How Blockchain can transform and elevate banking Sector?
Have you been into banking and investing over the past few years? Perhaps, you might be familiar with the term blockchain. Yes, blockchain is the distributed ledger technology, which facilitates recording transactions and tracking assets in any business network. Its advanced features like transparency, immutability and decentralization have been beneficial to all industries globally.
Right from cryptocurrencies, blockchain technology has created a hype and stepped far beyond rather than just powering bitcoin or ether transactions. The transparent secured nature of blockchain is the sole reason for its adoption into various industries for growth and development. Then, how banking sector will alone be an exception to this scenario?
Blockchain can transform the banking process in a more secure, reliable, efficient, transparent and flexible way. Banking is the most popular domain of blockchain because of security concerns.
Following IBM, 66 percent of banks are looking to implement blockchain in commercial production and scale in the next four years. The global blockchain in the banking sector estimates about 4112.5 million dollars by 2029, along with a CAGR of 18.4%
This article gives an overview of growing challenges and emphasizes the use-cases to transform the banking sector using blockchain technology. Here, the article focuses on how blockchain can transform the banking sector by answering the following questions.
- How can blockchain overcome the challenges faced by the banking industry?
- What are the use-cases of blockchain in banking?
How can blockchain overcome the challenges in banking?
The banking industry has been facing numerous challenges for a very long time. The safe, secure, transparent, decentralized and cost-effective nature of blockchain has the potential to solve these challenges. Here’s how a blockchain is a one-stop solution to all the existing challenges in banking.
Challenge: Inefficiency in handling records
The rising number of users imposes the need to maintain the complete records of the transactions. In traditional banking, this task becomes complicated with a large number of users. It ultimately results in consuming more processing time for payments. Therefore, it is crucial to handle and manage the transaction data with ease, speed and security.
Solution: With blockchain in banking services, data handling is ensured with security and transparency.
- Immutability: Blockchain is immutable. It implies that data remains unchanged. So, managing the records becomes more comfortable as the stored data is secure, authentic and accurate.
- Zero-Knowledge Proof Technology: The zero-knowledge proof technology is a privacy solution for blockchain networks. It results in authenticating the financial information without disclosure.
- Privacy: Securing data is a significant concern for any banking sector. The public and private keys secure stakeholders’ financial information. The public key is accessible to all users in the network. The private key is shared only between the stakeholders participating in the transaction. Therefore, the transaction becomes visible to all users with a public key, while the transaction details are visible to users having the private key. The blockchain maintains transparency while managing the confidential data of the stakeholders.
Challenge: Consistent Supervision
With the rapid shift into digitization, banks are processing transactions and payments in digital form. These digital methods increase banking sectors’ responsibilities to monitor and record the details from time to time.
Banks face a lot of risks in providing services like loans, such as:
- trusting mediators.
- Failure of the counterparty to meet its obligations.
- Credit risk owing to information failure.
For example, commercial banks that give importance to supervising and tracking loan usage are not reliable. In such cases, no option is left rather than trusting the intermediaries. So, the risk factors are high for the providers.
Solution: For blockchain-enabled banking sectors, every stakeholder acts as a node. Therefore,
- peer-to-peer (P2P) transactions reduce the need for intermediaries.
- Transactions get recorded on the network, thereby minimizing fund management risk.
- Smart contracts execute quick transactions.
Challenge: High Payment Cost
When third parties are involved, the cost factor increases with every transaction. Also, more time is required to execute the transactions. The payment costs are high and create a challenging situation for banks to engage their users.
The banking sector is generally centralized. So, it invests a lot of money in :
- buying, maintenance and security of central databases
- commission charge of intermediaries
- value transfer systems
The recurring cost leads to periodic investments. Therefore, the banking system becomes expensive without ensuring the prevention of data breaches.
Solution: Most of the expenses get reduced by adopting blockchain in banking organizations. Implementing smart contracts in banks can reduce the costs of:
- value transfers
Challenge: Time Consumption
When many users and third parties are associated with any transaction, the payment process becomes lengthy. The process consumes 2 to 3 days or even a week to clear the payment. The main reason behind it is the presence of intermediaries.
