A Technology Renaissance in Trade Finance

Try searching for the number of patents filed in the area of trade finance, or the number of fintech start-ups in this space and you’ll be pleasantly surprised. Fintech is slowly but surely modernizing the sluggish world of trade finance. Today, nearly every article in the trade finance world unsurprisingly mentions AI, Blockchain or both. Around the world, the multi-trillion-dollar industry and regulatory fraternity seem to be looking forward to nudging technology towards having greater impact on trade finance.

Let’s take a look at some of the latest advances in technology and business models re-inventing this industry.

Technological Advances & Adoption Impediments

Significant strides have been made in the application of technology to trade finance, in particular the digitization of paper-based data and the capture of relevant trade data. Using image processing, OCR and AI/ML, banks have made substantial strides in reducing costs, boosting productivity, and improving customer satisfaction. Paper digitization and data capture cannot be permanent solutions, however. Transactions that are fully digital and secure, right from the point of inception is necessary to increase speed of trade services. Perhaps a regulatory position that allows the usage of digital documents and signatures can act as a catalyst in this context. The technologies are available, larger adoption needs positive pressure.

The development in distributed ledger technologies, a variation of which is commonly referred to as blockchain, has also taken off in the past five years. The reason why blockchain is a darling of trade finance is because the open ledger structure of blockchain lessens the need for intermediate systems and middlemen by storing necessary data in a single blockchain that’s easily accessed, automatically updated, and highly transparent to participants on a closed trust network.

The use of blockchain-based solutions for products such as letters of credit and receivables discounting in international trade has predictably led to the rise of consortia and multiple technological platforms. As of 2020, there were already five major enterprise blockchain platforms, six major consortia networks with over sixty banks and twelve financial institutions using block chain for trade finance.

But despite the advances, a journey through the blockchain process in trade finance is still very fragmented. With the proliferation of competing platforms and lack of standardized processes, a key concern has been inter-operability across the various platforms and networks. In order to achieve interoperability at scale, technology firms have begun work on linking up blockchains to form “network of networks”. But problems of interoperability across the various actors in the ecosystem – from banks to regulators and service providers – persist. A second concern is the high barrier to entry, particularly for small businesses which are central to trade supply chains. With a focus from governments and trading zones, there have been important steps towards greater cooperation in the blockchain ecosystem.

A notable technology model attracting attention has been Open trade platforms, built on Open APIs. A good example is the PSD2 initiative in the EU which mandated all retail banks to develop APIs that trusted third parties can use, to receive data regarding specific bank accounts and provide instructions to the bank about making payments. APIs in the trade finance context can support peer-to-peer models that not only allow for innovation in the customer journey but also provide better flexibility to banks. Open APIs, unlike blockchain technology, have a much lower entry barrier and can be easily built using proven solution patterns.

Emergence of new business models

Complementing the proliferation and progress in technology, newer business models servicing the global trade ecosystem have also recently emerged.

The first is one that allows incumbent payment providers such as Mastercard to provide “gateways” to their digital assets and network to international trading firms. Managing Client identities, which is crucial to the KYC (Know Your Customer) function can increase operational complexity. Using digital asset gateways, such operational and compliance overheads in trade is reduced since the need to onboard entities multiple times to different platforms is obviated. Trusted digital identities with established payment routes can be a game changer in the slow world of trade finance.

A second interesting model is one that provides a KYT (Know-Your-Transaction) platform using chain analysis, which provides real-time transaction monitoring over and above KYC. The idea of chain analysis is to dynamically generate risk scores and risk categories for transactions and then broadcast the transaction on a blockchain with the KYT information. On the network, the scores are then used to determine whether a transaction is to be processed further or not, depending on the regulatory policies and the participating banks’ risk appetite. One clear advantage of chain analysis is to reduce operational burden on a bank by preventing potentially risky transactions, in early stages. Also, chain analysis systems are designed as overlay systems that do not require a rip-and-replace of existing banking communication channels, making the implementation easier for financial institutions

A third, and perhaps most interesting, model is that of enabling businesses to communicate trade information directly, easily and securely with banks of their choice over a trusted network. Traditionally, small and medium-sized firms experience difficulty in accessing timely financing due to risk-mitigation processes performed separately at all banks participating in a given transaction. Allowing businesses to submit and verify purchase orders and invoices to request trade financing from the banks of their choice, over a “trusted network,” provides the banks with access to reliable trade information and allows the banks to mitigate risk of double financing or fraudulent trades. This model allows banks to provide faster financing securely to deserving customers. Based on this model, the Trade Information Network, founded by seven leading banks, is already seeing early success.

With this new level of collaboration between the various players in the ecosystem, and the emergence of complementary business models, the international trade is poised for the next major transformation.

To learn more about Persistent’s Trade Finance Automation solution click here