Blockchain applications in the banking sector of Australia

Blockchain as an emerging technology can revolutionise banks is Australia. How can blockchain be applied in the context of banking? What are the initiatives global banks have already taken? Are there any benefits in terms of cost? What are the challenges for Banks in Australia for blockchain?

Australian Banks and the emerging FinTech companies have brought their attention to blockchain as a technology to improve the processes in the banking sector, particularly after the announcement of Westpac Banking Corp, Commonwealth Bank of Australia and ANZ bank’s agreement to partner with IBM to test blockchain technology to digitise bank guarantees in 2019. The objective of this agreement was to move away from paper-based bank guarantees, to reduce processing time and reduce risk of fraud (Reuters, 2019).

Numerous types of blockchain industrial consortium's have emerged in the recent past to promote application of blockchain and among them, R3 blockchain consortium is the most influential(Guo & Liang, 2016). It has brought together big names in the global banking industry such as Bank of America, Citigroup, Deutsche Bank, Morgan Stanley etc(Guo & Liang, 2016). IBM has stated that in 4 years’ time, 66% of the global banks will have commercial blockchain at scale(Guo & Liang, 2016). With these insights, it is worth to research into why Australian Banks should focus on blockchain? What specific scenarios in banking can blockchain be applied in? What are challenges in blockchain technology? This research will be mainly focused on discussing these questions

“Standard Chartered Bank uses ‘Ripple’, an enterprise level blockchain platform to execute cross-border transactions and it was revealed that it took only 10 seconds to complete a transaction whereas the current banking process generally takes 2 days to complete the same.”

Definition of Blockchain

Blockchain is a digital platform that records and verifies transactions in a public and secure manner (Standards Australia , 2017). This decentralised, cryptography-based solution has the potential to redefine transactions by removing the need for middlemen (Standards Australia , 2017). Blockchain is also defined as a decentralised ledger of all transactions across a peer-to-peer network (PwC, 2020). Due to the distributed nature and the transactions it stores, the blockchain system is also commonly referred to as a distributed ledger (ACS, 2019).

Blockchain – A Disruptive Technology

Blockchain received attention from the financial industry due to application of this technology in crypto currency ‘Bitcoin’ (Nofer, et al., 2017). There had been various instances where tracing back the ownership in long transaction chains were problematic. The business today has many intermediaries, therefore verifying the ownership of assets and transaction processing within a supply chain is crucial. The blockchain technology promises to overcome the tracing problem by taking off the human interventions and replacing with mathematical calculations and automated systems. (Nofer, et al., 2017).

Blockchain functionalities

A blockchain consists of data sets which are composed of chain of data packages known as blocks (Nofer, et al., 2017). A block comprises of numerous transactions as depicted in the diagram below. The blockchain is extended by each additional block and represents a complete ledger of the transaction history (Nofer, et al., 2017).

Source: https://www.paiementor.com/blockchain-explained-application-payments/

Each block consists of time-stamp, the hash value of the previous block and a nonce which is a random number verifying the hash and the hash values are unique preventing changes in the block in the chain would trigger immediately (Nofer, et al., 2017). If the mainstream of nodes in the network agree by consensus on validity of transactions, the block can be added to the chain. (Nofer, et al., 2017)

Blockchain technology to transform banking industry

The banking industry in Australia is facing pressure of reduction net interest margins and increased risk due to process and technological vulnerabilities. In Australia, there are many financial institutions operating online and without any physical presence. The customers find it easier to request for loans online rather than going to a bank with number of documents in hand. Banks need to compete with these FinTech companies and cater to new customer demands whilst maintaining the costs lowest as possible, but of course with greater efficiency.

Payment clearing system: distributed clearing mechanism

Inter-bank payments are relied upon intermediary clearing firms. In Australia, arrangements for clearing is made in coordination with AusPayNet which is a limited liability company, it manages clearing of cheques, direct entry payments etc. (Reserve Bank of Australia, 2020). The process of intermediary clearing firm conducting the process involves book keeping, transaction reconciliation, balance reconciliation, payment initiation etc, thus it is lengthy and costly (Guo & Liang, 2016). Cross border payments depending on the country can take up to 2 days to process a payment which demonstrates low efficiency within the clearing mechanism. Point to point payment could be implemented utilizing blockchain technology and this will eliminate the involvement of a third-party intermediary. Therefore, the efficiency will improve, and costs will be lower for Australian Banks. At present, a number of financial institutions have already started testing transactions on blockchain platforms, for example Standard Chartered Bank uses ‘Ripple’, an enterprise level blockchain platform to execute cross-border transactions and it was revealed that it took only 10 seconds to complete a transaction whereas the current banking process generally takes 2 days to complete the same (Guo & Liang, 2016). The National Australia Bank (NAB) has also used the Ripple ledger technology to test a scenario of transferring funds from a NAB account to an account in Canadian Imperial Bank of Commerce and the process only took 10 seconds (Guo & Liang, 2016).

Bank credit information system

In most Australian banks, the bank credit information systems are inefficient due to poor quality of data to analyse personal credit, difficulties in data sharing within banks and unclear ownership of user data (Guo & Liang, 2016). The solution to the problem may require cooperation and participation of different stakeholders in the industry and blockchain will be able to aid in addressing some of these issues.