The banking system involves multi-layered functioning. This means that every transaction has to pass through a couple of intermediaries. These intermediaries may be either front and back offices of banks or even third parties. For instance, currency exchangers in cross-border payments. The time required to execute each transaction is very long and leads to dissatisfaction among the users.
Blockchain Solution: The availability of peer-to-peer transactions in blockchain reduces the need for intermediaries. In addition to this, smart contracts execute and manage the transactions. Due to the elimination of multiple layers in the system, payments will get quickly settled. Implementing blockchain payment systems app can facilitate instant settlements.
These prevailing challenges in the banking sector need rectifying technology solutions. Blockchain is among such technologies that can help rebuild the bank sectors with speed, accuracy and transparency
What are the use-cases of blockchain in banking sector?
1. Clearance and Settlement
An average bank transfer usually takes few days to settle. So, moving money across the globe is a logistical challenge for many banks. The bank transfer system needs to go through custodial services and reconciliation process, which include:
- Fund networks
- Asset Managers
For example: If you want to transfer the money from a German bank to the United States, the transfer process will go through Swift. A swift protocol is centralized and it processes only the payment orders. The actual money is processed through intermediaries involving additional cost and time.
A decentralized ledger technology like blockchain can help banks to monitor and settle transactions. Therefore, banks will not have to rely on custodial services and regulatory intermediaries. The following steps will help you to know how blockchain works for clearance and settlements in banking.
Step 1: When a user requests a payment, the payment transaction is represented in the form of a block.
Step2: This block is sent to the network of computers, known as nodes. So, the block representing the payment is sent to every node in the network.
Step 3: Nodes validate the payment and user’s status using algorithms. These nodes receive a reward for proof of work. The verified payment may include cryptocurrency, contracts, or any other information record.
Step 4: Once the payment is verified, it is combined with other payments to generate a new data block for the ledger.
Step 5: This new block containing payment information gets added to the existing blockchain and the payment gets completed.
Cross-border payments are fast, cost-effective as compared to conventional banking systems. With blockchain for cross-border payments, third parties’ verification gets eliminated, resulting in speeding up the processing time. For example, the remittance cost is just around 2 to 3 percent, while third parties estimate around 5 to 6 percent of the total amount). Juniper Research’s report states that deploying blockchain in banks will save on cross-border payment transactions up to 27billion dollars by 2030.
2. Lending and borrowing
Lending and borrowing are the primary services offered by banks. The stakeholders involved are:
- Lender -the banks or financial institutions that give money.
- Borrower – the one who takes money from banks or financial institutions.
- Guarantor – the one who is the promising entity to repay the loan.
Let’s have a look at the workflow of lending and borrowing methods using blockchain.
Step 1: Lender generates a profile
A lender generates his profile containing:
- Personal details like name, address and ID
- Details of bank account
- Type of investment a lender would like to make. For example, a lender might wish to lend money to the borrowers requesting a loan for business purposes.
- Rate of interest associated with different types of borrowers involved in the network.
The profile details are provided at the marketplace. Based on these details, the lenders and borrowers can find each other at the market.
Step 2: The lender looks forward to a loan request from the borrower
After submitting profile details at the marketplace, the lender waits for a loan request from the borrower. Once the request is received, the lender schedules an interview with the borrower for further discussion.
Step 3: Borrower generates a profile
A borrower creates a profile comprising personal details(name, address, ID) and collateral information. The collaterals could be specified in terms of legal documents,crypto-coins, etc.
Step 4: Borrower requests for the loan
Once the account is generated, a borrower can send loan requests to multiple lenders—smart Contracts help the borrower to reach the lender, who meets the requirements of his investments.
Step 5: The lender starts the discussion with the borrower
When the loan request is received, a lender begins the discussion with the borrower and try to get through –
- The reason to apply for the loan.
- Monthly earnings.
- Repayment rate.
- The number of times the borrower applied for the loan.
These details help the lender whether to approve or dismiss the borrower’s loan application.
Step 6: Smart Contract decides the rate of interest
Once the request is accepted, the smart contracts check the CIBIL score to decide the borrower’s rate. Based on repayment rates, borrowers fall into high risk, low risk and medium risk categories.
When using the P2P lending blockchain platform, the rate of interest remains constant.
