Yet Another Definition of BPO: Bank Payment Obligations

Ivan Schneider, Writer, specializing in financial technology | 12/10/2012 | 5 comments

Ivan Schneider
To simplify supply-chain finance for import-export, the International Chamber of Commerce (ICC) and SWIFT have come up with Bank Payment Obligations, or BPOs. The idea with BPO is to have a payment instrument that's less risky than an open-account transaction and more automated than traditional letters of credit.

In a "Virtual Sibos" online session, Ashutosh Kumar, global head of corporate cash and trade for Standard Chartered Bank identifies the BPO as a boon for banks involved in global trade. "We have a huge opportunity in Asia, because most of the [trade] corridors are growing at a very fast pace," said Kumar. "The Bank Payment Obligation can be one of the solutions to help us capture that opportunity."

An open-account transaction occurs either when a buyer pays in advance, or when a seller ships the goods in advance of payment. Either way, one side is open to the risk of default or non-payment by the other side. The open-account approach also limits the banks involved to a very limited role as a transaction processor.

Banks have a more central role when buyers and sellers use letters of credit, which is (as defined by the US Department of Commerce's Trade Finance Guide) "a commitment by a bank on behalf of the buyer that payment will be made to the exporter, provided that the terms and conditions stated in the [letter of credit] have been met, as verified through the presentation of all required documents."

That's all well and good, but to mail, inspect, and process the paper documents involved with letters of credit is a time-consuming and expensive process. Even if the shipment of goods takes only a day, handling the paperwork may take a week or more. For that reason, many firms have shied away from letters of credit in favor of open account, despite the protections of LoC-based approach.

Over the past decade or so, there have been several initiatives to bring letters of credit into the Internet age through the electronic exchange of information, but these efforts have tended to run into the hurdles of low adoption and venue fragmentation. It's one thing to create an electronic exchange for trade data, and yet another to get an importer, an importer's bank, an exporter, and an exporter's bank -- not to mention tying in the intermediary firms and customs entities involved in shipping, transportation, and logistics -- onto the same platform.

Compared to these previous efforts, BPO has two key differentiators in its favor: the adoption of global standards and the possibility of using electronic matching venues.

The reliance on global standards ensures greater interoperability and increased the possibilities for adoption. The BPO standard is built on the message formats defined in ISO 20022, an international standard for financial messages. This ensures that modern, ISO 20022-compliant solutions can process BPO data without significant customization. Furthermore, the business rules underlying the BPO data are compliant with ICC Uniform Customs & Practice rules for documentary credits, which are widely followed in international trade.

SWIFT, the financial messaging entity, was instrumental in the creation of BPO, and also offers an electronic matching service through SWIFT's Trade Services Utility (TSU). Yet unlike previous business models for electronic trade finance, transaction matching doesn't necessarily have to occur within the TSU. As an ICC standard, the format and rules can also be applied not just through TSU, but also through any transaction matching application equivalent to TSU. While the greatest adoption in terms of bank participation, trade volume and message traffic will almost certainly occur through TSU, the open standard makes it possible for other players to offer their own implementations of transaction matching, opening up the door to any number of value-added services and features.

This is exactly the kind of business that banks should be devoting their energies to providing to their customers. By working with buyers and sellers in an increasingly global economy, banks can avoid the trap of being a provider of commodity banking services, while also staying away from the kind of financial engineering-based business models that proved disastrous in the global financial crisis. Instead, with BPO we have an example of banks facilitating trade, which in turn increases economic activity and overall wealth.

My only problem with it is the nomenclature, considering the potential confusion with the "original" BPO, business process outsourcing. I can easily imagine a cloud-based outsourced service for banks that want to offer trade finance to their customers without having to hire new people or deploy in-house technology -- a BPO for BPO, or BPO-squared.

In the comments, I'd love to hear from people who currently conduct business on open account, or who have found themselves limited by the slow documentary procedures involved with letters of credit. Would the BPO service appeal to you? Also, from a technology perspective, what kind of extra features from a transaction matching application might be interesting to you? Any other thoughts are also most welcome.

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Pablo Valerio   Yet Another Definition of BPO: Bank Payment Obligations   12/11/2012 12:53:50 PM
Looks like a Bank Guarantee
Ivan, This looks very similar to Bank Guarantees used in Europe. Normally is issued by the bank to back a business transaction.

It is mostly used for payment of construction work before is finished, this way the buyer knows that can recover the money if the contractor doesn't finish the job.

I can see the advantages of the BPO, I used letters of credit in the past; they are complicated and very expensive.
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Ivan Schneider   Yet Another Definition of BPO: Bank Payment Obligations   12/11/2012 12:38:15 PM
Re: great for exporters
@Michael: Agreed, this is great for exporters. On the flip side, it's equally great for  importers. So I don't see this in and of itself having a positive effect on the US trade deficit.

It does, however, give an advantage to banks that handle global trade in the most busy trade corridors, relative to domestic-focused banks. So, if a bank currently earns transaction-based fee revenue for handling either an incoming or outgoing payment, that revenue may come under pressure from someone who can structure that payment as part of a BPO. Not good news for domestic-focused banks.
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michaelsumastre   Yet Another Definition of BPO: Bank Payment Obligations   12/11/2012 10:32:21 AM
great for exporters
This is something that should be looked into by our exporters here in the country. So far, things are going very well for them despite the global slump. Nevertheless, soon other Asian markets will continue to rise, and those that have experienced financial problems will be able to bounce back. Anyway, hopefully this system, when it comes to full effect, can push exporters to become more aggressive and competitive. In fact, I can see more businesses participating in the trade since they can already guarantee revenues and banks can be more open when it comes to giving their support.
Ivan Schneider   Yet Another Definition of BPO: Bank Payment Obligations   12/10/2012 1:02:44 PM
Re: Nice Solution
I would say one of the biggest catalysts was ISO 20022.

Absent the international standard for financial messages, the industry would have required a consortium to come up with a specific format for messages just for trade finance, and then various parties would have had to lobby for the adoption of that format. While trade finance is important to banks, it doesn't always get the highest levels of attention by overworked IT departments. 

With ISO 20022, it's easier for banks to adopt standards such as this. As long as your core systems are ISO 20022-compliant, you're already much of the way there when it comes to processing messages based on that format. 

There's still plenty of IT work to do -- especially when it comes to integrating the information that comes out of transactions into the channel. In the past, the bank may have just sent a message when the payment was made. Now, the bank can get involved at various stages involved with the shipment and receipt of goods. The leading banks will be those that provide detailed information in the manner of an international logistics company -- with financial information layered on top. 

So yes, easy to implement at the start, but hard to deploy in a manner that takes into account the needs and demands of the customer.
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David Wagner   Yet Another Definition of BPO: Bank Payment Obligations   12/10/2012 12:47:28 PM
Nice Solution
Hi Ivan, this seems like a nice solution. So where is the catch? Did it just take this long for one standard to emerge?

What is this going to do for IT folks? It seems relatively easy from an implementation point of view. Is there a compliance problem?

Or is this one of those rare situation where an elegant slution has been made for a problem and everyone will be happy?


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