Blockchain a game changer for banks looking to 'Know Your Customer'

22 January 2018 Consultancy.uk

Blockchain technology could become a game changer for Know Your Customer compliance, according to experts from Synechron. Consultancy.uk sat down with Dennis Martens, a blockchain consultant at the firm, to understand more about the potential.

Banks face an array of regulations that they must comply with, set by regulators aiming to keep the banking industry efficient and curb excessive risks. One of the larger requirements for banks is ‘Know Your Customer’ (KYC), part of anti-money laundering regulation which forces banks to identify and verify the identity of its clients. Global money laundering transactions, some of which reportedly fund terrorist groups, are estimated to be as high as 5% of global GDP, or roughly $1-2 trillion annually. Meanwhile, according to the United Nations Office on Drugs and Crime, less than 1% of global illicit financial flows are currently being seized by authorities.

It is, therefore, of utmost importance that banks comply with a range of KYC requirements in different regions, including the infamous Patriot Act and Dodd-Frank in the United States, the Money Laundering Regulations of the United Kingdom, and India’s Master Circular on KYC Norms. The requirements necessitate the collection of huge amounts of data from every client, including operational, legal and financial information, all of which needs to be validated, alongside conducting standard background, tax and credit checks. Due to the severity of the issue, however, this process does not end at the point of on boarding – and the continuous surveillance of clients in order to remain vigilant of irregularities also takes up a lot of time.

Banks are subsequently lumbered with high levels of onboarding costs, being made even harder by the lack of standardisation across the industry – something which, in previous eras was probably impossible to alter, thanks to the monumental manual effort that would be required, as KYC is predominately a non-digital process. This contributes to additional risks of non-compliance in KYC requirements, with the consequences and costs that coincide with those risks blighting global banks. Now digital technology may be on the cusp of providing a seismic change in the way the banking industry complies with KYC demands.

Blockchain a game changer for banks looking to

Game changer?

Blockchain is a technology which allows the participants of a network to share one distributed ledger in which transactions are collectively recorded. This allows the participants of the network to exchange anything of value without the need for a third-party intermediary. Blockchain is also referred to as distributed ledger technology (DLT).

DLT’s features could provide the tools needed to eliminate the need for reconciliation as well as create a single version of historical events, with the technology also being touted to reduce the need for central authorities across market-participants, while reducing the regulatory load arising from lack of transparency. DLT is inherently transparent, with options to limit data availability and/or visibility, eliminating the imbalance of information among market-participants as well as increasing the ability for regulators and regulatory entities to cooperate. Most importantly, this could provide organisations with a never-before-seen autonomy.

These are challenges that the industry has looked to put to rest for a long time, and blockchain and other distributed ledger technologies provide a promising solution to the current state of affairs in the KYC segment and the current KYC utility model. A distributed shared ledger could see participating banks share one distributed ledger, with corporate profiles being recorded, as well as a full audit trail of all performed activities on the blockchain, including the writing/contributing and editing of profiles, and the payment of subscription fees. All based on the predefined view and/or write access to the applicable data, subscription and client consent based.

According to Dennis Martens of business consulting and technology services firm Synechron, “Blockchain can address some of the most prominent problems associated with current procedures, and in turn revolutionise how financial institutions, such as banks, will address KYC regulations and remain compliant while cutting costs and increasing efficiencies from the bank perspective, and ensuring an enhanced customer experience.”

“With the implementation of blockchain onto KYC processes, a single, consolidated view of all KYC corporate client data that can be leveraged by all firms across the board could be created. Ultimately, this feature would transform the way the entire financial services industry views and interacts with KYC and compliance matter by creating a blockchain-enabled KYC utility model”, Martens added.

Quote Dennis Martens

Getting to know you

The implementation of blockchain technology in KYC could lead to a number of benefits. Most obviously, this includes the opportunity to reduce operational risks, by increasing standardisation and automation. Martens highlighted that the standardised automated controls (smart contracts), pooled data collection and interconnectivity make the roles of regulators and companies far simpler, with a single source of ‘truth’ and increased transparency meaning firms can lighten their burden and reduce expenditure on compliance. Further to this, cybersecurity may also be tightened via blockchain, as hackers would need to hack every network participant simultaneously in order to change a ledger, while the lack of a centralised physical database reduces the risks of failing business continuity jeopardising records.

Blockchain can lighten the load on companies to maintain compliance, including notable cost savings associated with KYC onboarding, because they share one solution and data and processing standards, lowering the number of labour hours needed. Blockchain could also provide for lower data sourcing costs. "These costs can be shared, as only one feed to the network would be necessary, instead of a data feed for each and every bank," commented Martens.

He predicted, “A ball park estimate of the potential costs savings that result from implementing the blockchain KYC utility solution would include approximately 55% reduction in operations labour hours, and at least 30% reduction in compliance costs associated with KYC. A large bank with 100,000+ clients spends up to $100 million yearly on KYC and client onboarding. Therefore, savings benefitted from blockchain implementation could exceed $50 million.”

