5 Ways Blockchain is Poised to Disrupt Trade Finance
By Arijit Banerjee
Trust is limited in international trade as the process is prone to fraud in multiple areas, including invoices, warehouse receipts, and bills of lading. Trade finance processes are paper laden, further increasing the chances of fraud. In addition, much of the trade financing system involves infrastructure created in the 1970s -- before the deployment of digital solutions -- such as the SWIFT system and electronic data interchange (EDI). In a way, no other sector is ripe for blockchain-led disruption as much as trade finance because of the potential for digitisation and the immutable quality of data on the blockchain – a critical attribute to developing trust. Blockchain helps global trade networks reduce friction in the trade finance value chain by driving logistical and operational efficiencies and creating value for all stakeholders involved.
Blockchain is poised to dramatically change the trade finance game in the following five ways:
Increases trust with smart contracts: A key application of blockchain in trade finance is smart contracts. As self-executing programs stored on distributed ledgers, smart contracts automatically execute payments when conditions are met. They reduce the chances of payment processing errors or fraud by automatically triggering a payment when the receiving company has a verifiable record that it has received shipments. Trade contracts are created, updated, and amended directly on the blockchain through a multi-signatory mechanism. Organisations can easily carry forward and reference the data on the blockchain with the rest of the transactional activities. This increases the auditability of trade financing transactions, as no single party can alter the data or the contract information on the blockchain. Trade finance prototypes that use smart contracts are ideal for processing letters of credit (LC) and factoring transactions.
Reduces risks and redundant processes: Factoring and receivables financing involve multiple overlapping processes – including document exchange between parties such as the company that needs financing, the underwriter and the bank. With the distributed ledger of blockchain, different parties in the transaction can simultaneously view all the relevant data in real time, saving multiple process steps as well as time. An additional benefit is that banks can lower financing costs with the elimination of multiple steps and increase trust.
Reduces operational costs: Resolution of blockchain transactions is exponentially faster than paper-based transactions. This is because immutable contract information can be preserved and provided to all parties on the blockchain with minimal time delay. With faster resolution of disputes between banks and customers, banks can quickly free up capital for productive use. Network banks can also confidently assure the transactions, enhance efficiency and lower costs of operations.
Enhances identity and trustworthiness in management: Identity and trustworthiness in management are the building blocks of all trade interactions. The primary role of banks is to enable trade by covering for the risk of payment and delivery default by the counter party in the trade transaction. Blockchain facilitates credible and effective credentialing of parties in a trade transaction. Immutable and comprehensive records for payments and transaction history help assess trustworthiness and financial credibility of the party that is initiating financing. In addition, blockchain supports effective monitoring of transaction developments to disburse further financing.
Enables more direct transactions: Trade financing processes are typically cumbersome as they involve multiple intermediaries. Settlement can take weeks based on the jurisdiction of the transactions. The transaction chain for remittance, verification, and approval authorisations offer limited visibility, leading to errors and duplication of work. Blockchain helps banks, buyers and sellers involved in a trade finance transaction maintain direct relationships by directly engaging with each other on digital channels.
Indian banks are making rapid strides in blockchain adoption for trade finance
ICICI Bank pioneered the use of blockchain for trade finance in India when it successfully executed international trade finance transactions using blockchain with the UAE-based Emirates NBD bank. Blockchain helps the bank instantly settle transactions between corporate clients in India and traders in the Middle East. ICICI is not only the first bank in India but also one among the first few globally to exchange and authenticate original international trade documents such as purchase orders, invoices and funds transfer transaction messages in real time on blockchain. The bank is now focusing on achieving scale with this solution. In addition to customizing trade finance blockchains for two large Indian exporters and a client in the Far East, it is trying to bring several other banks on to the platform.
Similarly, Axis Bank has launched a bilateral inward corporate trade remittance solution with Standard Chartered Bank in Singapore. In early 2017, Kotak Mahindra bank, in partnership with Deloitte, was able to deploy blockchain to complete LC transactions with JP Morgan in a few hours – as opposed to the 20 to 30 days that it typically takes. Although the LC is a critical document in both domestic and international trade finance, it is one of the most time consuming to process in banking. The delay in completing the process prevents exporters from using their sales proceeds efficiently. Blockchain drives efficiencies in the LC processes at multiple levels – from transferring trade documentation for inbound LCs to facilitating the transactions on SWIFT and to issuing the LC for outbound transactions.
Mainstream adoption of blockchain hinges on interoperability
While the current SWIFT global money transfer system takes two to three days to execute transfers, blockchain enables cash transfers in minutes. To reduce the impact of the scale of change brought about by blockchain, many banks prefer a hybrid blockchain where a tiered blockchain network or a combination of private and public blockchains is used. However, over the long term, blockchain can be successfully used for trade finance only if banks agree on a common protocol for interoperability. Moreover, blockchain presents a regulatory grey area for financial institutions. Currently, there is no consensus on regulations between major financial institutions or governments. Regardless, given the rapid rate of digitization globally, the long-term impact of blockchain on trade finance is likely to lead to profound changes in the current processes.