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How India Is Missing Out On Combating Fraud

In a country where manual input is common in banking, a missed opportunity.

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Almost anyone following with knowledge of the financial markets of India is familiar with the fact that Indian banks have a history of being defrauded. Only last month, for instance, it was discovered that Nirav Modi, a businessman engaged in the diamond trade, siphoned as much as $40 million from Punjab National Bank, a small public sector bank.

A couple weeks later, the Indian Enforcement Directorate arrested the former director of Andhra Bank after reports alleging his involvement in a loan fraud case emerged.

Unfortunately, the Indian banking system cannot be considered a stranger to these kinds of incidents. The past few decades or so has seen several of the country’s top financial institutions merge or absorb smaller ones affected by scams. While company acquisitions are common in the world of finance and business, what sets these apart is the fact that they were all agreed upon in a desperate bid to prevent customers from losing their deposits.

The merger of Bank of Rajasthan (BoR) with ICICI Bank in 2010, as an example, came only after BoR suffered months of economic turmoil and scrutiny by government regulators. Some of the charges brought up against the bank by the Indian Securities and Exchange Board of India included “lapses in corporate governance and disclosure norms”, KYC violations, and misleading shareholders, which, in effect, drove it out of business. As a result, the bank became the seventh financial institution to be merged with the private sector bank since 1997.

In light of these incidents, a case can be made that Indian financial institutions are in dire need of an overhaul in the aspects of security, transparency and accountability. Luckily, such a solution already exists in the form of distributed ledger technology, popularly known as blockchain technology.

How Could Blockchain Help India Prevent Fraud?

A blockchain-based implementation of the current banking infrastructure will allow banks to store past transactional records securely. Furthermore, a blockchain has the ability to effectively eliminate the current system’s dependence on a centralized server, making it less susceptible to hacking attempts or other, more conventional acts of fraud. Finally, the shift may also result in a significant reduction in the operational costs currently required to keep the banking infrastructure running.

While digital currencies such as bitcoin have often heralded as the “future of money”, the truth is that most governments across the world have not taken too kindly to them. Given that some of them have gained a reputation for facilitating illegal transactions, it is not hard to see why. However, with their rapid gain in popularity over the the past year, several companies and governments are finally taking a renewed interest in at least the technology that underpins the functioning of digital currencies.

The solution could also address the problem of insistence on manual input in perhaps every facet of the banking industry in India. Given that labor is not only freely available in the country, but also far cheaper than migrating to a completely digitized infrastructure, financial institutions open themselves up to vulnerabilities that are very difficult to spot. Due to this, a large majority of the banking scams reported in the country turn out to be, in fact, easily avoidable.

Since blockchain technology is specifically designed to avoid human intervention and requires the consensus of every node on the network, there is virtually no way for inefficiency or malice to disrupt the entire banking infrastructure. A blockchain’s ability to be completely trustless is actually one of the key selling points of the technology.

Taking the case of bitcoin, thousands of miners safeguard the network by creating a distributed trustless consensus to solve the problem of double spending. Considering these advantages, there is almost no reason why the traditional finance infrastructure cannot adopt a similar solution.

Under such a hypothetical scenario, scams would no longer be easy to orchestrate by a small group of a particular bank’s employees. Instead, it would require months, if not years, of engineering manpower to successfully launch anything resembling an attack against the decentralized ledger. Bitcoin and other popular cryptocurrencies that rely entirely on the technology have, after all, not been compromised even after existing for close to a decade (even if their centralized exchanges have).

Smart Contracts As The Future of Banking

The introduction of smart contracts, a relatively new use case for blockchain, may further help reduce the number of intermediaries involved in a transaction as well. True to its name, a smart contract is a digital version of an agreement between two parties that is automatically executed once the required conditions have been met. The process results in the network acting as an escrow and the transaction being completely transparent for either party.

Even multinational finance behemoths such as Visa and Mastercard are looking into taking advantage of the technology in some way or the other. In 2017, the former announced that it would be opening up its blockchain-based platform, Visa B2B Connect, “to give financial institutions a secure, fast and predictable way to process corporate cross-border B2B payments”.

