McKinsey: Retail banking brings new opportunities with blockchain technology

When it comes to blockchain, it's understandable to be cautious, although this technology can create value for retail banks in many areas.

Currently, retail banks have made great strides in developing digital business models, bringing millions of people to mobile banking and becoming professional providers of data-based services. However, when it comes to blockchain, most retail banks still hold a wait-and-see attitude .

The hesitancy of retail banking to blockchain technology is in stark contrast to other agencies' efforts in this area: governments, investment banks and infrastructure providers are experimenting with this technology, and they believe that shared electronic books will help them. Cut costs and increase transparency . For example, investment banks envision the use of blockchain technology to make transaction execution, post-trade processing, and settlement real-time, eliminating a large number of intermediate and background processes. At the same time, they also focus on the potential of smart contracts to improve automation.

The blockchain sector is welcoming large-scale investments. In various industries, blockchain venture capital reached $1 billion in 2017. Wholesale banks have launched hackathon, innovative laboratories and partnerships with financial technology companies. New York-based software company R3 works with more than 200 organizations to develop blockchain solutions on an open source platform.

[Translator's Note: Wholesale bank (wholesale bank) is a concept relative to the retail bank , which belongs to the financial sector. Western banking divides banking into retail banking and wholesale banking. The main customers of the wholesale banking business are large enterprises, institutions and social groups, which generally involve a large amount of money; retail banking is mainly a comprehensive and integrated financial service provided to individuals, families and small and medium-sized enterprises, including Withdrawal, loan, settlement, exchange, investment and wealth management services. ]

However, it is understandable that retail banks are cautious. In the financial sector, any measures related to the use of blockchain technology have not been launched on a large scale. The strict regulatory requirements of the banking industry have set a high threshold for the introduction of blockchain , and the future regulation of the blockchain itself is still uncertain . Some regulators, such as the UK Financial Market Conduct Authority (FCA), are still developing relevant regulatory policies.

Despite these concerns, some retail banks are still involved in the blockchain . For example, in 2018, Santander partnered with California-based Ripple to launch a blockchain-based transfer service for the first time. However, if the retail banking industry is to make large-scale progress in adopting blockchain technology, it may be necessary to further prove the value of the technology.

The potential of blockchain technology for retail banking

The early enthusiasm for blockchain technology by capital markets, infrastructure companies and wholesale banks has not been widely reflected in the retail industry. Nonetheless, we believe that three retail use cases may eventually be deployed on a large scale, leveraging the three key advantages of blockchain, namely data processing, de-intermediation and trust. These three use cases include remittances , KYC/ID fraud prevention, and risk scoring .

01. Remittance

The total amount of cross-border payments is about $600 billion a year, and the market has recently maintained an annual growth rate of around 3%, driven by international trade. However, the processing of payments is often slow, opaque and highly intermediaries . Therefore, the transaction cost is very high , and the cost is usually 2% to 3% of the transaction value, up to 10%.

Competition among the many financial technologies emerging in the payments sector is intensifying and driving efficiency gains in certain parts of this value chain. In addition, some existing companies are developing their own payment solutions. For example, SWIFT (Global Interbank Financial Telecommunication Association) is working with banks through its global payment innovation program to improve the cross-border payment experience.

Blockchains may be able to repair some inefficiencies and thus generate value. For example, if the counterparty wants to exchange cryptocurrency assets (ie, digital currency that does not require a central regulator), rather than exchanging fiat money, then payments can be done in minutes via the blockchain , rather than requiring flowers as in the current system. It takes a few days to complete the settlement.

The distributed nature of the blockchain implies greater transparency and irreparability (data recorded in the blockchain cannot be tampered with). McKinsey estimates that applying blockchains in the cross-border payment space will save about $4 billion annually.

Some blockchain vendors have actively explored solutions in the area of ​​payments . Ripple connects banks and payment providers through its payment network, RippleNet, allowing them to pay in French or Ripple's own XRP tokens. The payment network is based on a private, non-distributed ledger that relies on a limited agent line ecosystem.

