  - Payment latency: how fintech may reduce counterparty and interest rate risk for corporate treasurers.
- Paper links these themes through the lens of collateral, including analogy between collateral reuse and digital tokens.

### II. Privacy Provision
- Key observations:
  - Regulators contend cash privacy facilitates illegal activity; legitimate demand for privacy exists (protection from counterparties and third-party misuse of transaction information).
  - Technological and policy developments have increased public and policymaker concern about data security breaches and central banks’ ability to provide privacy protection.
- Types of private payment arrangements:
  - Cryptocurrencies (e.g., Bitcoin): operate as fiat-currency substitutes independent of outside authorities; provide no guarantee of redemption and therefore need not hold reserves.
  - Stable coins: payment media tied to existing units of account and backed to some degree by assets linked to those units of account (precious metals, fiat currencies); organizers resemble “narrow banks.”
- Stable-coin economics and risks:
  - Liability side: a liquid instrument that holders accept with low or slightly negative rates of interest.
  - Maintaining redemption requires holding liquid assets in sufficient quantity.
  - Profit opportunity from spread between returns on reserves and interest paid on the stable coin, potentially inducing fractional-reserve arrangements.
  - Critical governance questions: how much to hold, portfolio quality (risk and liquidity), and whether rehypothecation by custodians should be permitted.
- Historical regulatory response:
  - Banking charters imposed minimum reserve holdings and asset standards to correct under-provision of payment-system safety driven by public-good characteristics of payment systems.
- Libra (as described in source):
  - Focus on cross-border payments and remittances, denominated in a basket of currencies and backed by a portfolio of liquid assets.
  - April, 2020 white paper (described in source) focuses on single-currency stablecoins requiring sufficient reserves across multiple jurisdictions composed of short-term government securities (80 percent) that cannot be pledged (i.e., no reuse); and the rest in cash-equivalents (20 percent).
- CBDCs and private-sector interoperability:
  - Some CBDC proposals enable private entities to build interoperable payments applications using a common medium denominated in existing units of account.
  - Some proposals akin to granting authorized payments providers central bank accounts (central bank reserves as the electronic medium) in return for safety and interoperability standards.
  - CBDC development incentive: new payment methods might prefer tokens as reserves that are more convenient than central bank deposits and more liquid than existing bonds.
- Structural implications:
  - "CBDC for everyone (retail and wholesale) will structurally disintermediate the banking system."
  - Potential adverse impact on market plumbing as good securities are drained to the central bank balance sheet (Bindseil, 2020) — as stated in the source.

### III. Payment Latency
- Historical design:
  - Legacy systems optimized for delayed net settlement rather than RTGS because of past constraints on computer processing and data storage.
  - Systems aggregated and netted payments within correspondent banks and settled on a net basis with central banks, often processing in overnight batches and taking days to settle business payments.
  - Netting minimized total payments settled and allowed central bank balance sheets to remain a small fraction of system-wide money and credit outstanding.
- Core issue: who bears costs of delayed settlement?
  - Delayed settlement introduces time value (interest rate) risk and default (counterparty) risk.
  - Access restrictions to payment platforms create inefficiencies: nonfinancial businesses often shoulder expense of payment latency despite higher weighted average cost of capital, creating deadweight loss.
- Exogeneity of risks:
  - Counterparty and interest rate risks are introduced by delayed net settlement design, not inherent to payments.
  - Improved technology could enable instantaneous peer-to-peer settlement and eliminate these exogenously introduced risks.
  - Powerful incumbents may resist change because they capture rent from the status quo.
- Illustrative numerical example:
  - Global company with 1,000 different bank accounts.
  - Company is 100 percent equity-financed with a weighted average cost of capital of 15 percent.
  - Its cash-management bank has a weighted average cost of capital of 3 percent.
  - Pareto-optimal allocation: the bank (3 percent WACC) would bear cost of payment latency rather than the company (15 percent WACC).
  - Status quo: banks allocate finite credit exposure to higher-margin products; require companies to finance their own payment latency via “comfort deposits,” trapping cash.
  - Result: company finances payment delays with expensive capital (15 percent) instead of the bank’s cheaper capital (3 percent), creating deadweight loss and incentive for treasurers to seek RTGS solutions.
- Consequences and incentives:
  - Companies with higher cost of capital have greater incentives to use RTGS systems to minimize trapped cash and increase balance sheet velocity.
  - Faster settlement reduces intraday liquidity risks, especially for internationally active banks.

### Box 1 — Counterparty Risks and Accurate Ledgers
- Corporate treasurers—especially those moving money across borders—experience payment-system delays and counterparty risk acutely.
- Treasurers must manage cash balances that often exceed deposit insurance limits (e.g., FDIC in the United States), necessitating counterparty credit risk analysis on deposit banks.
- Example behavior: due to concerns about European banks’ creditworthiness, some large U.S. companies transferred European cash deposits to U.S. money market funds and swapped them back to euros via FX swaps by the early 2010s.
- The connection between the repo market and corporate payments is important yet under-discussed; the two markets are highly intertwined (as stated in the source).

