In recent discussion with the CEO of a Swiss reinsurance company, we discussed the topic of digitalization and the impact of emerging technologies on financial institutions, particularly how Fintech and other financial innovations like the blockchain, are reducing costs and improving customer experience. To keep up, and successfully ride the wave of digitalization, identifying the right trends and aligning internal organizational structures to successfully manage transformation, was considered particularly important.
Amongst the myriad of emerging technologies, available for companies utilizing digital strategies, we are witnessing an uptake of blockchain-based solutions. For example, the application and relevance of smart contracts in the banking and financial services industries.
They extend the idea of the blockchain, which defines the mechanism of connecting databases to an ecosystem, governed by either a permissioned or permissionless protocol, to partial or complete legal documents.
Hitherto, banking agency functions, such as payment clearance and settlement services, have been marked by complex, timely, and onerous processes. Smart contracts and blockchain implementations are equipping banks with the right tools for the digital age.
Clearing and Settlements
The process of clearing and settling transactions is an important function of a financial institution. Within this business function, the institution is required to register the commitment of multiple parties to participate in an exchange and, once the terms of the contract have been satisfied, to manage the transfer of funds. Due to the nature and degree of complexity which can arise from such exchanges, financial institutions are required to invest significant resources into administrative and time-consuming duties.
Smart contracts, by only becoming actionable when the terms and conditions of the agreement are satisfied, are well-positioned to reduce the complexity and operational costs of clearing and settlements for banks. Additionally, as will be discussed in later parts of this article, by replacing administrative agents with an objective consensus protocol, both clearing and settlement functions are less exposed to human-error and subjective decision-making, prior and post contract execution.
For example, the US’s Citigroup and Credit Agricole have partnered with a number of shareholders to utilize the London-based blockchain payments and settlements platform offered by SETL. By settling and facilitating trading on their permissioned platform, the participants aim to improve the process of matching transactions and payments, as well as redirecting resources away from conventional transaction settlements, which were often plagued by high administrative resource requirements.
The Australian Securities Exchange (ASX), will also shortly rollout its blockchain solution for clearances and settlements of equity transactions. The planned upgrades of Chess, short for Clearing House Electronic Subregister System, are to be supplanted by the new blockchain technology offered by Digital Asset Holdings, enabling customers to enjoy lower transaction costs, and improving real-time feedback.
Compliance and Know Your Customer (KYC)
Changes in financial services regulation can create complexity within the operating environment of financial institutions. For example, new KYC and anti-money laundering regulations have had far-reaching, albeit positive, implications for banks. Such changes have been shown to burden these financial institutions with high upfront customer acquisition costs and slower transaction processing times. In the wake of the Global Financial Crisis (GFC), banks that have become increasingly burdened by these costs have either sought to implement new technologies, which reduce the burden, or to restructure their businesses.
It is within the compliance-related business functions that we may find rampant implementations of blockchain technology, and solutions that reduce the added complexity of operating in a rigid market. By utilizing the consensus protocol of the blockchain, banks can verify customer information against central records, thereby enabling disintermediation where inefficiencies exist. Furthermore, creating an immutable database on the blockchain offers serious cost-saving advantages.
HSBC has recently partnered with Moneycatcha, an Australian Fintech which is set to overhaul the bank’s reporting capabilities, thereby enabling the bank to collect rich consumer data and have this information readily available for regulators. Internal reporting and the safeguarding of information has been estimated to cost the four largest Australian banks around AUD $1 billion per year. By utilizing Regchain – Moneycatcha’s blockchain reporting platform – HSBC hopes to create a chronological record of immutable data that reduces the costs of manual information procurement processes.
The importance of smart contracts and other blockchain technologies, as tools to overcome some of the associated costs of compliance, have also been identified by JP Morgan and UBS as strategic imperatives. Both banks have recently cooperated on the pilot program of JP Morgan’s Interbank Information Network (IIN), which aims to improve the speed of cross-border payments by improving access to secure consumer information. IIN, which has been built on top of the Quoram blockchain, is set to reduce the time spent by banks conducting research and responding to compliance inquiries about cross-border transactions.
UBS has also cooperated with Barclay, Credit Suisse, and a number of other institutions to engineer its Massive Autonomous Distributed Reconciliation Platform, better known as Madrec. The technology was incubated in UBS’s London-based Blockchain Research and Development Lab, and will enable participants to easily reconcile and obtain recourse to data that normally requires procurement from counter-parties. The technology originally emerged as an answer to the institutionalization of the Markets in Financial Instruments Directive (MiFID) II.
Richer Customer Experiences
Smart contracts are enablers of the future, particularly when it comes to offering customers rich new experiences. Conventional long-term debt products like mortgages may soon be reshaped, thanks to the reduced complexity needed to verify and collect personal information about customers, their spending behavior, and their collateral. A database, which could be accessed by a smart contract to extrapolate information about ownership of title deeds and land records, may reduce the complexity of sourcing data and simultaneously improve the process underwriting loans. Instead of utilizing third-party verification for such information, a customer, who is assumed to have his private information stored in such a database, could be analyzed by a consensus protocol and could reap the benefits of faster response times and transaction costs.
Blockchains that enable users to tether digital assets to smart contracts, such as the solutions offered by Wanchain and Jibrel, have already begun paving the way for supporting end-to-end clearance and enabling better controls for lifecycle movement of structured products. Whether a user tethers a bond, mortgage, fixed capital asset, or a commodity to a smart contract, the information of the particular asset, or debt, can be tracked. In the case of commodities, if user B acquires a particular quantity and quality of gold from user A, a smart contract can be engineered to ensure that he/she obtains the desired goods – with predetermined preferences or requirements – at the price set by A. Upon delivery, the payment is immediately released from escrow-from online wallets- and is paid to the seller. No intermediary, such as a dealer, who may require a fee for facilitating such a transaction, would be needed to facilitate the exchange.
Finally, consumers stand to significantly benefit from the banks that utilise smart contracts for cross-border remittance. Ripple, the 3rd largest cryptocurrency, offers near zero transaction fees and incredibly fast confirmation speeds. Banks such as Santander, Unibancois, and other institutions that offer remittance services, such as the Singaporean-based InstaRema, have already begun cooperating with Ripple to offer customers a faster, cheaper, and less complex method of sending money abroad.
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