Ripple’s Claims Regarding Nostro and Vostro Accounts Could be Wrong
Ripple, one of the most popular cryptocurrency-related companies in the market has been trying to help financial institutions and banks to process cross-border payments in a faster and cheaper way. With one of the latest products released by the firm, xRapid, the intention is to use the XRP digital asset to reduce even further the costs of sending transactions to different countries.
One of the reasons that Ripple gives for banks to start embracing the XRP virtual currency is due to the fact that they can source liquidity on-demand. Ripple also says that financial institutions will not have to depend on costly Nostro and Vostro accounts located around the world.
However, Frances Coppola, a Senior Contributor for Forbes, explains that there is no such thing as ‘Dorman Funds’ in banking. According to the author of the article, these accounts are transaction accounts that most of the people call “checking” accounts.
On the matter, she wrote:
“‘Nostro’ means ‘my account with you’: ‘vostro means ‘your account with me.’ For every nostro at one bank, there is an equivalent vostro at another bank.”
She puts the example of an American bank that has to make a payment in Euros to another European bank. In this way, the American institution opens a Euro account at the European bank, having in this way a Vostro account that can be used to deposit Euro. The account must hold enough money to meet forthcoming payment obligations.
The article says that these bank accounts are also used to make a lot of money from interest payments on Vostro accounts. Thus, there is an incentive to have large balances on these accounts. However, there is a point to mark related to the fact that interest rates are close to zero.
Banks should always have the funds to cover the obligations for the upcoming 30 days predicting how much funds they will need. Banks can combine reports with spot FX deals or just use FX derivatives to set up future trading steam.
According to the article, the number of funds located in Vostro and Nostro accounts is higher than ever. A report released by McKinsey says that in 2015, Nostro balances around the world reached $27 trillion. The reason why Nostro balances are so high is due to the fact that transnational payments are growing.
Ripple claims that the funds stored in Nostro and Vostro accounts are not doing anything. Although they are locked up, they will be used to make payments in the future. That means that the funds cannot be used by the bank, but instead, they are going to be used to pay someone else.
The author asks the question of whether using XRP to source liquidity on-demand can eliminate large balances in Nostro and Vostro accounts. What Mrs. Coppola explains is that the same amount of money that was going to be used to fund a currency account in another bank will be used to buy the XRP and pay the other institution.
Using XRP for these large transactions would allow banks to use their own currency rather than foreign currency. Additionally, regulators would require the institution to hold liquid assets to cover these payments 30 days in advance as well.
Another thing that the author explains is that banks use Nostro accounts because they receive the most advantageous FX rate. That means that they will be funding Nostro accounts well in advance of a specific payment. Additionally, this money can be lent to short-term wholesale markets or used to buy liquid interest-bearing securities in a specific currency.
She went on explaining that banks will be losing their ability to control their own FX exposure. About it, Coppola explained:
“Rather than the bank choosing when to convert from dollars to Euros, and at what rate XRP hub would do it automatically when the payment was made, and the effective USDEUR exchange rate would be determined by the USDXRP and EURXRP cross rates at that time.”
In the example she provided, she says that the USDEUR is the most liquid FX market in the world. Why would banks use two low-liquidity rates rather than the world’s premier currency pair?
Another thing she talked about is the large sums of XRP that the company currently holds. She mentioned that the price of XRP is not fully market-determined when there is a dominant player rationing the supply. Moreover, she said that the transactions would also take a long time to be processed. Due to the fact that the firms would have to use exchanges, the transaction is not complete until the funds can be withdrawn from the exchange. In many cases, these withdrawal requests can take several days or even weeks.
Finally, Coppola shows that international payments take around 2 or 3 days to be processed. However, the final settlement is instant within the Continuous Linked Settlement (CLS) system.
She concludes saying that using XRP would not eliminate the real problems related to risk-averse banks. The major use case related to XRP is in providing payments around the world in countries that could be shut out of correspondent banking networks. In sum, for Frances Coppola,
“Ripple is trying to solve a problem that does not exist.”