Imagine if one bank, in one country, laundered almost ten times more than that country’s GDP. Imagine if that money came from non-residents in Russia, Ukraine, Azerbaijan, Moldova and other ex-Soviet states. It’d be one of the largest money-laundering scandals in history.
This is exactly what happened in September. Danske Bank, headquartered in Copenhagen and with over 5m customers, moved money from customers in the above countries through its Estonian branch – a staggering €200bn between 2007 and 2015. Estonia’s GDP in 2016 was $23.14, or around €20.15.
The sheer scale, and time frame, of the scandal, could mean
curtains for Danske Bank. But is it also the tip of the laundering iceberg? The usual line of argument is that financial institutions, and the governments that regulate them, are not doing enough to prevent money laundering. Yet perhaps the most egregious thing about the Danske scandal (and, of course, the litmus for laundering) is that people knew about it. As soon as Danske started operating in Estonia, the country’s financial regulator criticised the bank’s approach to compliance risk and KYC rules. Commentators have suggested that the lack of action could be explained by the fact that Danske’s Estonian branch accounted for 11 percent of the bank’s total profits. It is difficult to believe that what was going on in Danske is the sum of the financial system’s laundering problems.
For me, the most astonishing thing about all of this is that we have a viable alternative. In blockchain, we have the opportunity to build a transparent and secure financial system. Let’s just remind ourselves of just a couple of examples, beyond more secure and efficient transactions, of what blockchain technology offers.
A new era for regulation: if transactions are logged on an immutable, secure and transparent ledger, regulators, with access to those ledgers, could work smartly and proactively with institutions, rather than reactively. Moreover, illicit transactions could not, by definition, exist.
And, consequently, the end of audit trails: a consequence of putting blockchain underneath the banking system. It would not be just transactions that were logged on the blockchain; client documentation could also be stored securely, using public and private keys to enable them to have control, with the knowledge that nothing could be altered or tampered with.
The new Payment Services Directive (PSD2) has already required this: that documents be provided to customers in a way that means they cannot be changed. But the current banking infrastructure means consumers have left interfacing with giant conglomerates – faceless and leaving a lot of room for error. Using a decentralised system of document creation and storage would change this, and obviate the need for retrospective audit trail creation. It creates a perfect audit trail easily accessible by the regulator as well.
Changing the structure of products: as it stands, customers have little to no idea of underlying assets and where they come from. Blockchain can provide full transparency of an asset’s provenance, and how it fits into a particular product. Bond offerings, and the concomitant, complex syndication, are a good example. Using blockchain here would remove the opacity, bring immutability and auditability, streamline the long line of intermediaries, and do so in a semi-automated manner.
The overall capital market is another huge area where impact of blockchain will be immense. Imagine in ISDA transactions all nettings can be done via smart contract, visible on the market. This is not only transparency and process efficiency but also saving immediately around 5% on each transaction.
It’s also worth thinking about regulation itself, like the Basel requirements on capital reserves. Blockchain enables the identification of funds and an easier assessment of the exposure level on those funds. If you can more accurately assess risk via transparency, will stringent capital requirements remain as necessary?
The question one is left with is, do banks really want this change? It’s something I’ve been asking since I left the sector to set up a company that brings bank-grade compliance to crypto and blockchain businesses. You cannot get away from the fact that it is those doing the laundering who profit from it. But – and this is the vital point to note – if banks themselves don’t change, they will soon find themselves head-to-head with the new guard: innovative financial services companies using blockchain, with the transparency and efficiency it brings, as standard.
These new providers will see smaller profits initially, but their running costs will be far lower. They will use technology across the board, without the need to plug top-up software into cumbersome and insecure legacy systems. And because of this, they will rely on less human capital. The systems for audit trails, and the systems on top of those and people using them will be vastly diminished. Ultimately, this new sector could see faster, greater growth and higher margins, as it nimbly delivers a better service and experience to customers.
If any financial institution is at the stage of looking over its back, worrying about laundering, it is already too late. Those operating legally and compliantly need to focus on the future: using blockchain, the technology of the third wave of the internet, to transform the face of banking.