“We have just come out of crisis mode, a phase where banks were primarily concerned about processing payments, managing liquidity and survival,” says Paul Johnson, senior product manager, global trade and supply chain finance at Bank of America Merrill Lynch (BAML).
“So it’s back to the future, where we were in 2006-07, when we were more concerned about improving the financial supply chain in the same way corporates have their physical supply chain. We are on the brink of revolutionizing the process with the electronification of data flows, streamlining and automation, meaning greater efficiency.”
Some have questioned bank enthusiasm for bank payment obligations (BPOs) – a new payment method in trade finance – arguing it poses a threat to their existing businesses, such as letters of credit (LCs).
However, Johnson rejects this logic: “Smaller banks may have doubts about BPOs eating into their other businesses, but the big GTS banks can’t afford to resist these broad market shifts or they risk getting left behind.
“We have to see it as an opportunity and make sure we remain relevant in a growing business. Around 85% of global trade is now being conducted on an open-account basis and that is still a relatively untapped area for banks. We need to do what it takes to gain more traction in this open-account business.”
To focus on the lower revenues BPOs generate for banks ignores the bigger picture on the profit and loss accounts for banks. “BPOs are a low-cost business and allow banks to save time and cost from handling and checking all the documentation associated with LCs,” says Jeremy Shaw, head of trade finance for EMEA at JPMorgan.
The shift to open-account financing looks irreversible, reflecting the shift in the balance of power between buyers and sellers, and is likely to continue whether banks embracing it or not. BPOs can be viewed as a hybrid of LCs and open account, a solution halfway between the two, says David Hennah, head of trade at Misys.
“Suppliers used to hold all the cards and that was why letters of credit were so popular because they suit the suppliers,” says Hennah. “Today buyers have the power. They have so many options in a globalized world, they can do a reverse auction and buy goods from anywhere.”
Hence the shift to open-account financing more favourable to buyers.
Banks might also be enticed to BPOs if there was competition for Swift’s transaction matching application (TMA) for BPOs, the Trade Services Utility (TSU), says Hennah. TSU remains the only application capable of handling such contracts.
Swift charges all banks for use of TSU, though smaller banks pay considerably less than larger banks. Swift says there are 146 bank organizations registered for TSU, representing 83 banking groups in 45 countries.
“Swift should only charge top-tier banks to use TSU,” says Hennah. “Smaller banks should be given access for free to encourage more use. There needs to be thousands of banks registered for TSU, or some competition from other TMAs, before BPOs can really take off.”
However, TSU is attracting many smaller banks, such as Bank al Etihad in Jordan, TIB in Turkey and RHB in Malaysia, says André Casterman, global head of corporate and supply chain markets at Swift. “Cost isn’t the issue,” he adds. “The issue is the banks are required to invest in an entirely new set of processes and rules. They need to start from scratch and it is outside their comfort zones.”
Casterman is relaxed about the prospect of new TMAs emerging to compete with TSU. “There is an opportunity as BPOs are adopted for use at the national level, like a domestic payments system, in a big country like Russia, India or China, for someone to develop a national TMA,” he says. “Swift would certainly compete to build such a system. We want to keep these flows, but it would be healthy to see this kind of competition.”
JPMorgan’s Shaw says: “It is important that we focus our efforts on educating people about BPOs. What is the point of building new channels for BPOs before we’ve mastered the one we already have?”
And BAML’s Johnson adds: “TSU is just plumbing. Any big technology vendor that wanted to build a new matching application to compete with it could do so in a week, but that is not where the competitive advantage lies.”
He predicts competing platforms to match BPOs will emerge in time, but says this is a sideshow to the real issue, which is not BPOs but banks developing innovative products to meet their clients’ needs.
“BPOs are an enabler – an instrument banks use amongst themselves to help them meet their clients’ needs,” says Johnson. “There is a misconception out there, because of the way they have been promoted, that BPOs are a product in themselves they can sell to clients.
“But they are not. They are the packaging that other products can be wrapped in. They can make other products work better because two banks can accomplish more than one.”
Better use of BPOs could help banks to deliver pre-shipment financing, for example. Misys’ Hennah says: “I see a nascent corporate demand for financing earlier in the transaction cycle, and in particular for pre-shipment financing, but banks seem too risk-averse to provide it today.”
Pre-shipment financing is difficult for banks because it usually involves dealing with smaller and precariously placed companies in emerging markets such as Asia and Latin America. However, because BPOs incorporate real-time data on the track record of borrowers, from speed of payment to product quality, they allow banks to make better credit decisions.
“BPOs enable performance-based lending,” says Johnson. “If we can get that real-time information into the underwriting model, they can open up new businesses for banks such as pre-shipment finance.”
Similarly, by enabling banks to cooperate more, BPOs could make it easier for them to provide approved payables financing in a four-corner model, says Hennah, to a business within supply chain financing that currently operates primarily on a three-corner model.