BLOCKCHAIN AS AN INSTRUMENT OF BANK LOAN RE-ENGINEERING
By IMBA-Exchange on The Capital
Imagine that all loans to individuals are digitized. Selling loans will become a publicly available and faster way to mobilize resources for funding than attracting deposits. Digitized loans will provide collateral for interbank lending, as well as objects of repo transactions. On the whole, interbank interaction will improve, on the one hand, and specialization in lending in various market segments, on the other.
The formation of a profitable, risk-balanced loan portfolio is perhaps the most important task of banking management. Improving bank credit as a product, technological and methodological improvement of the lending process is today necessary conditions for the success of the bank.
The development of information technology provides new tools for the reengineering of bank loans. A particularly effective reengineering tool is, in our opinion, the technology of accounting in a distributed registry, otherwise referred to as a blockchain.
As an information technology system, a blockchain is a decentralized network of computers (called nodes) with the same programs that provide a continuous exchange of information between nodes. How does blockchain technology guarantee the immutability in the future of information once recorded on the blockchain network? The guarantee of immutability lies in the fact that each portion of the recorded information (block) contains the checksum of the previous block so that a change in previously recorded information is easily detected by calculating the checksums of the blocks along the entire chain. In order to not be able to rewrite the entire chain of blocks, information is stored and automatically synchronized in all computers on the network. An attacker changing information in any single computer on the network does not give anything since it is immediately detected and corrected by writing correct information from other nodes of the network to the attacked computer.
For the reengineering of a bank loan as a product, it is this blockchain property that is valuable — the preservation of information unchanged, guaranteed by technology.
The connection of the bank to the payment system includes the purchase of computer equipment, including specialized, as well as general and specialized software. After the software and hardware complex is created in the bank, it is connected to the network. This scenario was repeatedly passed by banks when connecting to payment systems: Visa, MasterCard, SWIFT, Western Union, CONTACT and many others. The blockchain network is just another network and with a low cost of connection and ownership. We predict in the near future the creation of blockchain banking networks for a variety of purposes, including for the reengineering of a bank loan as a product. If you install nodes in at least a tenth of Russian banks, you will get a stable, reliable blockchain network in which critical business information can be stored unchanged.
Suppose that such a network is created.
How to use it for credit business reengineering?
The answer is: blockchain should be used to accumulate and store information on loans, which will allow organizing interbank circulation of loans as treasury assets: buy, sell, pledge, repo and other operations. In the banking cooperation system, we implement the vision of bank lending reengineering, described below.
First of all, mass credit products can be re-engineered: loans to individuals and loans to small and medium-sized businesses. Consider the process of using car loans as an example.
A bank issuing car loans creates the infrastructure necessary for scaling up: a sales network covering tens and hundreds of car dealerships, and a system of comprehensive end-to-end automation of business processes — from accepting a car loan application to completing a loan life cycle by repaying or selling to a collection agency. In total, an expensive “credit machine” is obtained, which should work continuously, increasing the loan portfolio. However, the size of the loan portfolio is limited, on the one hand, by capital regulations, and on the other, by considerations of sectoral and territorial diversification of credit risks. If the “credit machine” works efficiently, then inevitably there comes a time when the bank will be forced to sell part of its car loan portfolio.
Today, a bank facing the task of selling credit assets has two scenarios: securitization or direct sale of a loan portfolio. The first scenario requires a fairly large scale of activity and therefore is practically accessible only to top banks. The second scenario is more accessible, but also limited from below by the size of the portfolio being sold. A direct sale of a loan portfolio includes the following steps:
- portfolio formation in accordance with the criteria of potential buyers;
- negotiating with potential buyers;
- checking the quality of the loan portfolio by a potential buyer, including an audit of credit documentation and cash flows on loans included in the portfolio;
- signing the contract;
- transfer of credit files and mutual settlements according to the schedule agreed by the parties;
- notification of borrowers about the change of lender.
As a rule, a transaction for the sale of a loan portfolio involves after-sales servicing of borrowers, maintenance and replacement of low-quality parts of the sold portfolio. In general, selling a loan portfolio is difficult and requires considerable effort, that is, it belongs to the category of “feat” rather than “routine activity”. In time, the procedure for selling a portfolio can take from several weeks to several months, and most of the time is spent on the process of portfolio audit and transfer of credit dossiers, accompanied by mutual settlements.
