Article

by Merlin Dowse, VP Product Manager Sr., TS Global Trade - J.P. Morgan

Small- and medium-sized banks generally prefer to market their traditional trade offerings - products such as letters of credit - while larger banks often aim at fulfilling the supply chain finance demands of their corporate customers. As a result, there is a remarkable lack of focus in marketing one of the most exciting innovations in trade finance: the Bank Payment Obligation (BPO). Why is this?

Thanks to mandatory compliance and due diligence requirements, letter of credit pricing has been on the rise and is expected to be driven even higher by the impact of Basel III. Banks have struggled to stay competitive due to the high cost of managing these required checks thanks to the physical nature of letter of credit documentation, which causes delays and increases complexity for traditional L/Cs. This also adds considerable strain to corporate customers' operating processes and inhibits their suppliers' access to working capital.

As a result, many banks are watching their letter of credit business shrink as customers move to alternative - yet riskier - processes such as open account. This strain will also be felt more by the small and medium-sized banks that will struggle to find ways to combat the client drain.

Solution

The BPO offers a solution that could counteract the impact of this shift. The BPO occupies the sweet spot between the letter of credit and open account/ supply chain finance arrangements. It provides the risk mitigation and access to liquidity typically associated with a letter of credit, yet it also brings many of the operational efficiencies of open account.

The BPO can help buyers and sellers increase their transactional volume and improve processing speed while reducing transaction costs. The BPO is a natural choice for those clients looking to venture from L/Cs toward open account structures without the complexities of establishing a full-fledged supply chain finance program.

Despite this, many banks are on the fence about whether or not to adopt the BPO, waiting for their customers to start asking about it before making the strategic decision to invest in this new wave solution. In many cases, this hesitancy is not driven by a lack of client demand, but rather by internal concerns that the BPO will cannibalize their existing trade business. It undoubtedly will - but the alternative is to lose that customer to a riskier, "bankless" open account process, or to another bank already offering the BPO - and once that happens, it is already too late.

Adoption

Some 49 banks as of this writing have adopted the BPO, according to the latest SWIFT statistics, and industry observers expect that number to rise - sooner than one may think. ICC has recently published the first version of the Uniform Rules for Bank Payment Obligations (URBPO), and the world of trade finance is likely to feel a seismic rumble. Although the supporting technology and accompanying rule book have been in existence for several years, the ICC BPO rule book brings a new level of standardization and clarity, and with them increased momentum for broad industry acceptance.

The business case for banks to adopt the BPO is compelling: it allows them to better compete to retain their L/C clients who are looking for cheaper and more efficient ways of facilitating their cross-border trade business. SWIFT - owner of the technological backbone on which BPO functions - has actively marketed BPO to the banking sector and had assumed that demand for the required technology and BPO would rise rapidly and justify the expense that banks incur in BPO adoption. But this uptick in demand has not yet happened, meaning that many banks aren't adopting it or even talking to their customers about it - and there are reasons for this foot-dragging besides the wait for published standards..

Hesitations

Many banks struggle to identify the members of their customer base already using open account. Others are afraid to mention BPO to their L/C customers at all until they've created the infrastructure necessary to support it. These banks don't want to go out of their way to move those customers away from L/Cs, even though they may already be considering it. It's a classic chicken/egg dilemma which ultimately slows the development of the BPO product and network.

Regardless of these concerns, it's crucial that banks start the conversation now about the BPO and a possible move toward open account with their most important trade customers. The benefits to the banks themselves are considerable. BPO and the required technology bring a level of technological streamlining and efficiency that many banks lack today. BPO allows customers to move away from labor-intensive L/Cs and toward a risk-mitigating, liquidity-enhancing, low-maintenance trade solution that's cheaper for the bank to provide. BPO also makes trade finance options available to those already trading on open account terms, yet for one reason or another are not a suitable match for a supply chain finance program. But most important, it allows a bank to retain clients that might otherwise go elsewhere - making it crucial for banks to engage their customers in conversations about the BPO today.

Analysis and evaluation

Bank executives should work to get a picture of the appetite for it within their local market. They should begin to evaluate and analyze the open account activity within their universe of clients. They should engage L/C customers in conversations about whether they're planning to move to open account, and they should explain the benefits that the BPO could bring. By gauging the level of interest, banks can quantify the evidence to support a compelling business case that fits their particular business model, with confidence that they'll have a customer base waiting for it.

By overcoming the internal roadblocks to BPO adoption, banks can incorporate this tool into their product mix and begin to actively reach out to clients as an advisor, providing a truly comprehensive set of trade finance options and offering a beneficial path forward for both the corporate client and the bank itself.

Merlin Dowse's e-mail is merlin.dowse@jpmchase.com