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DREP Research Institute | How Can Blockchain Improve the Internal Risk-Control Mechanism of Financial Institutions?

Recently, Zhaoxiang Qiu and Yongyuan Liu, researchers at the Beijing Xi Jinping Research Center for Socialism with Chinese Characteristics in the New Era, published an article in the Guang Ming Daily: “ Taking full use of policy-orientated finance in steady growth.” The article indicates that policy-orientated financial institutions should combine work resumption and domestic demand expansion, improve credit support, and help achieve the dual goals of short-term stable growth and long-term high-quality economic development. Make full use of financial technologies such as blockchain, big data, cloud computing, etc., improve the internal risk-control mechanism, fully prepared for bad debts, ensure the stability of asset quality, and maintain the stability of the financial system.

Taking use of Fintech to improve the efficiency of financial infrastructure is also a goal of financial institutions.

Relying on a cross-border matching platform “Jianrong Zhihe”, CCB Nanchang Branch completed the first cross-border exportation of anti-epidemic materials after overcoming difficulties such as flight suspension and local market entrance access, assisting medical device manufacturers exported 108,000 disposable medical masks successfully. Relying on the systematic “Internet + bank-enterprise financial blockchain” ecology, “Jianrong Zhihe” provides all-round financial services such as credit loan services, fund custody, guarantee services, and risk management for enterprises.

As one of the most challenging innovations in the field of Fintech, blockchain has fundamentally overturned the inherent logic, operating mode and business scope of traditional finance. It breaks through the limitations of the innumerable rules and regulations, entering a totally new application field.

What Are the Internal Risk-Control Mechanisms of Financial Institutions Represented by Banks?

According to statistics disclosed by China Banking and Insurance Regulatory Commission, the number of bank fines was 1,531 (excludes banking leases), and the total amount of fines reached 808 million in 2019. Overall, the number and amount of fines are positively related to the scale of operations. The fines are mainly focused on loan management such as illegal loans, inadequate review of loans, and the misappropriation of loan funds. A great number of violations are in real estate loan financing and the illegal inflow of credit funds into the stock market.

Even though the internal risk-control mechanism of banks is the most complete and formal among financial institutions, it fails from time to time. There are two important reasons:

1. There are branches, sub-branches, and business outlets in the bank. Each branch has 20 to 30 departments, with scattered responsibilities and regulations. The rapid development of Internet finance and banking innovation business challenges internal managers. The internal control management is impossible to achieve all departments, all services and all processes.

2. In addition to several important customers and businesses, banking business is basically handled by branches, sub-branches and business outlets. These managers and institution leaders have great power. However, the asymmetric information among them makes it difficult to control the internal management, which further results in “internal and external collusion”.

How Does Blockchain Improve the Internal Risk-Control Mechanism of Financial Institutions?

As the underlying technology of Bitcoin, blockchain is regarded as a financial technology. Its peer-to-peer, decentralization, and smart contracts characteristics can effectively solve some financial institutions’ problems in internal control, bringing new research directions for internal control system.

1. Real-time synchronization of information based on blockchain technology can quickly identify internal control risks

Since financial institutions has multi-department and multi-node corporate structure, it is difficult to obtain timely information. It makes internal control managers unable to identify relevant risks in time. The peer-to-peer transmission characteristic of blockchain technology enables each node to share the entire network in real time, realizing real-time information acquisition and timely identification of risks. Meanwhile, the decentralization and smart contracts characteristics of blockchain can also reduce part of the risks caused by “human factors” in the business process, establishing a solid foundation for intelligent identification of risks.

2. Based on blockchain technology, data is authentic and reliable, thereby strengthening the internal control level of financial institutions

Blockchain technology can ensure the authenticity of stored data, and any change records will also be stored. These data can not only provide reference data for accurate evaluation of internal control, but also effectively improve the efficiency of the controller. It helps the controller study the history, optimize control process and make the risk prevention more accurate.

3. Blockchain technology will promote the upgrade of financial institution systems

As one of the choices for Central bank’s digital currency, blockchain technology will be inevitably applied in finance industry, whether in internal control, accounting supervision, or internal audit. The advancement of digital currency will inevitably bring new challenges and opportunities to financial institution systems. Because of the difference between the blockchain technology architecture and the underlying structure of existing financial institutions, financial institution systems also need to be optimized and upgraded. It can better deal with new business risks and internal control risks.

Financial institutions have always attached great importance to the improvement of internal control institutions. In structure, they set up internal control departments and positions, and formulated internal control system processes in terms of institutional mechanisms. Every year, a great amount of funds will be invested in advanced technologies such as IT, big data, cloud computing, etc. to improve the internal control level. In addition to the conventional methods, blockchain technology has proposed a new direction for improving internal risk-control mechanism of financial institutions.

Blockchain, regarded as a revolutionary technology, will reconstruct the key underlying infrastructure of Internet finance and even the entire financial industry. We believe that more value of blockchain in the field of finance is waiting to be explored.

The development of blockchain technology has gradually matured, but there are still some technical and cognitive thresholds at the practical level.

DREP is committed towards building Connectors and Toolkits based on Blockchain technology, providing solutions that promotes the ease of use, flexibility and frictionless integration. It can effectively help financial institutions to build a more complete internal control system based on blockchain technology, thereby improving financial institutions’ internal control capability and achieving technological upgrades.

About DREP Foundation

DREP is committed to building “connectors” and “toolkits” based on blockchain technology, providing solutions that combine ease of use, flexibility and frictionless integration. Based on DREP Chain, DREP ID and DREP SDK, DApp R&D teams are able to release multi-public-chain asset versions, built-in wallets and asset trading platforms with one-click.

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DREP Foundation

DREP Foundation

DREP 2.0 is the decentralized credit-data middleware based on layer-2 facilities, to be the backbone of DeFi Credit Era.