Sam Mire Most banks examine the efficiency of their operations and the cost and reward of implementing new technologies as the primary controllable factors that can decrease efficiency ratio. One of these new technologies that is aimed at reducing fragmentation through operations and minimizing the cost associated with administrative manpower is the blockchain, which can fill a number of needs and occupy several roles within the financial sector.
Efficiency ratios are a key indicator of a bank’s success. With a 50% efficiency ratio, a bank spends $0.50 to generate $1.00 in revenue. A bank handling $1 billion in assets would experience an approximate $14 million increase in operating profit as a result of a 20% decrease in its efficiency ratio. There are a number of blockchain solutions that could tackle this problem, giving banks new opportunities to decrease their efficiency ratio, and improve service.
Interbank Transactions
When a customer at Chase wants to pay their friend at Bank of America, those banks must communicate to coordinate the transfer of funds digitally, and must also ensure that their books are adjusted properly. In Q1 of 2017 alone, there were $590.9 billion in net interbank transactions in the United States. In 2016, banks completed $42.4 billion in domestic payments by relying upon transferable balances held at other banks.
The process of banks transferring funds between each other remains complicated, with wire services and bank settlement processes incurring costs to the banks and customers that could be eliminated with a real-time, interoperable system of fund verification. Each month, digital clearing systems must be reviewed and settled between banks, proving especially costly when there is fragmentation between banks’ recordkeeping systems. As more players continue to emerge in the banking sector, trust between banks — created with a decentralized ledger — will reduce the headaches that arise from interbank dealings.
Companies Trying to Solve This Problem
- R3 (Corda) – Blockchain Smart Contracts for B2B Payments
- Billon Group – Blockchain ledger for enterprise and B2B transactions.
- China Construction Bank – Announced partnership w/ IBM to streamline transactions on the blockchain.
Cross-Border Transactions & Remittance
For individuals in the United States, sending money outside of the country costs an additional $42 and can take anywhere from 3 to 5 days to complete. With $180 trillion worth of cross-border payments executed annually, consider how much additional time and money is wasted on archaic payment processes between nations. While quicker payment processes such as SWIFT gpi are enhancing the old days of slow cross-border transactions, reducing transaction times to as little as minutes, there are added benefits that the blockchain can bring to how payments abroad are executed — namely security, transparency, and affordability.
Blockchain cross-border payment services charge less than 1% in fees, take only a few hours to process, and have been proven by expansive testing— billions of dollars in international transfers have been completed to date. And in cases where goods are exchanged, the ability to trace funds directly to the recipient using blockchain technology can decrease, or at least discourage, instances of fraud.
Companies Trying to Solve This Problem
- R3 (Corda) – Full-service banking solutions on the blockchain.
- Santander – First UK bank to facilitate live international payments with blockchain. Esp. between Europe and South America.
- CLS – Blockchain solutions for Global forex and clearing.
- Wyre – Faster international money transfer on the blockchain.
Smart Contract Enforcement
Even if you win a breach of contract suit, chances are that you’ll find yourself dishing out 25–40% of those winnings to your attorney. And if your lawyer is working on a non-contingency basis, you’ll have to pay him or her money out of your own pocket, on top of the filing fee, which can run upwards of $240. In the U.S., the cost of commercial claims resolved through litigation is $306 billion, and that number jumps to $870 billion when the global stage is considered. None of this even takes into account the cost of professional relationships burned by contract mismanagement, unclarity, and mendaciousness.
Smart contracts protect both parties, allowing pre-agreed upon parameters to be set into a self-executing algorithm. Money is kept in escrow, and only released when the conditions of the agreement are fulfilled. Whether one is the payer or the individual being paid, smart contracts significantly reduce the element of trust, which is to say, the level of risk inherent to financial agreements and the odds that you’ll find yourself in civil court over a financial disagreement.
Companies Trying to Solve This Problem
- JPMorgan Chase – Quorum Division. Enterprise-ready distributed ledger and smart contract platform aimed at high-speed payments.
- Polybius – Blockchain based use case in personal finance.
Cryptocurrency Banking Services
With a market capitalization of nearly $114 billion [at the time of writing], Bitcoin alone represents a massive demographic group of new wealth that traditional and investment banks have proven slow to adapt to. Additionally, financiers, hedge fund managers, and institutions are taking note of how the blockchain can improve their operations. Though it is difficult to say for certain, it is estimated that somewhere in the range of 20,000 to 200,000 crypto investors now qualify as millionaires. When well-known investors like the Rockefellers are getting in on Bitcoin investments, it’s clear that blockchain has the potential to completely disrupt mainstream banking services.
