Keeping Up With Changes in the Trade Finance Environment
Risk has increased at every stage of the physical and financial supply chains, so risk mitigation is of paramount importance to clients engaged in importing, exporting or both. Consequently, there is a noticeable increase in demand for tried and tested tools of risk mitigation, such as letters of credit (LCs) and documentary collections. Indeed, LCs are increasingly being used to cover payment risk from developed market purchasers.
These changing needs are, however, imposing a burden on many banks that have large local networks, but a less extensive global presence. Furthermore, the tools needed to operate in the modern trade finance arena are new ones, as the processing of LCs and documentary collections has evolved considerably from the expensive and slow practices of the past. LCs can now be initiated online, saving time and improving security. Advanced electronic imaging has further improved LC examination services, while documentary collections can likewise be easily initiated, tracked and managed through web-based services, providing similar advances in turnaround speed, management and security. Indeed, LCs and collections in their modern form can provide the speed, the capacity for close monitoring, and crucially the financial assurance that the import and export community requires.
None of this is to say that LCs and collections are the only solutions of use in the current environment: rather, they are once more playing a part in underpinning the trade services arena.
Indeed, cross-border trade conducted on open account is worth US$12.6 trillion a year. It represents 80% of all international trade, and provides significant benefits, particularly to Organisation for Economic Co-operation and Development (OECD)-based purchasers, who have been able to reduce costs, increase speed and secure cash-flow benefits through insisting on deferred payment terms and just-in-time delivery. Manufacturers have also benefited from the increased levels of trade promoted by the adoption of open account, but can suffer funding gaps without bank-guaranteed letters of credit. Also, documentation is still required for customs clearance – the cause of the majority of documentation in international trade – and areas of dispute still require reconciliation, potentially generating hidden costs, which are borne by the supplier. Advances in electronic imaging can facilitate these operations, while timely reporting and copies of documents can be made available to clients through web-based systems.
Yet for financial institutions with a more regional than international focus, the infrastructure necessary to offer such services is often prohibitively expensive to set up and run, as volumes of traffic would not necessarily be high enough to justify the initial outlay.
Such scenarios have led to partnership agreements between banks. Correspondent banking services were the first such arrangements, whereby banks in different countries agreed to hold reciprocal accounts with one another, to allow international payments to be provided to clients even though each bank had only a national network.
The next significant step in the tentative relationship-building process between banks has been outsourcing. This provided a solution – of sorts – to the common inability of local banks to offer certain services to their clients, due to the infrastructure requirements. Through outsourcing arrangements, larger financial institutions have allowed their smaller or more regional partners access to their systems and processing abilities. Local banks have then been able to provide their clients with these services, perhaps through white-labelling agreements, which leave the business client unaware that a second bank is even involved.
While such a partnership clearly provides valuable benefits to all parties, there are two major problems, at least from the point of view of the regional banks. These banks are generally very restricted in terms of their ability to tailor the outsourced services to match the exact requirements of their clientele. This is a largely inescapable problem, as it is caused by the nature of the infrastructure, which has usually been designed with the owner bank’s direct corporate clientele in mind.
The second problem, potentially even more serious for a local bank, is the issue of competition. While the smaller financial institution can provide more services to its clients thanks to the partnership, it is on an increasingly unequal footing with its larger partner. This is because the bank owning the infrastructure, having generated some business in area particular market through the outsourcing, can look to establish a presence, and even grow and compete for business with its partner. In effect, the locally focussed bank will have helped a future rival establish itself in the region.
The final stage in the development of mutually beneficial relationships between banks is worthy of being called a true partnership.
There are now systems, such as The Bank of New York Mellon’s Trade Workstation (TWS), that were developed with collaboration in mind. Indeed, TWS allows the bank using it to customise the service to match the needs of its clients. It constitutes the provision of market-leading technology, to be used as the banks and their clients require.
This flexibility resolves the first of the two barriers to full collaboration. The second, that of competition, is removed by the signing of non-competition agreements guaranteeing not to compete for partner banks’ local corporate business.
This collaborative approach is central to the thinking behind the development of SWIFTNet’s Trade Services Utility (TSU). The TSU is a shared infrastructure service, providing banks with a workflow and data matching engine and thereby removing their dependence on the restrictive supply chain systems provided by larger banks.
Through such an approach, local banks can meet the requirements of their import and export communities, which are seeking them with growing urgency. When combined with a considered and up-to-date perspective on the tools of supply chain finance and trade services, and an awareness of the changing nature of inter-bank collaboration and its attendant benefits, banks can successfully exploit the opportunities generated by the rapidly changing trade services environment, without any potential threat of increased competition as a result of doing so.
In a changing world, flexibility and adaptability are key. The market demands a variety of working capital solutions, including LC and open account. It also expects these services to be ever cheaper and more efficient. This does not, however, have to constitute a hurdle for local banks, as the technology exists to allow them to meet the needs of their clients. At the same time, the partnership model exists to allow them to do so without any risk of adverse effects to their business.