A simple view: Can a trade finance process be simplified with technology?
Since the 2008 financial crisis, trade finance has witnessed periods of stress and coupled with the fact that all parties of the trade and finance chain have been facing risks involved with “trust”, clients of these services are also suffering from costly and longer processing time to finance transactions based on manual handling of paper-based documents.
- Low customer satisfaction and high cost pressures: From the perspective of a bank or financial institution, multiple parties involved are confronted with poor end-to-end experience. It is understood that trade finance requires high level of coordination and efforts between parties, with each party potentially represented by each own’s legal jurisdiction or different platforms for different elements of a trade transaction. This complicates the process and lengthens waiting times and makes transparency harder to enforce the more intricate the processes and chains.
- High regulatory burden: There is a heightened awareness of the risks of financing trade transactions and in the recent years, we have also witnessed several banks being fined for breach of regulatory standards. On top of existing know-your-customer (KYC), fraud prevention and credit assessment procedures, banks and financial institutions have also beefed up their AML and Sanctions processes to ensure that they do not facilitate sanctioned transactions and/or transactions that are potentially used for money laundering activities.
It is understandable that to mitigate the potential risks, financing a trade transaction has become more complex and costly. However, it is highly desirable that these services could be supported with financial technology (Fintech). Fintech is defined as technological innovations in the financial services sector. These innovations have provided new solutions for entrepreneurship by facilitating disintermediation, addressing privacy, regulatory and law-enforcement challenges.
BLOCKCHAIN – How it helps?
Blockchain is a shared, distributed ledger technology (DLT) that facilitates the process of recording transactions and tracking assets in a business network. More clearly, it is “a peer-to-peer public ledger maintained by a distributed network of computers that consists of three components: a transaction, a transaction record and a system that verifies and stores those transactions”.
Blockchain makes it possible for the entire network to jointly create, evolve and follow up on the immutable history of transactions.
- Database and Distributed: Data can be stored in the form of ledger entries that are kept in strict sequence. Using blockchain to exchange the transaction details helps all parties keep track on the transactions’ real-time visibility. As a feature, it allows many copies of the same data to be made available on a distributed ledger for each participant in the network. Thus, it is able to help reduce and prevent fraud by building trust and ownership which is defined and identified by algorithms where no third party is required
- Immutability: Through the use of smart contracts, which automates certain actions upon occurrence of specified trigger events this technology may prevent the possibility of amendment of a transaction retroactively. It clearly offers the potential to provide a secure transfer of value. Overall, blockchain offers an ideal system to exchange assets without intermediaries and the lowest level risk of double spending. In addition, the transparency and consensus building help multiple parties reduce the operational costs of transactions. Let’s take a look at the figure below, which shows the simple illustration of a distributed ledger network.
As can be seen from the diagram, each chain of the blocks is held by each participant (a node) of the network. It constitutes an entire history of transactions that have occurred on the network and a set of these transactions is kept in each block.
In short, the use of blockchain with smart contracts may allow immediate electronic transfer of trade information to enable efficiencies for all stakeholders in the trade value chain. Hence, it is conceived that the advent of blockchain and distributed ledger technologies will reshape how the trade finance process is being conducted and could be highly disruptive to the current combination of manual processes and traditional core banking systems.
In the next few articles, we shall discuss the potential applications of blockchain in trade finance, as well as the early-stage Proof-of-Concept (POCs) that have been developed by JED to establish (i) Immutable audit trail to keep accurate records of trade interactions and financing agreements; (ii) Traceable invoice milestones retrievable for data verification; and (iii) Invoice status verification to check for double-financing/leverage risks.
“Applying cryptotechnologies to Trade Finance.” EBA Working Group, Euro banking association, May 2016. Accessed May 13, 2017.
Dhar, Vasant, and Roger M. Stein. “FinTech Platforms and Strategy.” MIT Sloan School of Management, December 2016. Accessed May 13, 2017.
Froystad, P., and J. Holm. “Blockchain: powering the internet of value.” EVRY Labs (2016). Accessed May 13, 2017
Sundararajan, Arun. “FinTech – NYU Stern.” Accessed May 13, 2017. http://www.stern.nyu.edu/programs-admissions/full-time-mba/academics/specializations/fintech.
Fintech can be exciting, but purposeful fintech that impacts livelihoods elevates the meaning of success
The purpose and bigger picture of FinTech. View resource here or here.
Emergence of FinTech and the LASIC principles
EY Global Financial Services Institute (2015) Emergence of FinTech and the LASIC principles. Download resource here.
The Advent of Blockchain & New Technologies
A need to tackle financial challenges and the importance of building trust. Download resource here.
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