Blockchain for Banks: An Implementation Guide
Blockchain is a technology that’s creating a lot of buzz. Fintech firms like R3, Chain, Ripple, Coinbase etc. are carrying out relevant research and development. Not far behind are financial institutions like ING, Barclay, Citi Bank, Visa, NASDAQ, DBS, and Commonwealth Bank who are experimenting on blockchain either on their own or in partnership with fintech firms.
Blockchain, based on distributed ledger technology, is available to all parties engaged in transactions. It helps store all the transaction details including transaction history in a block format. Being a distributed ledger, it benefits the financial systems—right from providing transparency, immutability, security, reliability, robustness to fraud prevention.
The following benefits of blockchain is making it popular not just among the financial institutions, but across many sectors:
- Distributed ledger: Blockchain involves a public ledger which is available to all parties involved in the transaction. This means that the moment any transaction is completed, it is entered into blockchain in blocks and a copy of the same is available to all the parties involved.
- Minimize role of intermediaries (central authority/third party): Since blockchain works on the principle of peer-to-peer transactions, role of any intermediary (central authority or clearing house) is minimized, resulting in faster and smooth transaction processing.
- Reduced transaction cost: As blockchain is built on the concept of sharing information across parties and consensus during transactions, it helps save on reconciliation costs between banks and losses because of documentary frauds.
- Traceability of transaction: Blockchain has the capability to trace the entire chain for a particular transaction which helps control fraud and black money.
Blockchain is secure, transparent, reliable, robust, and a trusted source of truth. And these benefits have a vast potential for adoption in banking and other industries.
Fig 1: Emerging blockchain landscape
Blockchain in banks
Blockchain can be applied across various business lines in banks. In fact, several banks have already started using blockchain for their own requirements and in partnership with other firms as well. I am giving below the different areas where blockchain can make significant impact for banks:
Fig 2: Application of blockchain in banks
The first step in blockchain journey for Banks is to implement the technology internally. Once they build the ecosystem, they can easily extended it to external parties. They can take a two-phased approach to blockchain implementation as given below, for a smooth and hassle-free transition.
- Phase 1: Implement blockchain for internal transactions and other areas of the ecosystem where there exercise control and access. E.g. loan documentation, information exchange across banks internal business groups, regulatory reporting regulators etc. Larger banks can go a step further to use blockchain for inter-country transactions across branches spread globally while small banks can start sharing data/document with their customers, regulators, vendors via Blockchain.
- Phase 2: Once banks have implemented and tested the blockchain ecosystem internally, they can start associating with other blockchain networks and partner with other financial institutions. They can also start sharing data on blockchain with other institutions. This data can be monetized with the benefits of blockchain as mentioned earlier in the article.
While implementing, phases have to unfold as waves based on identified use cases. It is recommended to use “time to implement” and “business value” to filter and shortlist the use cases. It is also recommended to take the iterative approach of implementation.
I am giving below three keyuse cases where blockchain can be leveraged in a phased approach in banks:
1. KYC and AML process: Banks can use blockchain to maintain KYC details of customers, which can be leveraged across different lines of business within the bank along with ensuring compliance of AML.
Once KYC is completed, the data can be stored in blockchain; it can then be accessed by different departments of the bank, if/ when they need to do KYC for the customer again. This will help reduce time required to complete KYC by different departments of the bank. (E.g. customer may need to complete KYC before they can open a trading account with the bank even though they already have a saving account relationship with the same bank).
Once bank has established database on KYC for customers on blockchain, it can start sharing the data with other banks and other institutions through private key. For e.g. a utility company will have to complete the KYC process for a customer before they provide services. This utility firm may complete the customer’s KYC by accessing the bank’s blockchain through private key easily and quickly; and the bank in turn can charge these firms for providing a trusted data source. This is a win-win situation for all parties involved:
- Bank can monetize the data existing with it
- Utility firm can complete its KYC process quickly and through a reliable source
- Customer is saved the time and pain of going through the KYC process at each and every bank/utility firm they associate with
Fig 3: Blockchain for KYC & AML
2. Trade Finance: Blockchain has huge potential in a trade finance transaction encompassing entire supply chain which involves parties like importer, exporter, importer and exporter banks, customs, shipping line, freight forwarder, and insurer.
Blockchain through smart contract features can be used to manage document transmission, validation and certification. It can process the transactions as per date, terms and conditions captured in the document (can be leveraged in a Letter of Credit transaction). Moreover, parties will be allowed to access the data based on available access rights. This has tremendous potential to reduce the time and cost involved in a trade finance transaction and bring transparency to all parties involved.
Fig 4: Blockchain for Letter of Credit transaction
3. Commercial lending and syndicated loans: Commercial lending involves a lot of document exchange between customer, bank and enabling parties like lawyers and valuation firms. During loan processing, various departments in bank also need to access these documents which involves front, mid and back office along with legal and compliance. Through blockchain, this entire process can be managed efficiently and effectively, streamlining loan document processing. Banks can extend the blockchain-based ecosystem to regulators, and provide them access to lending portfolio details for audit purposes. This document and information-sharing over blockchain will be very useful for syndicated loans where multiple parties like lender, co-arranger, agent, investors etc. are involved, apart from the borrower
Fig 5: Blockchain for document transmission in commercial lending & Syndicated Loans
Concluding, Blockchain is seeing good adoption among banks. Banks are successfully building proofs of concepts (PoCs) around relevant use cases. Big banks are trying to test blockchain for intra bank fund transfer between their branches across the globe, whereas small banks are partnering with each other to build interesting PoCs around derivative trading, document transmission and smart contracts etc.
Banks are looking at blockchain as an opportunity to improve trust, create transparency, increase data accuracy, reduce transaction cost and eliminate fraud. All of these factors are very important in the current business scenario not only from customer point of view but also from the regulator’s perspective.