International trade, a $16 trillion-dollar industry, is a finely tuned machine of multiple parts, that works on very small margins. The comparative advantage of one company against its competitor, works to its benefit and helps in securing a deal. In such a fast-moving industry, timing the deal is the most vital cog in the whole set up.
Trade finance by banks and other financial institutions is a vital function in international commerce, as it provides delivery and payment assurance to buyers and sellers, and it helps close the trade cycle funding gap for these parties. The growth and sustenance of the international trade market depends on the easy availability and robustness of financing mechanisms. Trade financing thus, becomes the grease that makes the wheels turn in this elaborate contraption between cross-border parties, customers and banks. In such a lengthy chain between entities that have no prior linkages, there are trust issues and opportunities for fraudulent activities. All these add up to create an atmosphere of uncertainty, leading to delays and orders being cancelled which results in loss of revenue. These hindrances and roadblocks can amplify both risk and costs for banks, which in turn results in unfavorable financing terms, especially for small businesses. It is estimated that almost 60 per cent of trade finance applications globally from small and medium-size enterprises (SMEs) are rejected by banks. Furthermore, as per a recent survey by Asian Development Bank, the total value of rejected trade financing demand comes to around $1.6 trillion. There has been a significant spike in litigation and fraud relating to trade financing over the last few years as per the findings of a recent survey by the International Chamber of Commerce. While traditionally, promissory notes, checks, drafts or bills of exchange acted as negotiable instruments that could be transferred to third parties like banks and other financial institutions. In light of rising cases of fraud and litigation, non-compliance, limited trade information, high cost of manual screening and non-reliability of documents, a need has been felt for a more secure route.
A distributed ledger or blockchain, is a database shared by multiple participants in which each participant maintains and updates a synchronised copy of the data. Rather than requiring a central authority such a bank or a financial institution to update and communicate records to all participants, DLTs allow their members to securely verify, execute, and record their own transactions without relying on a middleman, thereby speeding up and securing the whole process simultaneously.
The UAE government made a breakthrough in this regard by launching a blockchain based digital trade platform intended to help financial institutions fight fraud, invoice duplication and other crimes in the trade finance space in 2021. The UAE Trade Connect (UTC) system, co developed by Emirati telecom giant Etisalat, seven of the UAE’s major banks, and global technology firm Avanza Innovations, aims to counter the common problems faced by banks across the UAE. Specifically, it is to prevent the use of duplicate invoices to fraudulently receive multiple payments for the same transaction, which are difficult to detect using paper based systems. Using the UTC system, however, once a record is incorporated into a blockchain ledger it cannot be changed and, as the ledger can be widely distributed, each ledger can be compared to another, making counterfeit records quick and easy to spot. The solution is predicted to process Dh200 – 250 billion of domestic trade ($55-$68 billion) annually.
By participating in a blockchain-based platform for trade finance, banks can pursue new revenue streams through new financing products and alternatives to letters of credit. From the point of view of both the buyers and sellers, the platform will allow them to access trade finance products and services offered by participating banks more readily than through traditional routes.
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