How corporate banks can ride the disruptive wave of global trade

Historically, banks took the role of “trusted” parties in the global trade world, issuing letters of credit (LCs), financing trade flows and processing documents. However, as trust among buyers and sellers has improved, demand for LCs has reduced and alternate options for financing, including open-account trade (when finance is not underwritten with an LC) have started to emerge. At the same time, technology is helping shape trade facilitation, and we see more self-funding and investment from institutional investors flowing into the corporate supply chain.

The impacts of these changes are expected to accelerate as trade ecosystems evolve (as illustrated in Figure 1). Banks that want to retain their market share and revenues may be forced to take on riskier clients to fill the gap.

The fundamentals of trade are changing as geopolitical tensions and technology innovations challenge the status quo.

• Localization of supply chains: Companies are localizing supply chains to insulate themselves from the impact of trade disputes, including higher tariffs and delayed government inspections, customs clearance, and licensing approvals. At the same time, automation is reducing the labor component of goods and, with it, part of the cost arbitrage between low-cost manufacturing and high-margin sales regions. Perhaps the most transformative innovation is the potential of 3D printing. Decentralized production for near end-consumers could potentially replace global distribution of many mass-produced goods. Localized supply chains will need funding in the countries of their presence or manufacturing. Global banks without a physical or virtual presence in these local markets will risk losing business to local players.
• Growth in services trade increasing demand for new services: Intellectual property-related services, such as patents, trademarks, copyrights, licenses and industrial designs, could comprise as much as a quarter of all total trade exports by 2030. Providing financing for the transfer of the increasing volume of services exports is a huge opportunity for global trade banks.
• “Democratization of trade” expanding the client base: E-commerce has opened up international trade to companies of all sizes; online sales platforms have broadened small enterprises’ reach to an average of 30 different economies. The democratization of trade opens up a new client segment for trade financing, but serving these smaller clients cost-effectively may be challenging for many banks as they are currently structured. New ways to reach them will need to be considered.

Banks’ role as processors of paper-based trade documentation, particularly LCs, collection documents and bank guarantees is changing as greater trust and technology, including optical character recognition (OCR), robotic process automation (RPA) and artificial intelligence (AI) improve processing efficiency and turnaround times.

• Trust:
  • Open-account: Enhanced levels of trust and ownership have seen some buyers and suppliers start open-account transactions, reducing demand for LCs.
  • Trusted trader networks: As banks share challenges around document processing, some large players are creating consortiums or networks to exchange common trade information to mitigate fraudulent transactions and duplicate financing.
• Technology:
  • Distributed ledger technology (DLT): In the paper-intensive business of trade, DLT or blockchain could be a game changer, offering the ability for real-time review of trade documentation, traceability and transparency of ownership, while supporting data privacy.
  • Internet of Things (IoT): The physical tracking data generated by IoT sensors offers granular insight into the location and quality of goods, reduces counterparty risks in delivery or payment, minimizes friction from trade disputes and provides corporate banks with real-time data on customers’ merchandise for credit assessment. Visibility of cargo movements helps mitigate fraud and corruption, while reduced delivery risks enable open-account transactions.
  • Application programming interface (API) - enabled data sharing: Real-time data flows use APIs to link supply chains to financers for deep-tier financing.

But even as banks embrace these technologies, they are being disrupted by new players with a greater mastery of them. FinTechs have captured significant market share through their flexibility and speed in offering customized client solutions to corporates seeking open-account trade. Meanwhile, the rise of digital banks – new banks with the latest systems and technology – may even disrupt the disrupters, as well as displacing incumbents. FinTechs have already transformed consumer banking and now see trade as an opportunity to grow the asset side of their balance sheet.

The role of LCs in trade, as well as banks’ diversified deposit bases and ability to raise funding cheaper than others, has cemented banks as the cross-border financiers of trade. But, while banks have sought to strengthen this position by expanding into financing pre-shipment and post-shipment periods, and discounting LCs, their dominance is being challenged by:

Institutional investors: While banks, post global financial crisis, have faced more restrictions, especially on capital requirements when extending trade financing, the buy-side, including asset managers, pension funds and insurance companies, have surplus liquidity and are looking for yield. These buyers are exploring trade finance as a new asset class to diversify portfolios.

Captive financing: As cash-rich corporates question the interest and other costs paid to banks, some have set-up or expanded their own captive finance organizations to self-fund global trade.

The global trade finance gap of US$1.60t² , that banks are unable to meet, offers significant opportunities to non-banks. This may lead to new market disruptions, including the creation of a common digital infrastructure, connecting players across the trade ecosystem and shifting paper-based processing to an end-to-end digital interface. Some corporates are building their own networks – walled garden financing – that combine working capital financing solutions with payment gateways for their own ecosystems. For example, e-retail platforms directly finance users’ supply chains using data derived from a common infrastructure.

Ultimately, we may see banks circumvented altogether, where corporates link their end-to-end manufacturing supply chain through a technology platform to a parallel common infrastructure that includes digital processing and financing of trade transactions via institutional investors.