Banking might not know it (or admit it), but modernizing financial contracts - one of the field's unquestioned underpinnings - could reshape the industry.
Bitcoin, blockchain and smart contracts are promising to alter many industry processes.
The foundations of the global banking industry are sturdy enough (and traditional enough) that blockchain and Bitcoin won’t render the bank of the future unrecognizable. What the new technologies could do, however, is making financial contracts – the very lifeblood of the banking industry – more efficient and sound, thanks to their ability to improve transparency and security.
Within the blockchain world, the term “smart contract” generally refers to the automatic execution of payments. Smart contracts offer three chief benefits
- Because they’re unchangeable, they provide security and reduce uncertainty.
- As self-executing documents, they will reduce transaction costs.
- On top and most importantly, they will reduce analytic costs for banks and financial institutions.
“Covering the payment process can be considered a good step in the right direction. However, in order to deliver real progress in the financial world, much more is needed” said Willi Brammertz, founder of Ariadne Business Analytics, which recently joined the Thomson Reuters Incubator in Baar, Switzerland.
According to Brammertz, progress will be achieved via the smart financial contract. “If there is one contract in the world that was made to be modeled as a smart contract, it’s the financial contract,” he sid.
To come to a better understanding of the ways in which implementing smart financial contracts could benefit the banking industry, we sat down with Brammertz for a short Q&A.
What made you take an interest in applying this kind of technology to the financial sector?
“Financial contracts, are pure exchanges of cash-flows. Take a typical mortgage as an example where the borrower gets initial payments which then are paid back over many years. These cash flow payments are linked and follow strict mathematical rules. Consequently, financial contracts are the most suitable subset of all contracts for representation in machine-readable form throughout the entire life cycle. However, the financial sector has not benefited from this inherent advantage due to the failure to create an open standard. This standard is essential for realizing the promise of Fintech. Such a standard is needed in order to develop the capabilities of distributed ledgers, such as blockchain, from executing single payment transactions to supporting multi-payment financial contracts over their entire life cycle.”
What’s been the source of disconnect up until now?
From the FinTech side: “There is currently too little financial understanding in the FinTech circles. People think, banking is ´payment processing´. Payment processing is at best a fringe activity of banking and in actuality not even executed primarily by banks but by services such as Visa and Mastercard. Banking means loan-giving, deposit taking, paying interest, taking and controlling risk, valuation and many things more. In order to improve these parts and to avoid copying the existing banks, FinTech has to bring forward a smart financial contract. Without this, Fintech will inherit the current legacy problems of the banks and will not fulfill its promises to improve society.”
From the traditional banking side: “Banks have not yet realized that they miss such a standard. Yes, they have been successful in automating the transaction processing. But there is a huge problem on the reporting level which is responsible to about 50 percent of the entire cost of operation.”
Could you give an example or two of what kind of legacy problems Fintech has to watch out for?
“Overall, there are huge reconciliation problems on the reporting level. Typically, at a large financial institution, there are three main departments that create reports: Risk management, finance and regulation. The problem is, those departments often contradict each other, sometimes in small ways and sometimes in much bigger ways. A noticeable consequence is enormous expense, but one that gets mentioned less frequently is low quality.”
“The root of the issue is missing standards in data and processes. Most professionals are aware there’s a data problem, but there is not enough consciousness regarding the processes. Actually, the data problem is only a reflection of the missing standards on the processing level. The solution is the mentioned standard that normalizes financial contracts throughout their lifecycle. This standard will not only improve the processing of the financial contracts but also the analytic level because a Smart Financial Contract supports the entire lifecycle of the financial contract.”
What are your hopes for joining the Thomson Reuters Incubator?
“When you’re trying to effect a change as big as fixing financial industries data and processes problem, you need support to leverage your product and make it scalable. With the Incubator, we have access to tools and professionals that are going to help us take Ariadne and the ACTUS standard and really bring about change in the Fintech sector.”
In our 2018 AI Predictions report, our industry experts share their forecasts for how developing technology will shape our future.