Financial institutions are also making progress . At the end of 2017, Australia, New Zealand Banking Group, JPMorgan Chase and Royal Bank of Canada jointly launched a cross-border payment service, the Inter-Bank Information Network (IIN). JPMorgan Chase said in a statement: "By utilizing blockchain technology, the IIN network will significantly reduce the number of participants currently required for compliance and other data-related surveys, thereby accelerating the payment process.

Despite advances in blockchain-based payment solutions, there are still major obstacles to large-scale adoption. One of the problems is that the blockchain network is transparent to its members (Translator's Note: The author here refers to the private chain network), which means that in some cases anonymity is limited. To this end, some companies are experimenting with "tokenization", which uses a token as a reference to replace sensitive data to mask sensitive data. However, this approach is still in the early stages of development.

Another challenge is that due to the lack of substitutability between cryptographic assets and fiat currencies, instant settlement is not currently possible . Bitcoin is inevitably subject to friction in the process of converting into French currency, especially considering the recent volatility of Bitcoin (from December 2017 to November 2018, the value of Bitcoin fell by 75%). “Stable currency” is a solution whose value is linked to actual assets, but still requires a proxy bank for the final conversion.

02. KYC/ID fraud prevention

The KYC protocol is an important tool in combating fraud, and fraud is a major and growing challenge. According to research firm Javelin Stategy & Reseaech, banks only lose between $15 billion and $20 billion a year in identity fraud. Banks are also facing increasing regulatory pressure to protect customer data.

The EU's General Data Protection Regulations came into force in May 2018, strengthening citizens' data rights and unifying data protection rules. Some European banks have invested up to 30 million euros to ensure compliance in this regard. A related issue is money laundering. According to a report by WealthInsight, global spending on anti-money laundering alone exceeded $8 billion in 2017, a 36% increase from 2013. In the past five years, the total number of “anti-money laundering” personnel in major US banks has increased tenfold.

Retail banks have made significant efforts to combat fraud, protect data and prevent money laundering, invest in automation and standardization, introduce real-time information sharing, and build predictive models. These measures have increased efficiency, but have resulted in longer process times and higher costs, reflecting the need for major operational model changes and manpower requirements.

Blockchain can be a potential solution . Blockchain-based technology allows customers to use digital fingerprints when loading or opening an account. Like an actual fingerprint, a digital fingerprint can be used as a unique identifier, which can be stored on a distributed ledger and referenced by any bank in the network. The owner of the digital fingerprint can use it to submit a new account application and use it to prove his identity throughout the blockchain network.

The decentralized blockchain structure eliminates duplication of KYC and AML compliance checks (because banks can share authentication information), reduces the burden of information, and enables banks to disseminate this data as it is updated.

We estimate that blockchain-based customer information loading solutions can save up to $1 billion in operating costs for retail banks worldwide and reduce regulatory fines by $2 billion to $3 billion (see chart below). In addition, we expect the blockchain solution to reduce annual fraud losses by $7 billion to $9 billion.

Blockchain is testing and promoting identity fraud detection by creating digital identification networks .

In 2017, blockchain data storage startup Bluzelle collaborated with three banks in Singapore (HSBC, Mitsubishi UFJ Financial Group and OCBC bank) to test together A blockchain platform for KYC. The project should show that the blockchain platform can improve efficiency, reduce financial crime risk, and improve responsiveness to performance and scheduling needs. It is predicted that this will reduce costs by 25% to 50%.

Canadian financial technology company SecureKey has developed a digital identity and authentication service that simplifies consumer access to online services such as digital banking. The service was developed through collaboration with IBM and banks such as National Bank of Canada, Scotiabank and TD Bank.

In addition, Swedish startup Norbloc, which is building a regulatory application on the blockchain platform, is working with the Belgian infrastructure provider Isabel Group to create a platform that simplifies identity management. Mastercard has applied for a patent for its system of identity and certificate protection and verification through the blockchain.

Other startups working on identity recognition include Cambridge Blockchain, Spring Labs (founded by online loan company Avant) and Blockstack (owned by Digital Asset Holdings).

