Trade Finance has been a well established and important business for Banks and Financial Institutions. Hardly any domestic or international Trade activity can take place safely and successfully without some form of trade financing, in fact as much as 80% of annual global merchandise trade is enabled through some form of trade financing. This financing can range from traditional instruments like Letters of Credit, Bank Guarantees to a more contemporary form of open account based supply chain financing.
In an ideal world, banks would have mastered the art of running their Trade business successfully over donkey’s years but due to volatility in global economy, market conditions, changing customer expectations, Fintech disruptions, risks and more stringent compliance issues; it has not been an easy ride.
Cost, Revenue, Return on Equity (ROE), Risk and Compliance are key aspects of any business irrespective of its nature and size and the same holds true for Trade Finance as well. In order to run a business successfully one needs to bring down costs, increase revenue, mitigate risk and improve compliance. These are like four sides of a square and although they look mutually exclusive but they are very much dependent on each other. It’s a classic Catch22 situation where you cannot increase your revenue unless you focus on bringing down your costs.
Key stakeholders in a bank have always been plagued with their own set of role based challenges. Here are the 4 Strategic questions that should be asked if the bank is looking to transform itself into a leader in the Trade Finance business
- How can the COO minimize operational Cost, automate and improve productivity?
The main challenge faced by a COO typically is high transaction cost due to manual processes and lack of visibility. Bringing down cost is one of the biggest drivers for banks and financial institutions to look for technical advancements and automations in the Financial Supply Chain. And with Trade being very document intensive, these advancements need to happen in multiple areas of Transaction process automation, digitization using MT798 (SCORE), Bank payment obligation (BPO), e-Bill of Lading, Imaging solutions like OCR/ICR etc. The elimination of paper from trade finance transaction processing could increase throughput per transaction and process automation could potentially reduce compliance costs by 30% or more. Due to proven success, digitization is one of the top strategic focus areas for banks globally over the next 1-2 years. There are other areas of supply chain disruption such as smart contracts and blockchain which some of the global banks are now exploring but before investing in any of these technologies, a cost to income analysis needs to be done carefully.
- How can a Product Head Innovate, increase Revenue and yet get a shorter Time to Market?
Single solution supporting domestic and international business of customers, lack of configurability to offer new products and cross-sell opportunities are pain areas for a Product Head.
Over the last two year, globally we have seen a drop in revenues from trade finance from USD 41 billion to USD 36 billion. Banks not only need to look at ways of driving deeper wallet share of the large corporate client’s business but also look to grow its business from MSMEs and SMEs. With these falling revenues the focus is shifting from traditional Trade Finance products like Letters of Credit, Guarantees to simpler and cheaper open account based financing products. Today more than 80% of the Trade finance is done using open account and this number on the rise. Solutions like dynamic discounting offer new revenue streams for banks without putting risks on their balance sheets. Key would be to launch these products as soon as possible. It is important therefore that the technology solution that drives the entire business can cater to domestic and international business of customers and also ensures that there is the provision to configure on-demand solutions. The flexibility to package newer rules to scale to ever changing compliance guidelines and processes to deal with newer emerging segments and dynamic pricing is imperative.
- How can a CEO look to improve Return on Equity?
The CEO is always on the lookout for promoting capital light models that support originate-to-distribute strategies. With the advent of supply chain finance as banks move farther away from traditional trade, the biggest need of the hour becomes converging the cash and trade businesses to meet the needs of the end customer.
Trade Finance products are usually characterized by short average maturities and this has triggered risk-underwriting firms like insurance companies getting involved more in these transactions to mitigate risk. An ability to distribute risk across insurance companies and participating banks/investors will not only reduce risk for banks but also enable them to get more business from clients and hence more revenue. Banks need a strategy to move from “Book & Hold” to “Originate & Distribute” model by distributing the risk using one or more risk mitigating tools like funded/unfunded participation, syndication or insurance with capabilities of monitoring risks and handle NPAs by aggregating customer’s financial obligation data across multiple systems.
- How can a Risk Officer mitigate Risk and ensure full Compliance to regulations with minimal cost?
A recent ICC survey lists down top factors affecting Trade business of Banks and also reflects changes in Trade revenue in the year 2016 and it’s important to notice that compliance, risk and falling revenues are seen as major challenges by Trade banks.
As regulations around cross-border transactions continue to increase, compliance costs continue to spiral upwards. Banks adapt to comply with a growing and changing set of regulations covering sanctions, trade based money laundering (TBML) and non compliant banks risk incurring heavy costs. From 2007 to 2014, fines imposed on US and European financial firms grew from $30 million to $58 billion.
The need for a 360 degree view of risk portfolio and ability to monitor exposure across clients, countries, currencies, sectors, insurance companies has emerged as one of the key asks of the Risk Officer.
Banks and Financial Institutions need to invest in technology that can encompass data analytics capabilities to provide banks with a holistic view of customer portfolio and allow them to monitor risks across various risk attributes. Automating of due diligence workflows with help of natural language processing (NLP) and Artificial Intelligence (AI) based solutions is another major leap towards bringing the cost of compliance checks down. There are companies focused on simplifying compliance and TBML processes using AI, NLP and Big Data analytics and are invaluable additions to the financial ecosystem.
Banks looking to lead the race need to be prudent and invest in the right technology and partnerships while tuning their existing processes to maximum efficiency and evaluating newer revenue generating models. For both, global banks looking to enhance their global footprint and regional banks fending off the larger global players in local markets it is important that their strategy is charted aligning closely to the bank’s larger digital investments. Digitizing Trade process is not a silver bullet to solve all the problems discussed but it is certainly a significant step towards it.