Blockchain Building Block of the Future of Banking

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Rajashekara V. Maiya

Vice President, Business Consulting and Product Strategy, Infosys Finacle

The World Economic Forum in a 2015 report predicted blockchain to reach a tipping point in the year 2027. 73.1% of the respondents to the Technological Tipping Points survey believed that taxes would be collected using the technology by 2025, and 57.9% expected about 10% of the global gross domestic product (GDP) to be stored on a blockchain by this time.

Come 2017, and the government of China has already announced its plans of launching social taxation and electronic invoice issuance on blockchain. The Monetary Authority of Singapore (MAS) and the Hong Kong Monetary Authority (HKMA) are setting up a cross border platform on blockchain for trade finance. The European Commission as part of EU’s research programs FP7 and Horizon 2020, plans to fund projects worth €340 million by 2020. The commission has also launched the EU blockchain observatory and forum with the support of the EU parliament. In the U.K., the Bank of England is examining the distributed ledger technology for secure RTGS transactions. Banks and financial institutions across the globe are discovering new use cases for blockchain, and the willingness of governments and central bodies is further helping move the needle on its adoption.

Against this backdrop, the WEF estimate seems rather conservative.

Blockchain is finding application in powerful real-world use cases such as digital identity, digital vault, and more! Imagine the convenience and security of having all your data and information such as education certificates, employment proof, health records, etc. encrypted and validated in the form of a personal digital vault. You control read, write, modify or delete permissions to this information or a subset of this information. For example, being able to share your health records only with your physician. Or think of the autonomy a smart contract can bring by eliminating the element of mistrust. You can convert your insurance, mutual funds or bonds into a smart contract and even transact on the bourses using the technology. Lost the physical documentation? Not a problem, the digital authority is legally binding! It’s encrypted, decentralized, immutable, and safe.

The above possibilities are just a glimpse of the potential of the technology. Applications of blockchain range from supply chain management, intellectual property, or just about anything that requires a trustworthy record. Here we look at the key attributes of blockchain and explore how blockchain stands to revolutionize and transform the financial services industry.

Think of the autonomy a smart contract can bring by eliminating the element of mistrust. You can convert your insurance, mutual funds or bonds into a smart contract and even transact on the bourses using the technology.

1. Transparency – Blockchain is being peddled as the new standard for transparency. Instead of a central authority, blockchain passes on the power to the endpoints in a transaction. Each record or transaction requires a sign-off from all the members of the chain. The biggest worry for any regulator today is the absence of a single source of truth to ensure visibility to all of a customer’s relationships with different banks. Central banks have for years strived to devise a way to bind all the relationships of a single customer into one unique identifier. In blockchain they have found the answer to this, plus a way to access all the transactions taking place in a network. Regulators also benefit from access to the required view of transactions and customers to ensure authenticity of transactions, enhance their reporting, and utilize the information for applications such as tax collection.

2. Network effects – No conversation about digitization is complete without the mention of Uber, Facebook, Alibaba, WeChat, et. al. who have all embraced the platform business model and harnessed the network effects to take their respective industries by storm. While banking has largely been a laggard in adopting the model, the industry is finally catching up. With blockchain, a technology that cannot operate in isolation, banks can reap the benefits of network effects as they form diverse ecosystems within banking and beyond.

3. Security – Banking has traditionally been prone to fraud and phishing activities. With digitization, digital identity hacking and related frauds have also become rampant. A secure system like blockchain can help banks combat and potentially put an end to these threats. Blockchain doesn’t only offer the advantages of immutability and transparency but can make records and transactions even more secure with digital certificates issued using public key infrastructure.

4. Encryption – The sophisticated cryptographic encryption techniques of SHA-256 and above make blockchain extremely robust and resistant to attacks.

5. Flexibility – Contrary to popular belief, blockchain is not all public like Bitcoin. Bitcoin is essentially a public blockchain where a member doesn’t require permission to become a node, to add a block or to mine the network. There are other ways of building a blockchain that require members to attain permission to read the information and transact or add to the chain. Thus, based on the capabilities a bank needs, it can build a private or permissioned distributed ledger.

6. Cost efficiency – Most European and U.S. banks are struggling with falling ROE levels, reducing interest income, eroding margins and profits. With the advances in technology, the cost of transactions has consistently come down from the days of branch-only transactions to transactions at ATMs to online and then mobile. With the advantages of speed, security, and transparency, the total cost of carrying out transactions on a blockchain will potentially be the lowest ever.

No single technology in the past has held the promise of all of the above.

With blockchain, for the first time regulators and central banks have a chance at not only effectively containing financial fraud but also ensuring authenticity of transactions. A block-chain extended to cross-border networks can lend itself for authentication and validation of transactions transcending geographies. Thus customers who have relationships with financial institutions outside their country of residence or domicile for reasons including but not limited to low tax regime, can also be brought under the radar of regulators and central banks.

