Islamic trade finance no longer playing catch-up
Trade is a key driver for growth within any economy, and Muslim countries are no exception
Trade is a key driver for growth within any economy, and Muslim countries are no exception.
QISMUT is set to achieve US$1.6 trillion in Islamic banking assets by 2020, according to EY, and with Islamic finance and Islamic trade going hand-in-hand, the latt er will automatically increase. Established Islamic trade finance practices can offer new opportunities, are usually the preferred choice for emerging Muslim markets and are set to grow as quickly as Islamic banking. Yet historically, Islamic trade finance has lagged from a technology perspective. But now it no longer needs to play catch-up – Shariah compliant solutions can now offer the same advanced functionality as conventional trade finance solutions.
Islamic trade finance on the blockchain
Trade finance is often the area that off ers an obvious benefit from smart contracts simply because it’s currently a fairly slow paper-based process. It often has multiple intermediaries and quite a big time lag between events. Trade finance lends itself to smart contracts and with the internet of things, brings another level of benefi ts to corporate customers. It automates the entire contractual process for Islamic institutions, alleviating the additional administrative and legal complexities. Smart contracts are also easy to verify, immutable and secure. They naturally mitigate operational risks arising from sett lement and counterparty risks. In general, smart contracts have the potential to streamline the operations of Islamic financial institutions and automate the entire contractual process. We at Temenos have already undertaken a proof of concept to support letters of credit (LoCs) using distributed ledger technology. Although this was based on conventional LoCs, it can easily support Murabahah LoCs, Musharakah LoCs, Ijarah LoCs and Musawwamah LoCs and other forms of Islamic LoC contracts.
True Islamic trade finance liquidity through visibility
Trade finance helps to facilitate exports and imports and ultimately economic growth. It provides the liquidity support from the fi nancing perspective within the trade transaction itself. It can manage risks whether counterparty risks or country risks. Credit risk can be shared with another party through various types of trade instruments ranging from risk participation with a bank to using export credit agencies or multilateral credit agencies to provide credit risk mitigation. Recent years have seen a severe contraction of credit within the sector and corporates must be as liquid as possible and this starts with visibility.
Real time, instant access to information is therefore key to trade facilitation. This can only be ensured through the online availability of applications, issued lett ers of credit, amendments, drawings and shipping guarantees, etc, ideally through a single corporate portal. This information would be available to continually monitor banks, countries, projects and counter-party exposures in a live environment. Ultimately, to have true visibility, off ering the best ability to react faster to changing market conditions and a complete, single view are required. With this clear visibility, operational and fi nancial risk mitigation can really be eff ectively managed.
Automation means advanced efficiency
But effective management in trade finance liquidity isn’t just about information, it’s the ability to quickly act on this information as well. Areas to consider are having automated collateral management for corporates, available at the transaction level or limit level and the ability to waver credit approval and track the transaction documentary collection status. In addition, increased business opportunities can be realized through the ability to avoid using a line of credit or specifi c import.
Agility to evolve with changing needs
With constantly evolving corporate needs, their banking solutions, including Islamic trade finance instruments, cannot be fixed. Requiring lengthy change requests should be a thing of the past. Componentization where banks can add functionality according to Shariah auditors’ requirements or customer needs and enable easy customization is essential. Input can be through a single transaction, which automatically creates all necessary Shariah compliant postings. There should be no need for users to be industry experts in the underlying business rules or code, so flexibility, business agility and productivity are boosted simultaneously. Parameters can also allow corporates to centrally set up types of goods that are acceptable from an Islamic banking perspective.
Parameterization also allows the creation of any number of charge and fee types. The calculation methods used can follow industry standards, or can be tailored specifi cally based on the requirements of the customer or the Shariah board. If parameters are not comprehensive enough, a technical extension could specify charge and periodic fee types to be added, thereby allowing for any calculation method the bank may wish to employ.
No need to play catch-up
When corporates have the right Shariah compliant solution from their bank, they can increase their working capital, manage their trading risk or secure the sett lement of their payment. They should have the tools to be sure of timely payments from their buyers and minimize concerns about paying their suppliers. If their domestic trade runs smoothly, their exports are processed quickly and accurately and their imports are cleared effi ciently on favorable terms, all in line with Islamic values, ultimately, they will be loyal to their trade finance banking provider. And in an ever-competitive world, without loyalty, profi ting is impossible. Islamic trade fi nance instruments are now as advanced as conventional tools; it’s time for banks to have caught up and succeed.