Opening up Access to Trade Finance

By Joshua Kroeker, Chief Product Officer, Mitigram

The author William Gibson once famously said, “the future is already here – it’s just not evenly distributed.” This phrase effectively encapsulates the trade finance sector, and sits at the heart of the trade finance gap.

Everyone is well aware of the headline figure: the trade finance gap has risen to $2.5 trillion and is expected to widen further. A healthy world is a world with trade, and a healthy trading ecosystem requires easily accessible trade finance. Unfortunately, this isn’t the case today, especially with the more traditional products that benefit growing corporates and SME’s the most.

Joshua Kroeker
Chief Product Officer, Mitigram

We’re facing a dilemma as banks struggle with the cost of providing traditional trade finance, and corporates then struggle to access trade finance at a reasonable cost if at all. Digitalisation and technological innovations in the sector can certainly improve the situation, but this potential has yet to be realised.

Rethinking a costly exercise

The problem really comes down to the value of a trade. If most of the cost of a trade finance transaction is administrative, then a bank only wants to do high value deals. Low value transactions are no longer attractive and get shelved.

The other cost facing banks is capital. The capital associated with trade finance is usually dictated by the Basel Framework, and even though trade finance transactions are short-term, self-liquidating, and backed by some form of collateral, the data simply isn’t there to give capital relief to banks.

Beyond inflexible lending criteria and capital requirements, there are other factors at play. For example, there is often a lack of counterparties to facilitate trade due to correspondent banks pulling back from developing markets they deem risky, as well as the increasing costs of KYC, AML, and compliance with complex cross-border regulations. Often, the deals are simply not profitable enough.

Digitalisation is a great way to lower the cost of administration whilst providing the data needed to get that capital relief. But digitalising trade finance is incredibly hard to do. It’s estimated only 2% of traditional trade transactions are currently done digitally, and that trade finance generates around four billion paper documents per year, which is of course costly financially but also in environmental terms.

It’s thought that solving the trade finance conundrum will require at least $1 billion spend on trade technology, which looks daunting in a fragmented industry with a lack of interoperability. I’ve worked at banks, and within consortiums of banks, keen to solve this problem, so it isn’t for a lack of trying – we just need new ways of thinking.

Carpe Digitalisation

First, we need to expand the finance pool. The more lenders in the space, the more chance we have of closing the gap. It’s time to challenge the traditional bank/corporate relationship; in fact, we need to disintermediate it and encourage more platform-first interactions. I would like more corporates to be able to go to a trade finance marketplace, upload their track record, KYC details and so on, and then see who’s interested in providing them finance – whether it’s a bank, alternative lender or an investment fund. Trade finance is at its heart transactional finance, but many still treat it as a relationship driven business, limiting access to smaller and less frequent traders.

Secondly, we must connect the dots better. It’s a real challenge finding out what banks will actually deal with each other. If I’m using a local bank, how do I find out which banks in my customer’s country will accept their risk? It’s often impossible, so we need to use technology to create a route finder to identify what lenders can support a deal, and what the cost is. A Google Maps for trade finance.

Now for the big one, which brings everything together. Digital assets.

Financing trade often means financing real-world assets. If we digitise these assets, such as warehouse receipts or bills of lading, it gives lenders the ability to manage risk effectively, reducing capital costs and creating more flexible products. That will open up a lot of new finance. Digital assets can also create new financial obligations – like a digital bill of exchange – opening up new finance products and flexibility to make deals happen.

The good news is digital documents are coming, but there are a few hurdles to clear before we’re able to dematerialise all documents.

First, we need better trade finance software for corporate professionals that moves past Excel and Outlook, and these solutions need to be interoperable so we can move towards standardised data and documents. This is where the work of the ICC Digital Standards Initiative (DSI) will be critical in establishing a globally harmonised digital trade environment.

We will then need to integrate these solutions with the rest of the trade finance ecosystem. It’s not just banks, corporates, and alternative lenders – there’s shipping companies, ports, and insurers to name just a few. We have to connect all parties, and then digital documents can flow through seamlessly, finally reducing the trade finance gap.