Blockchain and Banks – Boon or Bane?

Blockchain, or distributed ledger technology, has now been around for a decade. As such, most people who are even remotely associated with the financial system, have an idea of what blockchain is and its potential usage. This however, is not the intriguing part about blockchain. Rather, it is blockchain’s relationship with the banking industry that has now presented itself as a captivating (and often polarising) topic.

There are two schools of thought on this debate:

The Advantage –

The technology has the potential to significantly reduce processing and transaction costs, thus saving banks billions of dollars. Additionally, the security offered by blockchain allows banks to reduce the funds directed towards security and maintenance systems, again saving a substantial amount of money.

The Disadvantage –

On the other hand, blockchain could spell trouble for banks. It presents itself as a technology that aims to remove the intermediary in financial transactions. That is, the intermediate entity which charges a fee for facilitating a transaction. So, theoretically at least, blockchain could threaten the revenue stream of banks. Furthermore, the ability to start a bank at significantly low costs is attracting numerous fintech start-ups to the market, aspiring to become fully-fledged banks.

Now, with presumably so much to lose, why are banks still gung-ho about blockchain?

There are numerous reasons why the banking industry is willing to overlook the dark clouds for the silver lining(s). Adoption of blockchain technology has some potential benefits for banks, impacting some of the more cardinal functions that banks perform:

Peer-to-Peer Payments –

Blockchain removes the need for intermediaries to process transactions between entities. With current cross-border transactions taking anywhere between a couple of days to a week to settle, cryptocurrency transactions reduce this time significantly to a few minutes or hours.

In addition, facilitation of payments is a big revenue generator for banks. Blockchain is disrupting this apple cart by offering a low-cost way to send payments without the need for an intermediary. Cryptocurrencies, which utilises blockchain technology, uses a public, decentralised ledger that is accessible by anyone to send and receive money. As such, it eliminates the need for a trusted third party (i.e. a bank) to verify transactions.

Credit –

Blockchain eliminates the underwriter in the loan and credit industry. It makes borrowing money more secure and provides lower interest rates. Banks provide credit/loans based on factors such as income-to-debt ratio, credit score and asset ownership status. This is seen as an inaccurate and insecure system, that often impacts borrowers negatively. In using blockchain technology however, borrowers are able to apply for loans based on a global credit score. It proposes a cheaper, efficient and more secure way of making credit available to borrowers.

Settlement and Clearance –

Blockchain has the ability to reduce operational costs and implement real time transactions between financial institutions. Current bank transfers must go through a complex array of intermediaries, including banks and other custodians, before reaching the designated account. The origin bank and the destination bank may have different ledgers, which have to be then reconciled at the end of the business day. This must occur across a global financial system of various financial entities including traders, funds and asset managers. Each intermediary contributes a cost factor to the transaction and also adds a probability of transaction failure.

Blockchain, on the other hand, uses a decentralised ledger of transactions that is accessible to all participants. It alleviates the need to reconcile each player’s ledger as it maintains a record of all transactions both publicly and transparently. Transactions can be settled directly on the blockchain, instead of going through a network of custodians and intermediaries. This reduces the costs of maintaining a global network of correspondent banks.

In summary, the benefits of blockchain relating to banks can be realised if banks decide to ride the blockchain wave and use it to their advantage. That is, establishing lower costs, cresting faster transactions, maintaining efficient operations and offering higher security. Banks need to take conscious steps to stay clear of the ‘bane’ perception of blockchain and rack up the advantages to such a level that the positives outweigh the negatives.

With customer experience provided by banks having long been a pet peeve for many, blockchain comes with the added benefit of enhanced services and therefore, happier customers.

Blockchain could be just the tool required to transform the peeve to a pet!

 

 

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