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Back to the Future: Blockchain and Trade Finance
February 16, 2017 Office of Small Business

The World Economic Forum reports that globally, small to medium-sized businesses have one major pain point: dealing with their finances and ensuring appropriate funding. Due to the complexity and low scale that characterize most small business funding needs, traditional lenders such as banks often find extending credit too costly. The global financial crisis of 2007-2008, combined with greater regulatory compliance costs have made it even more difficult for small businesses to access funding. Some hope since the crisis has come in the form of innovative and disruptive financial technologies, particularly for trade finance. One of the most promising for trade finance is Blockchain.

A Brief History of Bookkeeping

Modern financial accounting is based on a double-entry bookkeeping system. The earliest records of bookkeeping date back to about 8,500 BC in the Neolithic Middle East, shortly after the invention of agriculture. Agriculture allowed for the storage and trade of surplus food produced and with it the need to keep track of individual farmer's contribution to the communal warehouse. Each unit of food (wheat, oil, etc.) was represented by a clay token which was placed inside a clay envelope and sealed by rolling it with the pattern of the warehouse keeper. To retrieve the food, the individual farmer would present his clay token to the keeper, who broke the seal in the presence of a witness. This is perhaps the oldest known security protocol. Tripl- entry accounting (I.e., double-entry booking with the addition of encryption protocols) is an enhancement to the traditional double-entry system and is what Blockchain is all about.

Distributed Ledger Technology

Blockchain is the encryption technology that regulates both the generation of Bitcoins, a digital unit of currency, and verification of the transfer of Bitcoin funds, all operated independently of a central bank. Blockchain is based on Distributed Ledger Technology (DLT) which is basically an asset database that can be shared across multiple sites, geographies or institutions. Blockchain algorithms permit the maintenance of ‘keys’ and tokens to control access to the shared ledger. The tamper-proof nature of the blocks eliminates the possibility of fraud.

The Need for FinTech

Global Trade Review’s (GTR) series on Blockchain and trade finance highlight some of the recent trends in financial management and how smaller suppliers in the global supply chain (i.e., exporters) could benefit from the adoption of Blockchain technology by financial institutions.  Sound management of working capital is perhaps the most important metric to gauge the financial health of any business. There are three ways to improve working capital.

  1. Reducing Days Sales Outstanding (DSO)
  2. Improving Days Inventory Outstanding (DIO)
  3. Increasing Days Payable Outstanding (DPO)

The industry norm is towards extending payment by increasing DPO which has proven to be the most permanent and, in most cases, the most practical means of managing working capital. GTR reports that “studies show that over the past 10 years, nearly every industry has increased payment terms by 0.5 to 2.5 days each year. This has led to companies pushing payment terms to 90, 120 and even as far as 585 days”.

The inevitable strain this places on suppliers, especially those with high DSO’s, adds risk to the supply chain and costs to the supplier. Oftentimes, suppliers will seek expensive working capital solutions or take early payments at a high discount to continue operations. For smaller international suppliers, these costs can be quite high. Factoring, inventory financing, purchase order financing or short-term business loans can carry annual percentage rates of up to 50 percent.

The Promise of FinTech

The benefits of the technology come from reducing the time consuming and costly reliance on manual processing and co-ordination in the collection of information and documentation. A recent report by Barclay’s underscores what securely bridging the connection between trade finance participants and financial institutions can offer for trade finance, especially the small business exporter.

  • Transparency and Consensus. Reducing documentary fraud might reduce the cost of transaction reconciliation between and within banks.
  • Traceability. Provides assurance and authenticity of products in the supply chain.
  • Secure Transfer of Value. The immutability and digital uniqueness inherent to Blockchain offers a solution to the trade finance problem of endorsement.
  • Cryptography. The problem of data privacy among counterparties to trade transactions can be overcome by utilizing tokenization allowing information access only to those parties that have permission.
  • Resilience and Robustness. The distributed nature of Blockchain promises a more stable operating platform.
  • “Smart” Contracts. The possibility of self-executing contracts triggered by the efficient exchange of digital data could potentially revolutionize the long-serving Letter of Credit.

In the near term, the benefits are clear. By addressing operational risks through greater transparency and immutability, banks can significantly reduce their operational costs and subsequently reduce cost of service to small and medium-sized customers.

Until we arrive back to the future, contact EXIM Bank to learn about Working Capital Loan Guarantees. At EXIM Bank, no transaction is too small.

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EXIM’s Blog postings are intended to highlight various facets of exporting, but the postings are not legal advice, and are not intended to summarize all legal requirements associated with exporting.