IBLJ | 7th July 2021
Some Indian banks have formed the “Indian Banks’ Blockchain Infrastructure Company” (IBBIC), aiming to use blockchain technology for processing letters of credit (LC) in domestic transactions. The IBBIC is a world first in domestic trade finance, and its platform may also have applications in verifying data for goods and services tax invoices, and e-way bills.
Distributed ledger technology (DLT) allows the replication, sharing, and synchronisation of digital data in a ledger across multiple sites and institutions, with no central administrator. DLT allows multiple entities or nodes to store copies of the ledger, and independently update it according to the DLT’s network protocol or consensus mechanism. The most common DLT implementation is the blockchain, where the ledger is made up of “blocks”, which are used to record transactions, that are chained together using cryptographic hash functions.
LCs are the preferred payment instruments in trade finance, due to their lower risk, and the role banks play as intermediaries facilitating the transaction. Trade financing using documentary credits such as LCs, is based on centralisation: banks act as trust providers and also process LCs, through centralised business operations. This often leads to long turnaround times, a lack of flexibility, and possibilities of malicious alteration, tampering, and forgery, as LCs involve considerable paperwork and manual processing.
Of the types of blockchain, a consortium chain is most suited to trade finance, as it allows for easier interbank interactions. A buyer negotiates a purchase order, and submits to its bank, the issuing bank, an LC application, which is stored on the blockchain for review, and acceptance or rejection. If approved, the seller’s bank is provided with access to the LC to approve and forward it to the seller. The seller then approves the LC’s terms and conditions, upon which the LC is finalised as a contract between the issuing bank and the seller. The seller then ships the goods, and uploads the commercial invoice, shipping documents, and other documentation to the blockchain, which the issuing bank reviews. Once the issuing bank approves payment, payment to the seller is automatically made. The buyer’s account with the issuing bank is debited, and the shipping documents are forwarded to the buyer for collection of the goods, and the transaction is settled. Only the counterparties involved in each stage would have access to the transaction details and documents.
Benefits of using the blockchain approach include increased transparency, easier transmission of information, increased traceability and disintermediation, lower costs, and immutability of transactions. It removes the need for the physical presentation of documents. Parties monitor changes across trade processes without having to communicate at each stage.
Some banks have already carried out successful blockchain LC transactions for cross-border import-export transactions, with tangible benefits. Press releases on the conclusion of these transactions have lauded the advantages of end-to-end digitisation of information exchange over paper-intensive and time-consuming traditional LC processes, resulting in significant reductions in processing time – in some cases, from a number of days to merely a few hours.
DLT can reduce the time, risk, and effort involved in LCs; a trade transaction happening in real time can be confirmed simultaneously by each participant, achieving greater transparency and cost efficiencies. In a 2017 white paper, the Reserve Bank of India’s Institute for Development and Research in Banking Technology documented a domestic LC trade finance proof-of-concept using a blockchain platform with a shared document repository, automatic settlement, and a full transaction history recorded on a single system.
Blockchain LCs help make trade more efficient, reduce risk, and lower barriers to entry for small and medium-sized businesses. However, they are not a panacea; the examination of documents under an LC cannot realistically be automated at present. The system remains vulnerable to bad actors feeding false information into it, however there would now be a clear trail leading back to such occurrences.