While blockchain is already being used by many industries ranging from manufacturing, healthcare to real estate, or government application, one of the main industries that can benefit from this technology is trade finance. In this article, we will learn about trade finance, inefficiencies within the trade finance industry, and how utilizing blockchain can benefit trade finance.
Here are the primary benefits of utilizing Blockchain in trade finance:
What is Trade Finance?
To those people who do not belong to the financial domain, the term Trade Finance will be a new term for them. I will try to explain it in the simplest form. Trade Finance in its simplest form can be seen as the financial transactions of both domestic and international trade that take place between a seller and a buyer facilitated by intermediaries such as banks and financial institutions. These trade finance transactions generally include lending, issuing letters of credit, factoring, export credit, and insurance. 80–90% of ongoing trade between various countries depends on trade finance and thus these transactions make up an enormous portion of global trade. Whenever there is an import or export of goods among borders there is trade finance involved. It involves a vast number of activities and also faces many difficulties. One of the major issues that are involved with trade finance transactions is to deal with a large volume of paper documents. Dealing with these documents creates an even more complex trade network.
How does Current Trade Finance function?
Trade finance could be understood by the following example. Let’s assume that there is a company named MHW in India and this company wants to import a certain number of goods from a supplier company that is located in the United States. Let’s name this supplier company as SSI. Now to import the goods the company MHW needs to pay for the goods, but it wants to make sure that the goods should arrive as ordered and thus is hesitating in processing the payment. Now on the same hand, the exporter is also hesitant to ship the goods, without being certain that the payment will arrive for the goods they supply.
Now at this step, the banks get involved to solve the issues faced by the importer and exporter company. The importer’s bank issues a letter of credit to the exporter via the exporter’s bank and promises to pay the required amount once the exporter bank provides the valid documents proving the ordered goods have been loaded to the ship or any other means of transport. Thus the involved banks ensure that the trust is being built between the importer and exporter parties by holding the money for each party.
Challenges in current Trade Finance Process
The above process is going on for over a hundred years which involves a vast amount of physical paperwork. The systems currently used by banks and their corporate clients to manage trade transactions is highly manual, causing a lack of visibility, and overhead costs.
- UNSTRUCTURED DATA – All the Trade Documents consist of enormous data sets which are unstructured.
- VOLUME OF PHYSICAL DOCUMENTS – 400 to 500 transactions per day with each containing 20 sub documents
- LARGE COMPLIANCE CHECKS – On an Average 32 compliance checks existing in multiple documents
- ERODING MANUAL ACCURACY – Steady rise in volume of errors leading to poor risk compliance
Blockchain technology in Trade Finance
Blockchain Trade Finance Procedure:
- Receiving and classification of trade documents
- Extraction of data from the recorded documents
- Generation of valid reports for cross-documentation and transactions
- Automatically validating the data between documents and generated reports is done
- Document scrutiny is performed adhering to various rules and regulations
Benefits of Blockchain in Trade Finance
The key benefits of blockchain technology in trade finance is that it can reduce processing time, eliminate the use of paper, and save money while ensuring transparency, security, and trust. Removing intermediaries from the process removes the risk of manipulation by the participants in the process.
Here are some major points demonstrating the advantages of blockchain in trade finance:
Efficiency: Blockchain technology makes the trade finance process more efficient by completing the transactions directly between the relevant parties with no intermediary and with digitized information. With blockchain, the parties can operate smart contracts that trigger commercial actions automatically. This allows to dramatically streamline trade finance processes, thereby cutting costs and increasing the transaction speed.
Traceability: With blockchain technology, the importers and exporters can track goods and assets and where they are currently residing. Also, related asset information can be received from the previous and pass on to the new owner for possible action. This allows new financing opportunities and can improve the perfection of an interest in the trading of goods. This is considered one of the main benefits of blockchain in trade finance.
Transparency: Blockchain, being a distributed ledger technology can record multiple details of the transactions against commercial agreements and can distribute the data to improve further trust. This allows reducing the risk of tampering the records and offers more options for financing trade.
Auditability: Utilising Blockchain each trade finance transaction can be recorded sequentially and indefinitely. This provides a lasting audit trail for the life of the traded asset as well as better verification of assets authenticity with a reduction of compliance costs.
Security: Each transaction within the trade network is verified using independently verified cryptography. The encryption and cryptographically protected keys securely transmit data between different financial institutions and thus privatize the data.