Corporate TreasuryFinancial Supply ChainBank RelationshipsBanks and the Global Supply Chain – A Tipping Point for Global Trade?

Banks and the Global Supply Chain - A Tipping Point for Global Trade?

For banks who provide global trade services, the balance between letters of credit (LCs) and open account transactions is an issue they have dealt with for years, but recent trade figures seem to indicate the scales may be tipping towards the latter. In 2005, global trade volumes grew by 13% to US$12.6 trillion; largely driven by increased activity between Asian markets and the rest of the world. Open account transactions constituted the bulk of this increase and over 80% of all trade transactions worldwide are now conducted on open account terms. While SWIFT statistics show LCs are far from obsolete, overall LC usage is flat and it is clear that trade banks will need new strategies and products to help their clients (both small and large) as they review their approach to supply chain management.

All parties involved in international trade are attempting to make sense of this wholesale shift in the way the global supply chain is managed – especially banks. Spurred on by multinational corporations who are moving their Asian suppliers onto open account terms, this shift represents a threat to commercial banks whose traditional LC processing businesses represent predictable annual revenues. They now find themselves without a guaranteed seat at the supply chain table and potentially standing to lose millions of dollars in revenue.

According to a 2006 study by the Aberdeen Group, nearly 56% of corporations involved in international trade are looking at ways to improve their end-to-end supply chain management. The reason has as much to do with distance and information as it does cost cutting. At the same time as the expansion of trading networks beyond national or regional zones, the move to ‘just in time’ delivery has driven buyers to push for deferred payment terms and this has, in turn, forced many suppliers into a financing dilemma. A supplier’s local bank previously extended working capital against LCs, where their main risk was the issuing bank, but under deferred payment open account terms, the bank’s risk shifts to the buyer’s ability to pay.

Ironically, although improved communication tools bring buyers and suppliers closer in many respects, banks still tend to rely on local correspondent relationships for informed lending decisions. This is because suppliers or buyers’ local banks are often unfamiliar with the foreign buyer or supplier in an open account transaction. Without an LC as security, or in the absence of bilateral agreements, they often charge the supplier higher interest rates for working capital loans. In the end, even though extended payment terms benefit buyers in the short term, they may hurt them in the long run; as suppliers face increased borrowing pressure, they are eventually forced to pass on these increased costs to their buyers.

Role of Technology and SWIFT’s TSU

Logistics providers and technology firms have attempted to address the issue of information flow, by offering Internet-based systems that offer end-to-end visibility over the supply chain. The goal of such systems is to define key financing ‘trigger points’ based on the status of goods in transit, and ideally, to reduce the number of documents required. Results have been mixed and in some cases, the number of documents required under an open account presentation has actually increased. As corporations are increasingly discovering, physical documents are still the name of the game and they have to be checked by someone.

All of this provides opportunity for commercial banks. With their document checking and information management expertise, the shift from LCs to open account could actually work to the banks’ advantage. While many multinational corporations are interested in open account, especially where the lower fees and ease of document handling are concerned, many have begun to realise that they must now bear the back-office document checking workload, which was previously handled by banks. Many companies say that open account systems offered by third parties can be difficult to implement, because they require their trading partner to be trained on the new system; which can be difficult to manage in a world of ever shifting supplier networks.

While many larger commercial banks are marketing their own Internet-based end-to-end supply chain systems, each system is different (driven by the individual bank’s market philosophy) and they are all evolving differently. SWIFT’s Trade Services Utility (TSU) is the first industry-wide attempt to create a universal open account processing platform and involves an invoice/purchase order matching process that allows buyers and sellers to work through a common platform to execute trade transactions. Member banks can provide purchase order information to their partners, thus saving them membership fees and infrastructure costs.

Even as the TSU moves through its pilot phase, banks in Europe are adopting varied strategies to supply chain management and open account financing, many of which centre on small and medium sized companies. As open account is generally less profitable than LCs on a per-transaction basis, many banks are looking to loan interest spreads, FX conversions, forward contracts, and derivatives as additional revenue sources. Initially, banks will finance their home base customers and then gradually expand to foreign markets.

Some regional banks are succeeding by providing comprehensive solutions that hinge on the extension of pre and post export loans secured by collateral or guarantees, and then further covering themselves through the self-liquidated open account cash flow. They profit from high loan margins and management fees for the processing work. For all of these banks the challenge of moving into this space will be dedicating the necessary resources to managing the corporate credit risk and information flows that lie at the centre of open account transactions. Data and process management will be the keys to success in the supply chain world.

Conclusion

Global trade has reached a tipping point. Each year open account transactions represent a greater portion of worldwide trade and banks must figure out how to manage the related processing and finance issues. Suppliers and their banks will need reliable information about buyers in order to secure financing at reasonable rates, and buyers and their banks will need enough information about the various trigger points of an open account transaction to contemplate purchasing trade receivables. Even if this means LCs eventually yield to open account, and universal tools like the TSU, it may be that trade processing banks’ greatest open account strength lies in the document processing, data management, and correspondent banking expertise they already posses because of their existing LC businesses.

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