By Alex Knight, Head of EMEA, Baton Systems
It is tricky to think of another industry where speed and accuracy are of such paramount importance. It is, therefore, even harder to work out why the banking sector is still so reliant on slow, antiquated processes when it comes to payment reconciliations.
Next month marks five decades since midsized German bank Herstatt experienced a sudden collapse due to its involvement in risky FX speculation. The bank had received payments in various currencies from counterparties in different time zones, only to then fail to make corresponding payments in other currencies before it was closed down by rule makers.
The trouble is, fifty years on, the banking sector has ballooned in terms of its importance to the global economy. Many estimates place the banking sector at around 20-25% of the world economy (source: Research and Markets – Financial Services Global Market Report 2021: COVID-19 Impact and Recovery to 2030). Therefore, when stresses to the system emerge, the knock-on effects can be severe. When a globally systemically important bank like Credit Suisse is identified as facing liquidity challenges, as was the case last year, the prevalent use of outdated post-trade processes across capital markets, such as reconciling payments one or more days after settlement, can have serious ramifications. This means, if a full-blown crisis emerges, counterparties can’t determine how exposed they are, because they lack the critical information needed to identify which payments have been sent and received so far that day. A situation, like what happened to Credit Suisse and has also happened to smaller institutions, underscores the urgency for a significant shift towards real-time payment reconciliation systems. Failure to act doesn’t only jeopardise individual firms, but can also propagate systemic risk, leading to catastrophic consequences reminiscent of past financial crises.
When market speculation mounts into tangible threats of liquidity crunches, financial institutions naturally resort to safeguarding their interests. Payment controls are instituted to mitigate settlement risks, albeit in a fragmented and, in some cases, manual manner. This decentralised approach, often controlled at the individual business level, fosters inconsistencies, and could potentially introduce loopholes for errors, posing financial, operational, liquidity and reputational risks. Moreover, a lack of oversight could trigger future systemic instability, amplifying the gravity of the situation.
Central to the issue is the timeliness and accuracy of payment reconciliations. The existing practice of initiating the reconciliation processes only at the very end of each day (once the US dollar market is closed), leaves institutions operating in the dark regarding their exposure. This delay, while seemingly innocuous, can have dire implications – particularly in times of financial stress. The inability to ascertain real-time payment status not only undermines confidence but also perpetuates a cycle of uncertainty, compounding the risks for all parties involved. In certain scenarios, banks may hold all outgoing payments using their manual and fragmented controls. However, the dilemma lies in discerning which payments they’ve received from the counterparty throughout the day, hindering their ability to release funds appropriately. Without real-time reconciliation, firms may understandably take a cautionary approach and withhold outbound payments to the at-risk counterparty until reconciliation (generally delayed by at least a day, as outlined above) confirms which ones are safe to proceed with.
In addressing this pressing, and frankly longstanding, concern, the imperative is clear: real-time payment insight is non-negotiable. The convergence of business, risk, treasury, and operations necessitates a seamless flow of information, devoid of manual interventions and time lags. By embracing automated, real-time reconciliation processes, institutions can empower decision-makers with the information needed to navigate turbulent waters confidently.
Imagine a scenario where payment reconciliations occur seamlessly and continuously throughout the day. Armed with real-time information, institutions can accurately assess their exposure and make informed decisions regarding the release of outbound payments. This proactive approach not only averts potential defaults but also fosters market stability by honouring commitments and mitigating systemic risks. However, achieving this transformation requires a departure from complacency. The notion of ‘if it isn’t broke, don’t fix it’ is no longer tenable in a fast-moving and inter-connected banking world marred by uncertainties. Financial institutions must acknowledge the inherent flaws in outdated processes and embrace technological advancements to stay ahead of the curve.
Ultimately, the need for real-time payment reconciliations transcends mere operational efficiency — it is a matter of systemic and regulatory resilience. By prioritising the adoption of automated, real-time reconciliation systems, financial institutions can fulfil their obligations, mitigate risks, and contribute to a more stable and orderly market. The time for action is now; the stakes are too high to delay.
