Banks today face several challenges that impinge on the efficiency of their operations and, ultimately, on their profitability. Foremost among these, perhaps, is the ever-increasing strict regulatory framework – a result of the global financial crisis. Besides compliance, banks are also facing increasing pressure to meet discerning customer expectations in terms of tech user experience.
Industry experts believe banks risk becoming laggards in the market unless they jump on the bandwagon of change and adapt to the latest developments in technology. Indeed, some of the biggest banks have realised this and are already working on adopting new blockchain infrastructures that promise to revolutionise existing banking systems. This is because blockchain technology could potentially save banks billions by significantly reducing processing costs.
Blockchain’s key properties of decentralisation, immutability, efficiency, cost-effectiveness and security are promising substantial disruption, forever changing the nature of banking transactions. Touted as ‘the new economy’, blockchain technology lowers the need for trust because the platform is transparent, and transactions need the approval of all or most of the members in a community. This means that reputation accrues on the blockchain.
Trade finance is another major area set to undergo significant transformation on this platform, where old cumbersome processes become efficient once migrated on distributed-ledger technology. Blockchain can also replicate instruments for savings, treasury bills and money market funds, peer-to-peer.
Banks and credit rating firms facilitate the issuance of credit card debt, loans, bonds, T-bills and asset-backed securities. On the blockchain, anyone can directly check creditworthiness before issuing, trading and settling debt instruments, increasing transparency and efficiency. Indeed, this means entrepreneurs could even be able to access loans from peers. While in this respect, banks may face fierce competition, banks will be able to easily check the creditworthiness of companies or individuals and offer loans with more confidence.
As Fintech firms become increasingly popular in the banking sphere, banks are faced with a new reality – they will need to keep up with technical innovations to offer the level of service customers are demanding. Onboarding processes take very long since customers are often asked to provide data which they would have already provided to other banks or financial institutions.
A private blockchain between banks and financial institutions would allow individuals to facilitate the transmission of personal data while ensuring that the data remains secure and is only accessible by authorised parties.
Ensuring the identity of both parties through digital signatures, guaranteeing ultimate beneficiary ownership, speeding up the process by which transactions are affected and recorded, and solving the infamous double spend problem are some of the main cornerstones of blockchain technology. Such qualities make it a powerful tool for Know Your Client (KYC) and Anti-Money Laundering (AML) processes. To this extent, it could save banks billions in compliance costs. Indeed, global giant Santander has forecast the potential savings of blockchain as $20bn a year.
Experts believe banks risk becoming laggards in the market unless they jump on the bandwagon of change
While rare, there were instances where banks suffered cyber-attacks which led to customer data being leaked, or where funds were stolen by malware which affects the bank’s accounting systems and manipulates account balances. With its promise of immutability, blockchain technology has been dubbed as tamper-proof, or ‘unhackable’ – but is it truly so?
In truth, the blockchain’s decentralised nature implies that the client’s data will not be held by a single bank or intermediary. Instead, data is jointly recorded by a network of computers, also known as nodes. This framework removes the single point of risk which very often produces disastrous effects when corrupted. Effectively, depending on the rules which govern the blockchain as upon by all the nodes, a hacker would need to overpower the network by generating enough power to overpower all or the majority of nodes.
This would be unfeasible for several reasons. Firstly, the amount of computational power required often makes the processes expensive and not worthwhile to anyone with malicious intent. Moreover, while the hacker would be working to overpower the network, the network itself would be creating new blocks and in the process further solidifying the validity of the older blocks.
Naturally, we are dealing with software and code which can never be fully immutable. However, it is nearly fully immutable, because of how difficult it is to truly hack the blockchain. In this way, and through various algorithms, all records on the blockchain are permanent, in chronological order and available to everyone on the network (or to those who have permission to view such records in a permissioned or private blockchain).
It is predicted that blockchain technology might take three, five or even 10 years until it is fully integrated into our everyday processes. Nonetheless, banks cannot deny that to survive an increasingly digital world, they will need to embrace new technologies which might initially disrupt the industry, but which promise to improve processes using a bottom-up approach.
Banks are highly regulated entities, and also subject to very onerous penalties in cases of breaches, therefore it may be the case that traditional banks will not test the waters before a clear way forward becomes more mainstream.
Local banks may start feeling more at ease once a legislative framework is fully in place and the local financial services regulator has provided more guidance with respect to AML/KYC compliance of account holders investing in cryptocurrencies.
Nicholas Warren is a senior manager in the financial services practice group at Chetcuti Cauchi Advocates. Co-author Sarah Vassallo is a legal trainee at Chetcuti Cauchi Advocates within the financial services department.