It all started with the mad rush to buy bitcoins, a digital currency, also called cryptocurrency that is a powerful and most sought after blockchain application in the real world.
The world stood up to note the powerful features that bitcoin has to offer, all thanks to the platform on which it is built on.
And since currency is the most important means of transaction in the world today, banks and financial institutions take special interest in understanding, analyzing, researching and creating proof of concepts into how blockchain can be utilized to build more powerful and robust banking infrastructure.
Application of Blockchain in Banking and Financial Sector
Many institutions across multiple sectors around the world are taking blockchain seriously. However, banks and financial institutions have been the most active players showing very keen interest in adopting blockchain as part of the banking process.
Blockchain is, in simple words, a public database that contains a record of every transaction that has happened since the beginning. The data is secured using cryptography and owners possess public and private keys to enable transactions on their accounts.
As per a report by Cambridge University’s Judge Business School, banks account for 30% of all blockchain adoption in the world.
In this article, I will discuss how blockchain can revolutionize the banking and finance industry in the years to come.
Blockchain Banking Disruption for KYC
Financial institutions spend hundreds of millions of dollars for Know Your Customer purpose. Any senior official from the banking and financial sector would tell you what a big headache KYC is.
According to the survey, financial institutions with $10 billion or more in revenue have seen their average spend on KYC-related procedures increase to $150 million this year from $142 million in 2016, while their number of deployed employees has skyrocketed to an average of 307 KYC compliance professionals in 2017 from 68. Despite this rise in headcount, just over a third of firms reported that scarce resources remain their biggest challenge in conducting KYC and customer due diligence (CDD) processes.Thomsom Reuters 2017 survery on KYC in financial institutions
Maintaining customer due diligence and adhering to changing regulations is an overhead. Ensuring the identity of clients and ensuring that necessary care is taken to eliminate/reduce money laundering is an part of KYC process.
Banks and financial institutions are looking at ways to handle the KYC process better. Blockchain disrupting in the banking sector by making the KYC process more effective – faster and cheaper.
Banks can use blockchain as a shared platform where a customer’s KYC is stored securely this data can be shared across other financial institutions as and when required present in the system.
Role of Blockchain in Retail Banking Will Reduce Cost
I have already discussed a part of how banks can reduce costs in performing KYC process.
However, the entire banking operation contain many areas where cost is a factor and financial institutions are always looking to optimize costs in these areas.
For example, fund transfers are time consuming because they often require financial intermediaries which impose service charges to reduce fraud by taking additional steps. Blockchain can help by removing these intermediaries, leading to reduction of service and transactional charges across the banking industry.
The world banking sector will save up to $20 billion by 2022 through implementing blockchainAccenture Study
In the field of cross-border payments, Swift has been a leader for long. Swift requires additional costs and time for transactions to process. A growing number of financial firms aim to embrace Ripple to cut costs and time. The Ripple and Swift rivalry has just began, even as Swift is looking to embrace the technology.
Blockchain Benefits for Banks in Fraud Detection
The banking systems around the world is centralized – meaning that data is centrally available on a server that is heavily secured. However, all the security does not prevent hackers to fraudulently steal money or cause other financial crimes from banks, once in a while.
The data secured through cryptography, and hosted in decentralized ledgers/database would prevent hackers from causing a fraud.
The global banking ecosystem is built on good faith and trust. However, this faith has taken a hit time and again, whenever a major fraud happens.
With blockchain, customers and financial institution can improve on mutual trust and transparency
The customers are forced to rely on banks since no better option was available all this while. Banks would not have much to complain about now that blockchain is here.
Blockchain for Banks in Trade Finance
Around the world, trade finance is mostly based on paper bills and letters of credit, among others. These are sent over fax or posted to multiple parties that are involved in it, directly or indirectly.
It could take you a day to ship oil from Singapore to Malaysia and a week to deal with a the paperwork. You have to include not only the shipping companies, the agents and the freight providers, but also the ports, the customs and the insurers. The moment you need a physical stamp on a document, it can’t be digital. This has to be ecosystem driven.Vivek Ramachandran, Head, Innovation for Commercial Banking, HSBC
This is a very important element of the supply chain and blockchain can offer a vast amount of elements in this area. For instance, if you are shipping goods from China, as many as 50 people need to access the data.Accenture
Since multiple parties need access to the data, it can be stored securely using blockchain.
Clearance and Settlement in Banks Using Blockchain
Clearance and settlement is a big head ache for every bank and financial institution. The tangle of loan records and securities is very cost intensive and costs banks billions of dollars. In clearing houses manage these activities through manual records reconciled through myriad of messages.
Blockchain can help in digitizing and implement processes leading to cost cutting and faster turn-around time.
Syndicated loans take on an average 19 days to be settled by banks in the world’s most developed countries like the USA.
When a loan changes hands or borrowers repay loans earlier, much of the communication is done on fax.
Blockchain can help to communicate between different stakeholders and update changes to loan ownership across all systems. Of course this would require changes in the business process.
Blockchain Innovation in Banks Using Smart Contracts
Smart contracts truly make blockchain powerful by giving it the power to automate tasks and put laws and/or terms and conditions into code to execute as and when required on a decentralized, distributed ledger. This results in omitting any third parties that might be involved in the contract.
Room for error in finance-related transactions are minimized to a large extent since the smart contract would execute only when the conditions are met as per the code. Unless, of course, there is a bug in the code that gets unnoticed during the implementation phase. That’s how powerful blockchain implementation in banks can prove to be.
Loan reimbursements can be automated without the need for the customer and the bank officials running behind each other with a huge paper trail. If certain conditions are met by the customer, the loan is paid out. Similar approach can be considered for clearance and settlement.
