Ledger domain

Blockchain technology could be disruptive or merely transformative, but it’s coming to a financial institution near you.

From the pages of In Business magazine.

There is an interesting debate brewing in technology circles about whether the digital technology known as blockchain will be the next disruptive technology, or merely a transformative one, but that argument might be missing the point.

There are those who believe just as the internet changed how we share information, blockchain-enabled internet will provide a new, collaborative ecosystem to track and trade almost anything of value. One of them is IBM chief executive Ginni Rometty, who when speaking at the 2017 FinTech Ideas Festival, espoused her belief that blockchain will be as transformative as the internet itself.

“I’m not talking about an anonymous cyber security,” she told the gathering. “I’m talking about technology underneath it that allows you to have an efficient and trusted exchange of anything, and I think that will change the way the world works.”

Blockchain is not only for recording and verifying transactions, but also for accelerating the settlement of transactions while lowering the risk of tampering. IBM believes it will become an invisible, foundational layer for conducting transactions over the internet. Also called a distributed ledger, blockchain features an open, security-rich network that can be applied by business organizations across industries to more cost efficiently trade and transact. While the ledgers are shared and distributed, they are visible only with permission by all the participants.

Pramod Achanta, who leads IBM’s blockchain practice for the financial services industry in North America, calls blockchain a proven technology with applications in health care (where hospitals could cut claims processing costs), global supply chains (with estimated savings of more than $100 billion), and insurance, where “smart contracts” could bring unprecedented savings. “There is no reason why they can’t all be revolutionized using blockchain,” says Achanta, a presenter at WTN Media’s 2017 Fusion Conference. “The technology has immense potential. How fast an industry adopts and how quickly they will benefit depends on the industry participants and how conducive that industry is to change.”

Some of the fundamental concepts used in bitcoin have the same roots as blockchain technology — blockchain is the technology behind bitcoin that allows for a distributed, encrypted ledger — but the implementation process is different.

Looking for co-pilots

IBM has conducted numerous blockchain pilot programs and is working with several clients to build and provision blockchain applications, including one for IBM Global Finance. The company recently announced a pilot with Northern Trust Corp., and it also has announced a generally available version of blockchain through its own hyper ledger open source initiative based on the Linux Foundation’s hyperledger fabric.

Achanta sees several applications spanning the entire spectrum of finance. There are use cases within asset management in financial services, the broker-dealer post trade clearing and settlement space, and the payment space. In the wholesale banking space there are trade finance use cases, and in retail banking there are several use cases around mortgages — thanks to the aforementioned smart contract.

“My take on smart contracts is there is the application of business logic — that’s one part of it,” Achanta explains “Second, replacing an existing legal contract with a smart contract, that’s a different part of it. A lot of work is now being done on automating the business process using smart contracts.”

Achanta does not believe the cost-reduction benefits will come as the result of workflow elimination and therefore workforce reductions. The benefits come in removing the friction that exists today across multiple parties involved in a business transaction. “What it does is eliminate the need for reconciliations across multiple parties,” he explains. “It also streamlines the transaction in such a way that it can be executed in a more transparent fashion and much more quickly than what happens today.”

In the payments world, there are a lot of business-to-consumer or even consumer-to-consumer applications. Achanta normally focuses on business-to-business benefits, but he notes that IBM also is enabling its clients to reach out to customers. “It’s business-to-business-to-customer eventually, but there are a lot of creative ways in which this technology is being used to solve the current complexities that exist in the financial services world. It’s certainly not limited to business-to-business.”

So instead of taking days before funds are verified and money is exchanged, payments and transactions are exchanged almost instantly. Supply chains can be managed in real time, and manufacturers can share product information to help reduce product recalls. “Even simplifying the end-to-end business process across multiple dimensions, that results in cost take out and the elimination of more risk,” Achanta says. “So depending on the use case, clearly there are certain benefits the parties are looking to accrue. Disruptive is on the one side of the spectrum, but there are a lot of other benefits, as well.”

Some have speculated that if banks are slow to adopt blockchain technology, they risk becoming the victim of yet another technologically disruptive business model. Asked if he buys into that, Achanta notes that banking is a regulated environment and so blockchain would have to be introduced in such a fashion that regulators are comfortable with the way the innovation is being applied. “The technology actually simplifies the ways that regulatory oversight can take place today,” Achanta states. “The more regulators start to look at this technology and understand this technology, they can actually see the possibilities this technology provides to make their lives easy and witness the entire process enter into the marketplace. Most regulators are just getting warmed up in terms of trying to understand this technology, and as they know more they will get more comfortable with it.”

Achanta recommends that banks, no matter what their size, engage in pilot projects, which can be done at a very affordable cost, to see what value they can derive from it. “My advice is that it’s time for you to embrace this technology and start working with it.”



Ready for business

Discussions with leaders in the banking and credit union industry indicate that they, too, believe blockchain technology eventually will be ready for business, but larger banks and financial organizations probably will lead the way. Kim Sponem, president and CEO of Summit Credit Union in Madison, believes blockchain has the potential to be a very disruptive technology. It depends on how all the players come together because one of the bigger roadblocks would be getting widespread adoption. In digital transactions it could reduce fraud, errors, and risk, and perhaps remove cost from the interoperability process of getting electronic business systems to talk to one another.

