Testing the backbone
The Reserve Bank is experimenting with a platform used by cryptocurrencies to test its efficacy in interbank clearing and settlements
When Zuma “went missing” in early January, news-trawling high-frequency traders mistook the Spacex rocket mission (called Zuma) for an Awol SA president. The result: automated currency trades that led to a rand in disarray.
Fortunately, the volatility was short-lived, a cheap laugh was had, and life moved on.
But Reserve Bank deputy governor Francois Groepe says this type of high-frequency trading, which leverages artificial intelligence (AI), is of concern since it has the potential to cause flash crashes and, ultimately, financial instability.
“The big issue is that with high-frequency trading, you have stop losses that kick in and so you can have more pronounced price swings.”
This can affect collateral values, and introduces the prospect of liquidity and solvency problems in the market.
But, because of resource constraints and the need to prioritise, high-frequency trading will not be among the first focus areas for the SA Reserve Bank’s new fintech unit.
“Certainly, in the medium to long term we will have to look at things such as high-frequency trading,” Groepe says.
The fintech division — which was established in the second half of 2017 to ensure there is a “cohesive view” on fintech — comprises three full-time members.
It is tasked with keeping abreast of innovation and assisting policy makers to draw up appropriate frameworks. Moody’s last month said the move to establish the division was credit positive for the banking sector.
The Bank’s fintech head
Arif Ismail and his team’s focus will include reviewing the Bank’s stance on privately issued cryptocurrencies, and putting to bed Project Khokha — which involves experiments with distributed ledger technology (DLT).
Khokha is a collaboration between the Bank, six local banks and two foreign institutions. If successful, it could result in a complete overhaul of the way payments are processed.
This month, the parties will test how DLT — the backbone of cryptocurrencies like bitcoin — can be used for interbank clearing and settlements.
They will process high-value payments using Quorum — the DLT platform linked to the popular ethereum cryptocurrency and American bank Jpmorgan. Quorum was used in a similar experiment by the monetary authority of Singapore, in Project Ubin.
“We are not committed to moving to DLT, but we are committed to developing a proof of concept and seeing how it works,” Groepe says.
The proof of concept could be complete by the end of March, according to Ismail.
The hope is that DLT will reduce payment processing times, processing fees, and cut out the need for intermediaries.
But Ismail says the security of the DLT system is among the key concerns that need to be investigated during the testing phase.
“High-value payments are the heart of our economy.
“Would we move from a very well-established, absolutely secure system to a distributed ledger system where we process something like R300bn/day?
“Those are the things we’re trying to [investigate].”
The proof of concept will also entail stress tests. Ismail says the current system can handle about 70,000 high-value real-time gross settlement transactions a day, “but we will try to stress-test it up to perhaps even a quarter of a million transactions”.
For the time being, the bank is focusing entirely on local payments, even though some of its counterparts have progressed to testing cross-border transfers.
Saudi Arabia’s monetary authority signed an agreement with fintech company Ripple last month to trial international payments using blockchain. According to Moody’s, this could save banks in the country up to Us$400m/year.
But the Reserve Bank is cautious, perhaps with good reason. In addition to possible security risks, Groepe says shifting to DLT could mean the regulator would have to forgo some of the benefits of the current clearing and settlements system.