How blockchain can help shape the future of trade finance
Despite multiple efforts to streamline processes, modern trade finance operations remain bureaucratic, slow, and complex. This makes the entire sector ripe for disruption.
Trade finance refers to a range of financial products used to mitigate risks in trading between suppliers and buyers of goods and services. Trade finance is focused primarily on international trade operations involving exporters and importers.
The financing of international trade comes in two different ways: Bank guarantees something, such as a Letter of Credit or bank support through the documents (documentary collection).
A letter of credit is a formal letter laying out the terms of removing counterparty risk. It guarantees payment. Letters of credit and other trade finance products protect transacting parties from fraud, contractual disputes, externalities such as currency fluctuations, abrupt legislative changes, market and political instability, and so on.
Documentary Collection is the second form in which banks support trade finance. It is the process of banks moving paperwork around the globe.
Existing Trade Finance setup
Currently, the exporter and importer sign a contract for the sale of goods like oil, agricultural produce, or manufactured products.
The importer then arranges for a Letter of Credit (LC) with an issuing bank. This LC is sent to the exporter's bank. The exporter will receive money when the importer receives documents proving that the exporter put his oil or agricultural products on a ship.
The exporter’s bank sends the documents overseas to the importer’s bank. This triggers the condition in the letter of credit and the payment is made.
Despite multiple efforts to streamline processes, modern trade finance operations remain bureaucratic, slow, and complex. In most cases, they involve several intermediaries, which increases to the cost and complexity of transacting.
There are over 50 different types of documents and forms used like Bill of lading, invoice, bill of exchange, packing, list, insurance certificate, license to name a few.
This makes the entire sector ripe for disruption. Enter blockchain or Distributed ledger technology (DLT) which makes it possible for documentation to flow transparently yet securely among banks, trading companies, and other network participants like Insurance companies.
How can blockchain help trade financing?
Every transaction on the blockchain is immutably recorded with a timestamp and a unique cryptographic signature. For complete transparency, everyone with the right permission can access similar information, which helps to increase trust and prevent fraud.
A self-governing rulebook defines how banks and traders participate in business transactions, risk, and dispute management. Smart contracts codify the commercial and shipping terms of agreement between parties.
When certain conditions are met, such as the shipment of goods, smart contracts send payment notifications companies can apply online for bank-guaranteed payment or invoice financing using a simple user interface. The entirely digital process streamlines transactions and lowers costs for all parties.
Barclays was one of the first banks to use blockchain in trade finance. Barclays implemented a platform called Wave that was developed to allow bills of lading and other trade transaction documents like insurance certificates to be signed securely and exchanged through blockchain.
This platform improves existing supply chain processes by reducing the time it takes to complete global transactions.
The centuries-old bill of lading process is based on manual procedures. Once the goods have been loaded onto the ship, the receipt issued by the goods carrier must be manually couriered to each of the parties involved in the transaction in order to obtain all relevant signatures.
Buyers, suppliers, carriers, insurers, and banks are all included. Documents must frequently be couriered across borders to reach all parties. Because this is a time-consuming process, global transactions can take weeks to complete.
By digitising this process with blockchain technology, Barclays aims to complete transactions in hours.
Another pertinent example is HSBC. It went a step further by exchanging a similar letter of credit in what it claimed was the first commercially viable trade finance transaction to use blockchain technology.
Previous transactions, it claimed, had been successful as proof-of-concept, but its was the first that could be used commercially.
The letter of credit was issued to lender ING on behalf of Cargill, a US food and agriculture company. It was about a transaction involving soybeans being shipped from Argentina to Malaysia.
To summarise, blockchain has the potential to revolutionise trade finance in a number of ways. It can be used to track goods throughout the supply chain and relay information to and from the owner.
Digitising of details can be done without an intermediary getting involved while smart contracts can be used to initiate commercial actions automatically.
From an auditary perspective, it can be used to create audit traits which can be used to track goods throughout the supply chain and relay information to and from the owner.
It also ensures transparency, which could help reduce delays and increase trust among all parties involved process, while ensuring that the data is genuine and secure.
Edited by Akanksha Sarma
(Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the views of YourStory.)