Digitisation of trade finance is often stated as a goal for many fintechs, banks, corporates, and more – Contour included. But progress has been hard won, adoption painfully slow, and paper continues to be commonplace. Several technology companies have had to close their doors with poor adoption often quoted as a reason.
Maybe it’s a good time to question what digitisation is, and what it means to the global trade finance ecosystem and the wider world, and who is responsible for delivering it.
Is digitisation even the right goal? We believe technology can be a useful tool, but the real goals should be bigger that just removing paper or shifting to a digital platform. More meaningful goals could be reducing barriers to access to trade finance, reducing the cost to provide trade finance, or simply enabling the growth of international trade in relation to GDP.
Collectively banks, corporates, and fintechs need to work together to help trade finance as a business grow in a sustainable manner.
At Contour in 2023, we will focus on delivering sustainable growth by focusing on increasing the flow of capital to trade finance, and to increase access to traditional trade finance for growing corporates.
These are our new goals. Let’s dive in to our first goal of the year – to help increase the flow of capital to trade.
Increasing the Flow of Capital
Trade finance involves risk. The more this risk is shared, the easier it becomes to take.
Bank capital is scarce and getting scarcer and trade needs a lot of capital. For many banks, allocating scarce capital to trade finance is becoming a harder and harder to justify with high operational costs and limited preferential capital treatment for short-tenor structured loans.
Increasing the flow of capital to businesses will take a rethink about how to finance trade finance, and who can and who should finance trade.
Banks have been reducing their exposure to trade finance in two ways: by reducing the amount of counterparties they will take risk on (both banks and corporates), and reducing the amount of capital they want to allocate to trade finance in total.
The requirements on banks to maintain limits on risk counterparties continues to increase, with constant attention required to track and manage credit risk and KYC requirements. The result has been an ever-shrinking list of risk participants they are willing to manage, which has impacted the availability of capital with smaller players and in more developing countries.
From a total capital perspective, it is becoming popular for banks to limit the amount of trade finance assets they hold on their balance sheet so they do not attract capital that can negatively impact their capital ratios built on risk weighted assets.
There are solutions to these challenges, and they are based on using the community of banks to collectively hold capital and to share and distribute risk limits on the greatest number of counterparties. If a corporate brings them a transaction with a risk counterparty that they don’t have appetite for, they can either refuse to finance the asset on behalf of their client, or ideally, they can sell it to another bank that has unallocated capital and appetite for the exposure, creating a win-win-win.
While banks do this today, but there is much room for improvement.
The challenge is the process is manual, so only suited to larger transactions and easier to place transactions. A new globally distributed market can improve this process of determining what assets to put for sale, and who has appetite for them, and then facilitating their sale and settlement. Digitization of these financial assets is a great way to remove friction from the various processes required and increase the amount of capital flowing to trade, and Contour will build this.
Removing friction from this process will help improve lower the threshold for distributing risk amongst the banking community, but this is just the beginning. To further increase the flow of capital, we can leverage a larger pool of transactions, package these assets as required and make them available them to a much larger group of liquidity providers and those with a mandate to provide risk cover in emerging markets, such as development banks. This is where the digital assets use case really starts to shine. We can absolutely do this, and it is one of Contour’s top priorities.
The real beauty of solving the capital cost equation is that it will now create a situation that seeks trade finance transaction growth. Instead of banks being selective when lending money under a trade finance arrangement, it will now seek to create new opportunities, confident in the new, now optimized, distribution market available to them.
Increasing Trade Finance Accessibility for Corporates
Increasing the flow capital will help create more opportunities for corporates to access trade finance, but they must want to use trade finance products to begin with. There are several good reasons corporates prefer trade finance solutions over typical working capital facilities such as a line of credit, but there are also many reasons they will not.
Trade finance loans have many unique characteristics. The use of funds is controlled, repayment is from a known source, and the tenor is short and tied to the working capital cycle of the borrower. This structure can allow for growth and higher limits than a general facility, which can be very helpful to growing corporates looking to take advantage of new business opportunities.
But there is a problem with having so much structure for both lender and borrower – the transaction can require several rounds of communication, and the transaction must be evidenced. This is where paper enters the equation as the global standard of trusted data transfer. Because paper is not going to go away anytime soon, trade finance suddenly becomes less attractive for both borrower and lender due to the cost and administrative associated with these transactions.
Beyond higher limits, certain trade finance products also offer risk protections to corporates that are more difficult to replace. For example, a letter of credit allows the buyer to give their supplier the comfort of assured payment from their bank in return for shipping the goods they want accompanying by compliant documentation. In this case the amount of communication required, and paperwork expands tremendously, further reducing the attractiveness of the product and the willingness for banks to offer them for smaller transaction values.
This creates a challenging environment with a complicated and difficult to learn product for corporates combined with a banking community hesitant to provide complex and process intensive products for smaller transactions.
There are banks who specialize in SME growth companies, but these are often local banks who struggle to maintain risk relationships with larger banks in more established markets their clients are trying to access. This is where our first goal – increasing the flow of capital to trade can help.
To solve the issue of a complex product, we believe that Contour can significantly simplify the letter of credit solution and turn it into a low-cost, intuitive solution for the first time. Using digital documents, templates, workflows rather than messages, and on-screen tool tips, we think we can make the letter of credit the payment method of choice for growing corporates around the world.
This is where increased accessibility starts to the meet with the increased capital for trade finance, driving a virtuous cycle not only for the trade finance industry, but for the world.
These are our goals for 2023. What are yours?