Pramod Krishna Kamath, Lead Product Manager, Infosys Finacle
2016 saw banks engaged in a frenzied race to explore blockchain and pilot applications based on the technology. Their efforts are yielding early indications of what a blockchain enabled future might look like. A race to production is now well and truly underway.There is now consensus amongst banking and technology leaders that Distributed Ledger Technology (DLT) has great potential to bring in simplicity and efficiency in multiple business processes.
It is clear that DLT is one of many new technologies that will form the foundation of next generation banking. Cognitive Computing, Machine Learning, Cloud, and Robotics, alongside DLT, form the technology toolkit that will define the next evolution of financial services.
The transformational potential of DLT lies in its elimination of the need for individual books of record. As records cannot be changed once written, there is really no need for a custodian of trust in the ecosystem. Immutable data, which is distributed across participants in real-time, ensures that they reference and operate on a single version of truth. This alone has the potential to significantly increase transparency between market participants. As regulators can also participate in the DLT ecosystem, they can effortlessly access transactional data on demand. This can bring down banks’ regulatory compliance costs as the regulators can access data in a frictionless manner, in real-time.
Financial institutions stand to benefit greatly from blockchain and similar technology. The distributed ledger can automate legacy processes and thereby eliminate the need for reconciliation. It can also improve inter-entity processes that suffer from inefficiencies as a result of a lack of trust. A major benefit of blockchain is the smart contract, which is based on “shared trusted” processes and contractual terms that are enforced automatically upon fulfillment of certain conditions. This greatly reduces counterparty risk in any transaction.
Legacy processes typically need intermediaries, who add to inefficiency and cost.
In contrast, processes running on new technologies, such as blockchain, not only bring down liquidity costs but also improve working capital management.
That’s not all. Because the record of blockchain transactions cannot be tampered with, the transactions are protected against fraud. Last but not least, by forging direct, peer-to-peer connections, the technology eliminates the need for intermediary chains and a centralized supervisory authority.
Banks are approaching use cases based on whether they optimize cost or spawn off a technology-enabled new business line. Pilot projects show that opportunities exist in both areas.
Use cases abound in all three primary domains of financial services, namely, retail, trade and capital markets. While capital markets represent the biggest opportunity simply because of the value of traded assets, it might take four to five years for the use cases to hit production. This is because of the nature of the ecosystem, where all participants in the value chain, from Stock Exchanges to broker dealers to Asset Managers and Custodians, must agree to a common approach for the real benefits to kick in.
On the other hand, retail and trade finance use cases offer a much more realistic path to production. Remittances and trade finance, in particular, have some notable characteristics that make them very suitable for blockchain adoption: both represent significant revenue pools for banks, have processes that suffer from friction, lack a central counterparty, and have cost-and-inefficiency-creating intermediaries.
In both these areas, banks are already seeking to subvert intermediary costs (e.g. SWIFT) in high volume bilateral relationships. Today, they are doing this through peer-to-peer direct host connections between banks, typically implemented using custom protocols. Peer-to-peer custom arrangements are however not scalable beyond a limited set of partner banks and hence the efficiency gains are limited.
DLT democratizes these bespoke arrangements and enables banks to expand their partner network relatively quickly and with a standardized protocol.
While quick win applications do exist, the most impactful applications require a greater degree of collaboration between banks, technology providers and also regulators. Aligning competing interests to a common purpose, especially in the case of market competitors, is a key challenge. The good news is that regulators across the board are showing a growing appetite for DLT-enabled processes. Regulators in India, Dubai, Singapore, Japan, U.K. and Russia are studying the technology closely and working with leading banks in their respective regions to examine practical implementations.
In the latest edition of the Infosys Finacle – Efma “Innovation in Retail Banking” study, 61 percent of the banks said that blockchain/distributed ledger would have an impact on emerging retail banking business models in the next three to four years.
Progressive financial service institutions are already on board with Blockchain and are partnering with technology providers to improve current business processes and experiment with new technology-enabled business models. 2017 will be the year when Blockchain projects come out of the innovation labs and make their way into production, enabling banks to address real-life problems, albeit in a small way and in simpler use cases.