Improving Trade Finance Efficiency with Bank Payment Obligation

The banking industry has always been among the pioneers of computerisation and networking, which in turn have driven the adoption of worldwide standards. This is particularly true in the case of international trade finance, where financing often goes beyond boundaries making standardisation inevitable. In trade finance, open account and letter of credit (L/C) are the two dominant product categories.

Despite the financial crisis and the significant rise of counterparty risk concerns that have emerged, open account is still a dominant means of conducting international trade. Open account is a high risk option for trading partners, particularly exporters, and require a significant level of trust between the two counterparties. In addition, in industries where payment cycles are long, open account transactions curtail cash flow and increase cost for the exporters. Due to high competition in export markets, foreign buyers often press exporters for open account terms, and this will strain the exporter.

Although a rebound of L/C usage would have been expected during the past few years due to increased concern about counterparty risk, the reality has been different. In some specific industries and countries L/C usage has seen growth, but for a majority of corporations the ‘cash trap’ nature of L/Cs has counterbalanced their concerns about the solvency of their trading partners. They were more concerned about cash availability to weather the difficult economic conditions. The revocable L/C is less popular as compared to the irrevocable L/Cs that adds the endorsement of a seller’s bank (the accepting bank) to that of the buyer’s bank (the issuing bank). This arrangement provides a level of protection to the seller because the L/C cannot be cancelled unilaterally by the buyer, and also both banks involved in the transaction guarantee its payment on maturity.

While the drawbacks in both these products resulted in high risk, increased costs and concerns about the solvency of their trading partners, an alternative means of settlement in international trade was much needed.

A Recent Development

In the year 2009, SWIFT’s Trade Service Utility (TSU), a matching and workflow engine for open account transaction data, started to offer bank payment obligation (BPO) as an irrevocable undertaking given by one bank to another bank that payment will be made on a specified date after a specified event has taken place. This ‘specified event’ is evidenced by a ‘match’ report that has been generated by SWIFT’s TSU.

The BPO was designed by banks to provide complementary services to corporates who are either trading on open account already or planning to move from L/C to open account. It allows corporates to make use of related banking services such as financing, payments, collections and account reconciliation.

The combination of international trade rules with that of technology ensures two key elements:

  1. BPO ensures the buyer will make the payment.
  2. BPO acts as collateral for financing.

The BPO brings the best of both the L/C and open account. In L/C banks will play the role of intermediaries, and in open account the paper-based exchange of documents remains within the corporate-to-corporate space without going into the bank-to-bank space.

The BPO is more convenient than L/C in the sense that the BPO’s electronic presentation of data eliminates the physical documents in the process, and is thus more cost effective than L/C as it is linked to the automatic matching of data through the TSU matching application. It is also more flexible than L/C as it allows changes to be made anytime during the lifecycle of a transaction for any amount that can be different from the total value of the goods consigned.

Likewise, it is more secure than open account in terms of mitigating risk and providing assurance of payment to the exporter. It is also more adaptable than open account, as it acts as collateral for financing.

Figure 1: L/C Versus BPO Versus Open Account

Source: Celent

The flavour of BPO, apart from data matching exercise promised by TSU, is the conditional undertaking by the issuing bank in favour of the receiving bank. In the pre-shipment finance BPO acts the same way as an L/C. There is still a degree of performance risk; however this is heavily mitigated, as the data has been matched at the purchase order stage by both parties and independently verified under TSU. Thus, the success rate of such transactions is high from banks’ perspective.

At post-shipment stage, financing is made easy as the data match between the invoice and the purchase order has already been made. The performance risk at this stage is eliminated and therefore post-shipment finance can be readily availed against the risk of the buyer.

At present, a majority of the banks worldwide are yet to realise the importance and advantage of such transaction. The existing banks using BPO are in the learning curve and are waiting to see how effective this alternative instrument can prove to be in the long run. Banks will have ample opportunity to integrate the BPO into their existing trade services portfolio in the years to come.


The BPO will allow corporates to conduct more business as their risk will be better managed and finance will be more readily available to the supply chain. A key element, however, is the level of comfort that counterparties feel with the legal underpinnings of the new instrument.

Sellers see cash flow optimisation and improved liquidity forecast due to releasing of cash trapped in the supply chain through automated data matching. With improved payment cycles sellers can reduce processing effort, cost and risk. Likewise, buyers benefit from extended payment terms that further enable the possibility to negotiate improved terms with the seller. Improved cash flow, increased competitiveness and optional ability to trigger payment are some of the added advantages to the buyer.

Keeping all the above analysis in mind, Celent expects BPO to become an effective alternative instrument that brings the best of both L/Cs and open account to the international trade finance scenario in the years to come.


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