The financial services industry has been going through a somewhat speedy disruption in the recent past. You would probably respond to this statement without much of surprise, and ask me what is so astonishing in this statement. After all, many industries have been successfully trying to stand up to technological disruptions in the recent past. Financial services (FS) might not be the only industry that is going to be altered by Blockchain technology, but it is certainly making huge strides towards bringing about this change upon itself.
Blockchain as a technology (BCT)/software protocol has a lot to offer to the financial services realm. A major attraction for BCT within financial services is its ability for disintermediation, a cost-saving mechanism for most sector players. Blockchain trims down a need for costly infrastructure requirements that aid in transaction processing.
Before we begin, let us look at what is meant by Blockchain technology.
As per industry definitions, Blockchain is a distributed digital ledger (DLT) that allows transactions of value to be recorded and verified electronically over a network of computers (called nodes/blocks) without being managed by a central ledger. Data is encrypted inside each block to protect it from fraud /hackers. All data/transactions within the blocks are cryptographically encrypted.
Blockchains are more trustworthy than conventional centralized systems because each transaction on the chain is verified/validated by the participating nodes/blocks and also encrypted cryptographically. Any change/duplication of data in one of the nodes is synced with the other nodes and this leads to transparency. As per a recent article published in the Medium, Blockchain’s decentralized, open & cryptographic nature allow people to trust each other and transact peer to peer, making the need for intermediaries obsolete. (*Source:Medium)
So how will Blockchain prove to be a transformational force for the financial services domain? Let us check out a few scenarios:
1. International Payments: Global payment volumes have been rising with the passing years. Along with this rise is the increase in infrastructure and processing requirements along with the need for quick settlements. Security, of course, is important as it always has been. Transaction costs are another challenge. Competition from non-banking players is seen as a forceful change in the payments scenario.
Blockchain technology has great hopes pinned to it in the form of savings in transaction costs involving intermediaries as well as the time lags associated with the transactions. Real time payments with reduced settlement risks are another possible outcome of Blockchain implementation. This is in addition to lessening the threats to data safety, privacy and similar limitations.
2. Asset Management: Global asset management is cumbersome when it comes to clearance and settlement practices. Blockchain promises to simplify processes, bring down costs and delays. Blockchain implementation can speed up decision making, protect data sensitivity and provide much-needed transparency to transactions. This is in addition to simplification in the KYC, client onboarding, trading processes.
3. Trade Finance: Trade is an area that is largely prone to theft and fraud dangers. Documents involved in a trade process such as invoices, Letter of Credit, Bank Guarantees and Bills of Lading are not free from the dangers of forging. This is what Blockchain adoption can eliminate. Since it is a peer to peer network, middlemen are cut off, bringing down instances of cost and time savings. Asset tracking can be made simple as each asset is linked to a generated serial number within the chain. Another instance of the technology making trade finance simpler is in the execution and maintenance of Smart Contracts.
4. Investment Banking: It is said that Blockchain technology could save millions of dollars for investment banks. This includes a huge savings in office infrastructure in addition to savings involved in reconciliation processes, enhancement of data accuracy, transparency in dealings and auditability (Source: Accenture Report on Investment Banking 2017)
5. Capital Markets: Capital markets include a global network of financial institutions that act as trusted intermediaries. Such intermediaries possess volumes of isolated data, leading to challenges in the form of data inaccuracies, processing delays and resultant errors. What the Blockchain can do is to bring down the number of intermediaries and in the process, eliminate many of the earlier roadblocks. Capital markets also gain a number of benefits such as faster clearance and settlements, easier compliance requirements, and the operational efficiencies resulting from a mix of all these benefits.
6. Financial Inclusion: For the many nameless people on the planet, Blockchain can be a way to financial inclusion and creation of own identity. This way they could make more money by selling their wares directly to people who matter, without ever having to go through meddlesome intermediaries. An example is the Blockchain connecting several mobile wallet providers for quick services to people who are in need for money transfers and payments, yet not in a financial network.
7. Insurance Claims: A trusted technology such as Blockchain is the most suited for transformation of the insurance industry. The onus would be on increasing transparency to the entire process. The end-to-end process of insurance starting from customer evaluation down to claims processing is now covered by a haze of mistrust and formidable costs, which prevents even the most eligible parties from reaching out for cover. This is true globally, and is what Blockchain technology can correct. Smart contracts linked to Blockchain can enable a dynamic pricing policy for premiums.
8. KYC Process: Blockchain creates an internal identity process that is aided by storing data in the form of blocks and making this data tamper-proof using a hash format. This ensures greater data security, identity management and fraud prevention in transactions. Banks can be a beneficiary of such automation of KYC, leading to customer experience and loyalty.
9. Banking in general: Though banking as a whole cannot be overthrown by disruptive technologies including Blockchain, there is a greater chance for the industry to undergo a sea change as a result. More transparency, faster processing, cost reduction, bringing down cyber risks plus mediation and central controls will change banking scenarios for the better. Since Blockchain operates with blocks/nodes that are tamper-proof, all transactions that take place in the peer-to-peer network are relayed throughout the blocks and verified. A way forward for banks is to start testing the waters internally by automating back office functions, and gradually extend it to outside operations.
Challenges to Implementation
Blockchain technology needs agreement between the different parties/functionaries as well as regulatory approvals before it can be fully adopted into the various financial service realms. Infrastructural expenses can be another hurdle to adoption as legacy systems can be costly or even suicidal to interrupt, even for a few minutes or hours. Process and people changes are also an essential part of implementation, and this is not often an easy thing to accomplish.
Blockchain will definitely bring about a big wave of transformation into the financial services sector, with focus falling on Payments, Trade Finance and Banking. It may not eliminate intermediaries and banking altogether, but is poised to make the scenario much more customer-friendly and trustworthy.