Finally, a knock-on effect from the implementation of blockchain could well prove to be the improvement of customer experience. Corporate customers stand to see their journey significantly streamlined, as they only have to be onboarded onto a blockchain network once, as once their banking profile is on the network, other participating institutions can subscribe to that profile. While this means customers can obtain direct bank/customer contact more easily, it has also provided banks a further opportunity to save on effort obtaining data, and spend more time improving the experience of their clients during onboarding.

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The business and operating models of digital-only banks

04 April 2019 Consultancy.uk

In recent years, several digital-only banks have successfully managed to nestle themselves in the banking landscape, with their popularity continuing to increase. Looking at it from the customer’s point-of-view, there is little difference between these FinTech unicorns; looking at the bigger picture, however, reveals significant variation in their business models. Matyas Fekete, a consultant at KAE, explores some of the main similarities and differences in digi-bank business and operating models. 

What about the profit?

Unlike in the UK, in most of continental Europe, bank accounts and corresponding banking services are historically paid-for services. The fact that digital banks offer most of their services free of charge has undoubtedly helped them build a large customer base. On the other hand, despite comparatively low set-up and minimised operational costs compared to that of traditional banks, and given the lack of revenue stemming from the typically no-fee model, profitability has proved difficult to achieve. Monzo, for instance, recorded a net loss of £30+ per customer in its most recent financial year. 

In the start-up world, it is customary to focus on expansion rather than profit – see the case of Uber, for instance. Still, while profitability might not be their number one priority in their early stages of development, it must be a long-term goal of any business. With their ever-growing customer base, digital banks are increasingly under pressure to turn their business from loss- to profit-making. 

Credit where credit is due

Digital banks pride themselves on their fair (often meaning “free”) proposition and have so far stayed clear of offering loans (including credit cards & overdrafts), traditionally amongst the most lucrative products for traditional providers. Though somewhat reluctantly, newcomers are also realising that offering lending products is one of the most straightforward ways to offset losses made on their free, often high-cost services (e.g. overseas ATM withdrawals). Monzo, N26 and Starling have recently started offering credit products to their customers, with their loan offering expected to be extended to a wide range of services, from mortgages to overdrafts. Correspondingly, creating a lending portfolio can also pave the way for launching an interest-paying savings offering – a proposition seen as a basic banking product that is yet to feature in most digital banks’ portfolios. 

The business and operating models of digital-only banks

The premium customer

While most digital banks offer most of their products for free, some have extended their offering by paid-for premium services in order to create a revenue stream. As these premium features – including different types of insurance, unlimited free transfers/withdrawals, faster payment settlement or concierge services – are often offered in a subscription format, customers are typically prompted to pay for the full package rather than just the desired service(s), providing a significant revenue stream for the bank. Revolut, for instance, was amongst the first digital banks in Europe to break even earlier this year, a feat largely due to revenue from its premium subscription.

SMEs like digital too

Traditional banks typically service small and medium sized businesses under their retail rather than corporate banking arm. Having their product offering tested with consumers, and consequently gaining a reasonable customer base, digital banks have also identified SMEs as an ideal segment to extend their target audience to. The five FinTechs profiled have already gone, or plan to go, down this path by following up their consumer solution with a business account. While both propositions are typically built on similar features, some providers charge businesses a monthly subscription (e.g. Revolut), while others apply additional fees to specific services (e.g. TransferWise), banking on the expectation that businesses are more likely to be willing to pay for banking – something they are already used to doing. 

The marketplace model

While most digital banks offer a wide range of banking services, some of these tend to come from partnering with third-party providers. For instance, Starling Bank’s only proprietary product is its current account, which serves as a basis for the provision of ancillary services, ranging from loans to insurance, to investment opportunities. Instead of developing these services in-house, Starling enables a select group of partnering financial service providers access to its platform in exchange for a fee. In effect, Starling is using its customer base to create a market for its partners, charging a commission for each acquired customer. 

In such cases of digital banks applying this marketplace model, the majority of their income often comes from partners rather than customers. Naturally, only banks with a large enough customer base can be successful in this set-up, underlining the current intensity of competition amongst digital banks.

Banking as a Service

While customer-centricity is heralded amongst the main USPs of digital banks, some are looking beyond offering consumer-facing services to diversify their revenue streams. Starling, which is among the few digital banks built on its own proprietary platform, has recently leapt into the Banking as a Service (BaaS) industry, making its technology available to other start-ups looking to launch a digital bank. Naturally, this raises the question whether the two offerings could threaten each other’s success. Generally, as long as such partners operate in different markets, the two business lines should be able to thrive alongside each other. Further along the line, however, such partners could easily end up expanding their banking solution into the same market(s) as they aim for global success, and by doing so, becoming direct competitors. 

Different approach, same result?

It is fair to say that consumers in Europe looking to bank with a digital-only provider would have a difficult time finding relative advantages/disadvantages amongst the leading players in the industry. Still, despite the limited surface-level variety, exploring the business models of leading digital banks reveals different approaches to the challenge of making money. Alongside the more straightforward method of offering paid-for premium features/subscriptions, some are banking on the value that access to their customer base offers to third-parties, while others outsource their technology to neobanks wanting to focus on the Fin rather than the Tech. With competition amongst digital banks heating up, it will be interesting to see which business model(s) prove to be the winning formula in the long term.