OCC’s Hsu warns of liquidity risks arising from faster payments and tokenization

Rick Steves

“The future looks different. The time increments are shrinking towards “always on,” 24/7/365.”

Michael J. Hsu, the Acting Comptroller of the Currency, recently delivered a speech at Columbia University Law School in New York, addressing the topic of bank liquidity risk.

In his discussion, Mr. Hsu focused on the nature of recent bank runs and the insights gained from past bank failures. He emphasized the need for a targeted regulatory approach aimed at identifying high-risk deposits more accurately, ensuring coverage for short-term cash outflows, and reducing the risk of financial contagion.

The rise of the 24/7/365 system

A significant part of his remarks was dedicated to the future of liquidity risk management, particularly in the context of the evolving financial landscape. Mr. Hsu highlighted the implications of the shift towards faster payment systems and the potential tokenization of real-world assets and liabilities. He noted that traditional banking has operated on a daily cycle, with end-of-day book balancing and batch processes allowing for the netting of inflows and outflows. However, he pointed out that this is changing, with the industry moving towards an “always on” system, operational 24/7/365.

Hsu cited the progress in instant payment systems globally, including in the UK, Brazil, India, Singapore, Thailand, and the U.S. with the Federal Reserve’s FedNow service. He stressed that these developments, along with tokenization, could greatly increase the velocity of banking and finance. While acknowledging the potential benefits, such as improved financial inclusion, he also warned of new risks, like faster fraud and challenges in managing real-time transactions.

In his conclusion, Mr. Hsu reiterated the changing nature of bank runs and the urgency for banks and regulators to adapt. He advocated for the development of robust systems to ensure the safety and soundness of banks and to mitigate systemic risks. Emphasizing collaboration, he expressed his eagerness to work with peers, banks, academics, and other stakeholders to address these challenges.

The full transcript of Mr. Hsu’s remarks on future liquidity risk

“In the U.S., as we transition towards a faster payments system and possibly tokenization of real-world assets and liabilities, banks may need to further enhance their liquidity risk management capabilities to keep up. Historically, banking has proceeded in daily increments. Bank tellers balanced their books and cash positions were reconciled at the end of each day. Around this daily cycle arose batch processes, whereby inflows and outflows over the course of a day could be netted, managing the amount of funds flowing throughout the system and providing opportunities to correct mistakes. Many banks still operate this way today.

“The future looks different. The time increments are shrinking towards “always on,” 24/7/365. Instant payments systems are becoming the norm abroad, for instance in the UK, Brazil, India, Singapore, Thailand, and others, as well as domestically.7 The Federal Reserve’s FedNow service is a real-time, inter-bank, 24/7/365 gross settlement payment system. With FedNow financial institutions can settle payment transactions at any time, including nights, weekends, and holidays. In addition, to the extent tokenization reduces settlement frictions, it will also accelerate the velocity of banking and finance. This creates the potential for great benefits, including improving financial inclusion and financial health for many people.

“But a future of faster, always on, real-time money flows also creates new risks. Faster payments can lead to faster fraud and limit the ability to remediate erroneous transactions. The instantaneous nature of real-time payments necessitates enhanced liquidity risk management, third-party risk management, and fraud and compliance risk management. As the speed of payments accelerates, we need to think carefully about the associated risks and controls. Banks and regulators should start working now on building the right brakes for a more real-time financial system.

“I want to conclude where I started: The characteristics of bank runs are changing, and banks and regulators need to adapt accordingly. We need to develop better brakes to keep banks safe and sound and to mitigate systemic risk. I believe it is possible to take a targeted regulatory approach to address the lessons from the failures of SVB and Signature. I look forward to working with my interagency peers, banks, academics, and other stakeholders on this important task.”

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