Blockchain in Trade Finance
The Need for Change (Part 1)
The role of the bank in the trade finance industry has historically been to satisfy four main areas: 1) facilitation of secure payment execution; 2) the provision of finance; 3) the management of data and information, and 4) the mitigation of risk. In today’s market all these services are available through non-bank service providers, posing a threat to the trade finance establishment.
The over-reliance on paper and manual checks means that the current processing of transactions is fraught with inefficiencies and risk, which ultimately leads to higher costs. Banks often seek to protect their margins in traditional trade finance by passing these costs on to the corporate client, driving such clients towards open account trade that is riskier but cheaper.
This is a unique moment in our industry, when changing regulation, increased availability of emerging technology and changing expectations from corporate client are pushing banks to change their business models beyond the simple digitization of current processes.
In a sector particularly vulnerable to fraud, letters of credit, standby-letters-of-credit and other trade finance instruments are used to ensure exporters are paid on time by importers. Meanwhile banks guarantee that importers receive goods that match the terms of the letter of credit. Bank-intermediated trade provides confidence and fosters trade around the world while providing banks with a low risk source of revenue that is capital efficient under Basel III.
However, this business is undergoing deep changes:
- Globalization of the economy has increased knowledge of international trade, helping corporates to better understand cultural and local market requirements in emerging markets. The ability of corporate clients to be self-sufficient in mitigating some of their transaction risk has fueled the shift to open account financing. Although this type of financing does not guarantee payment in the same way a letter of credit does, it is faster, cheaper and relatively frictionless in comparison to a LOC. The emergence of multiple solutions for clients is now calling for a client-centric approach.
- Digitalization tends to change corporates’ expectations. Corporate treasurers are younger than ever before, and their experiences in shopping and conducting other personal business lead them to expect the same kind of experience in their professional endeavors. They are increasingly looking for an end-to-end digital experience, encompassing communication and documents, advanced reporting and tailored product and service offers. In parallel to Client experience, digitalization is a great way to improve Employee experience and strengthen the bank’s compliance and risk monitoring.
- Particularly in emerging markets, there is a shortage of financing available for small to medium enterprises (SMEs); this is due to the retreat by global banks from these countries and a lack of liquidity and correspondent banking relationships for local banks. Over 60% of SMEs in emerging markets are rejected for financing and nearly 30% do not reapply according to the ICC. In the volatile and rapidly changing world of trade policy the need to build shorter, more agile supply chains is even more pressing and the creation/participation in “Marketplaces” becoming a real opportunity, in particular for SMEs.
Out of this mix of social, technological and regulatory change, next-generation trade platforms and processes are emerging. Distributed business models, which no longer rely on banks being central to the financial supply chain, mean that those institutions are looking at ways to retain their relevance to corporate clients. Traditional competitors are collaborating through consortia of ecosystem players, working for the benefit of the entire industry instead of being self-serving in their approach.
In the second part of this series, we will look at how blockchain and other technologies are helping banks re-think and redesign their approach to trade finance.