The Role of Digital Ledger Technology in Core Banking Functions

FPC Digital Assets Work Group

Anyone who has worked for a financial institution knows that technological change within an organization can lag significantly behind the pace of innovation. There is no better example than the efforts to modernize core banking platforms, which have run the gamut of upgraded efforts ranging from incremental adjustments to full blow-out replacements. Further complicating the issue, most financial institutions that manage their own core banking systems have multiple banking platforms, operating several of the same functional components in parallel, not necessarily well-integrated.       

To start, it is helpful to better understand the components which make up core banking. Let's examine the key functional elements across six broad categories of core banking platforms which include:
  • Deposits/Savings
  • Lending (e.g., credit cards, loans, buy-now, pay-later)
  • Investment (e.g., stocks, bonds, 401k)
  • International & Foreign Exchange (FX)
  • Payments & Transfer
  • Managing Accounts/Accounting
These systems operate independently and yet they all run a general ledger, settlement, and clearing system. While data is shared among platforms, data repositories are often specific to a particular core platform. The first four systems on this list rely on payments and transfer capabilities for the movement of money/funds. 

Again, when new functionality is needed or processes need to be modernized, financial institutions have few choices. From an architecture and engineering perspective, financial institutions do not rip and replace core banking systems (even with big mergers) as they are too risky to replace outright.  More commonly financial institutions would turn to the third-party core banking provider to provide add-ons, but proprietary APIs provided limited integration capabilities to other core systems.  

While DLT offers the opportunity for harmonization of technology across all the core platforms outlined above, this blog will primarily contemplate the role that DLT can play in augmenting financial institutions’ core banking functions and providing greater opportunities for faster cross-border payments. The Digital Asset Working Group will await feedback and interest from our readers in expanding this overview into additional detail on the other financial services platforms.

Digital technology solutions
With the advent of blockchain and digital ledger technology there are major opportunities to streamline processes, support faster, more cost-effective transactions, provide system enhancements, and innovate with new products and services. Here are a few examples:
  • Big banks are looking at distributed ledger technology as a more efficient way to streamline payments for cross-border settlement. The Regulated Liability Network is a great example of the use of this technology to improve domestic and international financial settlement.[1]  The same functionality is needed for currency conversion as DAWG discussed in Digital Assets Blog.03[2] .
  • DAWG has been diagramming swim lanes to depict transaction process flows for specific use cases by examining functions linearly. Distributed ledger technology (DLT) can be used to shore up functions vertically across core platforms, for example, in support of settlement and clearing functions. Using a vertical approach, an organization can gain the benefits of an enterprise orientation to settlement and clearing from a cross-functional perspective without endeavoring a major overhaul of multiple core platforms.     
Use Cases – International Settlement
Supporting settlement across multiple platforms using a tokenized asset on a digital ledger is a highly sought-after solution to this use case. International settlement systems support multiple postings, e.g., to move money, post to a downstream application, etc. Additionally, there are several areas in the settlement process where data replication is needed. 

Decentralized ledgers have the potential to move funds faster, with fewer intermediaries involved, and with less cost, than traditional channels. SWIFT[3], widely considered as the primary interbank messaging service for financial institutions globally, has conducted several experiments using tokenized asset transfers across multiple blockchains in collaboration with BNY[4] and several other multinational banks, with the goal to be able to move funds back and forth without using traditional channels. By short gapping the number of postings and reducing the number of hops, funds can move faster, and float time is reduced. Digital ledger technology provides the bank with a more cost-effective way to support international clients and is expected to be cheaper for both sender and receiver.  

JP Morgan[5] believes the cross-border settlement in Asia is a huge opportunity. Their plan appears to start with one country and then build this for multiple countries.

How to proceed
There are several ways that an organization wants to take advantage of the benefits of digital technology solutions in support of their core processing.  First, find a use case or enterprise implementation that makes sense for the financial institution, such as domestic interbank money movement.  Then in conjunction with another pilot participant bank, define a test or pilot program to determine level of success and build a team around the pilot(s). Once this has been accomplished, the organization can turn the pilot into an enterprise-wide project or offering. 
 
Financial institutions are advised to find areas to grow and enhance the customer offering on the consumer and commercial side and look for areas to cross-pollinate swim lanes; settlement is a good start position, but opportunities exist in other functions such as enrollment, maintenance, authentication, risk, and reporting as well.

Blockchain, digital ledger technology, and smart contracts are all great tools that may help financial institutions to remain nimble and to make smarter business decisions. 
 
[1] Regulated liability network (RLN) is envisioned as an interoperable network for wholesale payments operating on a shared multi-entity distributed ledger.
[4] FPC Digital Assets Work Group Member Organization

Digital Assets in the Financial Industry Work Group
Thank you to the members of the FPC Digital Assets Work Group (DAWG) who contributed to this blog.

Digital Assets Work Group Leadership
Bo Berg (Work Group Chair), Avenue B Consulting, Inc.
Kevin Barr (Wok Group Vice Chair), BNY
Maria Arminio (Work Group Facilitator), Avenue B Consulting, Inc.

Digital Assets Work Group Contributors
Eric Peterson, BNY
Keith Vander Leest, Cross River Bank
Mark Dixon, Nacha
Kirsten Trusko, Payments as a Lifeline
Steve Wasserman, Photon Commerce
Larry Pruss, SRM
Lou Grilli, Velera

About the Digital Assets in the Financial Industry Work Group
Maps out how digital assets relate to the financial industry, focusing specifically on payments made with digital funds – central bank digital currency (CBDC), regulated liabilities and stablecoin.

About the U.S. Faster Payments Council
The U.S. Faster Payments Council (FPC) is an industry-led membership organization whose vision is a world-class payment system where Americans can safely and securely pay anyone, anywhere, at any time and with near-immediate funds availability. By design, the FPC encourages a diverse range of perspectives and is open to all stakeholders in the U.S. payment system. Guided by principles of fairness, inclusiveness, flexibility, and transparency, the FPC uses collaborative, problem-solving approaches to resolve the issues that are inhibiting broad faster payments adoption in this country.
 

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