Why Trade Finance Modernization Remains A Work In Progress

Trade finance has always been the topic of debate over its role in facilitating cross-border trade and protecting the financial health of companies. It is an undeniably vital tool to fuel global growth and support the world economy, but it is far from a perfect instrument.

For decades, trade finance has been caught in a web of paper-based documents, creating bottlenecks and friction at nearly every point of the process, from onboarding to financing payouts. As the industry pushes to modernize, it’s also facing scrutiny over its relationship with credit risk. Critics argue that some trade financing products have actually encouraged large corporates to pay their vendors late or force those suppliers into expensive financing arrangements. At the same time, as witnessed in the ongoing Greensill Capital saga, the success of trade finance largely relies upon insurers’ ability to cover for losses in the case of non-payment.

In general, the industry is rooted in the ability of cash to flow efficiently and appropriately between entities. And yet, its continued reliance on paper and the correspondent banking system can impede that flow.

Speaking with PYMNTS about the ongoing evolution of the trade finance sector, Triterras Chief Operating Officer John Galani warned against taking industry-wide generalizations from Greensill. But he did acknowledge the industry as a work in progress, able to continually learn from its shortcomings as stakeholders — from banks to corporates — embrace digitization.

Shifting Pain Points

In the broadest sense, many of trade finance’s biggest pain points can be traced back to paper.

“There is no illusion to the fact that a paper bill of lading is a completely anachronistic piece of paper in the 21st century,” said Galani, pointing to a staple of trade finance workflows that facilitates the movement of freight and acts as a receipt once a carrier completes that shipment. That proof of a completed job is key to exporters, buyers and their banks releasing funds in the form of payment or trade finance.

The bill of lading is just one example of a key document in the trade finance workflow, and a prime example of where so many things can go wrong. Errors on the document, or even forged bills of lading, can halt the flow of funding. But the problem isn’t with the bill of lading itself, noted Galani, it’s with the underlying issue of the industry continuing to rely on paper and legacy ways of exchanging information.

It’s a concept that can be applied to other areas of the trade finance workflow. Take onboarding, for example, which continues to be among the biggest pain points of the sector. As Galani highlighted, banks are in the business of making money. But processes like know your customer (KYC) and anti-money laundering (AML) checks at the onboarding process actually cost financial institutions (FIs) valuable resources, including time and money.

When a potential new client is a small business, or operating in an emerging market with foreign exchange (FX) risks, the cost of onboarding outweighs the potential value of financing trade for that entity. Again, it’s a workflow that is often riddled with paper and manual data entry, creating for a slow and cumbersome process for banks and businesses alike.

Digitizing Down The Chain

There are plenty of areas of trade finance workflows that face headaches resulting from reliance on legacy tools. While the trade finance arena continues to embrace digitization and automation, there is no silver bullet, considering just how many moving parts there are in any trade finance arrangement.

“As technology comes in, the pinch points are moved to the weakest link of the chain,” said Galani. “As you digitize documents, you see that the payment system itself is awkward and complex and takes a lot of time.”

Very simple breakdowns in the workflow can create massive slowdowns throughout the chain of operations, from KYC and AML, to bills of lading, to payments, to insurance. Digitizing the exchange of information between entities will solve one challenge, but bring to light another, like the sluggish and opaque movement of funds across borders.

In the case of Greensill Capital, Galani noted, “one should not generalize because of one specific issue.” However, the company’s challenges in the insurance link of the trade finance chain may shed light on broader lessons for the industry to mitigate risk through digitization. The creation of digital registries and the adoption of blockchain are two important opportunities for the sector that can help address friction in a variety of areas, from insurance to onboarding, said Galani.

It’s a work in progress, he said, and industry stakeholders should embrace a bit of experimentation and mixing-and-matching of technologies as the sector sorts out which tools can address pain points most effectively. After all, it’s not only what technology is adopted, but how it’s implemented, that matters.

“One has to encourage the development of competing technology,” said Galani. “That’s how capitalism works to achieve the best. Within three to five years, any competing technology will either wash out or succeed, but there isn’t one single source of success.”