Impact Of Blockchain In Banking Sector

Souvik Dey Souvik Dey
Dec 2, 2020 8 min read
Impact Of Blockchain In Banking Sector

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From early history, the banking industry has been acting as an intermediary to conduct financial transactions. Technology has always had an impact on the banking system. Major banks and financial institutions are realizing that blockchain technology could vastly improve the efficiency of their processes –particularly in cross-border payments – and reduce costs. A Blockchain is a digital, immutable, distributed ledger that chronologically records transactions in near real-time. Blockchain in the banking sector can play a key role in helping Indian banks and financial institutions realize significant benefits. Blockchain proposes a solution for this criticism as well as provides a competitive advantage over the Fintech industry.

The banking industry represents a major part of the global economy. Banks are the biggest and oldest financial intermediaries around the world. Over time, the technology-facilitated Automated Teller Machine (ATM), electronic fund transfer, electronic clearing service, real-time gross settlement, online banking, debit-credit cards, and mobile banking to the customers. Today, the banking industry is reliant on technology, and therefore, blockchain could prove to be the game-changer in the industry.

Blockchain
Blockchain

Fraud Prevention

Protection from identity theft and fraud is a constant challenge for everyone involved in buying and selling. Blockchain’s decentralized technology can enable banks and financial institutions to be more effective in the areas of fraud management and money laundering.

KYC/AML

Current KYC procedures which are used by leading banks and corporations around the world are completely dependent on human beings and are therefore slow and inefficient. Know Your Customer(KYC) and Anti-money Laundering(AML) is very essential for the identification of clients and also for preventing and tracking crime. Blockchain technology has proved to be very effective and compelling for cryptocurrencies to run successfully but it’s not the only thing that it can be utilized for. Creation of a common KYC & AML registry that could be utilized by various banks & financial institutions. This would drastically increase the process and reduce the expenses of KYC compliances. KYC & AML registry could be utilized for intra-bank purposes also. For KYC document storage, it makes sense for the banks to develop a shared private blockchain.

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Faster Payments

The World Economic Forum estimates that 10% of global GDP will be stored using blockchain by 2027. Most of this will be captured within cryptocurrencies. Unlike traditional currencies, cryptocurrencies enable quick transactions, secure, and global. Blockchains are revolutionizing the world of payments by fulfilling the bank’s desire for faster processing. Cryptocurrencies have barely been used for everyday payments and purchasing due to a few complications with regulation and trust. Cryptocurrencies have barely been used for everyday payments and purchasing due to a few complications with regulation and trust.

Forest is an open-source blockchain platform specially developed for high-speed private payment. This platform integrates a large number of the latest technologies in the field of blockchain technically. The main objective of a payment ecosystem is to use a decentralized network to enhance payments and financial settlement.

Centralised Payment System
Centralised Payment System

Clearance and Settlement systems

A Distributed Ledger Technology (DLT) like blockchain could enable bank transactions to be settled directly and keep track of them better than existing protocols such as Society for Worldwide Interbank Financial Telecommunication (SWIFT). DLT is viewed by many as having the potential to disrupt payment, clearing, settlement, and related activities. DLT could reduce the traditional reliance on a central ledger managed by a trusted entity for holding and transferring funds and other financial assets.

Proponents of the technology highlight its ability to transform financial services and markets by:

  • Reducing complexity
  • Improving end-to-end processing speed and thus the availability of assets and funds
  • Decreasing the need for reconciliation across multiple record-keeping infrastructures
  • Increasing transparency and immutability in transaction record-keeping
  • Improving network resilience through distributed data management
  • Reducing operational and financial tasks

The use of DLT, however, does not come without risks. In most instances, the risks associated with payment, clearing, and settlement activities are the same irrespective of whether the activity occurs on a single central ledger or a synchronized distributed ledger. Which said that DLT may pose new or different risks:

  • Potential uncertainty about operational and security issues arising from the technology
  • The lack of interoperability with existing processes and infrastructures
  • Ambiguity relating to settlement finality
  • Questions regarding the soundness of the legal underpinning for DLT implementations
  • The absence of an effective and robust governance framework
  • Issues related to data integrity, immutability, and privacy

Fundraising

Fundraising has been taking place for as long as people have been using money to carry out business transactions. Blockchain is becoming another source of capital for entrepreneurs.

