Netting
multilateral = network bilateral = between counterparties
Q: What is netting? A: A way of consolidating or reconciling multiple payments between two or more parties to create a single amount due to each participant. It simplifies doing business and reduces risk.
Netting refers to the consolidation of multiple financial obligations or payments into a single net amount. By strategically offsetting positive and negative positions, netting reduces the total number and value of payments involved as well as their associated settlement risks.
Example: Party A is due to receive USD 75,000 from Party B. At the same time, Party B is due to receive USD 30,000 from Party A. Instead of Party B paying USD 75,000 to Party A and Party A paying USD 30,000 to Party B in two separate transactions (called gross settlement), the payments can be netted. That way Party A owes nothing, and Party B pays Party A USD 45,000.
Q: Why blockchain for netting? A: The primary benefit for the banks is reducing the cost of cash logistics.
Lower costs for all parties
Reduce manual data entry and file uploads
Automate and speed processing of matching and netting transactions
Increase security through encryption and tamper-evident distributed ledger technology
Provide transparency and enhance trust with permissioned access to transaction data
Problem:
It is not uncommon for banks to find themselves flush with cash in one city and low on cash needed to fill ATM machines in another city. Physically moving cash from one city to another is expensive, requiring armored car transport, possibly air transport, and insurance, among other costs. Another option is to ask the central bank to absorb the excess money in one city and provide cash in the other city, but this is also a costly alternative.
IDN Liquidity Algorithm
At start of each day, participants send $$$ to a central funding account. This $$$ pool allows XFT to settle faster, larger payments via multilateral netting.
Multilateral netting: Offsets obligations across the entire network
Bilateral netting: Offsets payment obligations between two banks
Bilateral netting: If your bank owes another bank $100 million, and that bank owes your bank $80 million, XFT nets these so only $20 million needs to move.
LIQUIDITY MECHANISM FLOW OF FUNDS
Bank funds IDN wallet
Bank adds optional supplemental
Bank A pays Bank B
XFT debits A credits B
Uses supplemental then primary
Queues if limits hit
End of day net and settle
Liquidity saving mechanisms
Offsetting algorithm
Time-varying tariff
Payment splitting
Why liquidity saving mechanisms when IDN = instant + zero counterparty risk?
Bank balance sheet + large-value payments still require prefunding/cash on hand. Accelerate working capital flows for RDFI leg.
RESOURCES
GUIDELINES FOR FOREIGN EXCHANGE SETTLEMENT NETTING
What is Netting? How Does Netting Work?
Payment Systems, Comptroller's Handbook
Wholesale Payment Systems, FFIEC’s Handbook
Automated Clearing House, NCUA Examiner’s Guide
System and method for intraday netting payment finality with supplemental funding
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