Blockchain technology is a double-edged sword for banks

Baozou Comment : This article analyzes the pros and cons of blockchain technology for international banks from the perspective of its wide-ranging impact on existing systems. It believes that the high-speed system it provides can reduce the bank's manpower and system costs, while real-time settlement will greatly undermine the investment benefits it obtains through settlement delays. Therefore, international banks have been at the forefront of blockchain technology exploration, hoping to provide better services to customers through upgrading their own systems.

Translation: Annie_Xu

The much-hyped blockchain technology may initially hit the earnings of international investment banks, but its potential to reduce costs across financial markets could boost dwindling profits.

A new bank survey estimates that blockchain could cut costs in global currency markets by $15 billion to $20 billion.

Morgan Stanley and other global investment banks are also affected by so-called post-trade settlement, which involves custody of assets and verification of transactions, ensuring that corporate loans are in place, and is expected to be the first to be affected by blockchain in the next five years.

Many international investment banks act as custodians for the entire securities trading process and receive corresponding service fees; they also use the time gaps in large transaction settlements to make investments and profits.

The Australian Stock Exchange and others also make profits by providing clearing and settlement services, but now they say that up to $470 billion in clearing revenue is at risk, so they are exploring using blockchain to replace the existing settlement system.

Net loss

Huw van Steenis

Huw van Steenis, Managing Director at Morgan Stanley in London, said:

“Banks such as Bank of New York Mellon, Citigroup, Northern Trust, State Street, and JPMorgan Chase benefit from ensuring the correct valuation and circulation of securities, and the existing T+2/3 settlement method enables them to obtain investment benefits from the funds they hold; however, blockchain technology may threaten their added value, and the speed of releasing funds cannot keep up with the shortened settlement time, which will also reduce their income.”

Until now, banks have been able to take advantage of delays in trade settlements to use clients’ funds for short-term trading or investments.

But large international banks also see the potential for blockchain to reduce system and human costs in transaction verification; and to make up for profits lost due to regulators' interest rate hikes since the financial crisis.

All large banks, including Australia's four major banks, are at the forefront of blockchain technology exploration because being the first to gain the benefits of technology can make business models more in line with market conditions.

The current blockchain explorations mainly include the R3 Blockchain Alliance and the Linux Foundation's Hyperledger project.

“Securities depositories have been at the forefront of work on distributed ledgers in order to assure their customers that they are provided with the most efficient blockchain solutions.”

More convenient settlement

The report also pointed out that the instant settlement achieved by blockchain will become the main reason for banks' loss of income.

Although the technology can already achieve instant settlement, regulators, system upgrade costs, and whether instant settlement can reduce liquidity have all become obstacles to the implementation of the technology.

“Real-time settlement T+0 maintains less liquidity and higher volatility than markets with delayed trade settlement.”

One reason is that instant settlement eliminates the possibility of short selling, which can increase liquidity.

The next to be affected are likely to be trade finance, international currency exchange and international banking; international banks transfer funds by establishing debit and credit accounts for the same customers between different countries, hence the name “correspondent banking”.

Ripple, an American blockchain company, is working with banks in countries such as Australia to develop a distributed ledger that would free banks and even hedge funds from reliance on correspondent banks.