Payment transactions as top priority for banking and international trade
Executive Education / 9 August 2022
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Wolfram Döring ist seit 1996 für die Frankfurt School als Dozent und Autor tätig. Seine Schwerpunkte liegen dabei u.a. auf dem Firmenkundenkreditgeschäft und dem Zahlungsverkehr. In seiner beruflichen Laufbahn betreute er Banken, Finanzdienstleister und Family Offices. Er kennt die Sichtweise eines Kreditinstitutes von innen und von außen (Unternehmensberatung). Seit 2012 setzt er sich intensiv mit der Digitalisierung und den Auswirkungen auf insbesondere diese beiden Geschäftsbereiche auseinander.

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After many positive, relatively low-risk years for businesses around the world, 2022 saw profound changes impacting international trade, many of which were foreshadowed by earlier events. Diversification is now essential to success. In these uncertain times, business transactions – whether with new customers or suppliers, or within established business relationships – need more protection than ever before. Of particular significance are:

  • the exporter’s (seller’s) procurement and credit risk,
  • the importer’s (buyer’s) payment risk,
  • political risks in both importing and exporting countries, and
  • potential currency risks.

The traditional instrument for safeguarding international business transactions is the letter of credit (L/C). In simple terms, payment for a business transaction is made once the agreed documentation (as previously requested by the importer) is presented to the importer’s bank in full, without errors and on time (i.e. by the agreed deadline). If the importer (or importer’s bank) was hedging any credit or political risks, the letter of credit is confirmed.

Transport problems impact payment protection

Dramatic rises in food prices, interest rates and inflation are having a huge impact on many national budgets, especially in developing and emerging economies. In turn, this generally has a negative impact on credit ratings. Problems in supply and transport chains make it more difficult to manufacture, ship and deliver goods on time. From an importer’s perspective – or that of their bank – this also means that not all documents are presented on time. An example would be the bill of lading for shipped goods if the ship was unable to reach port. This may mean that the importer’s bank, in consultation with the importer, refuses to accept the goods and withholds payment. Consequently, transport issues also have a direct impact on payment protection. To provide even more effective protection, letters of credit are becoming increasingly complex and covering longer timeframes – two generally undesirable developments from the importer’s point of view.

The exporter’s bank benefits from this twice over. First, because customers need more advice than ever on these issues. And second, because there is growing demand for exporters to confirm letters of credit, and for importers to issue letters of credit. At the same time, both the exporter’s and importer’s banks face the same problem – how best to make payments securely. In recent years, banking institutions have significantly watered down the correspondent banking system, primarily in response to the “Know Your Customer’s Customer” (KYCC) imperative. Payment channels have become concentrated.

Lack of digitalisation of documentary payment transactions 

While many banking processes – especially payment transactions – are already highly digitised, this is not the case for documentary payment transactions, in which letters of credit and payment collections play a key role. In practice, the various processes surrounding letters of credit are still essentially paper-based. Almost all – indeed, all – of the documents required by an importer’s bank must be submitted in paper form. From a corporate and logistical perspective, this is both time-consuming and impractical. Efforts to digitise these processes – most of them initiated by the logistics industry – are still in their infancy. The reasons for this include, on the one hand, an absence of universal standards, and on the other, banks’ emphatic preference for processing documents in paper form. However, crypto-based transactions enable both parties to the transaction to exchange digital documents by prior agreement, which suggests that there is no real reason why these business processes could not be fully digitised in banks and companies alike.

The high volatility of crypto prices, as well as the first insolvencies of crypto custodians and exchanges, are raising serious questions about the risks associated with crypto, how such risks affect business processes, and how best to regulate crypto speculation and custody.

New technologies increase banks’ management overhead – more expertise is required!

For banks, this represents both an opportunity and a risk. Because banks are “used” to regulation, the rising demand could enable them to boost their earnings in an attractive area of business. On the other hand, while they are pushing “paper-based” business, there is a real risk that fintechs and logistics operators will digitise the relevant business processes and documentation. This would cause banks to quickly lose both their uniqueness and the associated income. For companies, the growth of L/C business means both higher costs (and as things stand, even more paper), but also greater protection. Because of this, they would be happy to consider offers by major carriers or fintechs to digitise their documentation. Indeed, most business processes in industrial companies are already highly digitised. Are all players involved in international trade fully aware of this trend?

Bottom line: Companies want to hedge their risks, including payment, procurement and counterparty default risks. Banks provide the necessary hedging infrastructure. Supply chains pose obvious risks – especially where shipping disruptions are concerned – and these risks are further exacerbated by a significantly more stringent sanctions regime. Banks must manage all these things. At the same time, banks are also facing new technical challenges, such as crypto applications. Payment transactions – non-documentary and documentary alike – have become a top priority in banking and international trade. For companies in the industrial and financial sectors, regular knowledge updates on the latest developments and trends are vital.