### Corporate Treasurers and Future of Payment Systems (Section 2)
- Economic incentives:
  - Corporate treasurers have strong economic incentives to use RTGS for payments, especially if their company has a high weighted average cost of capital.
  - Status quo systems trap capital in bank accounts to fund payments between subsidiaries globally; speeding up settlement can free this capital.
  - Example: One mid-capitalisation technology company calculated that the benefit of speeding up payment settle—mint to same-day was US$200 million.
  - Corporate treasurers are likely to be early adopters of RTGS as alternatives gain momentum.
- Existing corporate behavior:
  - Multiple Fortune 500 companies have been using Bitcoin in small amounts since 2014, predominantly for transactions in countries without well-developed banking systems.
- Pathways to faster payments:
  - CBDC
  - bank-sponsored digital currency (such as Fnality or JPMCoin)
  - private stablecoin (such as Libra or Tether)
  - decentralised cryptocurrency (such as Bitcoin)
- As corporate payments migrate from heavily netted systems towards gross systems:
  - Banks will need to offer more efficient cash management services.
  - Non-banks (e.g., mobile network operators) will play a role.
- Principal open questions: which faster payment technology will dominate, and how fast will adoption occur?

### Role of Collateral and Policy Implications
- Offshore U.S. dollar liabilities:
  - A significant quantity of U.S. dollar liabilities has accumulated offshore (outside of the U.S. banking system), and it is impossible to measure the size of these U.S. dollar liabilities accurately.
- Collateral measurement and rehypothecation:
  - Measuring collateral backing U.S. dollar exposures in the repo market is incomplete due to rehypothecation and other collateral re-use practices; accurate ledgers via DLT will bring transparency.
- Liquidity dry-ups:
  - Periodic liquidity dry-ups in the repo and foreign exchange swap markets can produce shortages of U.S. dollar collateral that cause the U.S. dollar to spike, potentially triggering losses for businesses, financial institutions, and countries with short U.S. dollar positions.
  - Such episodes—beginning with the financial crisis in 2008 and subsequent instances—lead corporate treasurers to focus more closely on the counterparty risk of their banks.
- Near-term drivers for issuance and use of digital tokens:
  - privacy provision
  - reduced payment latency costs
- Tokens vs reserves/deposits:
  - Underlying economics could favour issuing digital tokens in lieu of large central bank reserves and sizable bank deposits, especially as central bank and bank balance sheets are inundated with reserves and deposits due to asset purchase programs in advanced countries (United States., Eurozone, etc).
  - Tokens would be usable by all economic agents across market plumbing “pipes,” functioning akin to collateral reuse and improving market plumbing because tokens will be technologically more efficient and reusable like collateral (Singh, 2011).
  - Tokens issued by private vendors without bank charters would silo more collateral because they do not have access to bank deposits or central bank reserves.
- Libra example reiterated:
  - Libra’s recent white paper (April 2020) suggests that their coins will be backed (about 80 percent) by very short-term government bonds (i.e., good collateral).

### Changes in Money Aggregates (Box 2)
- Monetary policy transmission:
  - New payments systems may represent a leakage in the transmission channels for monetary policy.
- Demand shifts and aggregates:
  - Demand for cash depends on alternatives to cash; movement from cash to banking services tends to reduce M0 as a portion of the money supply.
  - In jurisdictions where regulations require holding reserves one for one against e-moneys, movement from cash to e-money will have no effect on broader aggregates.
  - Movement from bank deposits to e-money will reduce broader monetary aggregates.
- Observations:
  - Observed reduction in the ratio of M0 to GDP in some countries likely related to moving away from cash to nonbank alternatives; these countries include Sweden, China, India, Russia, Bangladesh, Kenya, and Uganda.
  - The behaviour of broader money aggregates has not yet changed significantly, implying no big differences in regulation and reserve requirements between different money substitutes.
  - The “float” in the monetary system (e.g., mobile money) may become more important to estimate than the gross and net concepts historically used.

*IMF Working Paper WP/20/148 (Prepared by Charles Kahn, Caitlin Long, and Manmohan Singh; Authorized for distribution by Jihad Alwazir; July 2020).*

### Section 1

### Privacy Provision, Payment Latency, and Role of Collateral (WP/20/148) — Section 1

### I. Introduction
- Fintech—defined as the convergence of artificial intelligence and big data, distributed computing, cryptography, the internet and mobile access—has produced new payment-system applications and raised questions about the boundary between publicly and privately provided payment systems.
- Two focal concepts:
  - Privacy provision: increased awareness of privacy problems in payment systems.
  - Payment latency: how fintech may reduce counterparty and interest rate risk for corporate treasurers.
- The paper ties these themes through the lens of collateral, including the analogy between collateral reuse and digital tokens.

