Trade finance market limited by perceived risks, inefficiencies, and high costs
Trade finance is a necessary underpinning of global trade. However, banks’ lack of confidence in the effectiveness of international trade finance rules has limited the size of the trade finance market and slowed growth in global commerce. Due to perceived risks and inefficiencies, the International Finance Corp. estimates a $2.6 trillion USD financing gap for global small and medium-sized enterprises (SMEs).
Blockchain technology may have an untapped capacity to reduce operational complexities, reduce transactional costs, secure value transfers, and restore some of the banks’ confidence in offering more favourable financing terms to SMEs.
Banks and financial institutions serve as vehicles for more than a third of global trade transactions, representing trillions of dollars in value, that are an integral part of the functioning of international trade. The smooth and efficient flow of trade needs a financial medium, which is a role played by banks internationally – but often forgotten is the necessity of a level playing field between banks themselves. An internationally agreed upon body of rules and guidelines is necessary to overcome and deter possible obstacles or confusion created by conflicting national regulations.
However, global trade is currently marred by lackadaisical trade finance requirements and regulations across political contexts and stilted by process inefficiencies and logistical complexities. Acts of fraud related to trade finance are infiltrating regular practices, which is exemplified by the $1.1 billion lawsuit levelled against Citigroup in 2016 as a result of financing falsified receivables.
A general lack of confidence in international trade financing regulations, in addition to the increased prevalence of fraud, has led to a scenario where banks perceive high risks and high costs in trade finance, which often leads to poor financing terms for SMEs.
Widespread digitalisation and the potential role for blockchain technology
Blockchain technology has the unique potential to restore bank confidence and re-energise trade finance. The elimination of fraud, an increase in the efficiency of trade processes, lower transaction costs overall, and more transparency in the supply chain are all achievable by trade financing platforms supported by blockchain technology. Blockchain is already being used to support trade financing platforms in certain contexts, such as the platform recently released in Hong Kong.
Hong Kong’s blockchain platform is putting private banks in a partnership with the Hong Kong monetary authority, and it will be run by Ping An and Deloitte. The concept is to digitize trade documents and automate trade finance processes using blockchain technology. In theory, the use of digitized records and contracts using distributive ledger technology should reduce the risk of fraud while simultaneously lowering transaction and financing costs.
Elsewhere, banks including NatWest, BNP Paribas, Commerzbank, ING, Standard Chartered Bank, Natixis, Bangkok Bank, SMBC, DNB and OP Financial Group have joined the trade finance initiative Marco Polo, which has become the largest network of commercials banks in the trade finance market. The banks are working with technology companies R3 and TradeIX to improve the transparency and efficiency of trade finance, by using blockchain technology. Marco Polo’s platform is powered by R3’s own blockchain technology allowing banks to offer participants more agreeable financing terms and easier and more transparent integration into trade contracts.
Furthermore, according to the International Chamber of Commerce’s 10th Global Survey conducted for 2017, 60% of banks are moving in the direction of greater digitalisation, and a remarkable 72% of banks considered trade finance to be a priority for the following 12 months. Judging by those results, digitalisation and trade finance are clearly areas to watch for innovation in the coming year.
Blockchain technology can undoubtedly transform trade finance and global commerce, but trade finance rules themselves will need to go digital as well in the short term, in order to restore a stronger sense of confidence to the trade finance market as a whole. The International Chamber of Commerce, which sets rules and standards for the global trade finance industry, recently formed a working group on digitalisation aimed at ensuring its rules are fit for the digital era.