“It could fundamentally change how we do business and who we need in that process in order to conduct business,” Sponem says. “I think it has potential implications for the lending process in that it could change the role of title companies, appraisers, and how we touchpoint with them. There are definitely applications for accounts payable and settlements, clearinghouses, and the identity of consumers. This has big implications in terms of the [Bank] Secrecy Act and what you need in order to verify who is who from an identity/security perspective, as well.”

Sponem notes there are two ways in which the technology can be implemented — as part of a private permissioned network or in a permission-less network, and Summit would prefer the former. “When you think of bitcoin, that is a permision-
less network,” she notes. “We would be much more interested in a private, permissioned network so that we know the people who are invited to participate in that blockchain, which helps the security side.”

Rose Oswald Poels, president and CEO at the Wisconsin Bankers Association, is not aware of any Wisconsin banks that are using blockchain technology, but it’s something the WBA is monitoring on a national level. She notes that banks already use electronic documents, but she thinks of blockchain more on the transactional side of banking. “From that standpoint, it’s certainly technology that is on our radar and I’m aware that some large banks are starting to look at how it could be utilized,” she states. “However, I know that most banks, certainly regional on down, are waiting to see how large banks might implement this and really get a proof of concept going.”

One of the reasons there isn’t a rush is that banks are in the process of adopting other technologies, especially the business-to-consumer variety, Oswald Poels indicated. Consumers are still using debit and credit cards or cash, but what has changed is there’s been more growth and acceptance for payment methods like Apple Pay, not only by banks but also retailers. “There has certainly been, again on the payment side, some advances that many banks, including community banks, have taken advantage of in the form of Apple Pay and other payment methods like that, which make it pretty easy for a consumer to have a digital wallet.”

Setting standards

Needless to say, governing rules will have to be established, but if this can be done with transparency, auditability, and trust, any business process can be revamped. If you go back to what the www.consortium did, that’s where things like HTML came from, Rometty notes. “It was a consortium that agreed on standards that allowed everything to work together,” she says. “The same thing is happening, and can happen, with blockchain.”



Growth by regulatory relief

Kim Sponem and Rose Oswald Poels know the financial sector must be regulated, but they aren’t crazy about the regulatory thrust coming out of the nation’s capital since the passage of the Dodd-Frank financial reform law.

In fact, if you could sum up their approach to being regulated, it would go something like this: It’s not about more regulation, and it’s not about less regulation, it’s about smart, common sense regulation.

Banks in particular could use some. Recent Federal Deposit Insurance Corp. data shows that Wisconsin bank profits slipped 7% year over year, from $1.2 billion in 2015 (243 banks) to $1.1 billion in 2016 (222 banks). Yet even as state bank profits declined, banks are still doing their jobs as total loans and leases grew to $77.5 billion, an increase of 3.5% over 2015’s $74.8 billion.

For Oswald Poels, president and CEO of the Wisconsin Bankers Association, the good news is that after a recent visit with the Wisconsin Congressional delegation in Washington, D.C., there appears to be bipartisan support among Democrats and Republicans for modifications to Dodd-Frank, which would have to be done legislatively in the Congress, not through an executive order.

“There is a lot of motivation on the part of both Republicans and Democrats to help community banks and sort of peel back the Dodd-Frank onion,” Oswald Poels states. “We’re not asking for a complete repeal but some changes that would benefit and provide regulatory relief in a meaningful way to community banks.”

That might take some time, however, with the current focus on health care and tax reform. The changes sought by local financial executives would not only improve the bottom line by reducing compliance costs, but also allow them to better serve banks and credit union customers. When elected officials are ready to shift gears, here is what they would like to see:

  • Passage of legislation exempting portfolio lending from qualified mortgage rules. Bankers have never understood why common mortgage products offered before the financial crisis, which helped consumers and did not pose a systemic threat to the financial system, were lumped in with malefactors that did. “That would be a huge benefit to both banks and consumers in Wisconsin,” Oswald Poels says.
  • Passage of the Tailor Act, which would require federal bank regulators to write rules that take into account the risk and complexity of a financial institution. “It’s trying to get away from one-size-fits-all regulation and changing it to one that is truly tailored to the complexity of a bank,” Oswald Poels explains.
  • Streamlining regulations and paperwork involved with mortgage lending. That was one goal of the Consumer Financial Protection Bureau, but instead it has gone in the opposite direction. “A lot of the regulations have made mortgage lending much more difficult, more time-consuming, and members don’t have as much flexibility as they had before,” notes Sponem, president and CEO of Summit Credit Union. “If they change their mind about something in the process, it slows down the process. Disclosures have gotten longer instead of shorter.”

Value proposition

Sponem would also like Congressional authorization to allow credit unions to devote a larger percentage of their assets for business lending, but the more immediate focus is on regulations that do not create value. “We need regulations in the financial services sector,” she acknowledges, “but we don’t need regulations that cost consumers more money and don’t provide any additional value.”

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