De-risking and its implications on trade finance in Asia Pacific
By Clement Hu
De-risking has proved to be more than the exiting of businesses for Asia Pacific’s trade finance industry. A strategic shift is underway which might just change the nature of trade finance for years to come.
- Fraud, illicit money laundering activities, and stringent compliance requirements are some factors forcing global banks to pull back from Asia Pacific.
- Regional banks have stepped up to fill the gap brought by de-risking although they still lack cross-border coverage and capabilities.
- Increasingly, trade finance businesses are pivoting towards an ecosystem-based supply chain finance, digitisation, and distributed ledger technologies to help ease risk and cost pressures.
Trade growth has traditionally outpaced gross domestic product (GDP) growth, but in recent years, this pace has not been sustained. Global trade growth slowed to 2.8% in 2015, and is expected to slow further in 2016 as China’s slowdown deepens and commodity prices remain in the doldrums. The current antiglobalisation mood, reflected in the UK’s surprise Brexit vote and rise of pro-nationalist leaders such as Donald Trump, is expected to make matters worse.
This decrease in demand clashes with the rapid build-up in trade finance capacity over the past decade. Banks have long depended on trade finance as a recurring, low risk and non capital intensive sourceof fee revenue. This excess in capacity led banks to compete on pricing and increase financing limits.
In recent years, the trade finance business has also been the target of fraud and illicit money laundering activities. A 2015 survey by the International Chamber of Commerce reported that almost 20% of banks saw an increase in trade finance related fraud. Regulators responded by introducing more stringent compliance requirements and imposing heavy fines on offenders. Banks have been fined billions of dollars for these compliance transgressions.
Unsurprisingly, these combined to tilt the cost-to-profit ratio against the banks, forcing many, especially the global players, to exit high risk relationships and markets, so called de-risking. However, de-risking in Asia Pacific carries a long tail of implications on how banks are approaching the trade finance business.
Implication 1 - Gaps to be filled
As global banks terminate correspondent relationships and exit businesses, coverage gaps emerged especially within the emerging arkets and the SME space. Domestic and regional banks, equipped with their superior local know-how, are fast expanding to capitalise on these opportunities, especially in the Philippines, India and Indonesia.
Domestic and regional banks that have stepped up have spent years beefing up their balance sheets and expanding their regional coverage. They also invested heavily in their compliance and risk management capabilities. All these allow them to provide services traditionally rendered by the global players. For these fast movers, business especially in cross-border transactions has been brisk with double digit growth.
A Taiwanese bank demonstrated capabilities on the level of international banks when it delivered a complex cross-border structured product. In this deal, they combined several trade instruments with insurance to mitigate risks and leveraged on their overseas platform to overcome regulatory restrictions for a foreign firm.
As a side note, rising trade finance losses, has resulted in the increased of trade finance insurance. This should result in greater partnership between insurers and banks in the trade business.
Nevertheless, a report by Asian Development Bank showed that the coverage remains flaky. The trade finance gap remains at an astonishing $1 trillion in Asia Pacific, with SMEs remaining the most underserved. On a brighter note, this suggests that there is ample room for the domestic players to expand.
Implication 2 - Pivoting towards supply chain finance (SCF)
Another trend that we are seeing is the pivot towards the relatively safer business of supply chain finance. The more robust balance sheets of the anchor clients allow banks to extend loans to the anchors’ distributers and suppliers on more secure terms. This also allows banks to tap on the underserved and yet ever-growing SME demand for financing. All in all, supply chain finance is estimated to grow by about 15% per annum for the next three years.
De-risking shaped much of the trade finance business in 2015/16
Figure 1. Emerging Key Themes in Trade Finance 2015/2016
Source: Asian Banker Research.
In preparation for this, various banks have overhauled their supply chain systems in recent years. Many domestic players now boast systems that have high level of automation, host-to-host connectivity and robust online capabilities. To minimise loan defaults and frauds, banks are rolling out paperless solutions that allow them to monitor the document and fund flows, ensuring the proper usage of financing. We are also seeing rising direct connectivity to port authorities that ensures physical goods are moving before financing flows.
