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Bank de-risking: how to repair a broken model and stop sidelining corporates

Published  3 MIN READ


Thousands of corporates are being pushed out of the traditional banking system as a result of de-risking, leaving them unable to access services such as trade finance and capital funding. Abbas Ali, Associate Director at R3 explores how blockchain can help repair the broken correspondent banking model, bringing corporate treasurers back into the fold.

While numerous technology solutions exist to help streamline know-your-customer (KYC) processes for banks, a recent study by Thomson Reuters shows that some financial institutions are still spending up to $500 million annually on ensuring KYC compliance. This, combined with additional industry pressures, has driven many banks to de-risk, terminating their relationships with particular institutions, countries and regions, at a significant disadvantage to corporates.

As other infrastructures in developing markets begin to evolve, corporates have new opportunities for expansion, which in turn, increases demand for capital funding and access to markets. However, the current trend towards de-risking means that these needs are not being met and some corporates are turning to less traditional means for securing funding – outside of regulated markets. This is often not the corporates’ preferred route – but they have few other options.

Thankfully, the emergence of blockchain technology has provided an opportunity for banks to re-engage with corporates and correspondent banks excluded as result of de-risking. But to understand how blockchain can improve KYC, and ultimately benefit corporate treasurers, it is important to first understand the scale and scope of the challenge.

Risk fines or de-risk?

Since 2010, 28 major banks have been fined for breaching US sanctions, with seven banks receiving fines exceeding $500 million, of which the highest was $8.9 billion. In one particularly pertinent example, the Financial Conduct Authority and the New York Department of Financial Services issued KYC/AML fines for an institution that formed a cumulative total of $628 million.

It is little surprise, then, that in response, banks have moved to reduce their risk by shedding correspondent banking relationships in developing countries leaving corporates with unmet needs. But as a result, the high and rising risk of fines and the costs of increased scrutiny have destroyed the tradition of banks extending services throughout the world, particularly to the poorest and most difficult-to-analyse regions.

The good news is that recent technological innovation in blockchain-based systems promises improvement in KYC compliance without the need for extensive networks with central administrators. Data on a blockchain platform’s distributed ledger is verifiable and immutable, providing increased transparency to relevant participants.

Regulators impose fines and penalties on banks that don’t conduct appropriate due diligence on the entities and individuals they directly deal with; therefore, banks use intermediaries and shift some of the risk to the middle men or reject processing the transaction altogether. The more readily a bank in a well-developed country can access information on the end user and the end user’s bank in an unbanked region, the more comfortable it will be with facilitating the transaction.

KYC registry on the blockchain

The shared nature of blockchain technology lends itself naturally to providing a single, unified registry of KYC information for banks. A KYC application built on R3’s Corda blockchain platform recently facilitated over 300 transactions during a collaborative four-day trial with 39 financial services firms, as well as various central banks and regulators.

In stark contrast to the typically complex and duplicative KYC processes banks (and corporates) are forced to endure today, Corda’s self-sovereign model allows corporates to create and manage their own identities including relevant documentation and then grant permission to multiple participants to access this data. This reduces duplication and costs by eliminating the need for each institution to individually attest and update KYC records.

Corda’s unique technology addresses any concerns around data privacy and security that may arise when sharing identity data. In direct contrast to traditional permission-less blockchain platforms, Corda only shares data with those with a need to see it. This is critical for its application in the KYC space, where sensitive data must be kept confidential.

Having KYC information readily available allows banks to spend more time analysing information rather than collecting and verifying the data received – a key issue in onboarding delays. In addition, all data is fully standardised, significantly reducing the time, cost and resources required to manage it.

There’s no doubt that de-risking is a complex challenge to address. Blockchain, when used in the right way, can significantly increase traceability to support financial inclusion for the countries and regions whose development hinges upon access to the global banking network – all of which will be beneficial for corporate treasurers looking to help their organisations expand into new geographies.