Trade finance is an important business for the banking industry, but a number of factors—including digital innovation, changes in corporate behavior and the threat of new competitors—are forcing banks to reconsider their approach. Edle Everaert examines how the landscape is shifting and what steps banks can take to maintain their competitive edge.
What makes trade finance so attractive right now?
As global trade grows, so does the market for trade finance. With the exception of a brief period in 2008, we’ve seen double-digit growth in the global trade of goods stretching all the way back to the early 2000s. Emerging markets, particularly those in Asia, are leading the way. In 2015, this region of the world accounted for roughly 25 percent of the total value of global exports. By 2030, the Asian Development Bank believes that figure could reach 40 percent.
Add to that the cross-sell opportunities that the trade finance business offers, its potential to develop lasting and sticky client relationships and the continued interest of global, regional and local banks, and its attractiveness is easily understood.
What makes trade finance so important for banks?
Banks have a stake in trade finance. The banking industry has played an important role in cross-border trade for years, providing payment execution, risk mitigation and financing and working capital services to internationally active corporates. As a result, banks have a key eye on defending this recurring and relatively secure source of revenue.
Not only are default rates in trade finance up to 10 times lower than in traditional corporate lending, but the cross-selling potential is immense. Trade finance fees can lead to foreign exchange and cross-border payment fees, which can lead to other transaction fees. Before you know it, $1 worth of trade finance has tripled or even quadrupled in value.
How is trade finance changing?
As businesses have become more familiar with cross-border trade and more comfortable with their partners, their interest in the risk-hedging services of banks has declined. High fees, time delays and process complexity are common deterrents, driving corporations to become increasingly selective in how and when they use traditional, bank-intermediated trade finance instruments. Open-account transactions are growing in popularity, accounting for 80 percent of the total number of transactions, and between 35 percent and 45 percent of the total value of all transactions. The obvious drawback of open-account transactions—to reduce access to bank financing—is triggering a quest for banks to develop new attractive trade finance services.
As cross-border trade matures and the trade cycle lengthens, businesses are increasingly dependent on—and vulnerable to—their global supply chains. Big players are beginning to look seriously at the health of the entire supply chain. This is adding to the demand for new trade finance services, moving towards programs that can meet the finance and payment needs not only of the large companies at the heart of large supply chains, but also of its up- and downstream buyers and suppliers.
How is digital innovation affecting trade finance?
Interactions between businesses and banks, including trade finance activities, are increasingly occurring through digital channels. Clients want access not only to basic transaction services, but also reporting, forecasting and simulation services. Some banks continue to invest in proprietary solutions, while others are turning to independent platforms offered by software vendors, such as portals and many-to-many host-to-host connections.
At the same time, the emergence of market standards for the electronic exchange of open-account transaction data offers a means to replace paper documents by digital data. The result? A reduction in the cost and time required to handle trade finance products, and an opportunity for banks to provide new services like purchase order and invoice matching.
Is there competition for the trade finance market?
Today, large global banks account for between one-quarter and one-third of bank-intermediated trade finance. As they look to expand into emerging markets, however, they’re finding strong competition from local and regional banks. These smaller players have deep, established relationships and a solid understanding of the local market that can be difficult to match.
Non-bank players still hold a relatively small share of the pie, but are increasingly finding success by focusing on niche markets—like trade finance for commodities, and small and medium-size enterprises (SMEs)—and by strongly building on technology innovation. The emergence of blockchain technology might be their next move.
How can banks maintain their edge?
By innovating and at the same time becoming more efficient.
As part of the innovation agenda, banks need to develop sophisticated online channels. Secondly, they must consider expanding their product lines to include supply chain offerings, such as financing, payment and liquidity management services. Finally, as new products emerge and traditional instruments face commoditization, banks must explore ways to streamline delivery, including new platforms, automation and outsourcing.
The race for efficiency is one of volumes, standardization and automation. Typical levers like process reengineering and platform replacement hold strong, while robotics is showing strong potential for fast efficiency gains.
Trade finance isn’t standing still, so banks can’t afford to either.