How Blockchain Is Changing the Banking Industry

By John Manning, International Banker

The cryptocurrency craze has been in full flow during 2017. Bitcoin seems to be setting record highs with every passing week. Initial coin offerings (ICOs) are turning traditional capital-raising on its head. And perhaps most significantly of all, blockchain technology is beginning to have a transformational impact on the world. Arguably, it’s the global banking system that could benefit the most from the implementation of this revolutionary distributed-ledger technology. Whether it’s payments, settlements or compliance, blockchain’s key properties of decentralisation, immutability, efficiency, cost-effectiveness and security are leading to a growing chorus of support for the technology’s adoption across the entire spectrum of financial services; as such, the industry is now expected to undergo substantial disruption over the coming years.

In terms of the impact of specific blockchain companies, few have done more for the global banking industry to date than Ripple. The San Francisco-based tech firm is now providing global financial-settlement solutions powered by blockchain to enable banks to transact directly with each other and lower the total costs of settlement. Its digital asset XRP has grown to become the fourth biggest cryptocurrency by market capitalisation (after bitcoin, ethereum and bitcoin cash), and banks are now joining in droves to improve their cross-border payment capabilities. Indeed, Ripple’s CEO Brad Garlinghouse recently acknowledged the rapid growth in adoption of the company’s blockchain by banks: “People know Ripple is the only blockchain solution for payments that is proven in the real world, and it’s driving demand from financial institutions of all kinds and sizes because they want to stay ahead of the curve.”

For instance, the end of June saw the rollout of the first blockchain-powered instant-remittance service, which has been jointly adopted by Japan and Thailand as a way to establish a new payment rail between the two countries. The collaboration between Thailand’s Siam Commercial Bank and Japan’s SBI Remit, which uses Ripple’s blockchain, will help to boost the speed, efficiency and cost of the countries’ remittance corridor, which sees around $250 million transferred every year, largely as a result of the 40,000 Thai nationals living in Japan. According to Siam Commercial Bank, a transaction that results in funds being deposited in the recipient’s savings account in Thailand can be completed in two to five seconds, which drastically reduces the current norm of “two business days” for payments between the nations.

Elsewhere, Ripple’s blockchain is being utilised in a coordinated manner by some of the largest banks in the world, which in turn is helping to usher in a new era of virtually instantaneous international bank transfers. Last September, the company launched the “Global Payments Steering Group”, which is the first interbank blockchain group for global payments, and which will enable member banks to facilitate the creation and maintenance of payment-transaction rules with formalised standards for money transfers over the Ripple blockchain. Its six founding members included some of the world’s biggest financial institutions, such as Bank of America Merrill Lynch, Royal Bank of Canada, Banco Santander, UniCredit, Standard Chartered and Westpac; since then, many more banks have joined.

Banks are also joining up to design a brand new blockchain-based digital currency that they are intending to launch in 2018. Six of the world’s premier lenders—Barclays, Credit Suisse, Canadian Imperial Bank of Commerce, HSBC, MUFG (Mitsubishi UFJ Financial Group) and State Street—have recently joined a project led by Swiss banking giant UBS—in addition to existing members Deutsche Bank, Banco Santander, Bank of New York Mellon and NEX—with the goal of creating the utility settlement coin, a digital currency that will primarily be used to quickly clear and settle financial transactions using blockchain. The aim of the project, therefore, is to reduce the time, cost and capital required for the post-trade clearing and settlement process, as well as to improve financial-market efficiency. As such, it provides yet another way for the back offices of banks to use blockchain to enhance the speed and efficiency of settlement systems, with the utility settlement coin allowing banks to transfer value and assets without having to wait for long periods of time, as is currently the case with traditional methods. The coins can be converted into fiat currency at central banks and will be stored on the blockchain, which enables them to be quickly swapped for securities that are being traded.

The payments sector is receiving an additional boost through the partnership between Nasdaq and Citi that was announced in May. The collaboration will involve the use of blockchain to record and transmit payment instructions in order to facilitate straight-through payment processing, as well as provide an automated reconciliation mechanism. A number of transactions have already been reportedly executed through the CitiConnect® for Blockchain connectivity platform and the Linq Platform powered by the Nasdaq Financial Framework. As such, liquidity of private securities could ostensibly be improved by streamlining payment transactions between multiple parties, while administrative functions in capital markets are also likely to undergo much modernisation. According to Nasdaq, key benefits of the venture include a seamless, end-to-end transactional process for private-company securities; direct access to global payments from Nasdaq’s Linq platform using CitiConnect® for Blockchain and Citi’s cross-border, multicurrency payments service; and increased operational efficiency and ease of reconciliation with real-time visibility of payment-transaction activity on the blockchain ledger. Moreover, the blockchain will enable real-time visibility of payment-transaction activity.

