Corporate TreasuryFinancial Supply ChainLetters of Credit/Open AccountHow Trade Finance is Changing and Who Will Lose Out?

How Trade Finance is Changing and Who Will Lose Out?

The face of international trade is changing rapidly. There is an unprecedented growth in both the number of markets and the volume of financial investment across the world as new economies and investment opportunities combine to expand the global economy. The rise of China and India, as two examples, demonstrate how new investment opportunities have arisen over the last decade, opening up markets that previously were either shut or undeveloped to banks and institutions, and have helped alter the way trade finance needs to adapt to new opportunities.

Alongside this massive expansion in international trade, the world of trade finance has been changing. Responding to new methods for underwriting finance and in answer to more efficient ways of transferring funds around the globe, traditional solutions such as letters of credit (LCs) are losing popularity quickly. Behind this is the fall in associated risk with individual trade shipments – in the face of perceived lower risk, firms are opting more for open-account trading rather than relying on documentary-based tools. New markets and record investment have opened up new methods for trade finance and, like water rolling down a hill, money will always find the easiest and most efficient route.

Delivering the Goods

Within this change, and responding to changes in IT capabilities, it is widely recognised that open-account trading is a faster, easier and less costly way of settling transactions than using traditional documentary credits and collections. Despite it being the least secure method for exporting, it now represents around 70% of the global international trade, compared to 15% for LCs. This trend reflects changing needs in firms across the globe, increased use of IT and a more global, inter-connecting finance market that can operate quickly and easily with other offices around the world, giving greater transparency and security with funds transfer. That is not to say the LCs are doomed, however, they still play an important role in international finance. Indeed, although the global markets are shunning LCs, evidence in the markets suggests that financiers in new industrial areas such as China are still hungry for LCs, perhaps reflecting a lack of underlying confidence in internal markets and operators.

The Market Players

One consequence of this new global economy has been the ensuing race for market dominance by the banks and financiers. Many commentators have recently stated that the increase in open accounts, as well as the demand from corporates to a more sophisticated trade services, will force many medium-sized regional banks either to get big or get out. Increasing their size may mean following their global competitors and taking their trade processing to low cost centres offshore. Getting out may mean outsourcing completely or exiting the trade services market. Perceived wisdom has decreed that either way, if you’re not a sizable market player, with definite cross-border, and even cross-continent capabilities, then the trade finance world will be getting a distinctly trickier place to operate.

Celent recently highlighted in their report Trade Finance at Regional Banks: What Are the Options? how trade finance houses are tending to adapt to meet their new market conditions. In particular, they noted how:

  • The top 20 leading banks in trade finance only account for 55% of the market – the remaining 45% is in the hands of over 400 different banks.
  • Only 5% of international banks have chosen to outsource their trade finance operations, compared to 15% of regional players and 25% of smaller banks.
  • Despite globalisation, most trade occurs among three major regions, North America, Asia, and the European Union. So the value proposition in trade finance of providing risk coverage for trading with distant and high-risk countries is only relevant to a very small portion of global trade.

Considering these facts, regional medium-sized banks can grow their business significantly and use their local knowledge and expertise to compete with their global competitors. Contrary to the thinking among larger players in the market, this regional expertise and legacy serves smaller players well, despite changes in new markets and global shifts.

In fact, according to our experience, most of the 400 banks that control 45% of trade finance are highly interested in remaining in trade services and are looking for creative ways to expand and improve their services. For these banks, despite strength in their regions and potential expert industry experience and knowledge, there is still the necessity of operating competitively, with a critical need for lower operating costs and a varied and diverse offering of more and better trade services.

In particular, one of the key ways for banks to achieve the cost savings has been to outsource operations to low-cost centres offshore. For smaller and medium sized players, however, this is often not an option, even with the lure of potential 45% reductions in operating costs. Therefore, they need to look to an alternative solution, with significant returns made possible through centralising their trade processing regionally. This would ensure that processing teams have critical size/volumes, their expert teams are used in better ways and their small branches can still support trade services regardless of their local trade volumes. Considering Celent’s estimate of fewer than, “400 trade finance specialists remaining in this business by 2010,” specialist teams will have to be centralised and trade services processing would have to be made more transparent.

We believe that the desire to centralise in order to achieve economies of scale is common to all banks but it has taken a different turn in recent years. Whereas the leading trade finance banks have taken their trade operations off-shore to low cost centres such as China and India to achieve economies of scale and significant cost reduction, our experience with regional banks trying to achieve the same thing is different. Regional banks would tend to centralise their operations, not to achieve cost reduction but to leverage their existing resources. We have seen several regional banks in Europe in the last year choosing to centralise their processing in Belgium or France. These are not low cost centres, but it makes sense to centralise activities where their expert teams and knowledge reside. In doing so, they would leverage their existing resources by reducing time spent on simple tasks such as gap analysis, correction of mistakes, etc. and focus their expertise on providing more specialised and tailored solutions to their local customers, thereby improving customer experience.

Strengthening their hand, regional banks have been keen to adopt new approaches to take on solutions and services that will give them ‘value add’ to their existing client relationships, strengthening ties. The need to re-architect trade processing infrastructure is a significant and necessary cost here, but would be justified through improved volumes and a significantly enhanced offering to potential clients who were seeking a smaller trade finance partner but with significant market capability.

An example of where this realignment could be implemented is the development of Internet applications, such as a corporate access solution. The development of a customer relationship management (CRM) solution such as this will strengthen banks’ commercial relationships with their customers and ensure involvement of the bank throughout the flow of trade along the supply chain. Using a strong Internet access will enable a bank’s customers to draw on their services and expertise in trade finance to improve efficiencies and offer better services.

As an example of how innovation is the way to stay ahead of the changing market, this use of technology to optimise client relations is symptomatic of how medium and smaller players in trade finance can stay ahead of game. Regional banks need to capitalise on their ingenuity and service to create their differentiator in the market. Changes in markets and demands for scale may be a factor, but it is in other areas, where value is added through strength of a bank’s offering and not just through the number of its international offerings, that will ultimately see who wins and who loses in the new global economy.

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