The technology is gaining acceptance from all quarters – industry reports, analyst commentaries, regulators and bankers. Even skeptics such as the RBI in India, a body that has nearly banned Bitcoin transactions given the volatility and uncertainty surrounding the cryptocurrency, has ascertained its confidence in blockchain. The regulator has implemented a blockchain solution for trade receivable discounting systems.

So while it is abundantly clear that the industry believes that blockchain is a transformative technology, how can banks unlock its full potential. Let’s explore some use cases:

1.Asset Registry

That certain customers pledge the same asset as collateral or security at different banks to secure loans is not new. There are cases aplenty of such a fraud in the history of banking. Now, if a bank provides a loan to a customer against an asset and insists on putting a record of the asset on blockchain, it can prevent the same asset from being pledged as collateral for a loan at any other bank. Banks can thus reduce non-performing assets, not with a remedy such as faster recovery but by preventing them from making their way into the system in the first place.

Customers who have relationships with financial institutions outside their country of residence or domicile for reasons including but not limited to low tax regime, can also be brought under the radar of regulators and central banks.

2. Corporate Bonds
Corporate bond, a popular trading instrument is also subject to considerable cases of fraud. If a bond issued by a corporate is put on a blockchain and is provided a unique verifiable ID, it can be traded across the globe without having to go through any intermediary such as a stock exchange or a brokerage house. Combined with digital identity where both the transacting parties have proper KYC check or equivalent in place, these crossborder transactions can be made completely transparent with unique immutable records on the blockchain.

3. Cross Border Remittance Transactions

The global remittance space is potentially the biggest beneficiary of blockchain. A standard remittance transaction involves fees, charges and loss due to currency conversions, which can be eliminated with the use of blockchain. The transaction can also be made quick since blockchain saves the time spent in approvals in a typical traditional remittance. When ICICI and Emirates NBD put their international remittances on a blockchain network, they reduced the transaction time from a couple of days to just 36 seconds.

4. Trade Finance

Trade finance transactions, typically plagued by process inefficiencies, trade regulation inconsistencies across geographies, payment and delivery delays, and absence of information on shipment can be significantly improved using blockchain. Cryptographic security of blockchain ensures immutable records that can only be accessed by permissioned participants of trade. Since the transacting parties have a single source of truth that is updated real-time with network consensus, the delay and need for reconciliation of payments can be greatly reduced and the risk of fraud mitigated. What’s more, with smart contracts banks can easily execute contractual terms of trade.

5. Trade Invoice Financing

If purchase request, purchase order, payment, and all the stages of a transaction take place on a blockchain, banks can reduce the risk of fraudulent invoicing. This way, the invoice has a unique hash number which cannot be broken or decoded to derive the contents of the invoice, or be used for lending anywhere else.

6. Retail Lending

In retail, the number of mortgage related frauds can be brought down by putting all land records, land registries, and mortgage documents on a blockchain. This reduces the risk of litigation, as an asset has a single owner and the blockchain is the single source of truth. Regardless of who has the physical documents, the transaction record on the blockchain stays legally binding. Governments in countries such as Honduras, Sweden and Norway are already making it a national practice to store land registries on blockchain.

We have thus far in this article amply established how blockchain can rid banks of frauds and inefficiencies. But is there merit in blockchain use cases for winning business? We reckon yes. Banks have been losing their peer-to-peer lending and payments business to agile startups and fintechs for some time now. With blockchain, a trusted entity such as a bank in a classic platform fashion can bring the lender and the seeker together and orchestrate a secure transaction. The key reason this model augurs well for all participants involved is because checks such as KYC conducted by banks can authenticate the transacting parties, banks can conveniently build a credit rating mechanism for lenders to make lending decisions, and lastly because banks have the advantage of trust built over the years to be the body that puts the transactions on blockchain and controls permissions to accessibiity of information in this arrangement.

As the industry leading digital banking suite, Finacle’s blockchain based solutions are powering transformations at leading banks across the globe.

In an industry first, a consortium of 11 banks partnered with Infosys Finacle to pilot a blockchain based trade finance network in 2016. Finacle announced the global availability of Finacle Trade Connect, a blockchain based trade finance solution for banks that help digitize the trade finance business process, including validation of ownership, certifying documents and making payments, while working on a distributed, trusted and shared network. The solution is available for a range of functions, including Bill Collection, Letters of Credit, Open Account for Trade, C2C Transactions for Trade, B2C transactions for Trade, PO Financing and Invoice financing.

In the truly digital world of banking, we believe this is just the beginning of the most transformative things to come. The confluence of blockchain, artificial intelligence, deep machine learning, analytics and the new generation of technologies can unlock possibilities that have been only figments of sci-fi imagination so far.