Future of payments: How central banks are driving innovation

Payments are the backbone to the global trade and the digital economy with many innovations coming out of the private sector.

Payments serve as the backbone of international trade and the global digital economy and have been revolutionizing rapidly.

While many recent payments innovations came out of private sectors, most notably in the form of cryptocurrencies, central banks are racing to build the future of payments infrastructures with their own versions.

If successful, those new infrastructures may fundamentally change the landscape of global economy and trade, as well as how public and private sectors work with one another in payments space.

Here are three key trends of central bank innovations that could generate the biggest impacts in the payments space.

While the cryptocurrency industry hits its winter, central bank digital currencies, or CBDCs – which are digital equivalents of a country’s fiat currency issued by a country’s central bank – are starting to blossom. At least 65 countries are thought to be in advanced stages of CBDC development.

China is by far the largest world economy that has launched its own central bank digital currency. Since People’s Bank of China (PBoC) introduced e-CNY or digital yuan in 2020, transaction volume in e-CNY has surpassed US$13.9 billion as of August 31, 2022.

An increasing amount of Chinese cities started to pay their public service employees in e-CNY, and major Chinese banks and fintechs have incorporated e-CNY into their platforms.

In addition to driving domestic adoptions, the People’s Bank of China also partnered with the Bank for International Settlements Innovation Hub (BISIH) Hong Kong Centre, the Hong Kong Monetary Authority, the Bank of Thailand and the Central Bank of the United Arab Emirates (UAE) to launch Project mBridge to conduct cross-border transactions via CBDC.

A total value of $46 million of real-life transactions were conducted through Project mBridge. BIS Innovation Hubs are also working with several other central banks to undertake other CBDC-related pilots.

One of the biggest advantages of cryptocurrencies compared to existing payment systems is their abilities to conduct instant transactions, particularly for cross-border payments.

Central banks are catching up not only through experimenting with CBDCs but also establishing and connecting instant or fast payment systems.

As of January 2023, there are 79 countries that have in place instant payment systems. Singapore, Thailand, Malaysia, the Philippines and Indonesia have started to connect their instant payment systems bilaterally since April 2021.

In the Middle East, Gulf Cooperation Council (GCC) countries established Gulf Payments Company in December 2016 to connect GCC payment and settlement systems for promoting regional trade.

And in Africa, the Pan-African Payment and Settlement System (PAPSS) was established in January 2022 to connect real-time gross settlement systems of African central banks to allow intra-continental trades to be settled in local currencies.

BISIH Singapore Centre launched Project Nexus in 2021 that interlink multiple instant payment systems across regions on a distributed network through a standardized and multilateral approach, in comparison to a bilateral approach.

Most recently, India is aggressively connecting its Unified Payment Interface with its major trading partners to improve cross-border payments.

Thanks to ChatGPT, AI is now in the headlines nearly every day. Central banks are also employing AI for information gathering and data analyses.

AI is particularly helpful when it comes to helping combat financial crimes as it can process large amount of information, reduce human error and work around the clock.

The annual volume of money laundering is estimated to represent between 2% to 5% of global gross domestic product (GDP), with most money laundering crimes being cross-border by nature.

At present, financial institutions – and, in some countries, fintechs – bear the regulatory burden of catching illicit transactions. Such an approach could lead to overreporting and create a lot of false positive information, reduce the speed of payments or block legitimate transactions.

Furthermore, when compliance costs do not cover profits, regulated financial entities would opt to leave a country, which results in the issue of “de-risking” and hence excluding certain population from global trade.

BISIH Nordic Centre has launched Project Aurora to assist central banks in detecting financial crimes through leveraging AI, along with other technologies, to improve the efficiency of financial crime data analytics.

For a very long history, payments have been a space where both the public and private sectors work together closely to provide services to facilitate trade and to ensure the integrity of the financial systems.

The emergence of bitcoin and other cryptocurrencies threatens to tilt the balance towards private sectors. However, the latest central bank innovations such as CBDCs, if deployed large scale across countries, could potentially help lower costs and improve efficiency for cross-border payments.

Those innovations could potentially make fiat competitive in comparison to their crypto counterparts, when it comes to facilitating transactions.

Amid ongoing concern about the global digital divide and financial exclusion, there have been more and more conversations around offering digital payments as a basic public infrastructure – either free or at extremely low costs.

In this light, what services should central bank offer? Will central banks crowd out some private sectors in the payments space? Those are questions worth a debate as the wider industry continues to rapidly innovate.

One thing we know for sure as consumers is that innovations and competition are often a good thing, particularly when it comes to payments.