In 2016 the European Central Bank (“ECB”) discussed the use of digitisation and new technologies and how such may affect the banking systems of tomorrow. The ECB reflected on the utilisation of Distributed Ledger Technologies (“DLT”), their potential impact in improving credit institutions internal efficiencies, the possibility of a critical core of market players making use of such technology leading to the shift in the modus operandi of a large market segment, and the revolutionary scenario of a peer-to-peer world without intermediaries.
The peer-to-peer reality is much stronger outside the European territories. China for example has been making use of peer-to-peer lending through WeChat for a number of years although a slow down has been recorded due to liquidity or insolvency matters.
Within the world of Central Banks, the use of DLT may not be as straight forward as one may imagine. In order for Central Banks to be able to continue to operate efficiently, the right DLT model needs to be adopted. The reality is that different DLT models exist and they differ in terms of architecture, validations, permissions, data sharing as well as replication and security measures. Whilst the technology is exciting and has potential institutions such as the ECB, Federal Reserve & Bank of England, amongst others across the world, need to ensure that they have a robust infrastructure which meets the needs of high security, safety & efficiency.
An interesting aspect which Central Banks would need to look into is how central bank money can be moved onto a DLT platform as well as the need to assess the legal, operational and functional dilemmas regarding the use of such DLT. The application of DLT from a Central Bank point of view could very well change the way different market participants interact in financial markets. The concepts of interoperability, standardisation and harmonisation are essential from a regulatory, functional and technical perspective.
On the flip-side from a commercial banking perspective, the use of DLT may bring about a friendlier banking – client relationship, reduce tensions from a documentation point of view, whilst providing cost-savings for both the bank and the end customer.
In a world of ever rising regulatory and operational costs, banks are desirous to seek ways of enhancing their customer service, ensure cost efficiencies and transparency to both their customers and regulators. They also want to safeguard their interests from fraudulent transactions and cyber-attacks.
Credit institutions and the banking industry at large may need to undertake a strategic overview of their current systems and processes and identify how a blockchain solution may assist them both as individual entities and as an industry as a whole. Aspects which should be looked into are their intermediary arrangements, transparency in transactions, storage of information, level of current automation, trust, adequacy of documentation and time sensitivity.
If we had to briefly analyse all of the aforementioned, the role of bank intermediaries would be re-dimensioned. Should a blockchain application be implemented, it would facilitate disintermediation, since the bank and the client are in direct contact. This increases the level of trust as the bank is obtaining the necessary information directly from the source. From a transparency point of view, records and transactions would be stored on the blockchain. They would also be executed via smart contracts, which are immutable and irreversible, thus providing a full audit trail through transaction recordation and increasing trust.
Data storage on the blockchain together with a consensus mechanism, probably through the use of a private or hybrid blockchain, would enhance consistency of information across the DLT platform whilst also reinforcing the bank’s security as no-one transaction can take place without the consensus of the other nodes in the peer-to-peer network. This will also heavily depend on the architecture of the DLT platform. Time is money, and the longer a transaction takes place, the costlier it is for a client. Through the use of blockchain technology, banks will be able to have near real-time settlements of transactions, reduce risk and provide enhanced customer service.
Banks are heavily regulated entities and they need to carry out due diligence on their customers, with intermediary or corresponding banks also requesting such information as part of the process. Presently all information is kept in isolated silos without sharing of information amongst the participating institutions. Know Your Client processes can be tedious and inefficient, especially if different banks need to perform equivalent procedures on the same individual or entity.
Without going into the merits of GDPR, through the use of blockchain technology an individual’s KYC documentation would be stored and verified on the blockchain, which documentation is then available to the banks, correspondent banks and other entities which form part of the transaction in a seamless manner. Such information is also easily accessible and verifiable by external agencies.
Whilst there are other areas of applicability to the banking sector which we have not explored it is also necessary to give some thoughts to the concerns. As mentioned above from a central banking point of view, the issue is somewhat more delicate due to the important role which such entities around the world hold in relation to our ever-increasing interconnected economies. Likewise, from a commercial point of view there are a number of similar concerns, such as integration into banks current systems, if not their total replacement. Other concerns revolve around control, security and privacy at a number of levels from membership to the ledger, to network security, transaction security and smart contract implementation and security features.
From a regulatory perspective, talk of any kind of regulation is still in its infancy, let alone world-wide harmonised laws. Whilst this provides opportunities for the development of ad-hoc systems, many are at experimental or developing proof-of concepts. The fact that blockchain will eventually lead to a shift onto a decentralised network, shall not only require the acceptance of its users, but also of its operators. There is also a cost to all this, whilst in the long run, cost savings may be significant, the investment in the technology itself may not come cheap.
We have witnessed how R3 and its consortium members have successfully developed a proof-of-concept application for KYC in order to address challenges associated with regulatory requirements whilst allowing the user to manage their own identities. VISA on the other hand has developed a B2B Payment Solution – VISA B2B Connect on a Blockchain platform for the facilitation of payment transactions. The challenges and opportunities are immense and time will tell if the opportunity cost outweighs the opportunity lost in not adopting blockchain technologies in our banking system.
For any assistance required please do not hesitate to contact our Fintech team on [email protected] or +356 2557 2557.
About the Author
This article has been authored by Nicholas Warren – Senior Manager Financial Services and Blockchain. He holds over 16 years of consultancy experience to international clients on the various possibilities presented by Malta as a Financial Services Centre.