The letter of credit (LOC) is one of the most commonly used forms of trade finance by parties during an international trade finance transaction. A letter of credit is a letter from a bank guaranteeing payment to a seller.2 Letters of credit are provided in electronic or original paper format.
Unlike the LOC, many functions and documents in trade finance have not gone paperless. A prime example is the bill of lading. A bill of lading is a legal document that serves as proof that goods have been loaded onto a ship for transportation to the buyer. The document accompanies the shipped goods and is signed by a representative of the carrier, shipper and receiver. Historically, these documents have been prone to fraud because of the complicated shipping process involved, and the large number of parties involved in an international trade finance transaction.
Looking Towards The Future For International Trade Finance: Digitisation
Distributed ledger technology has a potential role in digitising trade finance. The idea of applying blockchain technology to international trade and commerce is relatively new, but the pace of innovation in this area has recently increased. Blockchain, the technology behind decentralised cryptocurrencies like Bitcoin, is being piloted to simplify trade practices and solve the real world challenges presented by the current manual and paper-intensive processes being used.
Blockchain has the potential to improve the international trade finance industry by removing the need for a trusted third party. Blockchain uses a distributed public ledger to track transactions and could reduce transaction costs by eliminating intermediaries. Previously, the use of a trusted third party was the only means for mediating disputes and preventing fraud.
A study by Juniper Research found that during the first half of 2016, venture capital firms invested US$290 million in blockchain technology.3
Benefits And Concerns
The digitisation of international trade finance provides an opportunity to streamline processes, reduce transaction time and cost and mitigate fraud risk. Some experts believe it may increase the transparency of receipt and payment flow information, resulting in improved cash forecasting, streamlined credit collection efforts and more efficient deployment of working capital.4
However, the shift to digital is neither quick nor simple. There are concerns regarding the feasibility of getting all of the parties to a trade finance transaction on board the digitisation wave. Many parties are involved, including shipping companies, chambers of commerce, insurers, customs authorities and inspection companies, all of whom must use electronic documentation.5
