Lack of access to adequate financing jeopardizes the survival of an enterprise; small and medium-sized enterprises (SMEs) especially face the greatest hurdles in finding financing on affordable terms.
Considering this in the backdrop, there are several advanced technologies to simplify and expedite domestic and cross-border trade for SMEs while adding transparency to the complex world of trade finance. Blockchain is one such advanced medium of technology that is being explored as a potential solution.
As per a recent announcement, the Digital Trade Chain (DTC) consortium backed by seven European banks selected IBM (IBM) through a global competitive process to make commerce easier for small and medium-sized businesses in Europe by harnessing the blockchain technology. The DTC solution will run in the IBM Cloud and is designed to connect the parties involved in a trade transaction, both online and via mobile devices.
The process was initiated by European banks in the beginning of 2017. The seven banks—Rabobank, Deutsche Bank, HSBC, KBC, Natixis, Société Générale and UniCredit—signed a Memorandum of Understanding in January 2017 to collaborate on the development and commercialization of the new product now called DTC.
Gap & Complexities
The figures by the World Trade Organization reveal that up to 80% of trade is financed by credit or credit insurance, signifying the importance of trade finance—a lack of access acts as a major non-tariff barrier to trade. While SMEs account for 20% of U.S. exports and 40% of EU exports, they continue to face financing challenges.
It is further estimated that over half of trade finance requests by SMEs are rejected globally, against just 7% for multinational companies. Hence, there is a dire need to provide a better flow of finance to these enterprises while ensuring that the process remains simple, cost-efficient, and risk-free for the financial institutions.
International and domestic trade finance is highly complex and involves a web of intricate risks, while most of the bigger companies prefer a system known as documentary credit (letter of credit) to reduce the risks undertaken. However, small companies tend to prefer open accounts, which is a more convenient (although risker) option.
To cater to such requirements, banks offer diverse solutions that negate the need for an underlying documentary credit. This requires banks to work out solutions that optimize working capital, taking care of invoices and funding suppliers (and buyers) against invoices while reducing costs and gaining control over receivables.
The United Nations Economic Commission for Europe (UNECE) believes, “There is a huge potential market in open account transactions, and banks can take advantage of these volumes by promoting their foreign exchange and Supply Chain Finance (SCF) services more consistently.”
However, facilitating such services within the present systems involves a significant amount of administrative work and associated expenses.
Blockchain As A Solution
The DLT solution is designed to simplify trade finance processes by addressing the challenge of managing, tracking and securing domestic and international trade transactions. The maintenance of records in a secure manner will accelerate the order-to-settlement process and reduce administrative paperwork significantly. The transparency provided by such a platform will instill confidence to initiate trade with newer partners across different regions.
Blockchain, or the distributed ledger technology transaction, hosts the copies of all transactions across the network. These transactions are grouped in blocks that are protected by cryptography, making the transactions recorded immutable. An Accenture report suggests that blockchain technology could reduce infrastructure costs for eight of the world’s ten largest banks by an average of 30%, translating to $8 billion to $12 billion in annual savings for the banks.
Marie Wieck, general manager, IBM Blockchain, said, “In working with hundreds of clients around the world on a diverse range of blockchain projects, trade finance has emerged as one of the strongest use cases for the technology.”
IBM is emerging as a leading blockchain-based solution provider in the segment. In December 2016, India’s Mahindra Group and IBM partnered to launch a Cloud-based blockchain app to speed up invoice discounting. The process of invoice discounting involves bundling and selling invoices at a discount—a major source of working capital finance for many suppliers.
In March, A.P. Moller - Maersk A/S (AMKAF) and IBM collaborated for a new global trade digitalization blockchain solution. In April, an IBM-powered blockchain solution was announced in association with Sichuan Hejia Co., Ltd. (Hejia) to address the problem of an underdeveloped credit system for small and medium-sized pharmaceutical retailers in China.
With only 50% SMEs having access to formal credit, there is a definite need to resolve the problem of the financing gap. A blockchain-based solution wouldn’t just reduce the operational costs for banks but also open the gates for SMEs to establish newer trade partners and generate healthier revenue streams by minimizing risks. Overall, adequate financing can unlock the potential of SMEs to provide the much-required push to trade, employment and economic development.