Trade finance is a critical component of global trade, enabling banks to provide risk mitigation and working capital facilitation. Any transaction brings with it a degree of risk, and trade finance is no different – but the $18 trillion market is simply too profitable to abandon. So what are banks looking out for when it comes to trade fraud and, more importantly, how can they use new technology at their disposal to prevent it?
In March last year, two major banks issued a payment guarantee for a $76 million fuel purchase from a trader in Singapore. In doing so, they unknowingly became a victim in one of a series of trade finance scandals that resulted in billions of dollars in potential losses for global lenders.
At the same time that Hin Leong Trading Pte. was pledging the fuel to back the loan, it allegedly agreed to sell the same cargo to another trader, who sought Letters of Credit (LCs) from three different banks. Hin Leong subsequently collapsed the following month, leaving more than 20 banks owing a total of $3.5 billion.
Criminal organisations are experts in playing the trade finance system, leaving banks open to this kind of trade-based fraud, money laundering, credit risk and tax evasion. The opaqueness of traditional manual and paper-based processes involved in LCs and other trade finance services provide criminals with numerous opportunities to access financing, often even hiding amongst legitimate firms.
To protect against this, the bank needs to understand the end-to-end activity of the parties to the transaction for the full lifecycle of the trade. Only then can it detect, for example, that multiple LCs have been issued for the same transaction, or the shipment route does not match the nature of the transaction, and so on.
The less transparent a transaction is, the more conservative a bank will be in providing risk mitigation or financing in relation to that activity – and so there is also a detrimental knock-on effect on trade growth.
The problem is the vast amount of unstructured data banks must sift through, and the large number of parties involved in facilitating a single cross-border trade transaction. Finding the information available in the huge number of documents – all in different formats and often languages – to manage risk can be akin to searching for a needle in a haystack.
Now consider that the risk of a trade also changes during its lifecycle. Sanctions lists are updated regularly – sometimes even daily – but if the information a bank is dealing with is outdated and it is already halfway through a transaction, it can find itself in a very complicated position. In addition, the customer may have already paid for or shipped the goods, so they will also be compromised.
Clearly, the industry needs to evolve to tackle fraud more effectively and reduce the risks that can act as a barrier to a bank expanding its trade finance services.
Innovation has not been lacking in international trade, but breakthrough technologies have been rare. Digitisation is the answer, but all too often players in the industry have digitised their own infrastructure, simply creating ‘digital islands’ with no ability to share and exchange digital data securely to multiple parties in real-time. In practice, such digital solutions still need to be bridged using fraud-susceptible paper documents.
New technology holds the promise of improving transparency and completely eliminating paper. However, realising these advantages requires a decentralised network, mirroring the decentralised nature of global trade. This is where blockchain comes in.
Blockchain’s shared digital ledger allows banks to track and trace information related to a transaction as it moves between parties. The technology keeps all players in sync, reducing the need for reconciliation and speeding up transactions, whilst providing end-to-end visibility.
The technology is able to aggregate all the disparate data sources involved in a single transaction and support standardised digital documents in place of unstructured paper documents. Sanctions lists can be fed into the platform and updated automatically, eliminating the challenge of false positives and enabling banks to act immediately if a problem arises. Where appropriate, regulators can also be provided with a real-time view of essential documents to assist in enforcement and AML activities.
While the flow mirrors the existing LC process – including application, issuance, document presentation, bill settlement and so on – a single network is shared amongst all participants, instead of relying on multiple systems.
This greatly reduces complexity and improves transparency, ensuring all participants can see the same identical, cryptographically secured record of the transaction, updated in real-time. As a result, everyone involved can communicate with each other far more effectively, confident that ‘what you see is what I see.’ The potential for fraudsters to take advantage of the knowledge gap or opaqueness of a transaction is therefore virtually eliminated.
The seemingly simple premise of synchronising transaction data greatly reduces gaps in time where, previously, parties were frantically searching for updated information – and it is these windows where the opportunity for fraud is greatest.
Trade finance is a very complex industry, and it is within this complex web of networks that opportunistic criminal organisations can best camouflage their fraudulent activities. As adoption of electronic documentation and blockchain-powered digital networks continues to gather pace, the potential cloak of complexity that fraudsters can hide behind shrinks ever smaller. In turn, this will fuel banks’ expansion into new markets with new clients, setting the stage for trade growth in previously underserved regions and sectors. International trade is going digital, and banks must act today to protect themselves and their customers from fraud, and, ultimately, to future-proof their business.
This article was also published on Finextra.