A major roadblock for India to overcome, however, would be its terrible track record with implementations related to modern technology. This is an important consideration that is amplified even more so now that the country’s central bank, the Reserve Bank of India (RBI), has expressed interest in releasing its own cryptocurrency linked to the Indian Rupee in the near future.

Take, for instance, the case of “Aadhar”, an identification program designed to issue a unique 12 digit identity number to every Indian resident. While this may sound like the popular Social Security Number in the United States, the key differentiating factor between the two is that an Aadhar number is also linked to the individual’s biometric data, including retina scans and fingerprints.

Since its inception in 2010, Aadhar has suffered numerous data breaches and has been criticized by several security researchers, documented by local and international publications alike. However, not only has no attempt has been made to fix these glaring security oversights, but the Attorney General has also gone on record to state that user data is safe behind ’13 feet high and 5 feet thick walls’.

The clearly visible disconnect between modern technology and the government currently in power is an issue with no easy remedy. Assuming the rumors of the RBI unveiling a new state-backed cryptocurrency turn out to be true, the same concerns of security and privacy will likely never be addressed and left up to chance.

The Indian Government Response To Blockchain In Banking

Furthermore, it is not entirely clear why the Indian central bank or government wants to issue its own digital token. The only other countries that have either already implemented such a system or are contemplating doing so are Venezuela and Russia, primarily to avoid the several sanctions placed on them by countries such as the United States.

This is not to say that the Indian government or banks are completely ignoring the potential of blockchain technology when integrated into the country’s existing financial infrastructure. On the surface that might even seem to be completely false, considering that several public and private sector banks are collaborating to trial a blockchain-based project named BankChain. Upon closer inspection though, BankChain has not advanced beyond its primary objective of bringing KYC onto a blockchain.

Even if BankChain were to immediately pivot from its current state to cover some of the more transactional aspects of finance, the sheer magnitude of the project may unfortunately never allow it to succeed. India is a complex country that is riddled with bureaucracy at the government and commercial level, with too many moving parts for its own good. While the adoption of blockchain for smart contracts and KYC is definitely a move in the right direction, an all-encompassing solution is still several years out, if not decades.

Thankfully, there are private financial institutions that are working on their own blockchain-based projects of this scale. ICICI Bank and Axis Bank, two of the largest banks in the country by market capitalization, have both announced their own trial programs involving cross-border payments. Some other banks have also expressed some interest in pursuing blockchain-related development, albeit for different purposes.

Partnering with Emirates NBD, ICICI issued a press release on the subject close to two years ago, “ICICI Bank is the first bank in the country and among the first few globally to exchange and authenticate remittance transaction messages as well as original international trade documents related to purchase order, invoice, shipping & insurance, among others, electronically on blockchain in real time. The usage of blockchain technology simplifies the process and makes it almost instant—to only a few minutes. Typically, this process takes a few days.”

Importantly though, the government has not taken a concrete stance on the future of the technology in the country. Any developments currently taking place in the industry are based on the assumption that future regulation will be welcoming to new innovation, instead of stifling it.

Our Digital Assets Good… Your Digital Assets Bad?

One thing is clear; the RBI is currently doing everything in its power to keep traditional cryptocurrencies out of the country. On April 6, 2018, the central bank released a statement that said “In view of the associated risks, it has been decided that, with immediate effect, entities regulated by RBI shall not deal with or provide services to any individual or business entities dealing with or settling VCs (virtual currencies).”

The announcement triggered widespread mania amongst Indian investors, primarily because banks will no longer be able to offer their services to cryptocurrency-related companies, including exchanges.

On the other hand, the government’s push for an indigenous digital currency seems to have little to do with fraud mitigation. Instead, many argue that the move is more of a political stunt to further the rather unpopularDigital India” program. And a state-backed cryptocurrency does nothing to accomplish the principles of decentralization, censorship-resistance, freedom or anonymity that private citizens seem to cherish.

At the end of the day, until all Indian banks, regardless of their ownership or size, embrace and adopt blockchain technology, it is unlikely that the industry will be able to bring its losses under control.

 

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