Why your corporate clients should care about the Bank Payment Obligation

Why your corporate clients should care about the Bank Payment Obligation

In the ICC Guide to the Uniform Rules for Bank Payment Obligations, I characterised the Letter of Credit (L/C) as a "creation of commerce" whereas the Bank Payment Obligation (BPO) is the "brainchild of bankers".  

The genesis of the BPO has threatened change to well entrenched practices. L/Cs came into the world as a result of sellers of goods identifying a need to mitigate the commercial risks of trading with unknown buyers from other parts of the world. Financial institutions acted as trusted third parties in these transactions. Over several centuries the L/C has been extended to provide payment assurance and support alternative short term working capital financing.   

The birth of the BPO came as L/C volumes have declined. The amount of business conducted on L/C has at best remained stagnant for two decades, signalling that banks are being cut out of traditional trade as open account business prevails. Industry estimates suggest that some 82% of world trade is now subject to open account terms, and that this number is projected to rise to 89% by 2020.  

The BPO was conceived to enable banks to re-intermediate with the open account world by providing tangible bank assistance to these transactions. But have banks really identified a problem that customers currently experience? Corporates need to be educated and convinced as to the value of BPO but also need to acknowledge what problems lie in the existing system.  

Many bankers would no doubt agree that a majority of trade conducted on open account is done without the need for bank assistance beyond a payment at the end of the transaction. The BPO addresses an unknown percentage of the open account market where there is a residual need for risk mitigation, payment assurance and/or financing services.  

This space is currently occupied by services such as factoring and so-called reverse factoring on the financing side, and standbys/guarantees and credit insurance on the risk mitigation/payment assurance side. In recent years, there has not only been significant growth in international factoring but the business of reverse factoring, or approved payables finance, has come from almost nowhere to occupy centre stage.  

What compelling argument will catalyse corporate demand?

There is a need to dispel the image of the BPO as a Lite L/C. As long as that's the case its potential appeal and application will be limited, as will banks' appetite to sell. The limited numbers of corporates that have adopted BPO in support of live commercial transactions have tended to do so as a means of reducing the processing and confirmation costs of their residual L/C business, not to solicit bank assistance for open account.    

One area in which BPO may yet make its mark is in the space currently occupied by approved payables finance/reverse factoring solutions, often called 'supply chain finance' by banks today.  

Traditionally a three-way relationship has existed where one bank (the bank of the buyer) services the needs of both buyer and suppliers, placing reliance on the buyer's credit lines and credit standing to offer finance to the supplier. Supplier on-boarding and the related difficulties around KYC remain a challenge.  

Trade finance follows an 80/20 rule. 80% of the business managed by 20% of the banks. Given this hierarchy, how many banks will realistically have the financial strength, capacity and appetite to compete in this closed world of three-corner supply chain finance?

The only way that international banks to take advantage of future supply chain finance opportunities is to do so in a four-corner model where a buyer's bank collaborates with the supplier's bank, agreeing shares of both risk and reward.  A certain amount of supply chain finance business is already evolving in this way.  

It is in this area of four-corner supply chain finance that the BPO has the potential to come into its own.  

A BPO can be put in place very quickly and easily, at limited cost, providing an assurance to the seller's bank that the buyer's bank will pay on the due date and enabling the seller's bank to proceed with the financing, relying on the strength of the BPO as collateral. Alternatively, the due date of the BPO can be amended by agreement so that the buyer's bank is obliged to pay in advance.   

There are so many options attached to the issuance and application of the BPO that bank services can be tailored flexibly to match individual needs and circumstances. There is still inadequate awareness amongst corporates and only a handful of banks have had the appetite so far to foster awareness.  

Technology as an enabler

Also missing are the technology enablers to support the automated processing of BPO-based transactions within the banks' own back offices. Technology in banks today often doesn't support the ease of communication required to support automated and standardised data exchange between corporates and banks.  

The banking software industry can work with banks to exercise a material influence on market adoption of BPO by bringing to market the platforms and the channels that can simplify this data exchange. This is not so far removed from the work that has already been done in recent years to support the exchange of L/C and guarantee related data in the form of the MT798 message. It is not unreasonable to envisage the emergence of a world in which the corporate will demand a multi-bank delivery channel that supports not only the exchange of MT798 for traditional trade but also the BPO for bank-assisted open account transactions to better manage the financial supply chain.  

This is a natural extension of channels already used today to support complementary services such as payments, cash reporting and foreign exchange within the broader context of working capital management.  

About the Author

David Hennah, Head of Trade and Supply Chain Finance, spent eight years driving SWIFT's financial supply chain strategy. He is known for his work in recent years to bring the Bank Payment Obligation to market as an established business practice. David was a member of the ICC BPO Rules Drafting Group and is the author of the ICC Guide to the Uniform Rules for Bank Payment Obligations.  

Contact us to discuss the BPO in more detail or request a meeting at Sibos 2013.

Further reading:

Trade and Supply Chain Finance: Leveraging Cash to Compete

BPO Infographic

Join the discussion on LinkedIn