Small Industries Development Bank of India (SIDBI) is a state-owned institution that provides financial assistance to micro, small and medium enterprises (MSMEs) of India. SIDBI plays a vital role in the development of the MSME sector in India, providing support through a range of financial products and services including loans, guarantees and venture capital.
SIDBI and Infosys, which I consider a global leader in blockchain services, have now partnered to develop a blockchain-based platform for the MSME sector in India. I recently spoke to Parmendra Tiwari, CTO of SIDBI, to get an update on the project, which is still in its early stages but could potentially significantly impact the Indian economy.
Duplicate pledge of collateral has increased dramatically in recent years.
Since institutional lenders have a siled approach, a borrower can get away with duplicate pledging of collateral resulting in loss to the lender and a drop in confidence. As we have seen in the United States, trust is an asset that no bank can afford to lose.
The use of blockchain technology in banking, while not a panacea and still in its infancy, can potentially address vulnerabilities and reduce credit risk.
A blockchain is a distributed ledger in which each transaction is updated simultaneously across all nodes as a new “block”. All participants view the transactional record simultaneously throughout the chain. Each block in the chain contains a timestamp and other identifying data that proves who made the change and when. Verified transactions recorded on-chain are immutable and irreversible, making it impossible for anyone to tamper with the data without leaving a digital fingerprint.
Any new information added to a block can be easily reviewed and confirmed by all parties in comparison to a previously confirmed version. The iterative trail of information on the blockchain, along with ease of comparability, streamlines data requests and reviews and helps combat fraud.
Redefining Institutional Lending With Blockchain
Infosys has a strong track record of blockchain practice, with extensive consulting and implementation experience across multiple industries. Notably, Infosys has a significant presence in the financial services sector, and is an industry leader in blockchain implementation in capital markets. Infosys works with a wide variety of organizations, including investment banks, market infrastructure providers, custodians and institutional lenders.
The initial use case for SIDBI was security interest information exchange on the blockchain. A security interest is the pool of collateral that secures a loan. The platform is a multi-party platform, where security interest details flow from borrower to lender, and credit bureaus present credit check details. The project aims to create a gold standard in institutional lending by establishing a single source of truth for collateral information among borrowers such as Non-Banking Financial Companies (NBFCs), institutional lenders and credit bureaus.
If a loan between the lender and the borrower goes bad, the lender can recover the outstanding amount by liquidating the security interest in those underlying loans. Once information of security interest is stored on the blockchain, it becomes tamper-proof and immutable. On the platform lenders will have a comprehensive view of all loans pledged by borrowers. Credit check details from credit bureaus will act as an additional layer of due diligence on mortgage loans. When the lender approves the collateral information related to regulatory compliance, it is written to a block and becomes irreversible. The record thus becomes the baseline for any future iterations.
Benefits of asset tokenization
The project required Infosys to design a tokenized collateral network (TCN). Tokenization is becoming increasingly popular as it allows for greater liquidity and lower ownership costs. Asset tokenization involves the creation of digital tokens representing physical assets issued on a distributed ledger. Tokens carry rights to the assets they represent, acting as a store of value. Tangible assets live in the real world and, in the case of physical assets, are held in custody to ensure that they continually return tokens. In line with this, there is an important role for the custodianship of assets in token transactions.
Asset tokenization can also bring increased transparency for transaction data, issuer information and asset attributes, allowing for enhanced information recording and sharing.
The TCN represents each loan account as an NFT which allows loan accounts to be tracked across multiple security interests during their life cycle and also provides proof of loan ownership to lenders.
Blockchain will also increase transparency with respect to regulatory compliance and interactions with regulators. Automated enforcement of programmed regulatory restrictions is possible, and regulators are automatically notified via smart contracts whenever regulations are modified or discontinued.
Results of the SIDBI-Infosys Project
This system has resulted in real time exchange of information between the concerned parties. This has eliminated the possibility of duplicate use of the underlying debt for security interest, and optimized administrative overheads for managing the underlying debt. Operating costs are also reduced due to the reduction in manual verification using smart contracts. Smart contracts are self-executing computer code with embedded transaction rules, such as interest rates, loan amounts, and contract expiration dates, that are automatically executed when certain conditions are met.
SIDBI’s Chief Technology Officer, Parmendra Tiwari, was optimistic about the new blockchain solution jointly developed with Infosys. “The implementation has immense potential for the financial ecosystem. This solution will be a step forward in enabling real time security information sharing.
Could blockchain disrupt the banking industry like Netflix disrupted cable television, or AirBnB disrupted hospitality? Perhaps it is, but not anytime soon, as banks are just beginning to discover its potential. SIDBI’s approach has been to conduct a modest pilot, build a basic blockchain infrastructure, and generate interest and support from institutions and regulators.
Apart from the platform, SIDBI and Infosys are also planning several other blockchain-based initiatives together. SIDBI is creating a stir over the initial phase of the project. Even the regulatory body, the Reserve Bank of India, has shown keen interest in the potential of blockchain for the entire Indian financial ecosystem. For example, in December 2022, the RBI launched the retail segment of a CBDC (Central Bank Digital Currency). Pilot containing components of blockchain technology.
I look forward to future updates as SIDBI brings all the stakeholders onto the blockchain, which will then become the single source of truth, eliminating the existing challenges of double pledging and others.
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