### II. Privacy Provision
- Key observations:
  - Regulators argue that cash privacy facilitates illegal activity; however, legitimate demand for privacy exists, including protection from counterparties and third-party misuse of transaction information.
  - Technological and policy developments have increased public and policymaker concern about data security breaches and central banks’ ability to provide privacy protection.
- Types of private payment arrangements discussed:
  - Cryptocurrencies (e.g., Bitcoin): designed to operate as a fiat currency independent of outside authorities; provide no guarantee of redemption and therefore need not hold reserves.
  - Stable coins: payment media tied to existing units of account and backed to some degree by assets linked to those units of account (precious metals, fiat currencies); organizers resemble “narrow banks.”
- Stable-coin economics and risks:
  - On the liability side: a liquid instrument that holders accept with low or slightly negative rates of interest.
  - To maintain redemption promises, stable-coin providers must hold liquid assets in sufficient quantity.
  - Profit opportunity arises from the spread between returns on reserves and interest paid on the stable coin, potentially inducing fractional-reserve arrangements.
  - Critical governance questions: how much to hold, portfolio quality in terms of risk and liquidity, and whether rehypothecation by custodians should be permitted.
- Historical regulatory response:
  - Banking charters imposed minimum reserve holdings and asset standards to correct under-provision of payment-system safety driven by public-good characteristics of payment systems.
- Libra case and related design features (as described in source):
  - Libra’s proposal focuses on cross-border payments and remittances, denominated in a basket of currencies and backed by a portfolio of liquid assets.
  - Libra’s April, 2020 white paper (described in the source) focuses on single-currency stablecoins requiring sufficient reserves across multiple jurisdictions composed of short-term government securities (80 percent) that cannot be pledged (i.e., no reuse); and the rest in cash-equivalents (20 percent).
- Central bank digital currencies (CBDCs) and private-sector interoperability:
  - Some CBDC proposals envisage a technology that enables private entities to build interoperable payments applications using a common medium denominated in existing units of account.
  - Some proposals for CBDC are akin to granting authorized payments providers central bank accounts (central bank reserves as the electronic medium) in return for safety and interoperability standards.
  - CBDC development incentive: new payment methods might prefer tokens as reserves that are more convenient than central bank deposits and more liquid than existing bonds.
- Structural implications:
  - "CBDC for everyone (retail and wholesale) will structurally disintermediate the banking system."
  - Potential adverse impact on market plumbing as good securities are drained to the central bank balance sheet (Bindseil, 2020) — as stated in the source.

### III. Payment Latency
- Historical design:
  - Legacy payment systems were designed for delayed net settlement rather than RTGS due to past constraints on computer processing and data storage.
  - Systems aggregated and netted payments within correspondent banks and settled on a net basis with central banks, often processing in overnight batches and taking days to settle business payments.
  - Netting minimized total payments settled and allowed central bank balance sheets to remain a small fraction of system-wide money and credit outstanding.
- Core issue: Who bears costs of delayed settlement?
  - When payments do not settle instantly, someone bears risk of unsettled payment: time value (interest rate risk) and default (counterparty risk).
  - Access restrictions to payment platforms create inefficiencies: nonfinancial businesses often shoulder the expense of payment latency despite higher weighted average cost of capital compared with financial firms—an economic inefficiency (deadweight loss).
- Exogeneity of risks:
  - Counterparty and interest rate risks are not inherent to payments but are introduced by the delayed net settlement design of legacy systems.
  - Improved technology (low payment-system costs) could enable instantaneous peer-to-peer settlement and eliminate these exogenously introduced risks.
  - Powerful incumbents may resist change because they capture rent from the status quo.
- Illustrative numerical example (from source):
  - Global company with 1,000 different bank accounts.
  - Company is 100 percent equity-financed with a weighted average cost of capital of 15 percent.
  - Its cash-management bank has a weighted average cost of capital of 3 percent.
  - In a pareto-optimal allocation, the bank (3 percent WACC) would bear cost of payment latency rather than the company (15 percent WACC).
  - Status quo incentives lead banks to allocate finite credit exposure to higher-margin products; banks require companies to finance their own payment latency via “comfort deposits,” trapping cash.
  - This practice forces the company to finance payment delays with expensive capital (15 percent) instead of the bank’s cheaper capital (3 percent), creating deadweight loss and incentive for treasurers to seek RTGS solutions.
- Consequences and incentives:
  - Companies with higher cost of capital have greater incentives to use RTGS systems to minimize trapped cash and increase balance sheet velocity.
  - Faster settlement reduces intraday liquidity risks, especially for internationally active banks.

