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Exploring Blockchain in Retail Banking
Bitcoin first made its appearance in the wake of the financial crisis of 2008, when numerous financial institutions and banks failed worldwide, and governments had to step in to bail out these distressed institutions. This meltdown shook people’s faith in traditional financial systems and paved the way for a digital currency; a currency not governed by a centralised authority. Bitcoin was introduced as a peer-to-peer electronic cash system that did not rely on an intermediary and since then, has been recognised as a disruptive force within various industries, particularly in the financial sector.
Blockchain Technology in Banking
The creator of Bitcoin (Satoshi Nakamoto) designed it to solve the root problem of conventional financial systems, namely, the need for trust. People have to place their trust in banks, and likewise the centralized banking system, to deposit their money, and not debase the currency. Bitcoin’s underlying technology has received its fair share of the limelight with most industries attempting to leverage what it has to offer. While Bitcoin was first regarded as a disruptor of financial systems, blockchain is perceived as a disruptor across industries and sectors. Healthcare, supply chain management, real estate, payments and the retail sector are just a few domains that have aggressively experimented with blockchain technology. With such central features as decentralisation, transparency, and immutability, blockchain technology is regarded as the quintessential force of transformation for the financial system.
Blockchain technology is a critical technological advancement for the banking sector if it is aptly utilised. While investment banks have embraced this technology and undertaken several projects, retail banks have been ‘nervous and cautious.’ With data reconciliation at the heart of the banking system, blockchain could offer the possibility of a radical transformation regarding data management cost and efficiencies. Most of today’s bank-run processes and data infrastructure can be decommissioned to drive greater cost-effectiveness and value. Automation results in streamlining processes, transparency optimises the auditability of transactions, digital identities eliminate the associated risks, and effective settlement processes drive business efficiencies — and all these features are readily available to banks. All that is required for them is to leverage blockchain technology.
Interest in Blockchain Technology
The IBM Institute for Business Value recently conducted a survey of 200 banks in 16 countries around the world to understand their expectations and experiences of using the blockchain technology. These banks said they believe that blockchain could render time, cost, and risk benefits across three key areas: reference data, retail payment, and consumer lending. In addition, 15% of these banks planned to have commercial blockchain solutions at scale. At the same time, it has also been noted that the adoption of blockchain technology in retail banking has been sluggish, compared with investment and wholesale banks. It is estimated that the venture capital funding for blockchain-based projects in industry crossed $1 billion in 2017. Likewise, wholesale banks have been actively working with the technology by hosting innovation labs, hackathons, and other collaborations.
It is not just investment or wholesale banks that are experimenting with blockchain; central banks across the globe have been curious about this technology. According to a report by Bank for International Settlements (BIS) in January 2019, at least 40 banks worldwide are predicted to soon be working and researching with central bank digital currency (CBDC). However, central banks’ vision for blockchain is not limited to CBDC as they are expected to be experimenting with at least ten use cases of blockchain technology. This has also been clearly communicated via their projects. The Bank of France is known to have completely deployed blockchain technology, and other central banks including the Bank of England, the Bank of Canada, and the Monetary Authority of Singapore (MAS) are recognised both for having conducted multiple distributed ledger technology pilots, and for publishing several in-depth research reports. Worth particular mention is the Ubin Project by MAS, launched with a vision of collaboration with other industry partners to explore DLT usage to make financial processes more transparent, resilient, and cost-effective.
Blockchain, and the numerous merits that it offers, is now being deployed beyond financial institutions and enterprises. One highly significant recent example is that of Libra. The Facebook platform envisions that Libra will become a global currency, particularly for those in developing countries with no, or limited access to banks and financial services. With some of the biggest enterprises, financial institutions, and central banks leveraging blockchain, the technology is expected to revolutionise the traditional structures of finance.
Potential Areas Within Retail Banking
As far as retail banking is concerned, there are several potential areas where blockchain can be utilised to offer unrivaled optimization:
Cross-border payments can take up to seven days or more and involve a fee anything from 2-3% up to 10%. Platforms such as the Society for Worldwide Interbank Financial Telecommunications (SWIFT) also take several days, and seem unduly expensive. Several ‘trusted’ middlemen carry out the processes behind international remittances, such as correspondent banks, intermediary banks, and international money transfer operators, making the entire process excessively time-consuming, complex, and costly. Every year, cross-border payments soar beyond $600 billion and are expected to keep growing. Rather than taking days, with blockchain, transactions can be settled within minutes. The distributed ledger also drives disintermediation, eliminating the need for unnecessary third parties and introducing cost efficiencies.
Around one in every four fintech innovations focuses on the segment of cross-border payments, one example of which is Ripple. Ripple aims to provide a frictionless experience for cross-border transactions by connecting banks and payment providers via RippleNet. Its global network has over 200 partners, including American Express, Standard Chartered, MUFG Bank, and SBI Remit. Another example of a similar initiative is the Interbank Information Network (IIN), an international payment service launched by Australia and New Zealand Banking Group, Royal Bank of Canada, and JPMorgan Chase.
In the public sector, the US Federal Reserve has recently announced plans to develop a real-time payment and settlement infrastructure called ‘Fednow’ that will perform instantaneous transfers 24*7, even on the weekends. This will eliminate the pain points of current monetary transfer methodology, which takes several working days, and a premium charged by payment networks for same-day transactions. Despite no explicit mention of leveraging on blockchain technology, the Federal Reserve is currently soliciting feedback from the general public on how best to develop and implement such a service. Given the proliferation and potential of blockchain technology for payments, there should be no surprise if they would utilize distributed ledgers as the core layer of the payment network.
Know-your-customer (KYC) and Anti Money Laundering (AML) tools have emerged as the fundamental pillars of fraud prevention and customer safety. Given that banks lose between $15 to $20 billion annually due to identity fraud and embezzlement, measures must be provided that protect them against these acts. A report by LexisNexis Risk Solutions estimated that AML compliance costs $25.3 billion per year in the US alone; and according to Europol, European banks are spending as much as $20 billion on AML. Additionally, some European banks have invested around €30 million for their compliance with the EU’s General Data Protection Regulation. While retail banks have indeed invested substantial effort and money into combatting identity fraud, money laundering, and data protection, this comes at a high cost, and greatly increases customer on-boarding time.
When leveraged for KYC and AML, blockchain can offer a balanced solution. By making use of tamper-proof digital signatures (or fingerprints) and storing them on a decentralized ledger, blockchain delivers immutability and transparency. It also eliminates any risk of double counting and compliance checks. In addition to this, blockchain ensures data protection by storing it on a distributed ledger that is backed by the principles of cryptography.
The application of blockchain is not limited to data storage or enacting transactions; rather it can also be used for the development and enforcement of legal contracts with the functionality of smart contracts. In the existing systems, the fulfillment of legal contracts is a costly, cumbersome, and time-consuming process. Smart contracts are pre-programmed protocols that facilitate, verify, and enforce digital contracts based on predefined conditions. These are self-executing agreements with the terms and conditions written into lines of codes. By integrating smart contracts, banks can exercise their contractual rights without having to bear the cost of legal proceedings and agencies.
The application of smart contracts not only automates the process of lending to a great extent but also reduces the cost significantly; plus it renders transparency and secure storage of all transactions and data.
Blockchain technology has the potential to pragmatically improve the core parts of retail banking. From cross-border payments to data protection and contract management, blockchain is being seen as a transformative agent for retail banks worldwide. However, the acceptance and application of this nascent technology in this legacy-based industry could be a slow process. Regulatory clarity and a seamless transition from fiat to digital assets could well pave the way to a faster adoption of blockchain.