Foreign Exchange Transactions Take Center Stage in New BIS CBDC Report

A six-week pilot project to evaluate whether central bank digital currencies (CBDC) would be useful for foreign exchange transfers successfully had 20 different commercial banks conduct over 160 payments worth around a total of $22 million, the Bank for International Settlements (BIS) revealed in a report Wednesday.

Central banks – based in Hong Kong, China, the United Arab Emirates and Thailand – issued over $12 million on the platform, allowing the commercial banks to conduct payment and foreign exchange payment versus payment transactions (PvP), the report said. The pilot was part of BIS's ongoing Project mBridge, a collaboration between the international financial institution and the central banks of those four nations that is studying CBDCs and their possible role in cross-border payments and multi-CBDC transactions.

The group hinted at the trial in a brief LinkedIn post published last month, but only shared full details ahead of next week's Hong Kong Fintech Week conference.

Read more: Landmark International CBDC Test Deemed Success, BIS Says

Liquidity was one key concern for the banks involved, the report said.

"One important observation is the limited number of FX PvP transactions which were conducted during the pilot compared with one-way payments," the report said. "This reflected in part the relatively short window of time banks had to off-load their foreign CBDCs due to the requirement set by some central banks to clear balances of their CBDCs at the end of the day, along with the limited overlapping RTGS [real-time gross settlement] hours between the four jurisdictions."

According to the document published Wednesday, one issue the banks found was that the on-bridge transactions lacked "an efficient FX price-discovery mechanism." The FX rates were instead determined off-bridge, before the transactions occurred, which led to the banks needing to tap preexisting balances in nostro accounts rather than using mBridge itself.

"Given the need to rely on existing correspondent banking relationships for liquidity, the real-value nature of transactions and the short time span of the pilot, transactions took place, for the most part, between banks with pre-existing business and service relationships," the report said.

The group recommended integrating functions to address liquidity concerns in future tests.

Much of the report delves into how the pilot was actually set up, saying it "required extensive coordination and engagement both within and among central banks and commercial banks."

The banks also used a centralized version of the mBridge ledger for the purposes of the pilot, the report said. The group plans to look at "further distributing the deployment and operations" in future pilot programs.

The pilot itself occurred in three phases between Aug. 15, 2022 and Sept. 23, adding new jurisdictions in each phase.

Over the course of those six weeks, the banks trialed transacting in the recipient bank's CBDC, issuing and redeeming their own CBDC and swapping from one CBDC to another.

"On the platform, a commercial bank can transact with any other commercial bank directly in a peer-to-peer manner. Among the 20 participating commercial banks, five from each jurisdiction, this connectivity enabled 150 different bilateral and direct potential connections," the report said.

The pilot also incorporated safeguards to prevent excess or insufficient liquidity issues. Looking ahead, the report went on to note the potential implications of allowing commercial banks to engage in foreign CBDC transactions.

During this summer's pilot, a domestic bank had to be involved in at least one part of any given transaction, the report said, except for transactions in a currency foreign to both counterparties.

"During the pilot, while participating banks were able to directly transact in the CBDCs of other jurisdictions on the platform, foreign banks were limited in terms of how they could move CBDCs on mBridge," the report said. "... This ensures that significant amounts of domestic currency cannot accumulate offshore beyond the central bank’s control, limiting opportunities for the currency to be used for speculative purposes."

The central bank group plans to focus on liquidity management, FX price discovery, legal frameworks, data privacy, decentralized deployments and other business use cases in further pilot projects over the next two years, the report said.

"Equipped with the lessons from the pilot and earlier phases of the project, Project mBridge will continue its work," the report said. "This includes the technology-build and testing – including improving on existing functionalities and adding new functionalities to the platform – in an effort to move from the current pilot phase towards MVP and eventually a production-ready system."