A loan is a highly profitable but low liquidity item in the bank balance sheet. Using the blockchain, you can turn a loan into a “digitalized loan” — a highly profitable and at the same time highly liquid (sold and bought within one day) banking product.
Before revealing the mechanism of the digital transformation of a bank loan, we will consider what such a transformation will lead to if it is large enough.
Imagine that all loans to individuals that are in the banking system are digitized. That is, the full digitization of loans to individuals will lead to a three-fold increase in the volume of instant liquidity in the banking system and, accordingly, to a three-fold increase in the number of credit resources available to banks. Selling loans from an existing portfolio will become a publicly available and faster way to mobilize resources for funding than attracting deposits. Digitized loans will provide collateral for interbank lending, as well as objects for repo transactions. Banks with free cash will be able to quickly place them by acquiring digitized loans with an optimal portfolio structure by maturity. On the whole, interbank interaction will improve in the banking system, on the one hand, and specialization in lending in various market segments, on the other. Ultimately, the ability of banks to meet customer needs in raising finance will increase. Each individual bank — a participant in the system of circulation of digital loans — will receive (in its, of course, scale) the same effects.
Consider the digitization process using an example of a separate car loan, paying attention to the key points of the process, but skipping the details of the technical implementation.
- The bank receives an application for a car loan, considers it and makes a positive credit decision. From this moment in the lending process, elements of standardization appear that ensure the liquidity of the loan.
- The bank writes information on the issuance of the loan and the planned repayment schedule in its own node. Recorded data is depersonalized. From the information recorded on the interbank blockchain, it is known that a car loan has appeared in the economy, which will be repaid according to the schedule fixed in the blockchain, but it is not known who the lender is and who the borrower is. Additional tags can also be written to the blockchain.
- The agent of the bank (car dealership) generates a credit dossier in accordance with the requirements of the bank.
- The archive company, acting on behalf of the bank, takes the loan dossier from the agent of the bank, checks the completeness and quality of registration and creates an electronic copy of the credit dossier, which will be available to the bank or to third parties at its request. In the future, the credit dossier can be updated with new documents, which will also be added to the electronic copy. The credit dossier is marked and associated with the credit information accumulated in the blockchain.
- The bank transfers the loan amount to the car dealership in accordance with the terms of the loan agreement.
- According to the schedule fixed in the blockchain, the borrower is pre-set requirements for payment of the next payments. Payment occurs according to a unified procedure through the payment system. In this case, payment information is recorded on the blockchain by the payment system (the third person with respect to the creditor and the borrower who is not interested in distorting the information).
Thus, the blockchain consistently and reliably records the history of the loan, whatever it may be. The presence of such a story makes it possible to instantly check:
- the fact of issuing a loan;
- facts of loan repayment;
- loan documentation.
Now the bank can put up a loan for sale at any time by setting a price and at the first stage giving potential buyers access to information about cash flows and tags that carry additional information about the loan, and at the second stage (for example, after applying for the NDA) — access to electronic credit dossier.
Applications and acceptances of system participants for purchase/sale are also recorded in the blockchain. If the transaction is completed and fixed in the blockchain, then based on this information, calculations are made and the transfer of the credit dossier is made — both paper and electronic versions.
The blockchain serves as a trusted environment for interbank interaction, which accumulates reliable information necessary for the preparation of transactions and provides a radical acceleration of the process of buying/selling loans.
We would like to draw attention to the fact that the object of the transaction is each individual loan, which makes the system useful for a bank of any size.
Participants in the system can be not only banks but also collection agencies, as well as any financial market participants with credit resources and interested in effective investments. The consistent development and growth of digitized assets, in our opinion, will attract the attention of major players and the regulator to the system.
The digitized loan, being instantly audited, can not only be sold and bought but also used as collateral for interbank lending, as well as an object of repo transactions. In the future, the digital loan market may become an alternative to the securities market, more accessible to banks, regardless of their size.