Blockchain technology also enables users to control and share their personal data without the need for intermediaries by managing the private key (a digital signature used to approve transactions). Some operating systems and browsers provide key storage to protect private keys, and private vendors offer wallets and similar alternatives to defend against cyber attacks.

Despite the large number of experimental and proof of concept (PoC), retail banks still face challenges in implementing blockchain-based KYC and anti-fraud solutions.

First, the transition from a bank's own separate system to an information-sharing system can result in heavy capital costs . In addition, banks must adapt to the significant evolution of culture based on the need to share data. In an industry that is accustomed to secrecy, this is a relatively unfamiliar concept, and it also raises questions about accountability: if Bank A completes a customer's KYC process and shares it on the blockchain. Is Bank B responsible for errors or fraudulent issues in its own account? In addition, does Bank A have sufficient motivation to share its data? Data sharing is costly because it can undermine the bank's ability to provide personalized services.

There are also some practical challenges . Customer must agree to upload the digital fingerprint to the blockchain network and perform additional authentication steps during the setup process. Merchants are required to upgrade the certification system at the point of sale and adjust the online checkout process. Banks must create large networks to achieve economies of scale, which requires data standardization and collaboration. The latter challenge is whether a bank is willing to take the lead in creating a common blockchain network that does not provide a competitive advantage. – There is a so-called "coopetition paradox".

03. Using customer data for risk assessment

Financial institutions are often required to make risk management decisions based on limited data, which can be obtained from a small number of brokers and agencies.

In some cases, it is impossible to obtain data at all: people without a bank account (the unbanked, estimated to account for 40% of the world's population), subbank customers (the underbanked, who are difficult to use the bank's mainstream financial services) And micro-enterprises may not be able to obtain their credibility because they have not made enough non-cash financial transactions. Therefore, banks tend to be more conservative when making credit decisions for these people .

Blockchain technology makes it possible to aggregate large amounts of data that can be anonymized and protected by a ledger encryption protocol . At any time, the data on the distributed ledger can be accessed without explicit permission (customer consent can be obtained through pre-programmed smart contracts). In theory, banks can view data uploaded by any bank in the blockchain network. The result should be faster decision making, more efficient processes, and the potential for a more informed credit allocation process .

There are also technical and cultural challenges in this area. For example, powerful processing power is required to use scoring models distributed across thousands or millions of data sources. In addition, some customers have the option to restrict access to their data to protect their privacy and security. Financial institutions may need to work hard to get these customers to join.

Some fintech companies have begun to do business in this area, but most of them are relatively small. For example, Spring Labs launched a decentralized credit assessment network that raised approximately $15 million in the ICO in March 2018.

The road ahead

Blockchain technology can bring value to the core of the retail banking business model. However, retail banks are slow to participate, and the technology faces challenges in terms of scalability, volatility and trust in crypto asset prices . In addition, there is little evidence that existing companies are aware of the need to collaborate and share data.

Nevertheless, we believe that the following three aspects will help promote the adoption of blockchain technology in retail banking:

  • There is a need for a more seamless transition between legal and digital assets so that customers do not risk losing money because of back and forth conversions. One of the solutions is that central banks issue legal cryptocurrencies. This legal cryptocurrency will also support real-time peer-to-peer payments and may be used for cross-border interbank clearing and settlement.
  • Supervision is required so that participants can determine the legal status of cryptographic assets, participation rules, and investor protection.
  • The identity of the customer should be created on the blockchain so that the bank can provide real-time loan decisions to the customer based on the verified ID information. The current Dubai government is currently piloting such a project.

Finally, there needs to be a strategic watershed. Bank executives need to believe that the long-term benefits of the blockchain are worth the price. This needs to be considered in the long run, and it is also necessary to take into account the possibility of the blockchain in terms of the source of revenue. The key to eliminating these concerns is to focus on the rewards: lower cost, less friction and a safer retail banking system .

Author | Matt Higginson

Compile | Jhonny