The new boundary between publicly and privately provided payments systems and the role of collateral may be changing. Recent technological developments have made it feasible for markets and policymakers to contemplate abolishing physical cash and replacing it with electronic alternatives like digital tokens.
This paper focuses on two concepts: (i) privacy provision that results in increased awareness of and concern with problems of privacy in payments systems; and (ii) payment latency, and how the new fintech world is likely to result in reduced counterparty and interest rate risk for corporate treasurer. The paper ties these issues from the lens of collateral, especially the analogy of collateral reuse and digital tokens.
Corporate treasurers: counterparty risks and accurate ledgers
Corporate treasurers face a calculation that is not widely discussed: they must manage cash balances that far exceed the limits of deposit insurance, such as FDIC insurance in the United States (and similar insurance limits in other countries). Consequently, corporate treasurers must do something that few retail depositors have even thought about doing since the 1930s: good old- fashioned counterparty credit risk analysis on their deposit banks.
Most corporate treasurers are highly sophisticated on this very topic, even though this topic is barely discussed in the mainstream financial press. For example, owing to concerns about the creditworthiness of European banks, by the early 2010s some of the largest and most sophisticated US companies had already transferred their European cash deposits to US money market funds and swapped back them to euros via the FX swaps market.
The connection between the repo market and corporate payments isn’t obvious, and very little has been written about it. However, the two are highly intertwined. The primary job of the financial sector, after all, is to intermediate transactions between nonfinancial businesses, and, indeed, national statistics (such as the Federal Reserve’s Z.1 data) confirm that the financial sector’s aggregate balance sheet is not bigger than that of the nonfinancial sector.
The problem is that a significant quantity of US dollar liabilities has accumulated offshore (outside of the US banking system) and it’s impossible to measure the size of these US dollar liabilities accurately. One possible way to gauge it is to measure the collateral backing these US dollar exposures in the repo market, which is where this collateral changes hand. Yet, owing to rehypothecation and other collateral re-use practices, the true magnitude of the offshore US dollar-based credit exposures cannot be measured accurately in this manner either; accurate ledgers via DLT will bring transparency.
Role of collateral
In the near future, privacy provision and reduced payment latency costs will be the two key arguments that will incentive the issuance and use of digital tokens by the private and public sector. It remains to be seen which of the several avenues — CBDC, private digital currency or stablecoin, decentralized crypto — will dominate.
Silo-ing more collateral will matter especially amidst (and post) COVID, both central bank balance sheet and bank balance sheets are inundated with reserves and deposits, respectively, a by-product of the asset purchase programs in advanced countries (US, Eurozone, etc). Underlying economics would favour issuing such tokens in lieu of the large central bank reserves and sizable bank deposits.
Such digital tokens will be usable by all economic agents in all of the “pipes” that underline market plumbing, thus akin to collateral reuse. This would improve market plumbing as tokens will be technologically more efficient and reusable like collateral. However, tokens by private vendors without bank charters would silo more collateral as they do not have access to bank deposits or central bank reserves.