Blockchain has become the financial industry’s modern day penicillin – for almost any ill, distributed ledger technology is being prescribed as cure or remedy.</p> Be it moving settlement to T+0, or streamlining corporate actions, collateral transfers, securities clearing, trade finance or fund processing, blockchain has been touted as the solution to fixing a range of otherwise intractable inefficiencies.</p> Beginning life as a public ledger for Bitcoin transactions, the technology now looks set to outgrow and potentially outlive its original purpose as the organisations across the established financial sector seek to find new applications for the blockchain. In most cases, the aim is to reduce costs and increase speed, efficiency and transparency. On the downside, substantial investment and long implementation timetables are required to replace complex legacy processes with a new technology which still has to convince sceptics about its robustness at scale and ability to fit into existing regulatory frameworks.</p> In search of a remedy</strong></p> While the financial markets are bullish on the prospects for blockchain, correspondent banking is suffocating under the weight of regulation and rising costs. A key challenge for providers of correspondent banking services in recent years has been the rise in know-your-customer (KYC) and anti-money laundering (AML) obligations as policy-makers step up their fight against financial crime and terrorist finance.</p> Correspondent banks manage chains of bilateral relationships across multiple geographies in order to transfer funds safely and securely between originators and beneficiaries on a global basis. As such, they face significant counterparty risks – and ever increasing costs as they put in new process layers to minimise these risks and meet regulatory obligations. It is perhaps no surprise that correspondent banking is one of the areas being tipped to benefit from use of blockchain technology.</p> Blockchain can counter issues of uncertainty and risk, while supporting transparency, according to Edward Budd, chief digital officer, Global Transaction Banking, Deutsche Bank. “Blockchain technology can potentially be positively applied to correspondent banking as it would allow a process or an asset to be shared securely, efficiently, and with full certainty of its validity between several parties,” he says.</p> “Benefits in scope are increased transparency, reduction of errors and speed and automation of transactions, which might have a roll-on effect on fees.”</p> With regard to the regulatory and counterparty risk obligations of correspondent banks, blockchain has the potential to support due diligence requirements, experts note. And from a client service perspective, it offers the prospect of almost instant transaction processing, subject to critical mass being achieved.</p> Greater speed, greater insight</strong></p> Mark Buitenhek, global head of transaction services at ING, believes blockchain would increase transparency of the route and status of a transaction, while also reducing and removing reconciliation differences and other errors. Buitenhek adds that the technology would also allow banks to gain real time updates into liquidity and cash positions.</p> “Besides that, blockchain technology might be able to help banks enter into relationships or interactions with more parties than they are able to at the moment. Blockchain technology might also eliminate several steps in the current process, reducing fees and thus costs for the customer,” he says.</p> “Practically, what everyone hopes to solve using blockchain technology is greater insight into process, status and costs for customers with a higher certainty of transactions – and thus fewer errors – by reducing reconciliation differences and risk, by making transactions atomic.”</p> Blockchain may appear primed to solve the major issues within correspondent banking, but it is by no means a quick fix. Sibos 2015 – where blockchain developer Hyperledger was crowned winner of the annual Innotribe Startup Challenge – reflected the growth in interest and innovation around the new technology. But while several consortia are already testing proofs of concept for different applications of blockchain, implementation timetables stretch out for several years.</p> Industry expert and founder of 3C Advisory Olaf Ransome believes another driver of blockchain adoption in correspondent banking could be the challenges faced by transaction banking franchises in adjusting to higher intraday liquidity costs under Basel III. As part of efforts to reduce counterparty credit risks, BCBS 248 requires banks to monitor the provision of intraday liquidity to correspondents much more carefully and is having the effect of limiting the availability and hiking the cost of providing liquidity via nostro accounts. Banks are finding it hard to pass on these higher costs within existing fee structures for correspondent banking services, meaning opportunities to cut costs are at a premium.</p> “So now we face the challenge and the opportunity of making use of blockchain. If to use that we had to move our fiat US dollars and euros to a digital format, then an ideal solution would be a 1:1 exchange into a single digital equivalent,” he explains.</p> With the use of blockchain to curb the cost of intraday liquidity buffers dependent on banks agreeing a single digital version of each currency, Ransome believes a solution is at least three years away. “We need one year to agree what we want, one to design and agree a solution and a year to implement,” he says.</p> A scalable solution?</strong></p> Time aside, the key to blockchain implementation rests with the will to collaborate within the banking industry. The good news for correspondent banking is that connectivity and cooperation between the banks is well established, for example through industry-wide utilities such as SWIFT. If banks can agree on standards, rules and infrastructure then there is every reason to expect that blockchain can be rolled out successfully within the correspondent banking world.</p> “The success of blockchain in correspondent banking crucially depends on its reach and network,” says Budd, who nevertheless accepts that the technology still has much to prove. “Another challenge would be the scalability of a blockchain solution as thousands of transactions are processed every second. Further interoperability will be a key success factor, not only between different blockchains but also between legacy systems.”</p> Budd believes the timescale for the adoption of blockchain for correspondent banking services will vary based on existing market practice in different geographies, regulatory environment and complexity of implementation. Even so, he suggests we could see the first commercial examples in late 2017.</p> “Moving to blockchain would require new investments, and some markets and market participants may not want to move until it becomes standard,” he adds. “Full blockchain adoption might take another three to five years, and we expect the technology to be pervasive in five to ten years.”</p> Given that cross-border payments are one of the existing uses of blockchain, albeit in Bitcoin, it might appear the proposition of using the technology for correspondent banking is one of the more likely cases for a rollout. Regulators, too, are likely to welcome any technology-based innovation that helps banks achieve KYC/AML compliance in a more cost-effective manner. </p> Sibos 2016 in Geneva will be an ideal opportunity to assess progress.</p>