Step 7: Smart Contracts facilitate auto-payments
Smart contracts embedded with a crypto-wallet can assist borrowers in making their payments. If the borrower fails to pay timely installments, late fees are added to the actual amount and upgraded on the ledger.
Blockchain in lending can be beneficial to:
- make fast approvals
- minimize delays
- reduce the need for intermediaries
- enhance transparency in the process.
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3. Accounting and Bookkeeping
Accounting is an area in banking, which is relatively slow in terms of digitization. The sole reason behind it is the necessity to match the regulatory requirements associated with data integrity and validation. Therefore, accounting needs transformation with blockchain.
The blockchain plays a crucial role in simplifying compliance and streamline the conventional double-entry bookkeeping methods. Despite keeping separate records of transaction receipts, the transaction can be directly added to the joint register using blockchain. Thus, all the entries of this register can be distributed on the blockchain. It will ensure the transparency and security of banking data. A blockchain can be just like a digital notary for verifying the transaction details. Smart contracts would enable the payments for generated invoices. Blockchain in accounting and bookkeeping improves efficiency, reporting, and data access.
4. Trade Finance
Trade finance is concerned with all the financial activities to international trade and commerce. These activities still rely on paperwork such as letters of credit and invoices. Though management systems conduct these processes online, they consume a lot of time.
Therefore, trading based on blockchain solutions can streamline the process with less paperwork, low time consumption and minimum regulations.
For example: In traditional finance systems, all the users have to maintain their databases. They maintained databases for transaction-related documents and restored them continuously. If there is a single error on the page, this will duplicate this page’s copies in other databases.
With such challenging scenarios, blockchain-enabled solutions do not require multiple copies of the same page. It is so because the information gets integrated into a single digital document and then updated in real-time. This updated information is further access to all the users in the network.
Here’s how the blockchain is going to transform trade finance.
Step 1: When the buyer purchases goods from the seller, the sale agreement is shared with the import bank with smart contracts on the blockchain.
Step 2: The import bank reviews the purchase agreement and credit terms and then submits the obligation to pay to the export bank.
Step 3: The export bank reviews the received payment obligation and verifies it. Once approved, the smart contracts trigger the blockchain to include the terms and conditions and lock-in obligations.
Step 4: Once the obligations are received, the seller digitally signs the blockchain-equivalent letter of credit in a smart contract to proceed with the shipping.
Step 5: The goods are further monitored by third parties and custom agents in exporting country. All the goods are approved by signing digitally on blockchain smart contracts.
Step 6: The goods are transported from one country to another.
Step 7: On receiving the goods, the buyer digitally acknowledges the receipt and triggers the smart contracts for payment.
Step 8: The payment is processed from buyer to seller through smart contracts in blockchain.
5. Making Credit Reports
Blockchain in banking can also help clients to get loans quickly based on their credit history. Lenders take a lot of time in reviewing the credit history. The credit reports provided by third parties are not available for small business owners. Therefore, blockchain tools can serve the purpose of making credit reports for borrowers. These reports ensure accuracy, transparency and secure distribution. The following steps will show how it works with blockchain.
Step 1: The data owners stores their transaction history in the blockchain. This information is protected with a private key.
Step 2: The encrypted transaction details are stored outside the blockchain.
Step 3: The encrypted transaction is stored with hash codes in the blockchain along with timestamps and metadata.
Step 4: The buyer submits the criteria for information on credit history.
Step 5: Based on criteria, smart contracts identify and verify the required information.
Step 6: : Upon verifying the potential data, the blockchain filters the unnecessary information and shows the required information of the borrower’s credit history.
Therefore, blockchain-based credit reports reduce the costs, time and complexities related to data verification.
The ever-rising use cases of blockchain are about to bring major transformations in the banking sector. Blockchain in banking can disrupt conventional systems and make the existing systems more obsolete. Blockchain-based solutions are expected to minimize the annual fraud losses up to 9 billion dollars.
It is crucial to develop a secured database of client information and share it through numerous banking institutions. Therefore, it reduces the time, cost, and effort in inter-bank trade and ensures security and transparency. The blockchain in banking is a driving force to overcome the rising challenges and transform efficiently into a cashless society.
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