Embracing ecosystem & partnership
A key SCF strategic differentiation that domestic banks adopted is the creation of specific programmes that encompass entire industrial ecosystems like ports and hospitals. A big national bank in Indonesia created a distributor financing programme for the telecommunication industry that encompasses the telcos, their distributers and even down to the distributers’ resellers. It improved on this by introducing a programme for the logistics industry where payments are made through cards, reducing the costs of handling cash and at the same time increasing transparency and accountability. Through these targeted programmes, the bank helped its clients grow their business volumes and improve their operational efficiency.
Additionally, there is a rise in partnership between global banks and their domestic peers. In this arrangement, global banks serve the large Multi-National Company (MNC) anchors, while directing their suppliers/distributers, usually the smaller SMEs, to the domestic banks. A lot of synergy is created as each party has a better understanding of their clients and supply chain linkages. However, this is still in the early stage as many domestic banks still lack strong credit programmes that will enable onboarding of pre-shipment finance to be conducted on a bigger scale. Moreover, they still need to gain a better understanding of the anchor clients’ business models and cycles.
Notably, a Malaysian bank went a step further by starting a partnership with business networks such as SAP Ariba to leverage on their existing ecosystem to provide SCF solutions.
Looking ahead, an international bank sees the potential for multi-bank syndicated programmes that are like syndicated loans, have one bank as the core platform provider and five or six banks coming in for funding.
The rise of digital solutions and blockchain
Heightened risk adversity also led banks to turn to digital solutions such as edocuments and even blockchain.
E-documents such as bank payment obligations (BPO) provide increased end-to-end visibility and reduce the risk of fraud. E-documents also provide more security given that every participant in the transaction chain can be determined and located.
Banks have also started exploring the use of distributed-ledger technology to replace paper invoices and create a common platform to identify transactions already financed by other banks.
Supported by the Infocomm Development Authority of Singapore (IDA), two groups of banks, DBS and Standard Chartered (SCB), and HSBC with Bank of America Merrill Lynch (BAML), have started separate initiatives to develop a blockchain based system. The DBS and SCB initiative, code-named TradeSafe, uses details of the invoice to generate a unique hash value to be stored on a ledger. Another bank that tries to register the same details will be informed, thus preventing multi-invoicing frauds while preserving confidentiality. The other initiative aims to automate and digitise the Letter of Credit process by storing it on a ledger and execute the related trade deal automatically using smart contracts.
Trade finance is a business that connects multiple parties beyond banks and their clients. These include shipping companies, customs authorities, inspection companies and more. For the solutions to take off, all related parties have to adopt common systems, processes and standards. Moreover, going completely digital requires significant system and infrastructure investments, which might further slow adoption. Support from government agencies such as IDA should smooth out this process and bring about better cross-industry collaboration.
2015 has been a terrible year for the trade finance business, and those hoping for a better 2016 have got their hopes dashed so far. With much of global trade impeded by ongoing market uncertainty, ‘de-risking’ is expected to stay. On the bright side, the digital revolution that has come with this shift can potentially lead to a safer and more efficient trade finance business.
http://www.thehindubusinessline.com/The Hindu Business Line
http://economictimes.indiatimes.com/The Economic Times
http://en.mehrnews.comMERH News Agency Iran
www.thesundaily.myThe Sun DailyMalaysia
http://www.thestar.com.my/The Star OnlineMalaysia
Fraud, illicit money laundering activities, and stringent compliance requirements are some factors forcing global banks to pull back from Asia Pacific, which is also called as de-risking.
Regional banks have stepped up to fill the gap brought by de-risking although they still lack cross-border coverage and capabilities
Increasingly, trade finance businesses are pivoting towards an ecosystem-based supply chain finance, digitisation, and distributed ledger technologies to ease their risk and cost pressures.
Keywords: De-risking, HSBC, IDA, BAML, GDP, SME, Blockchain, BPO