Reimagining trade finance for the digital era

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Trade finance is the backbone of the global economy, yet the ecosystem remains constrained by capital requirements, outdated processes and a lack of standardisation. Christoph Gugelmann, CEO at Tradeteq, discusses how greater collaboration is leading to new approaches.

Recent events have highlighted recurring barriers to international trade: supply chain fragility, access to funding for SMEs and the lack of interoperability. A report from McKinsey and the International Chamber of Commerce calls out these issues and argues the need for greater digitalisation, the adoption of international standards and new approaches for banks and exporters.

The global trade finance gap – the shortfall between banks’ ability to lend and businesses’ funding needs – stands at $1.7 trillion, according to the Asian Development Bank, leaving many businesses without adequate financing. Meanwhile, the microchip shortage and energy crisis have global consequences and are reminders of how important it is for banks, factoring companies and businesses to be able to monitor and react to volatility.

The problem with solving these issues is that trade finance, as an industry, relies on decades-old processes – many of which are still paper-based. Without the right technology, banks struggle to increase lending amidst greater capital constraints and lack insights to make more informed decisions around credit. Automation and digitisation have become the norm across many industries and, after years of being left behind, trade finance is stepping onto a similar path.

The key to improving the global trade engine is to adopt and utilise new technology and incorporate modern infrastructure which enables more automation, less friction and reduced costs. This approach is already leading to widespread change – but it is just the beginning.

The technology and infrastructure needed to parcel trade finance instruments into investable assets which helps solve the trade finance gap now exists. Also, modern AI tools can give firms early warning signs of supply chain issues before they’re directly affected.

Increasing banks’ ability to lend

Many businesses struggle to secure trade financing from banks and the problem is banks are having to do more with less in the face of capital constraints. Regulation is a major contributing factor – particularly Basel III, which requires banks to put aside more capital when lending.

As a result, global banks active in trade finance have had to raise capital requirements and reduce their standardised risk weights. With Basel IV on the horizon, the problem is set to get worse.

A large part of the trade finance gap results from SMEs in emerging markets, so it will be difficult to address through additional lending or credit. An alternative strategy banks are adopting is the distribution of trade finance instruments to other banks and the capital markets.

They recognise that by adopting an originate and distribute model for their trade books, they can open up additional sources of funding. This benefits not only the banks but also their investors and the businesses and communities that depend on trade finance.

It used to be that a vital missing ingredient was the electronic trading infrastructure. However, in recent years, technology has opened the door to this huge market, enabling assets to be bought and sold through private distribution networks and settled like common fixed income products.

Adopting AI to tackle supply chain volatility

Numerous systems today enable businesses to track how consumers engage with them, send payments to counterparties and communicate with people all across the world. Similar approaches are also helping trade finance banks monitor risks in the supply chain more effectively.

The answer lies in the adoption of artificial intelligence – a technology that has made significant advances over the past decade.

For investors and sellers of risk, including banks and factoring companies, it holds the potential to help identify and monitor risks in the supply chain before they become a systemic issue.

If, for example, a supplier has a cash flow problem, unexpected weather patterns affect a supplier’s ability to manufacture a product, or an incident takes place that affects multiple companies with a similar size and profile… firms can receive an early-warning sign to investigate what happened, how it might affect them and parties across the trade finance chain and respond quickly.

This ensures they are staying ahead of potential risks and systemic events, rather than reacting to them. Crucially, it is an example of technology making the global trade and supply chain ecosystem more responsive, agile and efficient.

Banks can also use AI-powered analytics to assess the riskiness of clients, vendors and individual transactions – all of which can suffer from the knock-on effects of supply chain disruption. Banks can begin to do this with entirely new levels of granular insight and accuracy. In many cases, this can open the door to new financing opportunities for businesses that would have otherwise been overlooked using traditional methods.

AI helps by creating more accurate credit scoring models that offer deeper levels of analysis. This can include a company’s payment history, measurement of the risks of funding a specific transaction when dealing with different counterparties, and identification of specific supply chain risks – then benchmarking them against their peer group.

The future of trade finance

Modern approaches such as these are fast becoming a reality, allowing banks to not only replace outdated systems but also reimagine what is possible.

As a result, they can work their balance sheets harder, manage risk while increasing funding and adhere to international regulatory frameworks.

None of this is possible without collaboration.

The reason solutions have emerged is because banks, investors and fintechs have worked together to accelerate innovation – and this approach will prove to be the key to unlock the smooth running and growth of global trade.

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