Banking is at an inflection point. Most people think that banking is being reshaped by regulations since the global financial crisis. But that’s only half the story. The other half is about technology.
Financial innovation is the dominant theme at technology centres around the world. Banking is an almost entirely digital business and innovation using technology is an obvious choice.
The financial services industry is being disrupted and digitally re-imagined, and some of the disrupters could become mainstream. Yet, most banks — facing increasing pressures on returns, while challenged by regulators to simplify their business models, and hampered by legacy systems — are relative bystanders in this arena.
Enabling customers to manage their money on their smartphones or tablets is helpful and adds marginal value to the existing system. However, nimble disrupters are working to revolutionise current business models from the ground up.
The rapid growth of peer-to-peer lending in the US is an example of that. The stellar response to Lending Club’s initial public offering demonstrates how consumer attitudes to once-niche activities such as peer-to-peer lending have changed.
Another example of the change gripping the financial services industry is blockchain technology.
Blockchain is the underlying DNA of cryptocurrency Bitcoin. In simple terms, the blockchain is a decentralised ownership record or distributed public ledger of all transactions, which is mathematically signed to prevent unauthorised tampering.
Bitcoin has been viewed uneasily as an exotic alternative currency. Recent press headlines have focused on its volatile price, the dramatic crash of one of its exchanges (MtGox) and concerns that it could be misused as a means of illicit payment. But the banking industry is starting to see the many potential benefits of its underlying technology.
For banks, the blockchain has the potential to become a technology model for a low-cost and transparent transaction infrastructure.
While Bitcoin is unlikely to dislodge paper money, its greatest legacy would be the benefits of the underlying blockchain technology to the security of banks and the integrity of the financial system — which remain closely intertwined.
If this takes off, prices for trading, money transfers, remittances, credit cards and other products could potentially be undercut drastically to the benefit of consumers.
This infrastructure could be adopted to make financial transactions more secure and traceable for customers, banks and regulators.
One of the biggest challenges facing financial institutions is the need to prevent their systems being used to transfer funds for criminal activity such as the drugs trade or terrorism.
Banks are investing heavily in new systems and processes to prevent money laundering and blockchain could help.
With the use of blockchain technology, each leg of the transaction can be recorded and traced, making the ultimate destination and use of the funds clearer. This means combating financial crime such as money laundering also becomes easier.
Another area where the blockchain technology can be useful is trade finance. This has traditionally been a paper-intensive process but it is possible to use blockchain technology to digitise and authenticate the records. This can result in trade transactions that are secure with digital records of related data visible to various participants in the trade transaction.
Regulators are starting to acknowledge, and even embrace, the revolutionary potential of the blockchain and other digital innovations. In the UK, the Bank of England’s judgement that “the impact of the distributed ledger could be much wider than payments” shows that these technologies may likely move into the mainstream.
The Monetary Authority of Singapore also signalled their intention to encourage banks to consider the many applications of the blockchain in the financial sector where distributed ledger systems may potentially be “applied in any area which involves contracts or transactions that currently rely on trusted third parties for verification”.
Many of these new technologies started off seeking to disintermediate banks, but the trend is now shifting towards collaboration. Partnerships between banks, technology companies and regulators will bring benefits to consumers and the financial system.
Whether cryptocurrencies, the likes of Bitcoin, will fail or succeed remains to be seen. But if they do take off, it is not impossible to imagine a scenario where even the central banks themselves might look at issuing digital currencies. No bank can afford to ignore what it augurs for the ongoing avalanche of digital innovations to come.
— The writer is the Group Chief Innovation Officer at Standard Chartered
