Blockchain and Banking; The Death of Bank Fraud - Royal Institute of Colombo

Blockchain and Banking; The Death of Bank Fraud

Blockchain and Banking; The Death of Bank Fraud

 

The banking industry has a long-standing history stemming from the times of global empires that needed a way to pay for foreign goods and services, with something that could be exchanged more easily. In its early days, coins of varying sizes and metals served in the place of fragile, impermanent paper bills or other means of exchange such as livestock and precious stones. These coins, however, needed to be kept in a safe place and ancient homes did not have the benefit of security to keep their money safe and therefore the wealthiest people held accounts at their temples, which served as a precursor to banks as we understand them today. The First Actual Bank was put in place by the Romans who took banking out of the temples and formalized it within distinct buildings. Over the centuries, the banking sector has continued to grow and flourish and has rooted itself firmly within the foundation of modern society. This is thanks to the services that banks provide aside from monetary security such as interest generation, loan services, and facilitating credit-based transactions. Taking this vast history into consideration, one can be forgiven for assuming that the banking industry is one that is “too big to fail.” Many bankers themselves consider their industry to be a titan that can never fall. This hubris might one day be the undoing of the banking sector if they do not adapt to the new threat that poses the biggest risk that banking has ever had to face. This being; blockchain technology. New technology, throughout history, has disrupted and destroyed entire industries, and the banking industry is no different if they do not adapt and turn this threat into their strength.

Prior to elaborating on blockchain technology and how the bank can make use of it, it is perhaps best to first identify and explore the weaknesses and failures of the banking sector that blockchain can repair and reinforce. The banking industry has survived the ravages of time largely because it has been able to maintain the financial security of their customers. However, as both the technology and the world have developed rapidly, the ability of the bank to keep up with contemporary externalities has been called into question.

This doubt of the banking sector stems from its biggest weakness; bank fraud. Fraud, in banking, is a vast area of exploitation that the banking sector endures. Fraud can range from cheque kiting, (where it exploits a banking system known as “the float” wherein money is temporarily counted twice), forgery, accounting fraud, credit card fraud, and even money laundering. The issue of fraud is not one that can be written off or considered insignificant as fraud cost the world banking industry over 1,900,000,000 US dollars in 2019, a figure that is staggering to comprehend and account for(AARP, 2019).

This does pose the multi-billion-dollar question; why are banks failing to prevent this loss? The answer lies squarely with globalization. As the world has grown to be one giant village, the impact of such a change has been has largely been felt by the banking sector, as it has become virtually borderless through the free movement of money. At present, an individual could move their finances from America to Canada or to China or even to Panama with relative ease. Banking has been the recipient of a global market that greatly increased their profit margins. However, with this development came the complexity of having to defend against fraud on a global scale. In addition to this, the free movement of money creates a large and complex system where banks have to adhere to different international laws and interact with other banks with conflicting policies.

This system holds mountains of information within in, and ensuring transparency and safety within it has become a task that banks cannot perform, at its current state. The remedy for such a detrimental issue, as proposed by the authors of this discussion, would be the implementation of blockchain technology.

Blockchain, at its core, is a record keeping technology that uses ‘block’ and ‘chain’ model to earn its namesake. The block in this context is the packet of information that stores all the relevant data within itself. The ‘chain’ refers to how each block of data is linked together through the use of hash identification structure. Each time the blockchain is accessed, a new block is created storing all relevant data permanently on the chain, with each member of the blockchain having access to it. The aforementioned hash system is what creates the security of the blockchain. The blocks in a blockchain are laid out in a linear chronological order determined by the hash number.

This number is mathematically generated by a formula and is impossible to hack into, thereby making each block a truly permeant, infallible record (Investopedia, 2020). This would make blockchain the perfect record keeping technology opens a lot of doors for the bank to make use of this technology to solve their own shortcomings, especially in the case of fraud. For instance, a bank can implement blockchain to replace the intermediary system for all transactions. By doing so, they are able to perform real time fraud analysis along with the prevention of it, record all financial transactions in an immutable manner using smart contracts that can further develop security by enforcing specific stipulations.

This will all create better data handling, better trust and most importantly creating Disintermediation. Aside from these benefits, blockchain also offers further reasons for its adoption. This includes a cost reduction as banks no longer need to maintain round the clock security and monitoring of their activities, faster transactions as blockchain provides a more stable and secure transitionary system and easier integrability as blockchain has a very low barrier to entry for both the industry and its market.

Blockchain thus far has been discussed with pertinence to its uses and the advantages it can bring to the banking industry. However, as mentioned prior, blockchain poses a significant threat to the banking industry, largely through the emergence of crypto currency. Throughout history, banks were a necessity due to the fact that they were the only reliable body that could provide financial security and assurance. They were the essential intermediary body that existed between individuals and their finance. Blockchain, by nature supports disintermediation as it is a decentralized record keeping system. Crypto currency is a unique development in the fact that the currency does not need the security and the assurance that banks provide as they can support themselves through the foundation of blockchain technology. Here it can be understood how the banks face a threat of irrelevancy if they do not react swiftly to this threat. If the banking industry can establish itself as the primary body that supports blockchain technology, they can remain relevant and face the cryptocurrency threat head on.

The authors of this report recognize that the adoption of new technology may pose difficulties, as all transitionary periods do tend to have. Therefore, the authors of this report recommend two core strategic actions in order to ensure that the transition to blockchain is both successful and sustainable. The first recommendation is a significant investment into new information systems, either cloud based or physical. As all digital services, blockchain requires fundamental pillars that exist within an information system which is; storage, processing power and communication capabilities (Medium, 2017). Therefore, an invest into infrastructure that can host the blockchain model is a necessity. Furthermore, an investment into such infrastructure can remedy the shortcomings that blockchain hold today, such as speed.

 

This infrastructure can ensure a seamless service than banks can provide to their customers. The second recommendation is that the banking industry use a model where one blockchain is linked to one account holder. The reasoning behind this proposal is that it can provide full transparency to both the account holder and the bank, as with each transaction a new block is added to the chain. This will allow account holders to better keep track of their finances and well as allowing the bank to better monitor the security of the finances entrusted to them. This model significantly reduces the complexity of global transactions, thereby allowing banks to effectively remove fraud from their industry.

A similar model has begun to be implemented by the US federal reserve as well as private sector banks such as Deutsche Bank, Barclays Bank, and BNP Paribas (Fine Tech news, 2020), supporting the statement that blockchain in banking has moved beyond the theoretical and conceptual stages. The authors of this report recognize that this investment will require a significant amount of capital, However, this cost will pale in comparison to the losses that the banking industry will face if they do not adapt to the contemporary challenges of the modern age. In short, blockchain, if adopted by banking, can ensure the death of bank fraud and secure the future of banking for decades to come.

 In summary, the banking sector has enjoyed a vast and extensive history and can only continue to do if they are able to adopt and implement blockchain technology into their industry through the significant investment of both time and money. This implementation will allow the banks to not only survive the threat of irrelevance but also reap the benefits of blockchain by ensuring the death of bank fraud.

 

Written By:-

1. Rahul Matthew Jansz Rajaratnam (BSc Management and Digital Innovation)

2. Jiovani St Mark Vinoesh Kanagasundram (BSc Management and Digital Innovation)