The Trade Finance business is a critical segment of the banking sector, with revenues expected to reach ~US$48 billion by 2021 per the ICC 2018 report. It is one of the most complex businesses, involving as many as 12 parties in a simple transaction to as many as 31 parties in a complex transaction. The processing of business transactions for Trade Finance are manual, paper-based and labor-intensive, contributing to low margins for a bank vis-à-vis other businesses. In order to overcome these shortcomings and tap into the full revenue potential, banks must identify digitization opportunities in the end-to-end Trade Finance value chain.
A key question that needs to be answered in the long run is – How can banks remain competitive and profitable while preparing themselves for the digital journey? While there are no simple answers, modernization of Trade Finance could be the remedy to help banks address these challenges, which fall into three broad categories:
1. Systemic challenges
Non-integrated platforms across all parties involved in the transaction create systemic challenges for the Trade Finance business. These challenges are further accentuated by different reporting structures across nations due to varying regulatory frameworks. The banking sector is required to have updated systems and control frameworks to comply with regulations related to Know Your Customer (KYC) and Anti-Money-Laundering (AML) in the prevention of terrorist financing. Diverse and frequent changes in regulatory frameworks add to the challenges as banks engage in transformation programs to digitize, revamp, and grow their Trade Finance business.
2. Rapidly evolving ecosystem
The advent of new-age banks and technologically advanced non-financial services firms has changed the operating landscape in the Trade Finance business. Trade Finance offerings from these players have opened new avenues for small and mid-sized businesses (SMBs) seeking services and funding options. These firms, built on flexible and cloud-native platforms, react faster to changes than incumbents and are capable of offering new products and services at a greater speed without compromising the customer experience.
3. Operational challenges
Trade Finance products entail complex processes that involve multiple parties across the value chain. Most lenders and borrowers use physical documents to manage these transactions, resulting in operational inefficiencies and increasing the chance of errors. Ultimately, this leads to transactional delays. In addition, other challenges such as rising labor costs from high turnover, storage costs in handling physical documents, and increased employee training costs due to poor knowledge transfer are leading to a rise in the cost per transaction.
These challenges have directly impacted incumbents’ Trade Finance business. Banks need to plan and prioritize their Trade Finance modernization to mitigate the challenges and capitalize on the benefits from untapped business opportunities.
Wipro’s ACT Framework to Modernize Digital Trade Finance
Wipro’s ACT Framework can guide banks as they embark upon their modernization journey and invest resources to develop digital capabilities. This framework provides a layered approach to modernization built on three key pillars: Automation, Collaboration, and Transformation.
Automate for efficiencies
The first pillar deals with the automation of Trade Finance processes that are fully controlled by banks and have little or no dependencies on other parties. Automation brings efficiencies through multiple levers, including elimination and reduction of errors and mistakes, personalization of real-time information, increased potential for borderless operations, and deeper data insights.
In a typical traditional Trade Finance process cycle, most tasks in “Customer onboarding” through the “Document management and Reporting” phases fall within the “Automation” scope, as they are completed within the walls of the bank or involve limited client interaction (through channels like branches, internet, mobile or direct host-to-host ERP connectivity).
Customer onboarding touches multiple teams within the bank such as front office, operations, risk, legal, and compliance. The process is repetitive and time-consuming, sometimes taking up to 12 weeks. While clients get frustrated from delays in processing, such processes are not devoid of gaps, leading to breaches and regulatory violations for banks. During the time period between 2008 to 2020, global financial institutions incurred fines of approximately US$26 billion collectively for not complying with AML and KYC sanctions.
Banks also incur costs from documenting and storing physical paper-based documents. In addition to literal costs, there’s also the risk of losing documents or someone committing fraud by tampering, especially if a transaction is spread across multiple years or even decades.
These issues drive the need for automation in onboarding as well as document management and reporting activities in Trade Finance. Some ways in which banks can automate different activities in these processes and the associated technology are presented below:
In choosing the processes to automate, banks should start with client-facing activities (document handling, service enquiries, etc.) before more complex internal processes like due diligence and compliance checks. This strategy improves retention led by better customer experience and thus better revenues. A recent Deloitte study highlighted that a typical bank could realize cost savings of 30-50% just by automating their client onboarding process in a commercial banking value chain.
Collaborate with the ecosystem
The collaboration pillar of Wipro’s ACT framework goes beyond the processes executed within the walls of the bank. This pillar focuses on two main areas:
The intent is to help banks leverage mutual dependencies across the extended ecosystem and promote adoption of digital capabilities, with an emphasis on establishing STP outside of the bank’s environment. This requires an increased collaboration with a number of external parties as banks aim to establish end-to-end automation of processes and systems. Processing Letters of Credit (LC), bills, commissions and charges, tracking status of LCs and Guarantees, and managing related communication with customers are a few use cases that benefit from STP. Many leading banks have already perfected this approach in Trade Finance. For instance, a large U.S. bank implemented sophisticated STP for supplier finance and receivables purchase programs.
