Open Book, Ledger and Lender Accounting

Accountants  and Lenders of a certain age will recognize the term open book accounting, essentially it was a way of two parties having access to more than the usual information in a transaction. It was supposed to benefit both parties through smarter procurement and contract negotiations. Although it didn’t get widespread acceptance, especially in Public Services, if the contract was well managed and the book more open then both parties to the contract would gain from any potential cost savings. In the banking world it meant having access to internal management information not necessarily in the public domain which would bring an element of trust and security to the lending proposition and ‘nudge’ behaviour.

This fundamental ‘sharing of gains’ resonates with other types of finance , dependent on who actually is responsible for the costs. If costs escalate, then both share the risk and there have been many examples of ‘value engineering ‘ and a ping pong game about cost management and covenant compliance.

We have also examples from the printing industry where open book accounting has also meant a more transparent approach to financing the credit period between delivery and payment, quite often both parties sharing in the transaction costs. It would also be used ( occasionally ) in secondary lending scenarios where assets form the basis of security and provenance and certification of such assets ( be it tangible goods or  sales invoices/contractual obligations)provide the backing for finance and each party to the transaction has a vested interest in ensuring the asset value is resilient..

Fast forward to the present and future, these sort of discussions now involve technology and we have the ideas of Blockchain, crypto currencies and ‘smart’ contracts (Ethereum)

Blockchain is concerned about transactions and ownership in accounting terms it is maintaining an accounting ledger (Blockchain is sometimes referred to as a Distributive ledger technology (DLT)

Fundamentally therefore we can say that Open Book Accounting and DLT share the same DNA .Many transactions are fundamentally about measuring rights and obligations over property, provision of money , or planning how to allocate risk and reward

DLT has the potential to provide certainty, as did OBA,

Trust

More fundamentally OBA is about Trust and the custom and practice, especially in contracting services about managing client and contractor expectations.

Certainly in providing Fiat money, trust is the key, just as much trust is underlying and guaranteeing the finance provision when we talk about personal guarantees and sources of security and value.

The lender still applies the concept of discounting a value and ensuring there is still equity in the deal

Where DLT may gain traction and OBA did not was the human frailty of (mis) Trust.

Further involving AI in the process of buyer and seller may just be the impetus required to get DLT more widely accepted which would mean a set of algorithmic protocols which would be immutable and AI would be able to track at changes I the original contract that may affect lending or contractual conditions.

Even with this element of Trust restored there are still going to be questions about underling value and condition, we still have the age old problem of buying a pig in a poke, so caveat very much emptor.

Blockchain is not a wholesale replacement for bookkeeping  or good governance/monitoring when it comes to money , but it can potentially reinforce and monitor trust levels. Lenders will often relate tales of propositions which have started out in good faith nut due to circumstances have been changed and therefore the initial lending criteria become under strain. The use of AI could spot this and apply corrective or alternative action.

We heard ( accounting heresy alert) tales of triple entry bookkeeping whereby the DLT is not only connected to the MIS but also a further ledger that records history, provenance and changes in value. This information would be absolutely crucial to a lender when they seek to establish real time asset valuations which would affect their security.

Behavior

Certainly the increased Trust, transparency and certainty will allow greater focus on value however, if we go back to OBA we have seen different strategies emerge for data disclosure and behavior primarily to reduce costs which in itself has led to adversarial behavior even before the contract is committed. Sometimes lending conditions just become plain unworkable because of lack of customer knowledge or poor sensitivity planning

The issue therefore with DLT may actually be about establishing robust rules of engagement specifically with a focus on short term tangible gains just for that transaction rather than any longer term sustainable relationships which could emerge through joint product development. This may well create a space in financial services where we see  ‘one off’ lending propositions rather than the usual annual overdraft facility for ‘working capital’

OBA was heralded as an effective means of improving relationship quality, DLT strikes me as potentially an antiseptic approach such  relationships because every transaction remains a transaction in isolation. The upside of it is that if one transaction proves successful their is a layering effect on trust which means both parties may be willing to enter into further contracts and so relationships build over time.

When it comes to questions of value DLT would benefit from looking at the other party’s costs and margins and having a more situational approach or contingency theory approach to subsequent transactions for the same commodity with the same supplier.

However, the disintermediation and reduction in transaction and monitoring costs is one area where DLT has the advantage over OBA.

Scalability

The problem of DLT is also scalability because, in essence the whole world does not have to be party or included directly in the transaction and we are some way off with regulation that will standardize the way DLT works

Also DLT was not designed for scalability because Trust lies in the various nodes of the blockchain and high security means limited access. Also Blockchain and cryptocurrency transactions are cumbersome and slow compared with traditional electronic or card payments (although cheaper). One of the challenges for new tech companies is to speed up processing time and still retain data security and integrity.

Conclusion

Whilst it is tempting to believe the hype and marketing around DLT and the fact that this appears to be the next big thing, we still await clarification around pre contract behavior, security, value, trust and regulation.

All key issues when we stalk about the stewardship and agencies theories in lending.

If the history of OBA is anything to go by the issue of trust and behavior would appear to be barriers for greater acceptance, however with AI and machine learning on the horizon these human frailties may just disappear and Trust is ( literally) artificially restored by machines replacing humans in the transaction.

The fact that we can get into micro finance levels and look at individual assets and human behaviour much more closely can bring a level of transparency and greater openness in the lending environment.

Clearly we are some way off before widespread acceptance, even with the volatility around cryptocurrencies, the regulators will have their work cut out in keeping up with developments.