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International trade transactions

Averting exposure to frauds

Shah Md Ahsan Habib | Published: August 20, 2019 20:32:57 | Updated: August 30, 2019 21:42:11


In today's inter-connected global economy, banks are working to increase their market shares in trade services by linking importers and exporters though several payments and financing products. In the coming years, banks should expect to increase their shares in trade-related transactions and services and, as a by-product, their exposure to potential fraud and trade-based money laundering (TBML).

Trade services by banks include trade payment and financing products/services that may not have the same implications for the TBML risks. TBML risks may, in fact, vary from country to country; and different trade payment techniques may offer different levels of vulnerabilities in different countries.

In the global context, most trades are transacted on open account terms, and, therefore, enabled through techniques of Supply Chain Finance (SCF). Open account is an arrangement between the buyer and the seller whereby the goods are manufactured and delivered before payment is required.

SCF that covers factoring, forfeiting, and invoice financing is particularly relevant for open account transactions. Using SCF, banks provide technology and other services to facilitate payments and financing within supply chain of enterprises.

There are also some instances of cash in advance, where sellers enjoy notable bargaining power. In case of cash in advance and open account, involvement of banks is generally insignificant, and traders have relatively greater freedom in handling the process at reasonably low cost.

In a considerable number of cases, international trades are facilitated with trade services as provided by banks and financial institutions covering documentary credit (L/C or letter of credit), documentary collection, standby L/C or other bank guarantees.

Involvement of banks is significantly higher in the trade services techniques such as L/C, bank guarantee, standby L/C and documentary collection. Especially through L/C, banks offer payment, financing and risk management services to their clients.

It is a classic form of trade facilitation technique that substantially reduces risks for both exporters and importers. It is an undertaking or commitment issued generally by a bank to pay the exporter a certain amount, provided the documentary conditions of the L/C are complied with.

A standby L/C is functionally equivalent to demand guarantee or international bank guarantee, but differs in terms of structure. International guarantees may serve several purposes from indefinite range of payment, performance or non-performance obligation. Documentary collection is basically a payment tool having 'documents against payment' and 'documents against acceptance' techniques that provides means of payment whereby the exporter can ensure that the buyer should not be able to take possession of the goods until it has paid or given a payment undertaking.

Of the different trade financing techniques, traditional trade services products i.e. L/C, documentary collection and bank guarantees, have been at the focus, according to the most recent ICC (International Chamber of Commerce) survey. About 47 per cent of the respondents reported that their traditional trade finance and supply chain finance businesses were in the same business unit.

The survey findings showed a clear focus on traditional trade finance, with 85 per cent of respondents' activities in this area compared to 15 per cent in SCF. This is in contrast to the market: Roughly 80 per cent of trade takes place on open account - better suited to SCF solutions than traditional mechanisms.

Of the traditional trade financing techniques, commercial L/C is used most. Of different regions, the Asian markets have been the key ones for trade finance businesses run by banks.

The recently available SWIFT data, as published in the ICC survey, demonstrate that in terms of L/C business, the Asia-Pacific region accounted for significant market share for export messaging as a proportion of world L/C traffic.

Growth in trade finance transactions both in volume and value terms are no longer driven by China alone. Countries using SWIFT L/Cs the most for imports include Bangladesh, South Korea, China, India and Pakistan; and countries using SWIFT L/Cs the most for exports include China, Hong Kong, India, Singapore and Japan.

Trade payments and financing techniques involve different risks and regulatory issues that may be linked to the TBML. Regulatory issues for the trade service products are critical from the point of view of compliance and for addressing trade-based money laundering challenges.

Of the methods of payment, cash in advance and open account are the simplest and cheapest ones, but they create the greatest possibility of opportunistic misconduct by the trading partners. Involvement of banks is insignificant in these transactions and generally, regulatory authorities enjoy lesser control over these dealings.

Contract or purchase/sale agreement is the guiding document for cash in advance and open account transactions, and thus sound and legally enforceable purchase/sale contracts are crucial for ensuring responsible behaviour on the part of traders.

Generally, greater involvement of banks helps regulatory authorities to exercise greater control and thus minimises risks of trade-based money laundering. Banks' involvement is higher in documentary collection than that of cash in advance and open account methods; and it is costlier to the traders as well.

Documentary collection is cheaper than L/C to the traders. However, regulatory authorities may have relatively less control over transactions as compared to that of L/C. It is the costliest form of trade payment method where regulatory authorities may exercise significant control.

Banks have significant involvement in the L/C or documentary credit operation and the processes are formally regulated or guided by a classic ICC publication. Bank is practically amongst the main parties of the transaction. This is a very good risk minimisation tool for the traders and the best of the trade payment methods from the perspective of country risk.

In reality, L/C is considered the best trade payment method from the TBML vulnerability perspective. Regarding the ongoing approach to addressing trade-based money launderers, the Global Banking and Finance Review observed that 'despite a significant proportion of international trade being conducted on 'open account' terms, trade-based money laundering controls typically focus on transactions supported by traditional trade financing, such as L/C; and this is disproportionate and leaves a gap in the industry's response to TBML.'

Of different trade payment methods, the existing global regulatory approach to handling TBML is the most effective one for L/C or documentary credit followed by the documentary collection. It has the greater control, which is helping the most. 'Open account' as a payment method and the technology-driven and relatively recent supply chain trade finance products have their own advantages.

However, several of these cannot be brought under comprehensive regulatory and control framework. Thus, for many developing countries, greater use of L/C offers better protection, monitoring and control and also better means to address TBML challenges.

Dr Shah Md Ahsan Habib is Professor and Director (Training) at BIBM.

ahsan@bibm.org.bd

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