STP has evolved more from an incremental feature to a “must-have” capability among global banks. The recent transition in Trade Finance operations where clients request real-time processing and the introduction of real-time instruments including instant/real-time payments has accelerated the need for STP. Any human intervention in such operations introduces risks and costs that prevent banks from meeting their clients’ expectations. On the other hand, banks should also ensure that STP happens with limited supervision and activities. They should incorporate review mechanisms as part of the STP procedure to counter all possible risks and ensure compliance.
APIs enable the seamless and secure exchange of data and information with third parties. This further allows third parties to plug-in to new products and applications. In Trade Finance, APIs have allowed partner banks to create interfaces for clients with useful features such as providing the status of various products based on the parent banks’ network capabilities and data. In the UK, one large bank has been a pioneer in this area and developed APIs to allow clients to view the status of their bank guarantees in real-time. In addition to providing greater transparency, APIs also enable banks to deploy more sophisticated data analytics technologies that can address risk and allow for more affordable, lower-value trade financing deals, thus broadening Trade Finance services to smaller corporates and companies.
APIs also help banks in overcoming their challenges related to legacy and rigid backend systems that may inhibit them from providing state-of-the-art features for their corporate customers. Similarly, any updates to existing products and/or services can be introduced to the clients at a fraction of the cost and time it would take compared to using a siloed and legacy infrastructure.
As collaboration will introduce other parties into the transactions, participating banks can ensure security for the data shared in such integrations by implementing single policy enforcement points that will help guarantee information security and centralize the access of APIs across different systems. This will allow banks to mitigate fraud risk and enforce segregation of duties with the ability to access and review data between multiple systems.
Transform for the future
The final pillar prepares banks for changes in both the near and long term. Like the Collaborate pillar, such changes are driven by sector-related factors like structural changes and evolving industry standards that may transform the future landscape of the Trade Finance business. Banks need to closely monitor these developments and gradually embrace new technologies to be better prepared for this changing future. Some of these disruptive technologies include Artificial Intelligence, Blockchain, Internet of Things (IoT), and Machine Learning. These technologies will help banks prepare for the new future of Trade Finance that will move from a vertically integrated model (bank owns the entire end-to-end value chain) to a distributed model.
The future of Trade Finance will enable seamless connectivity and real-time exchange of data among all parties to the trade transaction. Blockchain, in particular, offers immense potential for dematerialization, efficiency, speed, and lower costs. A future digital ecosystem, leveraging Blockchain and other emerging technologies like IoT, will eliminate the need for manual processes, duplication, and other paper trails. Smart contracts based on Distributed Ledger Technology (DLT) are immutable and provide a single record. The movement and availability of real-time data provides the added advantages of reducing fraud and reconciliation issues. Leveraging blockchain further enables a significant reduction in the time required to process a transaction as data can be traced and modified through multi-signatory mechanisms. The real-time settlements and reporting characteristics are expected to reduce costs.
Moreover, integration of IoT can enable real-time shipment tracking and allow instant payments and release of invoices in open account trade transactions. These technologies will also prevent duplication of financing while strengthening the credit quality of borrowers. Integrating these technologies into a single platform can serve as an ecosystem that seamlessly connects trade parties across the physical and financial supply chains. The future state of Trade Finance aims to bring harmonization, process simplification, real-time data exchange, reduced costs, and enhanced security to reduce fraud.
These movements require time and capital investments, compelling most banks to invest in these technologies under lab-led innovations or through consortiums and industrial entities. We.Trade, Marco Polo, Voltron, Komgo and Hong Kong Trade Finance Platform are a few well-known examples of such consortia on emerging technologies. While such organizations are promising, integrating banks across different countries in a single platform requires time, supporting the notion that banks will gradually adopt such technologies.
The Trade Finance business is undergoing structural changes due to emerging marketplaces and new-age technologies. Banks continue to struggle to digitize their Trade Finance business in an effort to reduce the role of manual processes, yet many are considering modernizing their Trade Finance business to bring efficiencies and reduce complexity. As they work in emerging digital ecosystems to seamlessly connect parties and facilitate real-time data, financial institutions can leverage Wipro’s ACT framework to plan and prioritize the modernization of their Trade Finance business.
Global Consulting Partner - BFSI, Wipro
Kapil has over 24 years of experience as a banker and IT consultant focusing on IT solutions, IT strategy, Operations Management, Business Transformation, and Process & Performance management within retail and corporate banking. He can be reached at email@example.com
Kedar Nerurkar, Jack Leach, Shri Dhar and Balakumar Rengaswamy