In the seventh and final part of our series on “How Fintech is disrupting SME and Startup Financing”, we present to you the impact of digitisation of LOC conduct and blockchain technology on trade finance for SME.
SMEs from developed economies account for only 34% of exports. This is despite the advent of e-commerce platforms that render cross-border trade feasible.
One of the reasons is the SME lacks complete or sufficient access to finances.
The SME needs funding to develop products and marketing channels,
as well as deal with bureaucratic procedures. Information challenges and transaction costs often translate into higher interest rates and fees for SMEs. So, the difficulty in accessing affordable trade finance constraints SME from international trade.
Open account transactions paves the way for alternative trade financing
Given the financing difficulties, SMEs are left with no other choice but conduct open account transactions. An open-account transaction is the shipment and delivery of goods before payment is due, which means no bank guarantee of payment.
In open account transactions, trust becomes a huge factor.An SME, with sparse or no credit history, could face challenges when initiating a new commercial relationship.
The high prevalence of open account transaction represents the long-term shift among companies seeking alternatives to traditional trade financing.
Fin tech leverage their nimble form to develop inexpensive financing solutions
Fintech is making inroads and disrupting trade finance, much to the SME’s advantage. Non-banking technology companies are developing innovative digital solutions that provide SME with better and inexpensive trade financing. This is because, these companies are nimble with lower overhead, streamlined online processes, and alternative data sources without legacy paper systems. Documentation has already moved online. Integrated and automated electronic systems and platforms are allowing for the digitisation of the letter of credit conduct too. There is no dearth for 3rd party investors to extend capital to an SME towards trade finance, as long as the returns are lucrative.
Smart contracts or self-executing transaction agreements, designed using bitcoin technology, allow real-time data visibility to the participants. The bitcoin technology entails distributed ledger platform to process LOC transactions. The transparency, from the shared database, created, elicits participants’ trust in an open account transaction.
Blockchain technology is facilitating development of better alternative trade financing
Since it helps trace every transaction, blockchain technology is touted to realise cost savings.
It can also expedite the process from order to settlement, thus increasing liquidity. The blockchain technology would verify the shipment’s arrival with geolocation. A smart blockchain contract would automatically execute, transmitting payment to the seller. The whole process could take place in a fraction of the time. For SMEs with significant liquidity constraints, reducing the lag between sale and payment sets it on the path to solvency and growth. And all of this, without an intermediary verifying shipment’s delivery.
Trade finance presents a huge opportunity for innovation. Real-time tracking of goods will eliminate several process steps and reduce the risks for the participants. Fin-tech has the potential to facilitate SMEs competing in the international markets. The likelihood of self-executing contracts initiated by the efficient digital data exchange could transform the traditional Letter of Credit.