To date, the predominant focus of applying distributed ledger and blockchain technologies to real-world uses has been on securities and payment systems. But what if distributed ledger and blockchain technologies could be used by regulators in offsite collection and analysis of bank loan data to reduce the time needed for onsite examinations?
As theoretical as that endeavor sounds, there exists a discrete — though highly complex — category of loans for which bank examiners could test blockchain-enabled analysis sooner rather than later: the Shared National Credit Program. Each year the federal bank regulators announce results of their examination of SNC loans — syndicated business loans of $20 million or more that are shared by three or more financial institutions.
In late July, the federal bank regulators announced their 2016 SNC exam results. The release came significantly earlier in the calendar than in past years. The reason is that the Federal Deposit Insurance Corp., Federal Reserve Board and Office of the Comptroller of the Currency now conduct SNC exams twice a year, with results combined in an annual report.
But what if the regulators could collect and evaluate SNC data basically in real time? A key reason distributed ledger technology might be useful in the SNC context is to simplify the collection of data across multiple institutions that share a single loan.
Currently, SNC bank examiners gather historical SNC information from the bank that has taken on the responsibility of handling all administrative matters for the banks participating in the SNC loan. After collecting the information from the lead bank, examiners then review the SNC loan records of the participating banks as maintained separately by each bank. Examiners then compare and analyze these records across the banks that participate in a SNC loan.
Instead, imagine that there was only one database of record containing near-real-time information that examiners and all banks participating in a specific loan could view, add to and agree upon? That is the essence of distributed ledger and blockchain technologies — they effectively act as a database that is maintained not by a single actor, but rather, maintained collaboratively by multiple participants. The technology and algorithms forming the ledger's plumbing mean less room for human error and less wasted time and effort.
Regulators should lead the charge where use of distributed ledger and blockchain technologies provide a significant opportunity to improve the examination process. These technologies have the potential to lower costs and reduce inefficiencies at the bank level while also providing bank examiners access to near-real-time data on the largest outstanding extensions of credit.
In other words, these technologies could significantly lessen the need to deploy armies of examiners to banks for onsite examinations when reviewing the largest of loans — saving both time and money. And to the extent blockchain could enhance the quality of SNC exam data, the technology could effectively help regulators monitor safety and soundness.
Although banks and bank regulators are quickly becoming familiar with blockchain and distributed ledger technologies, there has been little focus on using them for actual regulatory oversight. Federal bank regulators should actively embrace and utilize these technologies..
How might distributed ledger technology work in the context of SNC loans?
Distributed ledger technologies can be deployed in two basic modes: open access and permissioned access. Almost certainly, banks and bank examiners would want to utilize permissions to limit access to information.
In a permissioned network, an agreed-upon gatekeeper (perhaps a regulatory agency) would determine which banks are properly network participants. Once designated as an approved participant, a bank could become approved in the network for all SNC loans to which it is currently — or in the future — a party.
Each bank participating in a syndicated loan could then be given permission to access the shared ledger associated with that particular loan. As data is added to the ledger for a loan, each bank with access to that loan would see updated information on the ledger on a near-real-time basis. The system would confirm the legitimacy of that information.
Further, permissions could be established not only to completely block all access to unauthorized parties but also to prevent confidential information from being viewed by other loan participants, such as the credit rating that each bank establishes for the loan. Permissions could also be established to allow examiners open access to ledger information from their offsite workstations for all SNC loans. This would provide significant timing advantages in response to negative information received on a specific credit or to emerging negative industry or systemic economic trends. For the banks, reporting would become more efficient, possibly resulting in less time consumed by onsite examinations.
To be sure, these technologies are still in their infancy. The financial sector is only beginning to grasp the potential applications for distributed ledger and blockchain concepts. Significant challenges lie ahead.
Acceptance of this technology will require fundamental changes to embedded business and cultural norms. The Financial Stability Oversight Council, for instance, has taken a conservative wait-and-see posture regarding use of this technology for "safety and soundness" reasons.
However, a cautious wait-and-see approach, as advocated by the FSOC, may be a missed opportunity. Providing examiners with a quicker mechanism to communicate and organize data around large extensions of credit will allow bank examiners and banks to detect credit weaknesses much earlier than is currently the case, resulting in enhanced opportunities to take coordinated proactive action.
Scott Lessne and Matthew Welling are attorneys at Crowell & Moring LLP.