The South African Reserve Bank (SARB) is making headway with experimenting with digital ledger technology (DLT) for interbank wholesale settlement.
Interbank settlement is the transfer of funds between the bank of the originator and the bank of the beneficiary in relation to a payment transaction.
Reserve bank governor Lesetja Kganyago yesterday announced insights from Project Khokha 2 (PK2), a proof of concept (POC) that explored the policy and regulatory implications of innovation in financial markets driven by DLT.
This was a continuation of the first phase of Project Khokha, which was designed to trial interbank wholesale settlement using DLT and aimed to contribute to the global initiatives that assess the application and use case for DLT.
PK2 was launched by the Intergovernmental Fintech Working Group (IFWG) to explore the policy and regulatory implications of tokenisation in the financial markets in South Africa.
DLT, commonly known as blockchain technology, refers to the technological infrastructure and protocols that allow simultaneous access, validation and record updating in an immutable manner across a network that is spread across multiple entities or locations.
Settling debentures
According to the central bank, PK2 was able to issue, clear and settle debentures on DLT using tokenised money as part of the technical POC.
It notes that industry participants were able to purchase the debentures with a wholesale central bank-issued digital currency in the primary market and a wholesale digital settlement token in the secondary market.
The project was launched in January 2021 as an initiative under the innovation accelerator of the IFWG, led by the SARB through its fintech unit.
“In our experimentation during PK2, two forms of tokenised money were created to allow for settlement,” Kganyago said.
The first form of money was a tokenised form of central bank money which was a liability of the central bank issued onto a specific DLT owned and operated by the SARB in the POC.
He noted this form of money was used to purchase SARB debentures in the primary market.
The second form of money was issued by commercial banks as a stablecoin and used for purchasing SARB debentures in the secondary market.
In this way, PK2 explored and expanded on how settlement in central bank money and commercial bank money can happen on DLT.
“The debenture token market benefitted from having a riskless settlement asset in the form of a wholesale central bank digital currency (WCBDC) used for settlement. This reduced the settlement risk, particularly that payment might fail or might be uncertain due to riskiness in the settlement asset,” the governor said.
He pointed out the WCBDC prototype developed in PK2 was also the preferred asset in other instances.
“It served as the reserve asset guaranteeing the value of the wholesale stablecoin issued by commercial banks, and it was used to make payment to debenture token-holders upon the maturity of the debenture. The role of the central bank in the tokenised debenture token market was therefore similar to the current role played by the central bank.”
No policy shift
However, Kganyago said since DLT-based innovation is still quite nascent, it is difficult to reach definitive conclusions on its potential implications.
“In this way, practical experimentation helps inform our thinking about different scenarios which may arise in the future.
“PK2 was an experimental research project. It followed an exploratory approach, which enabled the POC to contribute to the complex discussion surrounding tokenisation in financial markets.
“PK2 does not signal support for any particular technology, nor does it signal any specific shift in policy direction. The project was not about replicating the status quo. Rather, it was about challenging our thinking around designing for a different future,” he said.
Kganyago also noted that some may ask whether central banks and regulators will still be relevant in a world based on some of the decentralised principles explored in Project Khokha.
“From a regulatory perspective, I think it is unlikely decentralised markets will be suitable in all instances, or that decentralisation will guarantee the achievement of public policy objectives, such as consumer protection, financial stability as well as safety and soundness, which fall within the mandates of central banks and regulators.”
He believes the role of central banks, regulators and policymakers should, however, evolve with financial markets to ensure they continue to fulfil their mandates in future financial markets.
“Central banks, regulators and policymakers can – and indeed must – play an active role in shaping a potential move to DLT-based markets through playing with purpose, playing in a collaborative way, pondering the implications of innovation, promoting responsible innovation for the public good, and informing an appropriate policy and regulatory response,” he concluded.
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