MULTITASKING
Can banks move beyond traditional trade finance?
By Bennett Voyles

For at least 400 years, banks in the trade finance business could always count on one thing: more trade means more business.

No longer. In the current global trade boom, banks are still selling traditional trade finance products, but demand is not growing. Instead, more and more of the bank’s biggest customers will no longer pay for letters of credit for their suppliers. These companies are moving to open accounts, meaning that suppliers receive no guarantee of payment.

As they do, the banks are scrambling to try to find new ways to profit. Some banks, such as JPMorgan Chase, have even started moving into areas far from the traditional realm of trade finance. Two years ago, JPMorgan bought Vastera, a maker of global trade management software. More recently, the company bought Zine, which specializes in invoice management.

JPMorgan is not alone. "I see a lot of banks, especially large banks, trying to rethink this space and reposition themselves as value-adding partners for global supply chain operations," says Viktoriya Sadlovska, a supply chain finance research analyst at the Aberdeen Group in the US.

ABN Amro, for example, has a trading platform that provides software for invoice-shipment documentation, document sharing and reconciliation, along with open accounts and letters of credit, according to a recent Aberdeen Group report. Bank of America, Deutsche Bank, HSBC, and Citigroup are among the many trying to develop services in what Aberdeen describes as “supply chain finance”. Nor are banks alone in seeing new opportunities in trade finance: UPS also has its own in-house bank now, UPS Capital, which specializes in trade finance.

The just-in-time bank

The move away from letters of credit reflects bigger changes in supply chains. Just-in-time production – a low inventory manufacturing approach that has become standard among major producers – demands speed, and that means less time for paperwork. “Much of the process has to happen faster [now],” says Richard Brown, SVP and regional head of global treasury services in Asia for Bank of America.

Getting rid of letters of credit is seen by many big companies as one way to generate cost savings. Letters of credit were originally a financial product that enabled companies to do business with each other despite extreme distance and without much knowledge of each other. The buyer takes out a letter of credit from the bank, which promises to pay the supplier if certain terms are met. The buyer agrees to pay back the sum to the bank once that happens.

For both buyer and seller, the letter of credit removes risk. It protects the supplier in the event a buyer reneges, and it assures the buyer that the supplier won’t take the money and run, because the letter can typically be drawn only after certain terms are executed. For a large order, a letter of credit provides an additional level of comfort that the supplier will be able to deliver on an agreement: a bank seeing a letter of credit is likelier to give a supplier the financing it needs to buy the equipment or materials needed to execute an order.

Open accounts – direct payment systems that function with less documentation – require less paperwork and cut costs for the purchaser, who no longer has to buy letters of credit. But open accounts are riskier for suppliers, despite advances in technology that help parties know much more about each other than they once did.

It also makes financing a production cycle more costly. Without the assurance of a letter of credit, banks aren’t as easily persuaded to underwrite a production cycle and will charge a higher interest rate.

Commodity pricing

Compared with other markets, letters of credit remain relatively popular within Asia. But banks are trying to develop new services here too, because of the propensity of big companies to see trade finance as a commodity. Larger companies pick their banks mainly on the basis of price and execution speed, according to a recent survey of roughly 50 Asian corporate trade finance customers by consulting firm Oliver Wyman.

According to the survey, these Asian leviathans try to get the best price by using several products and standardizing the process. They also typically work with at least 20 different banks, keeping the banks’ bargaining power low.

In contrast, middle market companies tend to be less price-conscious, and typically work with several banks. Instead of being concerned about price, these companies look for faster turn around and credit flexibility. “If I have a line to a buyer in Senegal and I have to change it to a buyer in Bermuda, I need to know that that can happen fairly quickly,” explains Andrew Hardie, senior manager with Oliver Wyman. “It’s the flexibility of the trading relationship that’s important to these guys.”

With more profit now in the second-tier, banks have tried to develop services that focus more on the needs of these mid-market customers. These typically include automated systems for invoicing and document checking. The systems may also check client names against companies known for credit problems. In some markets, though, there are barriers to automation. “If you’re in China or India, in a lot of cases the law requires you to do everything by paper,” says Hardie.

Limited technology may also be a factor. “There are a lot of great ideas for streamlining import transactions,” says Mark Evans, senior manager of trade services and supply chain for HSBC in Hong Kong. “But when rolled out to a supplier in Bangladesh that may or may not have a PC in their whole company, that process grinds to a halt.”

Can it work?

While analysts say most of the new supply chain banking ventures have yet to make money, banks appear confident. “I think in five years you’re going to have four to five very large global financial institutions or financial institution-like companies that will basically be doing end-to-end trade and logistics, and customer compliance on a global basis,” says Paul Simpson, senior vice president and treasury services executive at JPMorgan New York.

Still, it’s not clear whether JPMorgan’s acquisitions have translated into new business or enhanced relationships of existing business, says Susan Feinberg, a TowerGroup analyst based in Boston.

HSBC executives, although they are also pursuing new services, see a much more familiar future ahead. “In five years, traditional trade instruments will still be very, very important in the successful completion of international trade transactions,” Evans predicts.

Open accounts, for example, might sound good, but there may be times when suppliers will demand more assurance, in Evans’s view. “Bankers often get involved in all the sexy connotations and evolution of the products, but we ignore the traditional products and services that banks provide in this space at our peril,” says Evans. “Every time there is a global hiccup – a credit crunch or the like – you see the demand for documentary credit and traditional instruments go through the roof.”

For 20 years now, says Evans, banks have tried to find ways to bring what he calls the financial supply chain more in line with the physical supply chain, but it’s never quite worked.

“[I]t’s true that the financial supply chain parallels the physical supply chain,” says Nathan Pieri, SVP of marketing for US-based maker of trade management software, Management Dynamics. But, he says, they have talked about how to combine the two for many years, and many details still remain elusive. “The vision’s great, but we’re still waiting for the hydrogen car too.”

Bennett Voyles is a Paris-based business writer.