Small Industries Development Bank of India Pilots Tokenized Collateral Network on Blockchain

Small Industries Development Bank of India (SIDBI) is a government-owned institution that provides financial assistance to India’s micro, small and medium enterprises (MSMEs). SIDBI plays an important role in the development of the MSME sector in India, providing assistance through a range of financial products and services, including loans, guarantees and venture capital.

SIDBI and Infosys, what I consider a global leader in blockchain services, have now joined forces to develop a blockchain-based platform for the MSME sector in India. I recently spoke with Paramendra Tiwary, CTO at SIDBI, to receive an update on the project, which is still in its early stages but has the potential to significantly impact the Indian economy.

Duplicate pledging of collateral has increased dramatically in recent years

Since institutional lenders have a foolproof view, a borrower can get away with duplicating the collateral resulting in lender losses and a weakening of confidence. As we have seen in the US, trust is an asset a bank can ill afford to lose.

The use of blockchain technology in banking, although not a panacea and still in its infancy, can potentially remove vulnerabilities and reduce credit risk.

Blockchain is a distributed ledger where each transaction is updated simultaneously across all nodes as a new “block”. All participants see the transaction record simultaneously across the entire chain. Each block in the chain has a timestamp and other identifying data to prove who made which changes and when. Verified transactions recorded on the chain are irreversible and immutable, making it impossible for anyone to tamper with data without leaving digital fingerprints.

Any new information added to a block can be easily reviewed and verified as accurate by all parties compared to a previously verified version. The iterative track of information on the blockchain, along with the ease of comparability, streamlines data requests and reviews and helps fight fraud.

Redefining institutional lending with blockchain

Infosys’ blockchain practice has a strong track record, with extensive consulting and implementation experience across multiple industries. In particular, Infosys has a significant presence in the financial sector, and is an industry leader in blockchain implementations in capital markets. Infosys works with a range of organizations including investment banks, market infrastructure providers, trustees and institutional lenders.

The first use case for SIDBI was the exchange of information about security interests on blockchain. Security interest is a collection of collateral that secures the loan. The platform is a multi-party platform, where the security interest information flows from the borrower to the lender, and the credit bureau provides the credit check details. The project aims to create a gold standard for institutional lending by establishing a single source of truth for collateral information among borrowers such as non-banking companies (NBFCs), institutional lenders and credit bureaus.

In the event that a loan between lender and borrower goes bad, the lender can collect the dues by liquidating the underlying loans with security interest. After storing the security interest information on the blockchain, it becomes tamper-proof and immutable. platform Lenders want a comprehensive overview of all loans secured by borrowers. Credit check details from the Credit Bureau will act as an additional layer of due diligence on the secured loans. When the lender approves security information related to regulatory compliance, it is written to a block and becomes immutable. The record thus becomes the baseline for any future iterations.

Benefits of Asset Tokenization

The project required Infosys to design a tokenized security network (TCN). Tokenization is becoming increasingly popular because it provides greater liquidity and reduced ownership costs. The tokenization of assets involves the creation of digital tokens that represent physical assets issued on the distributed ledger. The tokens carry the rights to the assets represented and act as a store of value. The tangible assets continue to live in the real world, and in the case of physical assets, they are put into custody to ensure that they are constantly backing up tokens. In line with this, there is an increasingly important role for custody of assets in tokenization transactions.

Asset tokenization can also provide increased transparency of transaction data, issuer information and asset characteristics thanks to improved information recording and sharing.

TCN represents each loan account as an NFT which allows tracking of loan accounts across multiple security interests during their lifecycle and also provides proof of ownership of the loans to the lenders.

Blockchain will also increase transparency regarding regulatory compliance and interactions with regulators. Automatic enforcement of programmed regulatory restrictions is possible, and the regulator is automatically notified through smart contracts when regulations are changed or disabled.

Outcome of the SIDBI-Infosys project

The system has resulted in near real-time information exchange between the relevant parties. It has eliminated the possibility of duplicate use of an underlying loan for a security interest, and optimized administrative costs for managing underlying loans. Reduced operating costs also came thanks to a reduction in manual verification using smart contracts. Smart contracts are self-executing computer codes with built-in transaction rules, such as interest rates, loan amount and the contract’s expiry date, which are automatically executed when certain conditions are met.

Paramendra Tiwary, Chief Technology Officer, SIDBI was optimistic about the new blockchain solution jointly developed with Infosys. “The implementation has enormous potential for the financial ecosystem. This solution will be a step forward in enabling the sharing of security information in real time.

Ends

Could blockchain disrupt banking the way Netflix has disrupted cable TV, or Airbnb has disrupted hospitality? Probably so, but not anytime soon, as banks are only just beginning to explore the potential. The SIDBI approach has been to conduct a modest pilot, create a basic blockchain infrastructure and generate interest and support from institutions and regulators.

In addition to the platform, SIDBI and Infosys are also planning several other blockchain-based initiatives together. SIDBI is creating a buzz around 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 RBI launched the retail segment of CBDC (Central Bank Digital Currency)^{pilot that has components of blockchain technology.}

I look forward to a future update as SIDBI gets all the stakeholders into the blockchain, which will then become a single source of truth, eliminating double collateral and other types of established challenges.

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