How Blockchain will Transform Banking?

Banks are the critical intermediaries in this complex economy that facilitates the transfer of value between multiple parties. Serving as a conduit for parties in a financial transaction, banks shoulder enormous responsibility and significant risk. Trust and integrity are highly valued aspects in banking industry. However, traditional banking and financial institutions have been plagued with several inefficiencies such as foreign exchange transfer costs and times, security breaches, double spending, poor customer experiences, lack of transparency, rising costs of compliance and more. In fact, the inefficiencies of traditional banking system not only causes added costs and delays, but also makes it easier for security threats and fraudulent activities. Global financial crisis of 2008 gave us a clear picture of what happens when we put too much trust in a centralized system. And this breakdown of centralized trust motivated and paved the way for digital money. Bitcoin, the brainchild of an incognito personality Satoshi Nakamoto was the flagship cryptocurrency introduced in early 2009 to serve as a viable alternative to the traditional channels of monetary transactions. Blockchain, the revolutionary technology behind bitcoin is poised enough to transform the global banking system and finance sector.

Where conventional banking systems are facilitated by a centralized architecture, blockchain is a decentralized, distributed ledger of all transactions across a peer-to-peer (P2P) network. A transaction is encrypted and added to the block which can be accessed by multiple parties (P2P nodes). The computers in the network verify the details of the transaction and reach a consensus. Verified blocks of transactions are added to the shared ledger, which is tamper-proof and secure. Decentralized architecture, immutability, transparency and cryptographic security are some of the notable attributes of blockchain technology that have made it a new buzz word in banking and financial services sector. Today, banks and financial institutions are experimenting with blockchain to see how this innovative technology can be leveraged to effectively address the inefficiencies and loopholes in the existing banking system. In this blog post, we are going to explore the top five areas that could be transformed by blockchain.

Money laundering and financial crimes are on the rise as criminals are constantly seeking new means and technologies to defraud the banking system. Data from key statistics show that organizations spent approximately $10 billion USD on anti-money laundering (AML) alone. Efforts to counter the increasingly sophisticated financial crimes has become a costly decision for banks and financial institutions. And that is why the banking sector has been looking for an innovative solution to tackle the issues such as identity theft, money laundering and other financial crimes. Blockchain-based KYC process can be a perfect solution as the data can be collected from multiple authoritative service providers and cryptographically stored in a decentralized network. Currently, KYC is a manual, time-consuming process that holds a higher risk of error, increasing the operational costs and processing time. Using blockchain in KYC would reduce the wait times and eliminates the likelihood of errors and duplication thereby providing greater visibility to regulators and better customer experience.

Introducing blockchain KYC utility also helps in intra-bank and inter-bank verification procedures. Since the data is available on a distributed and decentralized network of blockchain, permissioned third parties can access it. From a customer perspective, it would eliminate the need to submit the same information to multiple banks repeatedly. Replacing the long, drawn-out documentation process of KYC with blockchain technology helps in reducing the processing costs substantially, ensuring greater operational efficiency and increasing trust.

Huge rise in financial fraud has raised serious concerns about the vulnerabilities in bank’s internal controls and systems. Considered as one of the most significant threats in the global economy, financial fraud schemes have taken the shape and modalities of organized crime. Since fraud activities can lead to the downfall of companies, loss of public trust in financial markets and derail the national and global economy, That is why banking and financial institutions are in need for an effective fraud risk management program based on blockchain in order to identify, assess, and prevent fraud regardless of its origin. Adoption of blockchain technology can provide the fraud prevention capabilities banks are looking for.

With blockchain technology, it is possible to store, view and share digital information securely. Cryptographically encrypted records of all kinds of transactions are added to an open, transparent decentralized ledger, which is resistant to tampering. Since the records are maintained in a distributed platform, it prevents the risks of double spending, identity theft, hacking and other threats. Currently, financial transactions is a multi-process completed through collaterals, intermediaries, and currency denominations. Human interaction and time required for the settlement are vulnerable to security breaches and attacks. When banking payments and services integrated to blockchain, it provides a higher level of security and transparency to transactions.

Clearing and settlement is a manually intensive interbank process that relies on a number of internal and external banking systems, involves several financial intermediaries and reconciling redundant data sets. The amount of time taken to manage the manual reconciliation and processing often cause significant delay in clearing and settlement of a transaction. This area of banking is ripe for a technological transformation and blockchain promises greater efficiency and higher resiliency for trading platforms. Mitigating the risks and reducing the transaction time, blockchain technology can deliver immediate settlements with higher levels of security and transparency.
Restructuring clearing and settlement process with blockchain technology eliminates the need for intermediaries thereby cutting down transaction costs. Moreover, banks and financial institutions can automate compliance through smart contracts. NASDAQ is leveraging this revolutionary technology to issue and manage private securities, whereas London Stock Exchange and Australian Securities Exchange plans to restructure their clearing and settlement process with blockchain system.

Banks and financial institutions underwrite loans depending on a system of credit reporting. Since banks act as middlemen, extra layers of complexity and regulation is added to the process making it highly expensive for the borrowers. Blockchain can provide an effective alternative to the process of lending and borrowing- Peer-to-Peer lending (P2P lending) . Also known as marketplace lending or crowdsourcing, P2P lending is an innovative approach to connect borrowers and lenders directly. Not only it eliminates the financial intermediaries and overhead fees, but also increases the returns and economic efficiency of lending and investments.

Cryptographically secure and decentralized architecture of blockchain technology provide the borrower access to competitive financing choices from different lenders, regardless of geographical boundaries. Lenders can validate transactions, verify the credit score and conduct routine administration tasks through smart contracts . Since all the records of transactions are open and auditable across a peer to peer network, it ensures higher levels of transparency, lower risks and efficiency.

While globalization and digitization has opened up new doors of opportunities for banking and financial institutions, it has to deal with a broad range of international regulations now. As consumers shift their banking operations to digital world, the volume and complexity of financial transactions has increased significantly. Manual compliance processes often leaves the doors open for risks and errors leading to security breaches and malicious attacks. Regulatory technology or RegTech has emerged as an innovative solution to improve the overall efficiency and effectiveness of operational processes. RegTech focuses on leveraging blockchain, Artificial Intelligence and other breakthrough technologies to transform regulatory world.

Blockchain allows its users to document the transactions on its distributed ledger, thereby facilitating a secure and precise audit trail. As the data saved into the tamper-resistant database of blockchain network can’t be altered or deleted, it can be used for regulatory reporting, KYC process and AML compliance. Banks and financial institutions can carry out faster identity checks using blockchain, thus maintaining the trust and integrity of the system. Serving as a fully transparent and accessible system of records for regulators, blockchain-based regulatory systems can ensure substantial savings and efficiencies.

Whether it is about reducing costs or increasing efficiency, blockchain technology has the potential to transform the banking sector. Bringing transparency to the banking industry with technology-enabled mechanism of trust, blockchain solutions can address many of the existing bottlenecks and challenges.