Still, technology won’t replace relationships until it proves trustworthy
Use cases for blockchain technology are rapidly being developed and tested throughout the financial services industry—and beyond—from the Australian Securities Exchange to payments infrastructure providers. But perhaps one of the most compelling areas where blockchain could truly redefine financial services is in correspondent banking.
First discussed at Sibos last year, the use case for this has rapidly advanced, and in fact testing is already under way for a solution from Ripple that uses distributed ledger technology (DLT) to support direct bank-to-bank transactions.
The Bank for International Settlements (BIS), in a report late last year, noted that banks are reducing correspondent relationships as a result of rising regulatory compliance costs — especially requirements under Know Your Customers' Customer (KYCC) rules. Increasing risk is also driving this trend to reduce correspondent banking relationships, with compliance penalties and reputational damage among the risks cited by the report.
Correspondent banking relationships are based on trust—trust that is supported by legal documentation and years of interactions. But distributed ledger technology, of which blockchain is only one type, removes the need for that traditional “trusted relationship.” It creates a “trusted mechanism” to transmit, store and verify transactional information—and establish ownership.
And DLT-based cross-border transactions are not just the stuff of dreams. Three banks—CIBC, Santander and UBS—successfully completed a test of Ripple’s DLT-based cross-border payments solution earlier this year.
Rather than using local currency accounts at global correspondent banks, banks using the Ripple solution convert funds to its digital currency, XRP, then complete an exchange in almost real time. In a traditional correspondent banking relationship, settlement can take up to five or more days.
Still, it is far from end of days for correspondent banking relationships. DLT-based solutions are under review by various regulatory bodies—and the risks they pose are very real.
US regulators at the Financial Stability Oversight Council noted in a report that DLT-based systems may help lower transaction costs and improve financial intermediation—but, noted the FSOC, “operational vulnerabilities” won’t truly become clear “until they are deployed at scale.”
SWIFT and Accenture earlier this year released a report highlighting some of the key issues that need to be addressed before any DLT-based infrastructure could be considered for industry-wide adoption: strong governance, data controls, regulatory compliance, standardization, an identity framework, security and cyber defence, reliability and scalability. Recent hacking events—both at SWIFT and elsewhere—are prime examples of why secure infrastructure is critical. Until DLT matures to the point that these issues are resolved, solutions will continue to work more on a one-off basis than as an opportunity to replace major infrastructure within financial services.