Blockchain, a form of digital ledger technology (DLT), is a linearly linked information-containing block secured by cryptography and shared between participants. Blockchain technology provides a secure and naturally decentralized framework, integrating data processing and security into an algorithmically enforced protocol.
Blockchain technology is the bedrock of cryptocurrencies and has multiple other utilities and advantages in finance, record maintenance, payments, etc. While countries and banks worldwide have mixed perceptions about cryptocurrencies, they have started realizing that blockchain technology has proved advantageous to the financial sector. Blockchain technology can reduce infrastructure costs, improve security and data quality of transaction information, increase efficiency and faster settlement, and provide transaction transparency.
The utility of blockchain technology extends from merely keeping a record of financial transaction entries to the automatic implementation of the terms of multi-party agreements with digital contracts. With a shared database running a blockchain protocol, digital contracts auto-execute, and all parties validate the outcome immediately without a third-party intermediary requirement.
Financial contracting in India
Under the current regulatory regime, regulated financial institutions are required to adhere to anti-money laundering and know your customer (KYC) compliances, which have monetary and time-based implications. Blockchain technology may aid in eradicating the duplication of effort and assist in the smooth running of such compliance processes.
Blockchain technology can also help address and mitigate issues cropping from identity management, as the data would be saved securely on the block of blockchain technology, and it would be difficult to tamper with such ledgers.
The government of India and the Reserve Bank of India (RBI) have recently started acknowledging and monitoring the effects and impact of blockchain technology in the financial sector. To this effect, the RBI released a regulatory framework for fintech companies in August 2019, allowing market participants to test new products, services, or business models with customers in a live environment, subject to certain safeguards.
The RBI also published an article titled, “Distributed Ledger Technology, Blockchain, and Central Banks” in February 2020, to explain how DLT and blockchain technology shall be utilized, the recent developments to blockchain technology, and its applicability to central banks across India and globally.
In sync with initiatives undertaken by the RBI, several private and public banks have also co-joined their efforts to reap the benefits of blockchain technology and DLT by partnering and investing in the fintech sector, for example, The State Bank of India tied up with JP Morgan to use their blockchain technology; ICICI Bank, Axis Bank, and Yes Bank joining the Interbank Information Network launched by JP Morgan, and Axis bank working in sync with Ripple to use their blockchain technology to reduce customers’ transaction costs and time taken for payments, and to make cross-border payments faster and more efficient. Blockchain technology is also being used for digital lending, and a recent example of that is the State Bank of India, HDFC Bank, ICICI Bank, South Indian Bank, and IDFC First Bank investing in the equity shares of fintech company IBBIC to provide DLT solutions in the financial sector.
In addition to catering to financial inclusion, blockchain technology has contributed to the ease of doing business as DLT has been used to simplify lending to micro, small and medium enterprises (MSMEs). Eleven banks, including a few prominent names, are a part of the consortium of banks launching the country’s first blockchain-linked funding for MSMEs.
Impact of Blockchain on Banking and Insurance sector
- Banking space has been facing many issues in terms of recoverability of loans granted by the banks. Usage of Blockchain technology can be a breakthrough where all the transactions right from the disbursal till its end use will be recorded in a block. Generating the blocks of every transaction will help the banks in tracing the diversion of the loaned funds if any.
- The domestic payments usually take minutes to hours, but several days are required to complete the transaction for cross-border payments. Further, inadequate infrastructure creates security concerns while making the international transfer and therefore, these payments are open to cyber-attacks that can interrupt transmission. Therefore, blockchain technology facilitates payment systems, decreasing operational costs, human blunders, and falsification. It also facilitates banks to get rid of all intermediaries in the payment processing system to lower the costs to process payments between banks and clients.
- Blockchain technology can be of great use in administering trade finance transactions for the banks. Under blockchain technology, all the documents such as LCs, Bill of lading/ Shipping bills, Tax invoices can be recorded in a centralized repository where all the parties involved can access the real-time data. This will improve the efficiency tremendously and will allow the parties required to track the transactions with ease. Using smart contracts to automate workflows and clearing calculations reduces processing time and benefits the banks by reducing errors resulting from human mistakes. Barclays and an Israel-based start-up company have successfully executed a trade transaction using Blockchain, which reduced the processing time from 7-10 days to less than 4 hours. The Bank of America, Merrill Lynch, HSBC, and the Infocomm Development Authority of Singapore has applied blockchain in processing trade transaction using a paper-less letter of credit.
- All large amounts of record-keeping transactions and operations can be recorded using blockchain distributed ledgers that are unalterable and impede fraud. Further, the decentralized nature of transactions reassures the banks better security over the records.
- Smart Contract is a self-executing contract with the terms and conditions between the parties to the contracts are codes on a platform. Therefore, Smart Contracts extend the blockchain’s usage from simple record keeping to automatically implementing terms of multi-party agreements. With a shared database running a blockchain, the Smart Contracts are executed based on matching of terms and are validated by other parties instantaneously and without the need of an intermediary.
- It becomes essential for the banks and other financial institutions to build a database containing all the information of the customers including their identity proof like PAN card, passport, Aadhar card, driving license, etc. mainly to avoid money laundering, other forms of fraud, and complying with the regulatory KYC norms. Blockchain technology can help banks to overcome the problem of establishing identity by offering cryptographic protection that ensures the involvement of all parties in the transactions.
- The insurance sector also faces many difficulties, as there are inefficiencies involved, frauds in claim settlement, and other issues, which eventually push the costs up. The application of blockchain technology can be of great help in this industry as all the relevant information will be available to the parties concerned, i.e., the claimant, insurance companies. Blockchain technology can help the insurance companies (including re-insurers) and regulators to access the required data and it will, in turn, help them in settling the insurance claims at a much faster rate. In the case of property and casualty insurance, it becomes essential to have legal documentation of the property damaged. Owing to the proposed integration of the records, companies can now trace the history of that property with ease and can detect whether the claims made by the claimant are legitimate or not. This will bring in more efficiency, and eventually, companies will be able to reduce the operating costs significantly and can earn higher margins.
At the state level, blockchain technology is being used in the management of land ownership records and healthcare. Andhra Pradesh and Telangana have started using blockchain-related solutions for land registry and electronic health records, while Assam and Sikkim use it to help their tribal population secure ownership titles to their lands.
Banks and fintech players are exploring the various utilities of DLT. With the considerably developed features and complexities in offering solutions, there are opportunities for blockchain technology to become more ubiquitous in the future. The RBI, other banks, and several fintech players are coming together to explore blockchain technology and DLT in the financial services sector in the form of pilot projects, thereby paving the way for a new economy.