Real-Time Liquidity - Meaning, Importance and Challenges

The liquidity management paradigm in the commercial banking industry has undergone a drastic change. At one time, liquidity management was driven by constraints such as cut-off times and end-of-day processing. However, with the passage of time, the industry has witnessed continuous technological advancement. The industry now has the infrastructure as well as the regulatory mechanism in place to enable the real-time processing of transactions. As a result, the past few years have witnessed the migration towards the concept of real-time liquidity.

Real-time liquidity is very important for clients and provides several benefits. However, there are many challenges that commercial banks and companies have to face while implementing this real-time liquidity. In this article, we will have a closer look at the concept of real-time liquidity as well as how it is implemented.

What is Real-Time Liquidity?

Traditionally, there has always been a time lag between when payments were made and when they were actually realized by the beneficiary. This is because the sending and the receiving bank needed time to settle their books and then transfer the funds to the beneficiary. The clearing and settlement were manual processes till the late 1990s and early 2000s. However, the past couple of decades has witnessed advancement in information technology. As a result, most of the transactions can now be automatically cleared and settled with a high degree of accuracy.

The end result is that commercial banks all across the world are now able to enable their clients to make instant payments. The money gets instantly transferred to the beneficiary in case of domestic payments. However, in the case of international payments, there is still a small-time lag. This too is being eliminated with the implementation of the SWIFT global payments initiative.

Why is Real-Time Liquidity Important?

Corporations across the world expect their banks to provide them with real-time liquidity. This is because of the fact that real-time liquidity provides several advantages to corporations. Some of the important benefits which accrue to corporations have been mentioned below:

  • Netting Across Accounts: Real-time liquidity helps companies to make payment commitments to vendors without thinking about balances in specific accounts. As soon as a payment is presented for payment, commercial banks make a real-time connection between different bank accounts and if need be transfer money from one bank account to another based on a pre-defined algorithm. Hence, companies are saved from the extra administrative effort which they have to undertake in order to move money between different accounts.

  • Smaller Buffers: If companies can pay their bills in real-time, they can manage their working capital more efficiently. There will not be the requirement for having additional funds in the buffer to maintain balance while the earlier issued payments get cleared. Real-time payments and collections make the company’s cash flows leaner and more efficient.

  • Lower Cost of Capital: Also, since the company requires a lesser buffer and funds can be transferred between accounts, the overall cost of capital is reduced. This lower cost of capital helps the company become more efficient as it can pass on the lower cost of capital to its customers and gain more market share.

Challenges in Implementation of Real-Time Liquidity

Even though real-time liquidity theoretically seems like a good idea, there are many challenges that need to be overcome in order to make it a success. Some of the most prominent challenges have been mentioned below:

  • Lack of Standardized Definition: Firstly, there needs to be a standardized definition of the concept of real-time liquidity. In some parts of the world, payments are transferred every 30 minutes whereas, in other parts of the world, they are transferred every 3 hours. The commercial banks and the regulatory bodies of the world need to come up with a standardized definition of real-time liquidity so that the system can be uniformly implemented all across the world.

  • Transaction Values: In most parts of the world, there are transaction limits for real-time processing. This means that transactions with smaller amounts are processed in real-time whereas transactions with large amounts are not because of some regulatory hurdles. This poses some constraints for corporations. This is because of the fact that many countries all over the world are not comfortable allowing real-time transactions of large dollar amounts.

  • Forecasting Issues: Real-time liquidity brings along its own set of challenges. Companies all over the world are facing difficulties making forecasts about their payments and receivables. Because of real-time liquidity, the account balance of any company changes drastically within a very short span of time.

  • Regulatory Challenges: Real-time liquidity in cross-border transactions may be very difficult to achieve. This is because there are various regulatory bodies and central banks involved in this transaction. All these bodies have their own objectives. As such, they carefully evaluate the transactions before they are allowed to pass through. Commercial banks will face a huge challenge in streamlining the operations of these government agencies in order to achieve faster turnaround time.

The bottom line is that real-time liquidity has become a very important aspect of commercial banking. It is quite important for corporate clients. However, the idea is still in its nascent stage and is likely to face many challenges in the future.

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Commercial Banking