Similarly, the lengthy documentation and process can be done away with during onboarding of customers. If customer details are available on the blockchain, the smart contract can check and decide whether the customer has the required eligibility to open an account. If verified successfully, the smart contract can enable services that may or may not be based on smart contract.
These are a couple of examples and the number of use cases for banks are huge.
What are Banks Doing with Blockchain – Case Study Stories
As I have already mentioned before, banks across are using the blockchain for case studies, proof of concepts and in improving the banking processes. In this section, we will take a look at some examples from the real world of how banks propose to use the blockchain.
Blockchain Technology in Indian Banking System
Banks in India have not been laggards when it comes to embracing the technology and indeed have led the way.
The most important and notable effort has been through BankChain. BankChain is a consortium of mostly Indian and few non-Indian banks to explore and build on the blockchain.
The initiative is led by State Bank India, which is India’s state run bank and has the most number of customers. The other members include ICICI Bank, Dena Bank, Kotak Bank, Deutsche Bank, among others.
BankChain’s projects include anti-laundering money review, asset auction, blockchain based authentication, KYC and digital identity, loyally program, trade finance and many others.
Individual Efforts by Indian Banks to Use Blockchain
ICICI Bank has completed two pilots on the blockchain. For example, in August 2016, ICICI Bank became the first bank in the country and among the first few globally to successfully undertake pilot transactions in international trade finance and remittance in partnership with Emirates NBD. Since then it has onboarded 250 corporates for blockchain based domestic and international trade finance.
Similarly, Kotak Mahindra Bank has also implemented trade financing on the blockchain.
State Bank of India targets complete deployment of blockchain in
reconciliation, remittances and trade finance operations in FY19. The bank is also working to implement KYC on blockchain and create a blockchain-based exchange to recover bad debts.
Not to forget Axis Bank, that is using Ripple for cross border transactions to implement its remittance solution. This is being done in partnership with RAKBank and Standard Chartered Bank (Singapore).
Banks Experimenting with Blockchain Outside India
If I look outside India, there are leading banks that are heavily investing in the blockchain.
Nine banks in Malaysia in collaboration with the country’s central bank had partnered to build a trade finance project on the blockchain.
Australian Securities Exchange is moving its post-trade clearing and settlement to blockchain. The project is currently delayed by six months, as per a report on September, 2018.
Similarly, DTCC based out of the USA is scheduled to move its post-trade clearing of single-name credit default swaps on to a blockchain system by end of 2019.
Credit Suisse is part of a consortium that has already completed a project to demonstrate how blockchain can improve the syndicated loans. Through usage of smart contracts, the entire lifecycle of a loan, from creation to settlement can be revolutionized. Apart from cost savings, it also opens up doors to a lot of business opportunities, as per the blockchain in banking report by Credit Suisse.
Challenges – Points to Consider while Implementing Blockchain in Banking and Financial Sector
Notwithstanding the hype and hoopla surrounding blockchain implementation in banks, there are some complex challenges that need to be considered and taken care of during blockchain implementation.
I will discuss the most important ones here in this section.
Lack of Regulation and Interoperability
Currently cryptocurrencies are not regulated and that makes it tough for an investor in case of losses. As and when blockchain adoption in banks and financial sector is done, regulation will be necessary at both national and international level.
At the same time, blockchain platforms should be implemented in such a way that they can operate with existing systems to minimize design changes. Oracles can be a way to achieve the same and is an important factor for implementation consideration during feasibility study.
Blockchains are mainly public authorities where the data can be verified by any user on the platform. However, customer data needs secrecy and thus a private blockchain can be considered when it comes to shielding customer data from hackers.
The need might lead to a hybrid platform where the data is privately secured while the transactions can be verified publicly. Banks and financial institutions should consider this while deciding on the implementation plan.
Scalability and Security
In banking, the amount of data and the number of customers increase with time.
As the banks get more data to process, the blockchain implementation should take into account the growing traffic while ensuring that the speed of the network does not slow down.
As of now transaction speed in the blockchain is very low and far below what VISA and the likes of VISA. Blockchain will need to implement better models to match up and then improve on the transaction speed as well.
Blockchain is known to be already secure. The security features in blockchain is implemented through cryptography which makes the network difficult and complex to hack.
In case of banks, blockchain implementation should take into account additional security features. For example, participating authorities should be restricted throughout the network by providing the proper access permissions.
Similarly, private keys need to be stored very securely in the blockchain. A loophole can lead a malicious user to it resulting in unlawful transactions and monetary losses for the bank customer.
Proof of Work and Energy Consumption
Proof of Work is still the major consensus protocol that keeps a blockchain running. However the downside with PoW is that with time, the energy consumption increases manifold till a point where running gigs become next to impossible.
When banks look to implement blockchain, they would need to consider alternate models like Proof of Stake, etc. that will ensure that energy needs do not shoot up as time go by.
Blockchain in Banks – Probable Timelines
We are in 2019 and by 2020 you will see banks establishing a legal framework for bringing their operations on the blockchain. The first solutions will include leading banks establishing their own cryptocurrencies and implementing POCs or first solutions for one of their products or services.
By 2025, at least 30% of the major banks will have established a major chunk of their business on the blockchain.
By 2030 and then onward, expect blockchain adoption to be at 90% while blockchain systems and cryptocurrencies will be seamless connected.
Blockchain Looks Promising for the Baking and Financial Sector
The technology can have far-reaching positive impacts in the way banking transactions are carried out today. From transaction confirmation, to money management, identity management and asset optimization, blockchain will impact banking operations worth of billions of dollars.
Blockchain will do to banks what the internet did to mediaHavard Business Review
Most importantly, trust and transparency will be the most important achievements of blockchain implementation in the banking and financial industry.