Blockchain: A Bitter Pill for Banks

Contributed by: Sivananda Subudhi, CFA, AVP, Structured Finance Group, Axis Bank Ltd


During Indian Banks’ Association Banking Technology Conference held in 2017, Dr. Viral V Acharya, Deputy Governor Reserve Bank of India (RBI) highlighted that ever since Asset Quality Review of Banks during 2015 was initiated, the asset quality of most of the Banks in India has deteriorated because of recognition of stressed assets. While there is a lot of debate related to the reasons for the creation of such stressed assets, assigning any specific reason for the deterioration in asset quality is quite contentious. However, there seems to be a general consensus in the lending community that stringent/ apt monitoring of “end use of funds” could have ameliorated pileup of such high level of stressed assets across sectors. In last several years, there has been a significant increase in the pace of technological innovation across industries leading to structural changes which have affected the business models of incumbent players. Ever since Satoshi Nakamoto (identity still not known) came up with a concept paper on Peer-to-Peer Electronic Cash System in October 2008 followed by the introduction of Bitcoin crypto-currency in January 2009, there has been tremendous interest from industry participants over identifying use cases of the underlying technology, i.e. “Blockchain”.

What makes the Blockchain protocol unique is that it is an entirely peer-to-peer system that is not based on any centralised entity. The entire record of transactions in the Blockchain is accessible to all parties which is in direct contrast to the current Banking system. It is important to note the distinction between Bitcoin and Blockchain. Bitcoin is an electronic cryptocurrency that can be used to purchase goods or services. Bitcoins are awarded to specialized network participant nodes, called “miners,” for validating transactions. This serves to incentivize and strengthen the network. The blockchain is the underlying technology that enables the Bitcoin network to operate in an open, autonomous, decentralized model, where trust is enforced through cryptography and not its participants. In essence, there would be no Bitcoin without Blockchain, but there can certainly be Blockchain without Bitcoin. The distinction is important because Blockchain technology can be applied to other uses beyond the processing of electronic currencies.

Given the unique features of Blockchain technology, tracking and recording flow of money across various transactions is possible by way of collaboration amongst all the stakeholders i.e. Consortium of Banks, Suppliers, contractors etc. Once a transaction is recorded in the ledger and is validated by multiple parties/ nodes, the transaction can safely be assumed to be legitimate and shall be available for scrutiny to all the participants of the Blockchain (Private Blockchain). Due to its immutability feature, the entire ledger can be shared with requisite overseeing agencies including Auditors either in a con-current manner or at any later stage. It will increase the transparency levels significantly while reducing all associated incidental costs being incurred for justifying any specific transaction.

Broader Applications of Blockchain in Financial Services Sector:

The attractiveness of Blockchain technology and underlying potential of redefining trade settlement, reduction in settlement time, cross-border payments or enabling new business opportunities i.e. Smart Contracts for insurance claim settlements etc. have led to significant investments in the development of technology by Venture Capital funds and by existing Financial Institutions. Many top US and European Banks are exploring Blockchain application by either partnering with start-ups or creating innovation labs to their proof of concept. A consortium of more than 70 Banks/ FIs have partnered in a distributed database technology company named R3 contributing towards R&D of Blockchain database usage in the financial system. Similarly, a team of researchers at Institute for Development and Research in Banking Technology (IDRBT) in India have been brainstorming on the technology and possible use cases in the Indian scenario.

In my view, Banks have to increase the pace of adoption and enable the Blockchain technology to become mature and robust. The key is not to replace Banks with simply a technology platform (in turn moving the Trust factor into oblivion), rather to collaborate with the technology providers to feed off each others’ idea and experiments which in turn can overcome a lot of challenges being faced by the Banking sector.


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