Lending robot under smart contracts

How will loans be extended 20 years from now?

According to projections from consulting firm Capgemini, financial services on the blockchain and under smart contracts are expected to become mainstream as early as the first half of the 2020s. More specifically, lending institutions are predicted to change beyond recognition. Experts highlight three key trends in this regard, forecasting the scoring process to become exponentially simpler, transaction costs to drop almost to zero, and P2P lending to spread even further.

It’s time to “blockchain” lending

Roberto Mancone, Global Head of Disruptive Technologies and Solutions at Deutsche Bank AG, is eloquent about the stance of lending institutions and banks:

“It is high time that some of the systemic issues in mortgage processing are resolved. The loans are one of the main drivers of growth, but at the same time also of operational complexity in the retail banking industry. This creates an enormous need to enhance the efficiency of internal services and processes.”

In Roberto Mancone’s opinion, smart contracts have great potential and could transform the business model of many segments of the banks, solving many of the lending problems. But he also warns of barriers, saying:

The industry still has to test and ensure that these are as robust, autonomous and secure as they are promised to be by crypto enthusiasts and the adoption will vary according to geography and regulatory frameworks.

Timothy Willis, lead expert with RiskSpan, a consultancy, echoes Mancone’s words:

“Major lending players use cumbersome electronic data storage systems which hinder the saving of statements. What if all information is recorded on the blockchain instead of a single base with copies, accordingly, available to every investor? This would save us the trouble of reporting to shareholders on a monthly basis.”

The future of scoring

Equifax and TransUnion, two of the U. S. credit reporting agencies, have launched a test for personal identification system on the blockchain, with nearly $20 million already invested. Users go through an identification process using their mobile apps and confirm that their personal data has been passed on to the blockchain. Information owners are free to choose which banks and credit bureaus will be provided with their data to open a new account. Details of all transactions are saved on the network, yet confidential data is available to user-approved entities only.

Generally speaking, blockchain technology has provided an unprecedented impetus to the subscriber data management market. According to projections from research firm MarketsandMarkets, the total market size by 2021 is estimated to be roughly $14.82 billion vs. $8.09 billion in 2016. How blockchain identity is set to change scoring then?

“All information provided and confirmed by a person (year of birth, employer, income, credit history, tax return, etc.) is password protected and passed on to the blockchain. Once owning their own digital identity on the blockchain, the person will be assigned an identification number. In fact, the latter is only indicative of someone’s personal data on the register,” Igor Chugunov, CEO and Founder at CREDITS, draws on a near future scenario.
“The number can be stored on any data carriers, ranging from magnetic stripes to QR code. The person who went through an identification process is the only holder of a private key. From now on, it’s up to this person to decide who will be allowed to access his or her data and to what extent — by giving them a public key. This approach to the KYC procedure allows everybody (entities and an individual alike) to save time. Once the identification process is passed, persons are free to provide the identification number to confirm their identities and scoring at any bank. The need to fill in forms and scan documents would disappear without a trace.”

Igor believes that encouraging customers to hold entries containing their personal information on the blockchain is the key problem with the system’s practical application. Yet the problem is solvable. Lowering interest rates and improving the terms of lending are possible ways of encouraging customers.

Another way is to get rid of credit reporting agencies and pass all information on to the unified blockchain register of credit reports, which hardly comes into conflict with the previous solution. From then on, all new entries will be made by banks exclusively on the blockchain.

Transaction costs to tend to zero

“Imagine yourself opening the website of a lending institution. Uploading your identification number and personal account. Specifying the amount of money you wish to borrow. That’s about it! From here on in, it’s the smart contract ‘lending robot’ that gets a job done,” says Eugeniy Butyaev, CTO at CREDITS. “It analyzes all your data, completes scoring, calculates the interest rate, the schedule of payments and ends up displaying an agreement detailing all parameters of the loan on your screen. If the borrower consents, their electronic digital signature is affixed. Then funds are remitted to the borrower’s account. On specified days, a smart contract will withdraw monthly payments from the same account.”

A possible way to make the lending robot’s job more difficult is to request a foreign currency loan. In this case, a smart contract will continuously check with the current exchange rate and adjust the interest rate in the case of strong fluctuations if the terms and conditions so stipulate.

How would a smart contract respond to late payments? By accruing late payment charges, penalties, referring the agreement to court for further recovery.

“As you can see, the process is totally free from any hard-copy paperwork or bureaucracy. No negotiations with the personnel of lending institutions. No need to travel anywhere. On the other hand, a lending institution can thus optimize its staff. A smart contract doesn’t need to be administered. All terms and conditions are formulated by lawyers. This serves as the basis for developer to program a lending robot for subsequent independent functioning. Transaction costs are reduced almost to zero,” Eugeniy explains.

What are potential savings then? The methodology for measuring transaction costs was developed by U. S. economists Douglass North and John Wallis. Transactions account for about 17% of lending institutions’ total expenses in their calculation model. Showing total costs net of negative asset revaluations and the provisions for extended loans and advances will push transaction costs to 35%. It means that the payment and settlement system overheads represent an average of 35% of costs associated with a lending institution’s day-to-day operations.

Overwhelming peer-to-peer lending breakthrough

Peer-to-peer (P2P) lending means that individuals lend funds to/from each other directly, without resorting to traditional financial institutions as intermediaries. Moreover, the user of this service can act as either a lender or a borrower. The key markets for P2P lending are developing economies with large populations, such as China, India, the countries of Africa. This lending solution offers the advantages of accessibility and low interest rates.

Transparency Market Research estimates the global peer-to-peer lending market size to have the potential to grow many times to $897.85 billion by 2024. In contrast, its estimated value as of 2015 was as low as $26.16 billion. In other words, the market is expected to rocket by an overwhelming 48.8%. Professionals believe that blockchain technology explains this breakthrough.

“Every participant in the P2P lending blockchain system will have to register and provide their e-mail address or Facebook,” Igor Chugunov talks through possible ways of arranging everything. “This alone is enough to be a lender. The list of information necessary for obtaining a loan looks more extensive: participants have to add their passport details, provide their phone number, domicile, specify the employer, salary level, attach a bank account statement or a tax return. That done, the platform participant is assigned the borrower’s credit rating. Then he or she submits a loan request specifying the desired amount, currency, interest rate, maturity, and investors select the loans they consider to be suitable from the list of requests. Investors are free to fund loans fully, partly or jointly.”

In a model like this, loan recovery will be handled by online arbitration firms. They already exist. For example, Internet-ARBitration has been active in the United States for more than eleven years.

In lieu of afterword: where are smart contracts already legal?

The United States are slowly but steadily recognizing the validity of smart contracts on the blockchain. Arizona pioneered this law-making practice. Vermont followed. Florida is about to join. Currently, there is at least one known software solution designated to integrate blockchain into the mortgage segment, still at the prototype stage. In January 2018, the U. S. real estate market players test launched a blockchain-based information recording and storage system, Bloomberg reports. The system testing participants include Credit Suisse Group AG, U.S. Bancorp, Wells Fargo & Co., Western Asset Management Co.