Consequently, select institutions are educating themselves on the ins and outs of cryptocurrencies and offering crypto-centric financial management services to clients. As public understanding of how cryptocurrencies work and how they can be utilized to diversify asset holdings increases, high-value clients are likely to urge banks to dive further into the cryptocurrency sphere. Banks who are able to comply with regulators to pair their strong reputations with cryptocurrency offerings could find themselves in a position of significant competitive advantage.
Companies Trying to Solve This Problem
- Hypothekarkbank Lenzburg (Hypi) – Announced opening business accounts for crypto companies.
- Falcon Private Bank – Private Swiss bank. Blockchain asset management service, accepts crypto-derived wealth.
- Bermuda Government – Signed MOU with Shyft Network. Did the same with Binance Group for blockchain projects.
- Goldman Sachs – Owns Circle, which launched Circle USD Coin. Opened “Bitcoin trading desk”.
Record Sharing and Storage
One report pegs the potential savings in the financial sector resulting from blockchain adoption at $8 billion–$12 billion per year, or 30% of eight global banks’ infrastructure costs. Much of the recordkeeping costs for financial institutions arises from outdated paper-based storage methods. Estimates show that between 60–70% of retail banks’ records management associated costs can be eliminated by going paperless, resulting in as much as a 25% cut in operating expenses for processing divisions.
The variety of functions and the sheer number of customers that large banks must service means that their record stores are massive, and the nature of the financial sector makes that information very valuable to bad actors. The blockchain provides the potential benefits of being digital, and thus less expensive. It also stores records in a decentralized way that provides an added measure of security and accessibility and also reduces the concerns about complete records loss that compels many businesses to remain stuck on physical, paper-based recordkeeping.
Companies Trying to Solve This Problem
- Bank of America – More blockchain patents filed than anyone. Includes one aimed at improved records storage/transmission.
- InterPlanetary File System – Blockchain based storage protocol and system.
- Oyster Protocol – New approach to file storage on the blockchain.
Clearing and Settlement
Currently, slow processes for payment clearing and settlement are causing banks to leave billions of dollars on the table. The Boston Consulting Group estimates that large institutional broker-dealers could make a reasonable investment — $15 million–$20 million per bank to cut settlement time down to T+1, or a single day after the transaction date — with near immediate payoff. These investments are predicted to provide $175 million in operational savings, in addition to $35 million in reinvested capital. With this in mind, imagine the operational savings that can be reasonably anticipated for clearing and settlement processes that outpace the T+1 model, instead of rendering near-immediate clearance and settlement, and for any size investment. This is the precise vision that some hold for blockchain’s application in the clearing and settlement process — employing blockchain technology as a decentralized alternative for central counterparty clearing houses.
Companies Trying to Solve This Problem
- Equibit Group – Blockchain based clearing and settlement use case.
- Australian Securities Exchange – Testing blockchain driven platforms.
Loan Syndication
The combined risk inherent to syndicated loans carries with it unique challenges. The market shattered records in 2017 — more than $2.41 trillion in syndicated loans were cleared even before year’s end — but the largesse of the syndicated lending landscape doesn’t solve the issues facing it. A return to a borrower-friendly mortgage market and a tax-friendly corporate environment are both spurring on trends in syndicated lending, and many of the largest lenders are already establishing a blockchain-based system for accommodating the continued upward momentum in syndicated loans.
The primary issue with syndicated loans is the lack of transparency arising from several underwriters. By forming unified records systems specifically for the purpose of lowering the cost and heightening the efficiency of establishing a syndicated loan, those in the business of syndicated loans are leveraging the blockchain to transform the industry indelibly.
Companies Trying to Solve This Problem
- Fusion LenderComm – Reducing the cost and burden of agent-to-lender administration with blockchain solutions.
RegTech for Cryptoassets
Earlier this year, a Vietnamese company called Modern Tech launched an ICO for its Pincoin token, raising a whopping $660 million from 32,000 people, then promptly disappeared like thieves in the night. And in April 2017, 18 executives of the now-infamous OneCoin cryptocurrency were arrested and $2 million in investor funds were seized by authorities after the company came under fire from several experts as likely being little more than a Ponzi scheme. At the time of the arrests, OneCoin had already been entrusted with $350 million in investor money.