### Box 1 — Counterparty Risks and Accurate Ledgers
- Corporate treasurers—especially those moving money across borders—experience payment-system delays and counterparty risk acutely.
- Corporate treasurers must manage cash balances that often exceed deposit insurance limits (e.g., FDIC in the United States), necessitating counterparty credit risk analysis on deposit banks.
- Example behavior: due to concerns about European banks’ creditworthiness, some large U.S. companies transferred European cash deposits to U.S. money market funds and swapped them back to euros via FX swaps by the early 2010s.
- The connection between the repo market and corporate payments is important yet under-discussed; the two markets are highly intertwined (as stated in the source).

*IMF Working Paper WP/20/148 (Prepared by Charles Kahn, Caitlin Long, and Manmohan Singh; Authorized for distribution by Jihad Alwazir; July 2020).*

### Section 2

### Section 2

### Corporate Treasurers and Future of Payment Systems
- Corporate treasurers have strong economic incentives to use RTGS for payments, especially if their company has a high weighted average cost of capital.
- Status quo systems trap capital in bank accounts to fund payments between subsidiaries globally; speeding up settlement can free this capital.
- Example: One mid-capitalisation technology company calculated that the benefit of speeding up payment settle—mint to same-day was US$200 million.
- Corporate treasurers are likely to be early adopters of RTGS as alternatives gain momentum.
- Multiple Fortune 500 companies have been using Bitcoin in small amounts since 2014, predominantly for transactions in countries without well-developed banking systems.
- The switch to faster payments may take many forms:
  - CBDC
  - bank-sponsored digital currency (such as Fnality or JPMCoin)
  - private stablecoin (such as Libra or Tether)
  - decentralised cryptocurrency (such as Bitcoin)
- As corporate payments migrate from heavily netted systems towards gross systems:
  - Banks will need to offer more efficient cash management services.
  - Non-banks (e.g., mobile network operators) will play a role.
- The principal questions: which faster payment technology will dominate, and how fast will adoption occur?

### Role of Collateral and Some Policy Implications
- A significant quantity of U.S. dollar liabilities has accumulated offshore (outside of the U.S. banking system), and it is impossible to measure the size of these U.S. dollar liabilities accurately.
- Measuring collateral backing U.S. dollar exposures in the repo market is incomplete due to rehypothecation and other collateral re-use practices; accurate ledgers via DLT will bring transparency.
- Periodic liquidity dry-ups in the repo and foreign exchange swap markets can produce shortages of U.S. dollar collateral that cause the U.S. dollar to spike, potentially triggering losses for businesses, financial institutions, and countries with short U.S. dollar positions.
- Such episodes—beginning with the financial crisis in 2008 and subsequent instances—lead corporate treasurers to focus more closely on the counterparty risk of their banks.
- Near-term drivers for issuance and use of digital tokens by private and public sectors:
  - privacy provision
  - reduced payment latency costs
- Underlying economics could favour issuing digital tokens in lieu of large central bank reserves and sizable bank deposits, especially as central bank and bank balance sheets are inundated with reserves and deposits due to asset purchase programs in advanced countries (United States., Eurozone, etc).
- Tokens would be usable by all economic agents across market plumbing “pipes,” functioning akin to collateral reuse and improving market plumbing because tokens will be technologically more efficient and reusable like collateral (Singh, 2011).
- Tokens issued by private vendors without bank charters would silo more collateral because they do not have access to bank deposits or central bank reserves.
- Libra example: Libra’s recent white paper (April 2020) suggests that their coins will be backed (about 80 percent) by very short-term government bonds (i.e., good collateral).

### Changes in Money Aggregates (Box 2)
- New payments systems may represent a leakage in the transmission channels for monetary policy.
- Demand for cash depends on alternatives to cash; movement from cash to banking services tends to reduce M0 as a portion of the money supply.
- In jurisdictions where regulations require holding reserves one for one against e-moneys, movement from cash to e-money will have no effect on broader aggregates.
- Movement from bank deposits to e-money will reduce broader monetary aggregates.
- Observed reduction in the ratio of M0 to GDP in some countries likely related to moving away from cash to nonbank alternatives; these countries include Sweden, China, India, Russia, Bangladesh, Kenya, and Uganda.
- The behaviour of broader money aggregates has not yet changed significantly, implying no big differences in regulation and reserve requirements between different money substitutes.
- The “float” in the monetary system (e.g., mobile money) may become more important to estimate than the gross and net concepts historically used.

*Source: wpiea2020148-print-pdf - Section 2*

---


_Source: https://www.imf.org/-/media/files/publications/wp/2020/english/wpiea2020148-print-pdf.pdf_