Trade finance is one major area within banking that could experience considerable transformation as a result of blockchain adoption. The currently outdated processes that litter this area of banking, coupled with the sector’s overall size, means that it is ripe to be upgraded by distributed-ledger technology, in terms of cost and efficiency. Furthermore, it appears to be among the top priorities for global banking blockchain consortium R3, one of the leaders in blockchain development for the banking sector during this early stage. The New York-based company, which currently boasts more than 80 members comprised of banks and financial organisations, managed to raise a record $107 billion in a fundraising round in May, the biggest single investment for any blockchain to date. And now the collective is close to launching its first pilot commercial product. Eleven of the banks—Bangkok Bank, BBVA (Banco Bilbao Vizcaya Argentaria), BNP Paribas, HSBC, ING, Intesa Sanpaolo, Mizuho, RBS (Royal Bank of Scotland), Scotiabank, SEB and US Bank—are preparing to use R3’s blockchain software Corda to test an application aimed at cutting costs and increasing efficiency in the processing of sight letters of credit, which, as it is intended, will be payable immediately upon receipt of the letter and supporting documents by the relevant financial institution.

The product is reported to have a few key standout features. Firstly, it will offer a standardised interface to its users, such as carriers and shipping companies, for inputting shipping details, even in the absence of Corda. This means users won’t need to buy a new platform or train people to use it, and will be able to acquire users more easily. Secondly, the application could result in reducing the costs and complexity of existing processes, which in turn means that SMEs (small and medium-sized enterprises) will ultimately be able to access funds more quickly using sight letters of credit than other methods of trade financing. It will also mean that trade finance could be accessed by a wider range of potential users. The banks have been working on the product for more than a year, and are on schedule to launch in 2018.

R3 is not the only entity currently seeking to improve trade-finance processes through blockchain. On the contrary, seven of Europe’s biggest banks—Deutsche Bank, HSBC, KBC, Natixis, Rabobank, Société Générale and UniCredit—have hired tech giant IBM to build a blockchain platform to facilitate cross-border trade finance for small businesses. At present, companies often have to wait several weeks for cross-border orders before they are paid. The blockchain platform, however, will also allow companies to track orders and use smart contracts to automatically trigger payments on specific events, such as an invoice notification or delivery being recorded. It will also add more banks, shipping companies and freight forwarders, all of which will be assessed before being added. Much of the existing payment methodology will remain in place for the time being, but in the words of Rabobank’s chairman, Wiebe Draijer, “The whole infrastructure, the administration is done on the blockchain; and ultimately we will also move the payment into that blockchain solution, when the payment in blockchain is ready to be robust for large-scale applications”. The technology solution will be built on Hyperledger Fabric, an open-source blockchain framework, and is expected to go live before the end of the year. Thus, there is much optimism surrounding blockchain’s role in the transformation of trade finance. “We are convinced that blockchain will have a huge impact on banks in the future and that trade finance is one of the biggest areas of potential for the technology,” according to Rudi Peeters, chief information officer at KBC.

The IBM blockchain itself is proving to be increasingly valuable for banks across a range of use cases. The tech giant recently joined Thai lender Kasikorn Bank (KBank) to launch a new enterprise Letter of Guarantee network based on its blockchain. According to IBM, the project will help to simplify and expedite procedures for KBank’s Letter of Guarantee process, including strengthening security and reducing costs for both the customer and the bank. Most notable is that the enterprise solution will be completely paperless, which will facilitate a more convenient flow of information between banks and customers. Being on the blockchain, moreover, means that transparency is improved over incumbent guarantee processes, which in turn minimises the potential for forgery; while the entire length of time taken to complete the process will now also be considerably reduced. KBank has the biggest market share in Thailand as far as Letter of Guarantees issued by the country’s banking system is concerned, and accounts for 25 percent of the approximately $40 billion issued in total per year. The lender hopes to increase its share to 35 percent by the end of next year, with 5 percent of this amount being processed using blockchain.

There are many more applications of blockchain currently being adopted by banks—Bank of America has filed numerous patents relating to using the technology for conducting and settling transactions; Deutsche Bank is trialling a corporate-bond platform that uses smart contracts to issue and redeem bonds; and DBS and Standard Chartered Banks are working on a trade-finance collaboration with Ripple to better track invoices and avoid invoice duplication. What’s more, it’s not just ordinary lenders that are seeking to utilise blockchain; central banks around the world are also undertaking trials to see how the technology can enhance their monetary-policy capabilities, with the Bank of Papua New Guinea the latest to report such research. As such, it is clear that blockchain is having a profound impact on existing banking processes; and now that the early exploratory phase of the technology is gradually coming to a close, one should expect its adoption in real-use cases to begin to accelerate.