Overview of how blockchain can support compliance activities The reason why blockchain is generating a large amount of buzz across the financial services industry is the potential for complete industry disruption. Many banks are looking for applications of the blockchain to support bank operations. In particular, one key bank operation that requires many man hours and resources is around compliance (AML, KYC, etc), and efficiency and accuracy could be improved by leveraging the blockchain appropriately.
Banks must abide by many regulations, such as the Patriot Act in the USA, regarding the onboarding and monitoring of clients to ensure they are not tied to illegal activities. In general, most banks are required to include the following four elements into their KYC procedures:
Customer Acceptance Policy (CAP): due diligence on vetting the client by collecting a variety of documents and information and assigning a risk profile to each client accordingly
Customer Identification Procedure (CIP): verification of a client’s identity by leveraging existing databases to cross reference information provided during the CAP phase
Monitoring of Transactions: ongoing tracking of client transactions to understand trends and flag unusual or inappropriate spending, with special attention given to those labeled as high risk
Risk Management: ensuring that proper roles and responsibilities are established, training to staff is conducted regularly, and controls on the process are implemented
The blockchain infrastructure is also known as a distributed ledger system. That’s because it relies on several separate “nodes” to agree with one another in order for new data to be written – this makes incorrect data input almost impossible. The distributed nature of the blockchain ensures that data is consistently validated and can be referenced for historical purposes as needed (which helps for audit trails). Rules can also be integrated into the network that automatically trigger certain actions once an event occurs. For example, when transactions are flagged as suspicious, an automatic notification can be sent to the proper regulatory agency.
Current FinTech startups innovating in this field There are already many startups that are in the process of building capabilities and marketing their solutions for compliance, with blockchain as the underlying infrastructure. Below outlines some of the key players:
Elliptic offers financial institutions protection from anti-money-laundering regulations specific to digital currencies by implementing a platform that monitors digital currency transactions and prevents fraudulent activity
CryptoCorp has developed fraud detection and recoverability tools leveraging multisignature protection on the blockchain to ensure client transactions are protected
Roadblocks to bank adoption
Though this technology is promising, there are many hurdles and questions that must be overcome before there is widespread adoption among banks to leverage similar tools and techniques. Some include:
Privacy: Bitcoin, the famous cryptocurrency, is built on a completely permissionless and public blockchain which adds to the sense of trust put into the data written to it. This existing network can be leveraged by banks to add basic information such as document transfer timestamp data. However, banks may feel that more sensitive data, such as confidential client information, should not be added to a public system. Instead, they could build private, premissioned blockchains specific to their own use. An ideal solution could involve all banks adopting the same permissioned blockchain so that KYC data can be openly shared among all financial institutions, but would not be completely open to everyone. However, this would require a large scale effort with coordination among competitors and regulators.
Integration: In order to adopt blockchain technologies, banks will need to integrate with their existing processes and technology. This will have large impacts on the current organization and processes of the bank, from IT to Compliance and Operations. Additionally, new processes and standards will need to be clearly established to ensure compliance. Simply put, it will take some time for old processes to change!
Regulatory concerns: while the overall goal is to leverage this technology to ease regulatory constraints, there is still no firm position from regulators as to whether this data would be deemed appropriate or satisfactory to their needs. As such, it is important to work closely with Regulators to onboard them upfront and easy the approval process of a future solution.
In conclusion, some near-term opportunities remain Clearly, with the rise of blockchain innovation and the growth of digital currencies, there will be some opportunities for banks to leverage this technology to create efficiencies. On the compliance front, while there may be a long time before full KYC and AML practices are integrated into the blockchain, pieces of the existing processes are ripe for change. For example, by using the blockchain with digital signatures, there can be a more seamless and secure process for document transfers with timestamps for auditing purposes. Once banks begin experimenting with approaches such as these, there may be more willingness to adopt blockchain solutions. However, this will take time and could take another 3-5 years before we see true full-scale implementations.
What are your views on blockchain applications to AML/KYC compliance? Email us, we would be happy to have your insight.
Happy Reading! The CH&Co. Editorial team
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Chappuis Halder & Co. is a consulting firm specialized in Financial Services with offices in North America, Europe and Asia. We help our clients in several industries, Corporate & Investment Banking, Commodity Trading, Insurance and Retail & Private Banking, with a permanent focus on expertise and research, especially in the Digital area.
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