Distributed Ledger Technology in Banking: Friend or Foe?

My previous blog explored the lexicon of Bitcoin, blockchain and distributed ledger technology (DLT). As Julie Sweet, CEO of Accenture, suggests: “Blockchain is moving beyond cryptocurrency, and it's worth paying attention – especially since successful prototypes show that blockchain, also known as distributed ledger technology, will be transformative.” In this blog we’ll consider the disruptive potential of DLT in banking. 

Distributed ledger technology (DLT) offers a unique way to transact securely on a shared database without using an intermediary. In practice a distributed ledger is simultaneously owned by nobody and everybody. All parties have access to the same shared data so a blockchain offers a secure, single version of the truth – a “holy grail” that bankers and technologists have pursued for decades.

So why the delay in its uptake?

Many banks have reservations about DLT and some of these doubts are justified. Banks clinging to legacy technology stacks will struggle to implement DLT; some banks perceive DLT as simply another manifestation of the legacy challenge; and many banks have a fundamental fear of being disintermediated by DLT. However, consider this:

• DLT is not an evolution of what’s gone before, but a fundamentally new way of doing business that requires modern technology.

• The challenge is about much more than technology – success also requires fresh thinking and a new approach to how software is designed, developed, deployed and managed.

• In practice, DLT is both a threat and an opportunity for banks.

As we know, COVID-19 affected banking significantly, and highlights the need to accelerate digitalization. An International Chamber of Commerce survey conducted in April 2020 highlighted the pandemic’s negative impact on international trade and how banks are accelerating digitalization and exploring blockchain as a strategic solution.*

Banks can embrace DLT as an opportunity for banking in the modern age. Following are several compelling use cases for blockchain-based financial services:

Know Your Customer (KYC) and Fraud Prevention. By storing customer data on decentralized blocks, blockchain technology can eliminate redundant efforts and make it easier and safer to share information between financial institutions in real-time. Blockchain KYC solutions can provide much needed relief to ongoing administrative and regulatory burdens.

Payments. Blockchain technology can facilitate fast (potentially real-time) payment processing services. Encrypted distributed ledgers provide real-time verification of transactions without the need for intermediaries, such as banks or clearing houses. Payment servicing (particularly for cross-border transactions) is highly profitable for many banks, so DLT may pose a significant revenue threat. However, it’s worth noting that although there’s strong growth in transaction volumes for cryptocurrencies, they are long way from supplanting the world’s major currencies.

Clearance and settlement. Today’s clearance and settlement mechanisms are a cumbersome accident of history. Moving money around the world is slow and expensive for banks and their customers. There are often multiple intermediaries involved, including custodian banks, correspondent banks and the Society for Worldwide Interbank Financial Telecommunications (SWIFT) which provides the supporting financial messaging. With this labyrinth of parties and messages it can take up to three days to settle. Using DLT, a decentralized interbank blockchain could obviate the need for intermediaries and allow banks to clear and settle as soon as a payment is made and for far cheaper. This is a benefit for banks and their customers.

Loans and credit. Lending and credit provision is as old as banking itself. Since the earliest days, banks and lenders have underwritten loans using a system of credit checking and reporting, often involving specialist credit agencies. This can be complex, time consuming and potentially frustrating for borrowers who may have an urgent need for funds. DLT opens up a new world of opportunity for digital lending that’s potentially more economical, efficient and secure. DLT can also be a catalyst for a practical and secure means of peer-to-peer lending.

Blockchain technology offers some unique advantages when lending involves several parties, and is particularly relevant for syndicated lending. In 2018, BBVA signed the world’s first blockchain-based syndicated loan arrangement, and several other banks have since followed suit. BBVA cited the benefits of using the innovation to deliver a better client experience by automating the process for ease while minimizing operational risk because of the underlying principles of the blockchain. They noted that the entire negotiation was closed over a blockchain network, which significantly expedited the process with full documentation tracking and negotiation transparency.**

Trade finance. Another core banking activity, trade finance facilitates transactions between buyers and sellers worldwide. Trade finance lubricates the wheels of international commerce, providing credit, payment guarantee and insurance on terms that benefit all parties. Once again, this is traditionally a paper-intensive iterative process that involves several parties and takes time.

Blockchain has the potential to enhance transaction transparency, transform supply chain traceability and boost automation in trade finance. This could reduce costs, eliminate errors and accelerate document delivery to customers. In this new world, banks can increase efficiency and generate more business by making trade finance more transparent and accessible to customers in global locations.

How to Prepare for DLT

Banks need to choose which role/s they wish to play in the new value chain. Doing nothing is not a viable option. DLT is moving from theory to practice, and will undoubtedly progress.

Some banks have already moved beyond proof-of-concepts to running live DLT solutions. As noted above, syndicated lending is a good example of how individual banks can benefit from collaboration and pooled knowledge. It also highlights the need for collaboration to drive DLT uptake through the “network effect”. By its very nature DLT requires collaboration to gain critical mass. Forward-thinking banks should include DLT as a critical component of a core modernization program and acknowledge that it’s here to stay.

* https://www.tradefinanceglobal.com/posts/the-application-of-blockchain-in-trade-finance-opportunities-and-challenges/

** https://www.bbva.com/en/bbva-signs-world-first-blockchain-based-syndicated-loan-arrangement-with-red-electrica-corporacion/