The reality is that, left to their own evaluative devices, investors have proven unevenly capable of identifying ICOs that are little more than fundraising scams. Fraud is often discovered once it’s too late. Some see a middle ground between free crypto trade and beneficial regulation by which cryptocurrencies don’t become governed by stifling, burdensome legislation but are allowed some level of regulatory oversight so that bad actors and fraudulent practices are discouraged. Utilizing blockchain-based technology and algorithms to monitor patterns of potential criminality in cryptocurrency markets makes sense for regulators hoping to keep up with bad actors. Additionally, successfully designed decentralized systems are more open to oversight than traditional banking methods, as a sound blockchain ledger is near impossible to manipulate.
Companies Trying to Solve This Problem
- Codify – RegTech incubator for RegTech platforms serving emerging tech like blockchain.
- CoinFirm – Transactional compliance verification through cryptography.
Know Your Customer (KYC)
Financial institutions face unwieldy Know Your Customer (KYC) requirements, and the average onboarding time for financial institutions takes as long as 26 days as a result. The average annual cost of KYC processes per financial institutions is $48 million, with banks averaging $70 million to investment managers’ approximate $23 million in KYC costs. For institutions with $10 billion or more in revenue, KYC costs ballooned to $150 million this past year. 2017 KYC costs were 15% higher than the previous year, and this upward trend in KYC expenses is expected to continue going forward, at least until a greater measure of automation and innovation is adopted.
A blockchain-based record of one’s financials and other pertinent data could be a simpler way to verify applicants for loans, bank accounts, and other financial services. As an easily-shared yet secure ledger of comprehensive financial information, the blockchain may serve as a gold standard for storing trusted information about a customer’s source of funds, history, business interests, and other details that banks currently spend valuable time and assets tracking down and verifying.
Companies Trying to Solve This Problem
- Deloitte – KYC as a service, managed KYC offering leveraging blockchain.
- KYC Chain – KYC platform on the blockchain.
Anti-Money Laundering (AML) and Counter-Terrorist Financing (CTF)
In 2012, international banking giant HSBC was ordered to pay $1.9 billion in fines after it was determined the bank had laundered $881 million for the Mexican Sinaloa cartel and the Colombian Norte del Valle cartel. In 2017, the German lender Deutsche Bank was fined over $630 million for its role in allowing Russian criminals to launder parts of $10 billion through legitimate banks into offshore accounts. Commonwealth Bank of Australia incurred $534 million in fines for failing to observe laws against money laundering and terrorism financing. And Danish Danske Bank is investigating its Estonian branch to clarify whether $150 billion in laundered Russian funds have passed through its coffers.
Clearly, anti-money laundering and counter-terrorist financing practices and laws need to be strengthened. Industry-wide adoption of blockchain-linked ledgers would make compliance easier for honest banks, as well as making investigations of potentially corrupt institutions far quicker and cheaper. Because data logged on the blockchain is distributed across hundreds or even thousands of nodes, altering the entire decentralized record is nearly impossible, creating a far more trustworthy source of evidence for investigators and regulators to draw from when determining the extent of criminal activity.
Companies Trying to Solve This Problem
- CoinFirm – AML through blockchain based transaction verification.
- Chainalysis – Tracking relationships between crypto addresses.
- Elliptic – Real-time AML tracking for cryptocurrencies.
Regulatory Reporting
The cost of reporting in the financial sector is immense, with nearly 40% of financial firms claiming to spend at least $40 million on their global regulatory reporting processes. A combined 61% of firms spend anywhere from $5 million to $30 million on those very same processes. The cost of toeing the regulatory line is not cheap, and it’s understandable why: the Great Recession cost the U.S. alone more than 7.5 million jobs, $16 trillion of net worth, and doubled unemployment. But good compliance is not necessarily expensive compliance, and the trend is headed in the wrong direction, with 61% of compliance offices expecting their costs to be higher this year than they were in 2017.
Because the blockchain is a ledger that can be securely shared and is a store of immutable, trustworthy figures, the cost of reporting and auditing promises to be far lower. The self-executing nature of the technology is also likely to result in smaller compliance departments as automation proves more effective and cost-efficient than time-consuming, error-prone human-governed regulatory reporting systems.
Companies Trying to Solve This Problem
- AIIS – Partnering with IBM to streamline regulatory reporting for insurance.
- iComplyICO – Platform for maintaining regulatory reporting in the ICO sector.
