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Does Blockchain spell the Death Knell for Core Banking Software Vendors

Blockchain….the word has the freed the banking word from the chains of imagination...anything and everything is possible using blockchain technologies. It can mold itself in many ways across various industries and provide freedom from any attached chains of the past and the present.  

 Having implemented than a dozen Core Banking and Risk Management programs , Blockchain the newest technology block on the kid , could address many of the issues and challenges faced by business and technology in the Financial world. Having been a banker myself and a technologist and seen both of them from very close quarters this could be a panacea to some of the problems that are being faced by the Financial services business today.

 Over the last 20 years there have been endless round of discussions on the replacement, modernisation, rationalisation etc. of legacy core banking platforms and it is yet to see the light of the day . Most of the pundits thought it is a very cumbersome process, benefits are not much, it takes a minimum of 3-7 yrs for replacement and costs billions of dollars. Yet we did go ahead with Digital transformation and Customer experience using the same legacy platforms with the same minimal functionality and spent billions of dollar on the same . But reports still indicate that the customer experience and service levels have not made major impact. I love Chris Skinners quote" A bank cannot be digital with a core system built for the last century”

 Then , there comes a next generation set of professionals called “Fintech’s” in popular parlance who are looking to create a space for themselves and create a differentiation in the market and a bunch of VC’s who are always looking at diversifying their investments and lay bets of the future technologies that will bring in the actual transformation in business.

 Let’s analyse the statement “Does Blockchain spell the Death Knell for Core Banking Software Vendors” a little further. It think it can be done and I do not see why it cannot be. Today we have Fintech’s who are actually developing Banking and Financial Applications across Lending, Syndication, capital markets (buys-side /sell –side), Risk analytics etc. All these applications are being developed using the Blockchain technologies. This means that all these modules which normally are there in most core systems are being developed as individual components which needs to be brought together.

 If we analyse blockchain as a technology in a little more detail, the four mains aspects of Block chain functionality is being used in a very efficient manner and they are:

  1. Distributed Ledger
  2. Consensus
  3. Security/ Cryptography
  4. Smart Contracts
  5. Real-time transactions  update

 All the other elements of transactions management , integrity of transactions, messaging , mining etc. . are inherent features of the blockchain.

 As we uncover a little more, Blockchain allows the creation of a Customer with unique ID and also attaches a unique code. This is very much similar to what we do in creating a Customer ID in a CRM or an Banking application. The banking application allows us to have various types of products like a Saving Account, Checking account , Term Deposits , overdrafts etc. which are product within a same family but varying characteristics. This is very similar to the execution of a contract in the Blockchain terminology. Everything in Blockchain is executed by a well-defined concept called Smart contracts which is nothing but a set of business rules which can be enhanced based on the product characteristics e.g. the simple difference between the savings and checking account is of interest application on saving but not on the checking which is nothing but a business rule to be defined as a Smart contract which can be further extended to the need to a debit card and whatever is needed to be defined in the contract.

This provides a fantastic way for banks to standardize their product offerings across the system and offer similar products in other markets . All this is done by simple replication of the block across the enterprise and is available to anyone and everyone . This in my view is a huge potential saving for banks who today grapple with a ton of products and have no way of standardizing or identifying when and who created the products etc. Add the concept of mining and with a few more rules one can easily find out the product utilisation and profitability.  

Also if there are tweaks to be made on the product for certain countries or regions depending on the popularity of the product, regulatory requirement etc. a tweak in the business rule and it can be made available across the chain instantly based on the consensus of each of the nodes and a classic e.g. a product used in India like the PPF and the IRA , 401K in US have many similarities but the rules may vary and this can help solve a lot of business problems and also reduce the IT challenges. This solves a huge amount of issues for the bank who actually have to configure and make those changes and see the deployments individually and have it tested for months together whereas here they will be able to launch and do it in matter of seconds/minutes.

Skeptics would argue that we could do the same in a modern core banking system as well …agreed but then the replication of the data across the various countries and regions at the products level today is still a time consuming effort and takes days and months. The beauty of the blockchain is the inherent feature it possess of distributed nodes and a completely distributed system yet being available across the Bank or the Financial institution. This concept did appeal to me in a lot of ways and having implemented Core banking system in  country and having implement Core banking Systems for banks Globally across 17-20 countries multiple times have really made me appreciate this technology. 

