Blockchain for Trade Finance
Is Your Bank Ready for Adoption?
Trade finance with its manual, cumbersome and often expensive processes, provides a major field for adopting emerging distributed ledger technologies (DLT). Not surprisingly this has led to various market initiatives and consortia over the last years. Yet, an early adoption of any of these concepts presents substantial operational and financial risks for any party involved. Therefore, banks must decide on a suitable adoption strategy for DLT, first.
Worldwide trade finance is a multi-billion-dollar market for banks and expected to grow steadily over the next years. However, procedures of executing open account and documentary trade finance transactions still involve long winding manual efforts and paper-based processes. Therefore, the trade finance market in particular qualifies for technological innovation, making its processes easier, faster and cheaper. It is currently evaluated whether the recent emergence of blockchain and distributed ledger technology (DLT) could lead to some pain relief and additional profits in the trade finance industry. This evaluation is undertaken by various consortia (joint programs of participants such as banks, exporters, importers, ports, shipping companies, etc.) along different parts of the trade value chain. Based on our market assessment, these consortia still operate in the experimental stage: First proof of concepts were presented in 2016 and 2017, initial pilot transactions have been successfully completed in 2018 and some consortia target a productive state as early as 2019. To attain a first mover advantage these consortia often race each other to reach the productive state as fast as possible, set standards for the industry, and position themselves as innovation leaders.
Market radar for trade finance consortia
With new projects being announced every month, the plethora of ongoing market initiatives is difficult to oversee. Hence, we have developed our market radar, it categorizes the most prominent trade financing initiatives with strong bank participation and compares them based on their product emphasis. The market radar features four consortia categories, focusing on:
- Open account trade finance (i.e. supply chain finance);
- A hybrid form / combination of both open account and documentary trade finance;
- The replication of traditional documentary trade finance;
- Structured finance and syndication.
The market radar compares its use cases along the expected transaction amounts (Figure 1 provides a high-level overview on the compared consortia.).
In terms of progress, we see some consortia with early success stories reported whereas others already appear to vanish. The overall outcome of the race to success is still open. Major investments by banks are still required in order to transform these concepts from first test transactions into production state and marketable offerings.
Challenges for banks
Besides the required technical development to make productive use of DLT for trade finance, banks face additional challenges in adapting the technology to their current business model.
At this level of maturity, the technology adoption requires high investments whereas it is yet unclear if such an adoption will solely lead to cost reduction or will also open up new sources of income. Only a solution that reaches a sufficient range and number of participants can replace the existing processes and procedures with the new technology.
Currently there is no standardized solution on the market, nor are the ongoing initiatives and platforms known to be in any way interoperable. . It is likely that the battle for first mover advantage will quickly result in first productive solutions, which may create a considerable network effect thus attracting numerous early adopters. With every additional network participant and successful executed trade on a DLT solution the respective consortium may strive for becoming the new industry standard.
While a high degree of standardization of the trade finance sector is desired by end customers, it comes with various disadvantages for some of the service providing banks. With greater transparency of the services provided and fewer opportunities for differentiation (e.g. correspondent banking coverage, service levels, handling speed etc.), competition could be driven solely by price, which could ultimately drive some banks out of the trade finance market.
Furthermore, as DLT are not yet part of the daily business of bank’s trade finance departments it will be a challenge for the employees to get involved in such a new initiative next to their daily tasks. Even in technologically advanced banks, DLT topics are often driven by the more tech savvy innovation and IT teams. In many cases fueled by innovation hype, marketing opportunities or simple fear of missing out. Trade finance teams often face other and more immediate challenges such as increased regulation, cost saving targets and a growing competitive landscape. On top of that, it is very time consuming for banks to acquire the required knowledge about DLT to proactively participate in the definition of future industry standards.
Banks therefore need to develop strategies on how to deal with this growing trend.
Adoption approaches for banks
We have identified the following strategies:
1. Wait & ignore
This strategy simply ignores all efforts in DLT for trade finance. Banks stick to their current business model and wait without joining any consortium that develops a DLT based solution. While this is certainly the cheapest of the identified strategies, it misses out on any opportunity to ramp-up the bank’s knowledge and skill on this topic and access gains from new technology adoption.
2. Wait & actively observe
In this case banks do not join a consortium due to the challenges discussed. Yet they actively observe the market to keep abreast of current developments in this field and to become one of the early movers. Thus, they can detect additional successful test transactions or production announcements at an early stage. Moreover, direct activities of competitors are monitored in order to not fall behind in competition whenever the other banks move towards DLT adoption. While this strategy involves minimal efforts, it also lacks on the build-up of internal know-how and makes implementation difficult, while benefits of an early adoption should remain.
3. Join & contribute
The third strategic option advises banks to join an existing consortium. By evaluating in advance which consortium is developing a relevant use case, the strategic fit of consortium and bank, the expected benefits for the bank and the value that a bank can add to the consortium, banks thoroughly assess their strategic roadmap to DLT adoption. This strategy demands banks to actively invest and participate in testing the new technology and defining future business models as well as industry standards.
4. Create & lead
Last but not least, we see a strategic option for banks to create their own consortium, find players along their value chain, secure a technology provider and partner with their most important clients of their trade finance business. By leading this initiative and participating in the race to build a new solution, they might become the future industry standard. This option is surely the most costly and risky one, but offers banks the greatest potential for exploiting and defining new business opportunities.
Finding the right approach
Banks need to asses which of the proposed strategic options are best suited to their situation and risk appetite. The assessment must take the bank’s own growth strategy into account as well as customer requirements, product range and international presence. Please refer to figure 2 for other advantages and disadvantages of the discussed approaches.
The assessment criteria are:
- Required attention (from the bank and their employees);
- Required effort (costs and FTE);
- Opportunities (potentially emerging out of the initiative);
- Risk (e.g. client, market; associated with choosing the option).
Conclusion & recommendation
Banks are required to assess their current situation along with their view on DLT and blockchain potential and strategic fit for adopting this technology. Banks should create scenarios to start an ideation process of possible outcomes and impact of the new technology on their operating model. As a basis for a profound ideation phase we recommend an initial enablement and education session to develop DLT and consortia know-how within the organization.
Please get in touch with us to discuss the right approach for your organization.