Smart Contracts for Smarter Lending

Lending is a contract-intensive process with an extensive lifecycle. Every step involves third party intermediaries, a pile of paper and an incredible amount of “trust”. Sure Mr. Lender, here’s a copy of my W2, bank statements, my identity on a platter. Would you like my first born too or shall we hold her in escrow?

And then there’s the cost involved with every step. Each step involves a combination of legal, financial and real-estate transactions for any one of the buyer, lender or seller by these intermediaries with someone footing the bill. In mortgage transactions, 1 – 2% of the property’s value is added to the cost of the transaction to support these third party verification.

So let’s breakdown the convoluted process chain that is mortgages today:

-         Multiple structured steps with predefined conditions for completion

-         Fees to multiple third party entities

-         Paper-intensive with multiple types of forms, each in standard(ish) formats

-         Compliance requirements to maintain transparency at every step

-         Acknowledgement and confirmation at every step by multiple parties

Each of these adds not only cost to the lending process but also time and of course, require an incredible amount of trust.

So take a step back and imagine a world where all of these transactions happen not only real time but also in a safe, secure, impersonal setting. A world where we all parties have complete transparency into every stage in real time, where we are no longer dependent on a mountain of paper to authenticate ourselves or the assets involved. A world where you do not have to pay for the illusion of trust. This is the world that blockchain technology shines a light on.

Technologies like blockchain could transform the financial services industry by heightening efficiency, providing granular visibility into financial transactions, and yet significantly reducing cost. They also play well into mitigating the increasing regulatory compliance pressure, banks and lenders are under. The immutability of blockchains is a huge advantage in this need for compliance since once a transaction is recorded in the distributed ledger, they cannot be deleted or altered. This ledger also provides a secure chain-of-custody for the transfer of any digital asset to authenticated users, so complete traceability.

Going back to the convoluted steps of mortgages today, let’s address them from a blockchain perspective:

-         Multiple structured steps with predefined conditions for completion

This is ideal for smart contracts which are a set of code-based rules that allow workflow type processing. You could set these rules to:

• Identify the type of loans a customer is eligible for based on credit score, savings etc.
• Transfer title to the new owner, post loan funding
• Add a certain loan to a specific Mortgage Backed Security pool based on tranche criteria
• Verify MISMO mortgage loan data and transfer to appropriate mortgage servicers
• Streamline all agreements
• Notification of current status across the board to required parties

The possibilities are endless and the potential incredible. We’re talking real time, transparent, irrefutable transactions.

-         Fees to multiple third party entities

As a step up from P2P lending, blockchain could reduce or eliminate the need for a third-party intermediary in the mortgage process and instead allow parties to interact directly with trust coming from a combination of their blockchain defined identity and smart contracts authenticating their transaction. Traditional banks have an opportunity to gain foothold back from shadow banks. Consumers get a cost break from this streamlined process.

-         Paper-intensive with multiple types of forms, each in standard(ish) formats

The myriad of identity authentication documents can be combined to a single blockchain identity with elements exposed as needed. Many components of this are already in place across the world. For example the decentralized data storage and mesh network of devices laying the foundation for a borderless, digital society in Estonia. Dubai, which recently appointed a minister in-charge of Artificial Intelligence, is planning yet another transformation: to become the world’s first blockchain-powered government. By 2020, the emirate wants all visa applications, bill payments and license renewals, which account for over 100 million documents each year, to be transacted digitally using blockchain.

-         Compliance requirements to maintain transparency at every step AND

-         Acknowledgement and confirmation at every step by multiple parties

Every transaction is recorded on a distributed ledger – multiple crypto copies – incorruptible, transparent and neutral. Smart contracts define and enforce exit criteria for each step, shape the workflow and maintain complete visibility

As with the examples of Estonia and Dubai, relatable PoCs beyond cryptocurrency are plentiful. IBM, Natixis and Trafigura, a commodities trading group, introduced a distributed ledger solution to let commodities traders conduce U.S. crude oil transactions. Trading partners on the ledger would be able to share trade documents, shipment updates, and delivery and payment status. The process cycle for bill discounting at Bajaj Electricals has come down from four-five days to almost real time after the implementation of blockchain. Synechron recently won a leading position in a hackathon in Dubai for its Land Registry team’s blockchain submission which built an application to automatically generate title deeds on the blockchain. Just last week, Credit Suisse Group AG, U.S. Bancorp, Wells Fargo & Co. and Western Asset Management Co. said that they successfully tested the distributed ledger technology as a way to standardize the data involved in securitized home loans and make it more transparent.

“Structuring securities is complex, involving many different parties, manual processes, duplicated documents and data in different formats,” David Rutter, chief executive officer of blockchain startup R3 which is organizing the consortium, said in a statement. While the group is starting with residential mortgages that aren’t backed by the U.S. government, it plans to expand to other types of asset-backed securities.

Faster authentication across steps means a more liquid, accurate market - beneficial for consumers and institutions. Like any emerging technology, there are going to be a range of opinions on its viability. But the hope of a world with real time settlement, with neutral decision making – transparent, automated utopia.

Also published on Mortgage Bankers Association Newsletter.