Trade Finance
The World Trade Organization estimates that 80–90% of the world’s trade relies upon trade finance. Financial institutions act as the guarantor of payment between the seller of a product and the buyer, issuing a preemptive letter of credit to the seller that is fulfillable once the product is received by the buyer.
Using these traditional letters of credit requires the services of several intermediaries — banks, financiers, insurers, export credit agencies, etc. — which all must be compensated by the buyer and seller for their roles. These moving parts create inefficiencies in the form of unmet trade demands that have been estimated to cost as much as $2.6 trillion. Smart contracts on the blockchain could potentially help decrease the overall cost of recordkeeping and eliminate some intermediaries. The technology is also essential to wean trade finance off of its archaic, paper-based systems that cost time and money. Firms that serve these intermediary functions will need to pivot quickly to new business models to prevent their demise from more efficient and trustworthy systems.
Companies Trying to Solve This Problem
- IBM’s Batavia Platform – Open Source ecosystem for cross-border trade.
- Marco Polo Network – Trade and working capital finance network with blockchain technology.
- We.Trade – European trade finance network testing blockchain.
Data security
One study suggests that the cost of a single breach of a financial institution’s data is $7 million. The Heartland Payment Systems breach of 2008 is one of the most notorious hacks in the financial sector’s history, resulting in the compromise of 100 million-plus debit and credit card numbers stored on the payment processor’s database. Heartland ultimately paid out $145 million in fraudulent payments as a result of the breach. Institutions in the financial sector are the target of a disproportionate amount of attacks, accounting for 8.5% of data breaches in 2017. Considering that this means financial sector businesses are 300 times more likely to fall victim to a cyber attack, the need for greater security in the banking industry is self-evident.
Malicious attempts at acquiring data through back doors are more easily detected and blocked when the blockchain’s decentralized brand of authentication and security measures are deployed. The ability for information to be both secure, as just noted, yet also kept highly private through encryption and cryptographically-protected passkeys is ideally suited to the banking industry, where both security and privacy are critical.
Companies Trying to Solve This Problem
- Edge –Decentralized, blockchain driven edge-security for login.
- Bank of America – Security token patent.
- JP Morgan – Leveraging ZCash solutions for privacy.
Increasing Transparency
The opacity shrouding financial institutions has proven costly in some cases, and in other cases, lack of clarity has resulted in full-blown catastrophe. Wells Fargo is the most prominent recent example of this, systematically opening 2 million fake accounts in customers’ names, incurring exorbitant fees and damaging some customers’ credit scores so that salespeople and their bosses could hit bonus-inducing sales goals. But no bank represents the shroud of mystery covering many financial institutions like the now-defunct Lehman Brothers, which reported revenues of $19.3 billion and a record net income of $4.2 billion in 2007. In 2008, Lehman Brothers was exposed for its high-risk practices, eventually filing for bankruptcy and leaving its 25,000 employees out of work.
Wells Fargo’s reputation has been damaged greatly — perhaps irreparably — and a technology that would allow such disgraced banks to share their regulatory compliance efforts with their customers could reinstill confidence and reputational value. The greater amount of information that can be shared, the more trust a financial institution can garner, and the blockchain allows for unparalleled, unprecedented levels of funds tracking, data aggregation, and transparency. All of that will help expose and reduce risky banking practices while bringing value to those who handle their customers’ finances responsibly.
Companies Trying to Solve This Problem
- Ripple – Providing transparent solutions for banking.
- Finterra –Building more transparent money services platforms.
Serving the Unbanked
One of every 13 households in the United States gets by without a checking or savings account. While many of the most concentrated areas of unbanked individuals are rural, Miami leads the pack with 20.1% of its population unbanked and another 21.4% underbanked. The total number of unbanked Americans sits at 15.6 million, while 51.1 million U.S. adults are considered underbanked. The global picture is even more bleak, with 2 billion adults living without banking services.
Without access to or knowledge of traditional banking, the poor are often forced to turn to hostile alternatives with exorbitant fees that are unsustainable for those already struggling financially. To remedy this, several startups are seeking to extend systems of credit and lending to underserved populations, in many cases using financial technologies to do so. Undergirding these platforms with the blockchain provides an inherent measure of security, as well as the ability to create a decentralized, two-way network by which lenders and borrowers could establish terms and transact, among other benefits. Blockchain and cryptocurrency based solutions could completely replace predatory businesses like check cashing, payday advances, and other high-interest lending, with more fair and transparent systems.
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