Trade finance has had a bad press lately, with the high-profile collapse of Greensill, the supply-chain financing business. Even before that it wasn’t the commercial lending market’s favourite thing to do. Trade finance products have traditionally been complex and costly for banks to deliver, involving resource-heavy manual processes.
Despite Greensill, and the relatively complex nature of these products, trade finance has a bright future. It can be facilitated and automated by cloud-based technology platforms such as Trade Ledger, and regulatory initiatives like Open Banking vastly improve the economics of this essential banking product. Even services-based businesses with few tangible assets can offer security based on their invoices to raise capital.
Trade finance has been critical to human success since the dawn of history. It was one of the first banking products ever invented (Mesopotamia, as long ago as the 8th century BCE) and it remains an important financing source for SMEs and corporates. There is huge demand for trade finance and working capital solutions, estimated at over US$7.5 trillion. It is a significant aspect of financing the SMEs that employ over 50% of the world's working population.
Trade finance also has advantages for lenders: income diversification and attractive risk-adjusted returns. Returns from large corporate investment-grade lending products such as syndicated lending continue to be under pressure, and banks and other lenders need to diversify away from such low-margin business. Goldman Sachs, the leading investment bank whose history is far away from receivables financing, has announced a partnership for SME lending with Amazon, explaining that "the application process is fully digital and can be done in minutes, and most customers will get approval results in real time". The strategic logic of an expansion like this, away from investment banking, is multifaceted but ultimately driven by what is seen as a great opportunity to realise attractive returns from lending. This is also true for commercially focused banks which see the attractiveness in the product for both SMEs and larger corporate lending, but are struggling with the manual, cost-intensive nature of the product.
Banks can also benefit from increasing interest in trade finance assets from institutional long term investors. S&P and Tradeteq estimate that trade finance distribution will grow to a US$3 trillion market for investors, helped by new technology and growing interest in the asset class.
HSBC, one of the world’s largest trade banks, is seeing unprecedented levels of interest from investors in trade finance assets, driven by their attractive risk return profile, with low volatility and low correlation to other asset classes. This growing ability to also distribute these assets will further improve the return on equity (ROE) for regulated lenders facing increasing capital requirements from Basel III regulations.
At Trade Ledger, a UK-headquartered enterprise software company, we’ve built a cloud-based platform for invoice discounting and other commercial credit products, to enable financial institutions to remain competitive in this field of financing – as well as help them to improve margins.
Trade Ledger’s platform, which is used by the leading global trade finance banks, aggregates and analyses information from borrowers’ accounting systems, credit bureaux, open banking, company registers and other market data providers. Its analysis and visualisation then support decision-making for banks, lenders and third-party stakeholders, on one simple, accessible platform. The platform provides a highly efficient solution to sourcing and verifying borrower information. Not only does it build a richer and better verified picture of borrowers, it also allows everyone to work from a single version of the truth, so there are fewer re-keying or copy-and-paste errors as processes move from one siloed system to another. For invoice financing Trade Ledger has achieved amazing results for banks, in terms of reducing time from onboarding to credit approval from months or weeks, to hours and minutes.
A shift to digital processes for complex lending has significant implications for banks. McKinsey, the consulting firm, has noted three principal factors of digital lending processes that bring benefits to banks: huge gains in customer experience, the ability to make better quality decisions, and huge cost savings [video]. Importantly, while digitalisation has already been applied successfully in retail banking, this has yet to happen for SME and mid-sized corporate banking – which will allow the early adopters of these new technologies and platforms to gain significant market dominance. They can not only reduce operational costs but also wield pricing power and increase net margins as borrowers are willing to pay for the ease of application and speed of credit decisioning provided by the platform-enabled lenders. This has a significant impact for banks and all their stakeholders, including investors. McKinsey has estimated a mid-sized bank can improve annual profits by over US$200 million from digitalised lending.
Using third-party best-in-class platforms is a great opportunity to build a differentiated and highly profitable business while minimising development and implementation risks. Trade Ledger enables lenders to offer their SME/mid-sized corporate customers to apply for finance in a few clicks. The customers allow the lender to connect to their accounting and banking data, so the lender can do an accurate, up-to-the-minute risk assessment. A relatively basic loan facility can be completed within a day, and more complex transactions requiring communication between the company and the lender can be concluded in days. These are amazing improvements to the majority of existing lending processes, which typically take months. Existing bank staff can support clients who need help in the cloud-based application process, further improving the client experience and allowing for expansion of the engagement into new products, thereby further improving the profitability of the SME and mid-sized banking division.
Importantly, a data-driven approach to risk scoring may also allow lenders to price credit facilities according to a risk scale populated by data points such as their trading track record, leveraging non-financial variables and so allowing for a higher proportion of approvals and significantly higher returns for lenders (relative to a less dynamic pricing model). This will enable institutions adopting new technology to gain market share and build truly differentiated client solutions in a large and growing marketplace.
We would welcome a conversation with you about lending technology and creating better customer experiences. Do get in touch.