Canadian financial services companies are closely watching the developments in blockchain technology, and many discussions around how it can be applied to add business value are underway – featuring a healthy range of opinions from the skeptics to the full believers. I am seeing some areas where this technology (once it’s ready for prime time) holds strong appeal, with one example being the lending space.
Lending is a contract-intensive area of the banking portfolio, and one that carries significant risk and limited trust across the value chain. Loans have an extensive lifecycle: customer facing, product selection, adjudication and pricing, funding and fulfillment, servicing, and securitization, or asset management. Customer information gathering is process-intensive on the front end, needing to be validated and confirmed during onboarding to counter fraud and AML threats. While tackling this, banks need to remember that customer experience is a key sales factor.
During adjudication and pricing, facts and figures need to be verified and evaluated. The risk department often has a different outlook to the front-line sales team, but both need to rely on the facts about the borrower and any related collateral. There are often numerous parties involved in these processes: co-borrowers, lawyers, pledge-holders, escrow agents, brokers, estimators, and insurance providers, to name a few.
All of what I’ve mentioned thus far is focused only on the loan process up to funding and booking the asset. After this, it often takes on a new life as it becomes packaged into a security, perhaps as a bond or part of a pooled structured asset. The quality of lending assets is under constant scrutiny by third parties, holders of bank bonds, and industry analysts.
Dunning and arrears management are also very complex, contract- and information-intensive processes. Loans on the books carry many questions that will be asked along the lifecycle by finance, risk, and treasury—questions about the expected liquidity of the asset, the risk associated with the underlying collateral, and the borrowing party. Each of these parties has its own business rules and is continually verifying and validating the facts. Many parties can revert or alter the course of the process, meaning that sometimes even understanding the status of the loan in the process is a challenge.
As I write this, it’s even more clear in my mind that this complex and challenging area of banking needs to be reconsidered from the ground up and simplified. Lending is a target-rich environment for process renovation,to put it kindly—but what is it about blockchain that can help with this?
Blockchain, as a concept, seems to have several characteristics that could form a solution to the increasingly intrusive complexity affecting the business of lending. First, its inherent transparency as an open ledger makes all transactions irrefutable and open to incorruptible analysis. Also, in what seems like a strange combination with transparency, blockchain offers privacy to lenders and borrowers by not publicly naming the parties involved. Involved parties are of course privy to the relevant facts, and changes to key information is clear.
Moving to a single and shared view of the truth will allow each party in the value chain to remove duplicative processes and save money and time. This approach could also be used in the front-end processes to bring in third-party identity providers and other information providers, who can help to counter fraud and AML risks while making the process easier for customers and sales associates.
There is no central trust authority in the blockchain itself. Instead, transactions link to create a form of referential integrity that ensures parts of the chain are not replaced or substituted unknowingly. This, along with the prohibitive cost and effort involved in even attempting to falsify activities on the blockchain, gives it a level of stability and reliability that paves the way for a revolution in the lending industry.
In a world where lending and borrowing happens on the blockchain, time and resource-taxing business rules and processes are taken care of by algorithms. Reconciliation no longer exists, because all the data is true and the need for trust is virtually eliminated. Trust is in the algorithm. The integrity of the assets behind the security are no longer in question, as key facts and changes are transparent.
Despite the opportunities and threats presented by blockchain, big questions hang in the air of bank boardrooms around Canada: “Can blockchain lending really be 100% transparent?”, “What are the regulations and compliance restrictions?”, and of course, “How can a bank of this size and with the complexity of our IT hope to adapt to this?”
These are not easy questions, but answering them will be a game-changer.
For more on blockchain, see Believe The Hype: Blockchain Is The Next Frontier For Banking.