The other important area in a Core banking solution is about the ledger which is used a sub-gl to the main General ledger . In most cases we define the Core banking GL’s as the sub GL to the enterprise GL of the bank which is a rather good way of doing things. But it has its own inherent challenges and some of them include creation of codes, sub-codes , management of them , real-time updates etc. Most banks are getting out of the mess created over the years by using the new verbiage” Financial Transformation” and trying to clean up the dust accumulated over the years . In some cases many of the codes lying unused over the years are getting closed and in many cases they are being rationalized and the need for granularity at the GL level is something that is being recognised today. I still feel and am clear that if the GL is created at the most granular or atomic level, 90% of the Bank’s reporting issues are resolved . many have nodded their heads when this topic has been discussed but few would like to dive in . I believe this very much a necessity for proper Risk management and no amount of Hadoop or big-data is going to solve this problem if data is not diagnosed properly.

I see a possible solution in this area using Blockchain as every transaction is uniquely identified and the creation of codes for these transactions can be classified properly. Using smart contracts the transaction type can be assigned to the correct GL codes and this can also be mined later to create a report. Also the GL codes can be replicated across the various Geographies to create a standardisation and also localization can be achieved with relative ease. The proof of work concept in blockchain will also identify the codes in the blocks that are lying unused and it will also help showcase the codes that are lying idle and help them close it or block it else the cost of those nodes goes up. This will really bring in the much needed transformation needed in bank.

Let’s looks at one more classic example of how complex business procedures like KYC can be addressed using the distributed mechanism feature of blockchain. Today doing KYC  and AML is one of the most expensive operations for banking business especially in the Corporate Banking due to the multiple complexities of business needs like global compliance, local compliance and many other features and documentation , blockchain allows Banks to do this in a distributed manner and yet offer a single view of the KYC of the customer using the inherent features and also the Miners. The other important feature is also that KYC details needed to be renewed every two years and this can be done automatically using Smart Contracts features i.e. by setting the business rules when defining these contracts.

If I were to extend this feature a little more if Banks were to tie up with each other using the Blockchain frameworks like Ripple, it would help Banks reduce the cost and bring down the credit risk or counterparty Risks , thereby reducing Risk in the Banking sector. This does require Banks to have consensus of each and every counterparty by passing the token amongst Banks and whoever has that counterparty will approve the same and also validate the counterparty. Similarly if we exist this logic this could bring down the overall costs of doing business in the Eurozone since they have a single ECB constitution. This would open up a new era in the Banking & Financials services sector..   

 The other business areas in the Assets part of the business like lending , Syndication, Securitisation , Trade Finance etc. which is already being done. Payments is another important pillar in the Banking sector. Today most Banks internationally face a huge problem with payments. But yet today payments form an expensive part of the Banking business. There are multiple initiatives from central Banks to make payments more effective, real time etc. However banks still have a long way to go and also to achieve a solution to this problem. Partially this problem is caused due to the legacy architecture and inflexible systems which have to be tailored to achieve this.

The other business issue of managing the float which is being managed by the Banks today and are really afraid of losing the same. However blockchain using its realtime transaction posting and processing capabilities this can be extended. Blockchain framework like Ripple today allows the payments across the globe instantly. This change the entire dimension of the payments market and its associated business .This could extend to cards , loyalty points and many other associated business. The same logic can be applied when use a little more complex situations pricing , billing and many others today which are missing in most core packages today and is done using externally or some of them have them in the roadmap.

 So what we need is someone who can bring all these various components together to create the unique Core Banking solution which could really be a panacea to most of the issues faced by banks . This is also something that can be done much faster and quicker than the time taken by any Core Banking Vendor. The power is with the Banks as they have to decide and how they will use or misuse the power . Will they use this strengthen their hold and improvise the banking system or will they make futile attempts of “ applying lipstick on a pig” is to be seen.

But I definitely think that the Blockchain concept will have to be adopted by the Core banking Vendors soon in-order to survive or they die a natural death , hence the terminology.

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