# Insights

Apr 8, 2020

Blockchain and the future of lending

Reading time: eight minutes  

Blockchain technology has plenty to offer the financial services industry, but there are challenges that need to be overcome for banks to harness its potential. 

Since its inception a decade ago, blockchain has been one of the most hyped technologies in financial services, heralded for its potential to eliminate pain points across the industry, including payments, trade finance and, indeed, lending.  

And the latter is in dire need of a face lift. Outdated lending processes are creaking under the pressure of rapidly changing technology and consumer expectations. And while the last ten years have seen P2P lenders make a splash, the majority of loans still come from banks, credit unions and financial institutions. Many of these lenders are shackled by legacy tech and slow, bureaucratic processes — ripe conditions for disruption. 

The process of credit evaluation and loan approval is filled with administrative lag and third parties like credit agencies. Getting a student loan, a mortgage or consolidating debt can still be fraught with inefficiency. There’s no view of an overall credit score for an individual or entity. And tasks like data entry into multiple systems and manual data aggregation are also common problems. 

Then there’s security. Traditionally, bank ledgers have been created within relational, centralized databases, such as DB2, Oracle and other outdated software. This centralized model has been susceptible to cyber-attacks as all the information is located in one place — with a long list of incidents serving as testament.  

The introduction of blockchain technology is primed to solve some of these problems. And, while it’s not yet there, it is already driving significant change and will be vital in the future. 

Disruption in lending

In recent years, there has been a significant uptick in loans underwritten by fintechs or alternative lending platforms. 

According to Experian, fintech consumer lending has more than doubled in just four years, growing from a 22.4 percent share of personal loan originations in 2015 to 49.4 percent in 2019. And it’s not only banks that are losing ground – credit unions and traditional finance companies have been steadily ceding market share as well. 

This is largely down to the new industry entrants’ ability to innovate (thanks to their agile startup-like approaches and the less complicated regulatory restrictions they’re faced with). In terms of lending, these new players are leveraging the latest in blockchain and data analytics to make their products faster, more efficient, more transparent and easier to access. 

With non-bank lending gaining momentum, blockchain-based lending platforms are cropping up, and fintechs are offering an ever-more diverse selection of products — banks need new ways to compete. Many have responded by bolstering their digital capabilities. Alone this isn’t enough, however. Banks need to aggressively cut operating costs, pursue partnerships and technologically overhaul lending processes. 

Enter blockchain

… or not quite. While blockchain has the potential to solve many of the lending issues banks are faced with, the practicalities are slightly more nuanced. The technology, for instance, requires a unique level of organizational cohesion — companies need to agree on technical, functional and legal methods, which is no easy task. Despite spending $1.7 billion annually on blockchain, many FIs have failed to actualize benefits from early investment, and a number of pilot projects have been shuttered.  

But the allure is understandable, and once the early hurdles have been passed, successful adopters of blockchain technology will have plenty of benefits to reap. Below, I’ve outlined a few of the key benefits that blockchain would bring to the financial services industry: 

Speed  

Blockchain can manage, approve and log any transaction instantaneously. The technology directly contrasts today’s slow, often manual authentication, verification and data-sharing workflows that lenders rely on. 

Flexibility  

Blockchain technology further opens the door for peer-to-peer loans and complex, programmed loans that can approximate a mortgage or syndicated loan structure. 

Transparency  

Blockchain offers unprecedented stakeholder visibility into the entire lifespan of a transaction within a bank’s operations — it reduces the need for expensive and time-consuming third-party verifications along the way. 

Security  

With a distributed network, banks can minimize attack surfaces and eliminate single points of failure, thus reducing the threat of fraud and data theft. 

Improved customer experience 

Further, blockchain provides the ability to put the user in the center of the lending equation, giving them access control over their sensitive data. While responding to GDPR demands, the transparency generated by blockchain can lead to more confident borrower-lender relationships. 

Preparing for the future

Large-scale adoption is unlikely to materialize in the short term, but that doesn’t negate the need for planning.  

First, banks that want to launch blockchain projects must have a clear vision and strategy. The critical question: does a solution require the sharing of trusted data between the parties with less centralized control? 

In the case of lending, the answer is a relatively clear yes. The weight of regulation and the frequency of audits are typical indicators of loss of trust in an industry. Blockchain solutions, which guarantee an auditable, unfalsifiable version of the truth are valuable in terms of restoring trust.  

Second, building a blockchain is a team effort, and the most benefit can be gained by participating in an ecosystem made up of multiple partners. From the onset, it’s best to have experts who have intimate knowledge of the existing business, the sector, regulatory and technical context. 

In terms of ideation and preparation, a creative and collaborative approach is required to make protocol design a more inclusive activity. Design thinking style workshops with a creative method and a facilitator trained in this approach will be necessary to better understand the capacities and the limits of blockchain. 

The governance model is also a critical piece that needs a lot of attention on the front-end. This is what makes it possible to accept potential new entrants and the possibility of partners leaving, i.e. getting the system off the ground. Ensure that the principles of governance are included in a contract or collaboration agreement between partners that can be inspired by a memorandum of understanding of collaborative projects proposed by competitiveness clusters. 

Last, be ambitious but act incrementally. Blockchain projects must be agile and avoid tunnel effects. It is recommended to start from a first stage based on an MVP and a viable ecosystem and to enrich the functionalities and the ecosystem progressively. 

Redefining loans

Financial institutions may feel stuck in legacy systems and unable to accomplish the agile environments and instant-gratification that today’s consumers expect.  

To gain back lost ground from encroaching fintechs, banks must adopt a bold, technology-centric approach. By leveraging new data sets and innovations, financial institutions can improve their loan offerings and service more customers. 

Blockchain may still be a nascent technology with legitimate scalability and regulatory concerns, but to think that it won’t play a role in future lending markets is shortsighted. It’s time to redefine loan processes to be able to match the experience offered by non-bank lenders. Blockchain will be one of the tools to achieve this. 

Philippe Serafin, Digital Innovation Manager at Sopra Banking Software