Technology and collaboration – the formula for reconceiving trade finance


A recent report from McKinsey and the International Chamber of Commerce titled “Reconceiving the global trade finance ecosystem” pulls out a number key issues with global trade: supply chain issues creating fragility, the insurmountable barriers for SMEs attempting to access funding and lack of interoperability.

It calls for banks and exporters to help improve this system by fully digitising their decades-old processes and adopting an international framework of trade finance standards.

At the heart of each of these problems is legacy infrastructure and the reliance on paper processes such as faxes and spreadsheets which are slow and have no transparency or standardisation. With the need for automation and digitisation becoming the norm in all industries, it’s clear these outdated approaches are quickly becoming unfeasible.

The key to improving the global trade engine is to adopt and utilise new technology and incorporate modern infrastructure which enables more automation, less friction and reduced costs. This approach is already leading to widespread change – but it is just the beginning.

The technology and infrastructure needed to parcel trade finance instruments into investable assets which help solve the trade finance gap now exists. Also, modern AI tools can give firms early warning signs of supply chain issues before they’re directly affected.

Turning trade finance into investable assets

Many businesses struggle to secure trade financing from banks and it’s a persistent problem that has led to the widening of the trade finance gap – the shortfall between supply and demand. Research from the Asian Development Bank found that this gap has increased to $1.7 trillion.

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The problem is banks are having to do more with less in the face of capital constraints, so affecting change means first resolving this fundamental imbalance. Understandably, regulation is a major contributing factor – particularly Basel III, which requires banks to put aside more capital when lending. As a result, global banks active in trade finance have had to raise capital requirements and reduce their standardised risk weights. With Basel IV on the horizon, the problem is set to get worse.

A large part of the gap results from SMEs in emerging markets, so it will be difficult to address through additional lending or credit. An alternative strategy banks are adopting is the distribution of trade finance instruments to other banks and the capital markets. They recognise that by adopting an originate and distribute model for their trade books, they can open up additional sources of funding. This benefits not only the banks but also their investors and the businesses and communities that depend on trade finance.

It used to be that a vital missing ingredient was the electronic trading infrastructure. However, in recent years, technology has opened the door to this huge market, enabling assets to be bought and sold through private distribution networks and settled like common fixed income products.

Tackling supply chain risk through AI

Numerous systems today enable businesses to track how consumers engage with them, send payments to counterparties and communicate with people all across the world. Similar approaches are also helping trade finance banks monitor risks in the supply chain more effectively.

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The answer lies in the adoption of artificial intelligence – a technology that has made significant advances over the past decade. For investors and sellers of risk, including banks and factoring companies, it holds the potential to help identify and monitor risks in the supply chain before they become a systemic issue.

If, for example, a supplier has a cash flow problem, unexpected weather patterns affect a supplier’s ability to manufacture a product or an incident takes place that affects multiple companies with a similar size and profile, firms can receive an early-warning sign to investigate what happened and how it might affect them and parties across the trade finance chain and respond quickly.

This ensures they are staying ahead of potential risks and systemic events rather than reacting to them. Crucially, it is an example of technology making the global trade and supply chain ecosystem more responsive, agile and efficient.

Banks can also use AI-powered analytics to assess the riskiness of clients, vendors and individual transactions – all of which can suffer from the knock-on effects of supply chain disruption. Banks can begin to do this with entirely new levels of granular insight and accuracy. In many cases, this can open the door to new financing opportunities for businesses that would have otherwise been overlooked using traditional methods.

AI helps by creating more accurate credit scoring models that offer deeper levels of analysis. This can include a company’s payment history, measurement of the risks of funding a specific transaction when dealing with different counterparties and identification of specific supply chain risks – then benchmarking them against their peer group.

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The road ahead

Through eradicating legacy systems and adopting more modern approaches such as these, the entire trade financing process has the potential to run more smoothly and efficiently. Banks will be able to work their balance sheets harder, allowing them to issue more trade finance without taking on additional risk and remain compliant with international regulatory frameworks.

Collaboration across global trade is a vital component to realising this future, and existing solutions have come about through banks, fintechs, investors and other stakeholders working together and adopting innovative technology. Ultimately, this is the formula required to truly revolutionise this centuries-old industry.

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