The Trade Finance Circle of Trust.
Traditional trade finance is becoming unfit for purpose. As sanctions and regulatory burdens take their toll, banks have moved away from all but the safest of bets, and correspondent banking relationships are scrutinized like never before. While this is a good thing in terms of security and control — access to the global financial system should indeed be tightly policed — there has also been collateral damage: the end consumer. The Asian Development Bank estimates a $1.5 trillion trade finance gap as the banking networks that previously watered some of the more arid lands in the financial landscape have disappeared, and along with them access to finance for the emerging market businesses who need it most.
So what is trade finance?
In simple terms, trade finance reflects the time value of money and solves a problem that companies have faced throughout history: in order to fulfill a contract to deliver a product — rolls of fabric, a tanker of gasoil, a batch of smartphones — a supplier needs to purchase upstream raw materials. And in the majority of cases, that purchase of raw materials requires cash on-hand, a lot of it, before the buyer pays for the finished product.
That’s where trade finance comes in. Banks who provide trade finance provide cash in advance against the product being delivered, and collect repayment when the buyer receives the finished product. By lending against an asset (the product to be delivered) that has value, banks have more security, and the supplier can purchase raw materials under better credit terms than an unsecured loan. There are plenty of variations on this of course, but all largely take the approach of minimizing credit risk by including recourse to the product or to the invoice provided by the end-buyer, and the idea is generally the same.
Trade finance banks however, often play a bigger role than just facilitating cash management; they also act as trusted intermediaries. There is an implicit bond of trust required in any supplier/buyer relationship, and trade finance banks are key mediators for these interactions, particularly when it comes to international trade. A well known tool in the trade finance industry, the Letter of Credit, sets out a bank’s commitment to pay on behalf of a buyer once conditions have been met, but in essence it represents an indemnity from a third party that the buyer will pay the supplier and the supplier delivers what it promised. It represents a form of bank-mediated trust.
Banking networks then, are the quality control, the ‘checkatrade’ of the international trading world. They provide confidence and local credit analysis, or at least they’re meant to. And that’s the problem. Increasingly banks don’t trust other banks, especially those in emerging markets, to do the correct due diligence on end-clients, which breaks the circle of trust. Furthermore the cost of a due-diligence mistake is steep. Very steep. To compensate, banks apply stringent checks, which increases the revenue hurdle to approve a correspondent bank, which in turn strangles the banking network to all but the safest and highest revenue relationships.
So if trade finance banks are useful for cash-flow and faith in good-delivery, but their network effects are hamstrung by a mistrust of their peers, what then is the solution?
We think part of the solution is to help correspondent banks, and their software providers, be more efficient when it comes to managing their trade finance books. If we can relieve the manual burden of checking Letters of Credit and associated documentation, and feed details directly into sanction and credit checking applications, then we can help correspondent banks to become more efficient, and more secure. In doing this our hope is that the banks and software providers that use our services can allocate more attention to the jobs they do best: helping the right companies access credit, and closing that $1.5 trillion trade finance gap.