Regulatory compliance

Australian banks have a manual and time-consuming process for reviewing, reconciliation, auditing of compliance related issues. Blockchain technology could give access to the real time data to regulators requiring fewer updates from banks (Business Insider , 2019). It will enable secure recording, storage and review of customers and transactions resulting lower reporting costs.

Establishing data ownership

As individuals, we produce large number of data on the internet which is extremely valuable for banks in the credit assessing process. Unfortunately, the Australian banks currently utilise only the data provided by the customers. It a known fact that these data of individuals on various internet platforms are being owned and monopolised by large internet companies such as Facebook. Blockchain technology can perform data encryption which will enable to establish ownership of big data (Guo & Liang, 2016). If big data ownership of individuals could be established, it will make the data more reliable and genuine. Furthermore, it will reduce the cost of data collection and give holistic view of commitments of an individual customer in credit assessing process. This could establish a foundation for future credit systems (Guo & Liang, 2016).

Distributed innovations in trade transactions

Blockchain technology could eliminate the paper-based transactions and employ smart contracts to digitise procedures. When a smart contract is employed among the bank, suppliers, buyers, trading parties and share the contractual information on a decentralised distributed ledger, payments can be made automatically once a predetermined time and result is reached (Guo & Liang, 2016).

As per McKinsey, blockchain technology enables banks to reduce costs by US$13.5- 15Bn annually whilst the trading parties costs can also be reduced by US$ 1.1-1.3Bn annually (Guo & Liang, 2016). Barclays Bank and an Israel based startup have completed the world’s first blockchain based trade transaction. The normal transaction period for this sort of transaction is approximately 7-10 days, however using the blockchain technology the transaction was completed within 4 hours (Guo & Liang, 2016).

Challenges in implementing blockchain in the banking sector

Trust – A key principle of blockchain is that information stored is available to all participants in the chain, which means sensitive information such as transaction history could be exposed to participants who are not involved in a particular transaction (Business Insider , 2019). For Banks, this is a concern in terms of privacy. Any information leak will be unfavourable, especially if the information is in the hands of a competitor. For example, if one participant within a chain reveals certain trade transaction rates, a competitor bank who gets access to these data may try to undercut the rates to compete (Business Insider , 2019).

Security – Blockchain systems are frequently attacked by hackers and these attacks clearly threaten the privacy and assets of users (ACS, 2019). Therefore, implementing standards that deal with vulnerabilities is required to protect the blockchain users (ACS, 2019). Although Bitcoin system is known as un-hackable, the hacking attack on DAO (Distributed Autonomous Organisations) alarmed on security susceptibilities.

Regulation – There is lack of governance in terms of compliance and regulation process and does not provide guarantee to users on privacy and ownership (ACS, 2019). This is especially true in Australia where privacy is governed by the Privacy Act 1988 rather than being a general right (ACS, 2019). After the International Organisation for Standardisation (ISO) approved Standards Australia proposal for new International Standards on blockchain, it is said to support Australia’s global leadership in blockchain regulations (Standards Australia , 2017).

Conclusion

Blockchain could revolutionise payment clearing, trade transactions, regulatory compliance and credit information systems in Australian banks. However, Australia is facing significant challenges in exploiting the benefits for economy and society. Some of the key challenges in Australia are trust, security and regulation. Although some of these challenges are inevitable, blockchain has a promising future in the banking sector in Australia.

References

• ACS, 2019. Blockchain Challenges for Australia , Sydney: Australian Computer Society .

• Business Insider , 2019. BLOCKCHAIN IN BANKING : AN INSIDE LOOK AT FOUR BANKS’ EARLY BLOCKCHAIN SUCCESS AND FAILURES , s.l.: s.n.

• Guo, Y. & Liang, C., 2016. Blockchain application and outlook in the banking industry. Financial Innovation, pp. 1-12.

• IBM , 2020. IBM. [Online] Available at: https://www.ibm.com/in-en/blockchain/what-is-blockchain?p1=Search&p4=p52660644437&p5=e&cm_mmc=Search_Google-_-1S_1S-_-AS_IN-_-ibm%20blockchain_e&cm_mmca7=71700000065346096&cm_mmca8=aud-382859943522:kwd-312411548340&cm_mmca9=EAIaIQobChMImv3IyJK46gIVTw4rCh3 [Accessed 05 July 2020].

• Nofer, M., Gomber, P., Hinz, O. & Schiereck, D., 2017. Blockchain. Business & Information Systems, p. 183–187.

• PwC, 2020. PwC. [Online] Available at: https://www.pwc.com/us/en/industries/financial-services/fintech/bitcoin-blockchain-cryptocurrency.html [Accessed 05 July 2020].

• Reserve Bank of Australia, 2020. Reserve Bank of Australia. [Online] Available at: https://www.rba.gov.au/payments-and-infrastructure/payments-system.html [Accessed 05 July 2020].

• Reuters, 2019. www.reuters.com. [Online] Available at: https://www.reuters.com/article/us-australia-banks-blockchain/top-australian-banks-join-ibm-scentre-in-blockchain-project-idUSKCN1TZ01V

• Standards Australia , 2017. Blockchain Standards Initiative. [Online] Available at: https://www.standards.org.au/getmedia/dd5321aa-2a74-4799-bb04-766122b6669d/Blockchain-Standards-Initiative.pdf.aspx [Accessed 5 July 2020].

• Zheng, Z., Xie, S., Dai, H. & Wang, H., 2016. Blockchain Challenges and Opportunities: A Survey. Work Pap.