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There are over 85,000 financial cooperatives, or credit unions, worldwide. Unlike a bank, these cooperatives are non-profit financial institutions and exist to serve their members. Since these institutions are not-for-profit, their collaborative nature often causes them to work together to achieve the common goal of providing the best service to members, leading to the development of credit union service organizations, or CUSOs. A CUSO is an organization formed and/or owned by one or more credit union(s) to provide a specific product or service within the industry.
By collaborating through CUSOs, credit unions compete on a larger scale by trying new technologies that increase efficiencies and improve the member experience. This setting has created the perfect opportunity for credit unions to explore the use cases of some of today’s newest technology — blockchain.
Innovators across multiple industries are rapidly identifying the potential uses of blockchain, and its underlying system, distributed ledger technology (DLT). The financial services sector is a natural fit for this technology and credit unions are playing a key role in this initiative. In addition to being among the first to adopt self-sovereign identity (SSI), a decentralized member-owned digital identity built on DLT, credit unions are seeking to take advantage of some of blockchain’s unique benefits.
Every interaction a member has with their credit union starts by confirming the member’s identity. Credit unions must comply with Know Your Customer, or KYC, requirements, in which the organization must obtain information about the identity of the customer. This is often in the form of verifying the member’s address, transaction history or, sometimes, last four digits of their social security number, and can take more than a few minutes to complete.
DLT presents a faster and more secure alternative way to confirm a member’s identity regardless of the channel — in person, online or by phone. By leveraging SSI, members can confidently and easily prove who they are, often in under five seconds or less. Since this type of digital identity is self-sovereign, credit unions can provide members with a lifetime portable digital identity that does not depend on any central authority and can never be taken away — an appealing offer to anyone concerned about controlling their online data. Additionally, SSI serves as the basis for any future applications built on DLT.
Credit unions often provide indirect lending services, typically in the form of an auto loan that a borrower obtains from the financial institution through a dealership. One of the major benefits of working with financial cooperatives is that they offer extremely low interest rates, typically at least one percent lower than most banks’ interest rates.
Indirect lending is viewed by many credit unions as an opportunity to expand their membership base in the community. In addition to offering better rates, credit unions using DLT can improve the overall lending process by leveraging the benefits of SSI and reduce fraud. When a new or existing member establishes their own self-sovereign digital identity, they are then able to take advantage of a new blockchain application: smart contracts.
Smart contracts can streamline the current time-intensive, paper-laden processes for processing consumer loans. A recent article explains how smart contracts work in a car buying setting. To summarize, credit unions leveraging SSI enable their members to share verified digital credentials ad hoc with car dealerships and credit unions, processing loans within seconds. Utilizing blockchain technology provides credit unions with an opportunity to attract and engage new members in an efficient, yet indirect way.
Credit unions also have an opportunity to leverage distributed ledger technology to disrupt cross-border payments. Currently, sending and receiving funds internationally is a slow, expensive process, taking a day or two to clear and typically costing between two and three percent of the value of funds transferred. In some cases, the cost can exceed 10 percent, depending on payment volumes and values.
DLT presents an opportunity to shift away from slow, costly wire transfer services by reducing the cost and accelerating the speed of transactions. This new technology can address the points of friction historically associated with cross-border payments, which conducts transactions almost immediately while reducing operational costs associated with these transfers. The natural security features associated with DLT can also help reduce risk associated with international remittances.
While loan participations embody the cooperative philosophy — spreading the risks among borrowers while sharing the rewards of strong yields — they are often viewed as challenging, complex and come with increased regulatory burden.
As the current process stands, whenever loans are syndicated by credit unions, one organization is chosen to lead in constructing and managing the deal while the others essentially become passive investors. This process can be highly disadvantageous to credit unions because the leading organization bears the weight of managing the workflow while the others must rely on, or trust, the leader to share all relevant information. The risks associated with loan participation can cause tremendous barriers to syndicate loans together.
Just as with indirect lending and cross-border payments, blockchain is positioned to completely transform loan participation for credit unions. By utilizing a distributed ledger network, blockchain stores and spreads information regarding the loan across participating organizations, allowing for full transparency throughout the process, eliminating the need for a leader and ultimately reducing risk.
These examples are just the tip of the iceberg in terms of discovering blockchain’s potential. Financial cooperatives around the world are working together to uncover ways this new technology will benefit members and change the banking experience. Indirect lending, cross-border payments and loan participation are simply a few illustrations of this new technology’s impact on financial services. From streamlining processes, to cutting costs and reducing risks, blockchain holds the promise of endless possibilities to disrupt the status quo in financial services, and credit unions are front-and-center of this digital revolution.
Julie Esser is chief experience officer of CULedger, a CUSO that focuses on delivering innovative applications to credit unions through its cross-border global distributed ledger platform. CULedger is an IBM Blockchain partner. For more information, please visit culedger.com.