‘It's a brand new way of transmitting money without the need for traditional banking networks, as well as a means to store data in a transparent and unalterable way’. - Sean Williams of Motley Fool

Blockchain can be used as a source of funding. The main thing is the ‘ICO’ or Initial Coin Offering.

There are three types of ICO tokens:

  • A currency token is one that has a corresponding ‘fiat’ value. Bitcoin is an example.
  • A utility token is a hybridized token that has a stored value based on the economics of supply and demand. Utility tokens are typically used for things like in-app purchases. An example is Ethereum.
  • A security token represents real-world securities or assets. A security token can be efficiently fractionalized and can represent ownership in a fund. Examples of security tokens include Blockchain Capital (BCAP).

To gain funding for the project, the developer issues a limited amount of tokens (could be utility or security). The tokens must have a limited amount because:

  • It makes sure that the ICO has a goal to aim for
  • As the demand rises and the supply of tokens diminishes, it makes sure that the value of the tokens will go up. The tokens have a predetermined price which may go up or down depending on the demand.
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Security in Banking Sector

Blockchain technology is being used to protect sensitive records and to authenticate the identity of a user. Keyless Security Infrastructure (KSI) stores data hashes on blockchains and runs a hashing algorithm for their verification. Public Key Infrastructure (PKI), an encryption approach that is particularly vulnerable to man-in-the-middle and DDoS attacks. Blockchain has emerged as one of the most disruptive technologies and has minimized the prevailing security issues in financial transactions.

  • Blockchain removes the middleman in asset rights transfers, lowering asset exchange fees, giving access to wider global markets, and reducing the instability of the traditional securities market
  • Moving securities on the blockchain could save $17B to $24B per year in global trade processing costs

IDC’s most recent five-year forecast, which goes through 2023, indicates that blockchain spending will be led by the banking sector with approximately 30% of the worldwide total.

Banking Security
Banking Security

Loans and Credit

According to Experian, fintech consumer lending has more than doubled in just four years, growing from a 22.4% share of personal loan originations in 2015 to 49.4% in 2019. Before the rise of banks, loans and repayments took place peer-to-peer. People had to trust each other. Built on a distributed ledger, the very nature of its design is trustless and decentralized. This makes it possible to transfer ownership of an asset from one person to another. The benefits for banks of utilizing blockchain technology are much the same as for individual loan providers, but perhaps even more useful for larger institutions.

According to a report issued by the World Economic Forum, by the year 2025, 10% of the world’s GDP will be stored on the blockchain.
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Trade Finance

Trade Finance in its simplest form can be seen as the financial transactions of both domestic and international trade that take place between a seller and a buyer facilitated by intermediaries such as banks and financial institutions. These trade finance transactions generally include lending, issuing letters of credit, factoring, export credit, and insurance. While blockchain is already being used by many industries ranging from manufacturing, healthcare to real estate, or government application, one of the main industries that can benefit from this technology is trade finance.

Blockchain Trade Finance procedure:

  • Receiving and classification of trade documents
  • Extraction of data from the recorded documents
  • Generation of valid reports for cross-documentation and transaction
  • Automatically validating the data between documents and generated reports is done
  • Document scrutiny is performed adhering to various rules and regulations

Digital Identity Verification

Digital identity arises organically from the use of personal information on the web and the data created by the individual’s actions online. The identity and access management market is expected to grow from $8.09 billion in 2016 to $14.82 billion by 2021, representing a 12.9% CAGR. Managing digital identities done by three Cs – Cumbersome, Costly, and Challenging. Blockchain has evolved significantly from the distributed ledger technology created to track bitcoin ownership. Blockchain can empower users to have greater control over their own identities. Blockchain has facilitated the so-called self-sovereign identity, which is inherently unalterable and more secure than traditional identity systems.

Users sign up to a self-sovereign identity and data platform to create and register a DID. During this process, the user creates a pair of private and public keys. A decentralized identifier (DID) is a pseudo-anonymous identifier for a person, company, object, etc. Each DID is secured by a private key. Only the private key owner can prove that they own or control their identity.

In principle, self-sovereign identity would allow users to :

  • Control their identities
  • Access and update information
  • Choose the information that they prefer to keep private
  • Transport the data
  • Delete the identity if that’s what is wanted

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