The U.K.-based FinTech Network published a whitepaper in cooperation with BNY Mellon and Rabobank, outlining four use cases for blockchain technology in banking. The whitepaper highlights reduction of fraud,Know Your Customer (KYC) procedures, trading platforms and payments as four key blockchain use cases for banks.
Blockchain technology is widely considered to be a disruptive force in the financial services industry as it allows for the secure recording, storing and transferring of data, which makes it an ideal technology to make operational processes safer and more efficient.
Reduction of Fraud
According to Chris Mager, Head of Global Innovation at BNY Mellon Treasury Services, one of the primary issues that the banking sector is facing today is the increase in fraud and cyber-attacks.
Currently, the majority of banking systems are built on a centralized database, which makes them more susceptible to cyber-attacks as all information is stored locally in one place. Also, many banking systems are outdated and are, therefore, more vulnerable to new forms of cyber-attacks.
By building new banking systems on top of blockchain technology, the chance for fraud and data theft can be reduced substantially as the distributed ledger technology secures records; it stores, encrypts and verifies every single bit of data in a transaction. Therefore, should any data breach or fraudulent activity occur, it would be made immediately obvious to all parties who have permission to access the transaction data on the ledger.
KYC (Know Your Customer)
Compliance and KYC procedures have become increasingly important in the banking industry as regulators are keeping a very close eye on who banks are doing business with to avoid potential money laundering or terrorist financing. According to a Thomson Reuters Survey, financial institutions spend on average $60 million on KYC and customer due diligence while some banks spend up to $500 million per year.
Regulators want better access to banks’ customer client bases and transaction histories, while banks want to comply with the regulator’s wishes to avoid regulatory fines at all costs.
By developing compliance platforms and KYC processes on top of blockchain technology, banks can not only reduce operational costs in these departments but also increase the efficiency of compliance processes and develop a closer relationship with the financial regulator.
Chris Huls, Blockchain Specialist at Rabobank, proposes in the whitepaper that the KYC statements can be stored on a distributed ledger. He believes that when a bank has verified a new client, they can put the client’s data on a blockchain that can then also be accessed be other banks and accredited organizations, such as insurers or loan providers, without the need for the KYC process to be started all over again by each individual party. These parties would know that the client’s information has been independently audited and verified so that no further KYC checks are necessary. This, in turn, would substantially reduce administrative costs in compliance departments.
According to a report by investment bank Goldman Sachs, a 10 percent headcount reduction would be achieved with the introduction of blockchain technology in KYC procedures, which would equate to $160 million in annual cost-savings.
Moreover, as data stored on a blockchain is immutable and irreversible, the risk of duplication or errors would be greatly minimized.
The whitepaper further identifies trading platforms are a key use case for blockchain technology. By building securities exchanges on top of distributed ledger technology, there would be no need for a centralized trust or intermediaries as well as no risk of double spending in the securities-trading supply chain.
The risks of fraud and operational errors would also be drastically reduced as the blockchain would make the securities-trading process transparent, secure and immutable. This, in turn, would create a clear audit trail of all historical trades, which would provide assurance for the authenticity of all transactions.
If each security is digitized by a trusted central authority that authenticates the security, these digital tokens could then be traded and transparently tracked on a blockchain-based exchange. As the digital token would act as a certificate of authenticity, the chance to forge securities becomes much harder than when dealing with paper documents. That would give securities trading a new level of verifiable trust that has not been available so far.
There are already several exchanges, including NASDAQ and the Australian Securities Exchange, that are already developing blockchain-based exchange solutions to reduce costs and improve efficiencies in the securities-trading supply chain.
The payments space is the fourth use case that the whitepaper has identified where blockchain disruption would be highly beneficial for banks, which is one of the most prominent use cases for the blockchain in banking.
Rabobank’s Huls believes that the blockchain could be used as a new way for institutions and their clients to pay each other that does not depend on SWIFT or other payment schemes.
BNY Mellon’s Mager considers that the blockchain’s potential in payments could lead to an “unprecedented period of change and transformation.”
By conducting payments between banks themselves as well as with the customers using blockchain technology, banks would be able to save a substantial amount on costs as well as improve the safety and speed of domestic as well as cross-border payments.
The whitepaper cites Ripple’s protocol as an example of blockchain-based payment system for banks: “Ripple can be used by banks for an open-source approach to payments to replace many of the common intermediaries in the payments industry, thereby passing on savings to partner institutions, and thus by extension, to their customers. Thus blockchain can be used to make payments in real-time globally, with real-time execution, complete transparency, real-time fraud analysis and prevention and also at a reasonable cost.”
Challenges for Blockchain Adoption in Banking
While blockchain technology can provide solutions to a number of issues in the banking sector, challenges still lie ahead for the technology to become a fully integrated part of the industry.
The primary issues that the FinTech Network’s whitepaper cites are privacy concerns, integration with legacy banking systems, regulatory uncertainty and scalability.
Blockchains that the industry would use to store, record and transfer data would need to be permissioned blockchains in order to comply with privacy laws and to ensure that customers’ data is safe. Cyber-security concerns would need to be addressed before blockchain technology can be fully deployed in the market. Furthermore, new blockchain-based systems would need to integrate with current banking systems for blockchain adoption to work.
Regulatory uncertainty is another hindrance to blockchain adoption as there is no clear regulation on this new technology.
Finally, scalability is also a challenge since banking blockchains would need to be able to hold and process a massive amount of data. Hence, it is paramount for these systems to be constructed so that scalability will not become an issue, as it has with the Bitcoin blockchain, for example.
While blockchain technology would become a huge cost saver for banks in the years to come, challenges for its adoption need to be addressed before blockchains will become a fully-integrated part of the financial services industry.