How blockchain can help shape the future of trade finance
Trade finance refers to a range of financial products used to reduce risk in trade between suppliers and buyers of goods and services. Trade finance is primarily focused on international trade operations involving exporters and importers.
The financing of international trade comes in two different ways: The bank guarantees something, such as Letter of credit or bank support through the documents (documentary collection).
A letter of credit is a formal letter that describes the terms for the removal of counterparty risk. It guarantees payment. Letters of credit and other trade finance products protect transaction partners against fraud, contractual disputes, externalities such as currency fluctuations, sudden legislative changes, market and political instability, and so on.
Documentary Collection is the other form in which banks support trade finance. It is the process by which banks move paperwork around the world.
Existing Trade Finance setup
Currently, the exporter and the importer sign a contract for the sale of goods such as oil, agricultural products or manufactured products.
The importer then arranges 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 has put his oil or agricultural products on a ship.
The exporter’s bank sends the documents abroad to the importer’s bank. This triggers the condition in the letter of credit and the payment is made.
Despite several attempts to streamline processes, modern trade finance operations remain bureaucratic, slow and complex. In most cases, they involve several intermediaries, which increases the cost and complexity of transactions.
There are over 50 different types of documents and forms used such as 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 enables documentation to flow transparently but securely among banks, trading companies and other network participants such as insurance companies.
How can blockchain help trade finance?
Each transaction on the blockchain is immutably recorded with a time stamp and a unique cryptographic signature. For complete transparency, anyone with the right permission can access similar information, helping to increase trust and prevent fraud.
A self-governing rulebook defines how banks and traders participate in business transactions, risk and handling disputes. Smart contracts codify the commercial and shipping terms of agreement between the 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 completely 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 such as insurance certificates to be securely signed and exchanged through the 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 are loaded onto the ship, the receipt issued by the freight forwarder must be manually sent to each of the parties involved in the transaction to obtain all relevant signatures.
Buyers, suppliers, carriers, insurance companies and banks are all included. Documents often have to be sent across national borders to reach all parties. Because this is a time-consuming process, global transactions can take weeks to complete.
By digitizing this process with blockchain technology, Barclays aims to complete transactions in hours.
Another relevant 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 using blockchain technology.
Previous transactions, it claimed, had been successful as proof-of-concept, but it was the first to be used commercially.
The letter of credit was issued to lender ING on behalf of Cargill, an American food and agricultural company. It was about a transaction where soybeans were sent from Argentina to Malaysia.
To summarize, blockchain has the potential to revolutionize 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.
Digitization of details can be done without an intermediary getting involved, while smart contracts can be used to initiate commercial actions automatically.
From an audit perspective, it can be used to create audit trails that can be used to track items throughout the supply chain and relay information to and from the owner.
It also ensures transparency, which can help reduce delays and increase trust among all parties involved in the process, while ensuring that the data is genuine and secure.
(Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the views of YourStory.)