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Banking /
Retail Banking
August 18, 2020
Letter of Credit Issuance - Powered through Blockchain
Blockchain has quickly become one of the hottest tech buzzwords. But what is blockchain technology and how can it be utlised by financial services companies in the day to day running of the business?
Blockchain technology is a digitized, distrubuted form of a ledger that is decentralized and shared among the participants (or nodes) of a transaction. In this distributed ledger model, multiple nodes record the transaction and its details at the same time, which completes the life cycle of a transaction. Distributed ledger technology (DLT) makes it possible for digital documentation to flow securely among participants based on permissions granted. Each participant can feed in the data as per the rights and permissions granted. The data is highly secured, and once fed in, the system becomes immutable.
An Example of Decentralized Distributed Ledger
The application of blockchain in trade finance transactions is going to be a significant disruption as it will open a whole new world of opportunities for import and export transactions. These trade transactions depend on the physical movement of paper-based documents and are known as documentary credits. With blockchain, the physical flow of documents would be reduced or eliminated, and the term 'documentary credit' may itself be changed.
A Blockchain Example for Letter of Credit Life Cycle
Let us take an example of the life cycle of a Letter of Credit (LC), which includes the issuance of LC as the first part and presentation of a bill under the LC as the second part. We will compare how the blockchain powers the LC transaction and reduces the transaction turn-around time to almost a quarter or even less then what it takes through the conventional method.
LC Issuance through Blockchain
The assumption in this example is that all the participants in this transaction are part of the blockchain ecosystem.The core banking system is Know Your Customer (KYC) enabled and directly interacts with credit scoring/rating agencies. These other external parties that are ancillary to trade transactions. Additionally, the system also provides different templates of trade proposals that can be used by users to create and draft client proposals.
The participants in the LC Issue transaction include:
i) ‘The Applicant’ (Importer) who is the customer of ‘Issuing Bank’,
ii) ‘The Issuing Bank’, which is issuing the LC for ‘The Applicant’ to ‘The Advising Bank’.
iii) ‘The Advising Bank’, which is the bank of ‘The Beneficiary’.
iv) ‘The Beneficiary’ (Exporter) for whom the LC is being issued.
If the applicant is new to the bank, the bank will undertake a credit appraisal of the customer. For this, the bank could interact with external credit agencies and sought credit reports of the customer, or the bank will contact the existing bank of the customer to request an account conduct report. This grants a facility limit to the customer for which LC will be issued. This information exchange between different banks and credit rating agencies etc. will happen on a blockchain platform. The data once received is processed to decide on granting the facility limit to the customer.
Figure 1.0 LC Issurance via Blockchain
Transaction Flow as depicted in Figure 1.0:
- The Applicant and The Beneficiary get into a trade agreement or understanding supported by an LC. The agreement is stored on the blockchain network.
- ‘The Applicant’ issues a ‘purchase order’ on ‘The Beneficiary’ in his Billing System, which becomes the underlying contract for LC and requests his bank, which is ‘The Issuing Bank’ to issue an LC.
- The Applicant captures the LC Application details in his system, which is on the Blockchain Network. The system interacts with ‘The Issuing Bank’ and requests his bank, which is ‘The Issuing Bank’ to issue an LC. ‘The Applicant’ provides all the information for LC, including the purchase order in digitized form to ‘The Issuing Bank’.
- The LC details are received by ‘The Issuing Bank’, and the bank processes the LC. The LC is transmitted to the Advising Bank.
- ‘The Advising Bank’ receives the LC and advises the LC to ‘The Beneficiary’ in digital form through the blockchain network.
- The Beneficiary provides its digital acceptance/rejection of ‘The Advising Bank’ through the blockchain network.
With the acceptance provided by the beneficiary, a contract gets established between the Importer and Exporter. The exporter will provide goods as mentioned in the LC, and the Importer will make payment against the goods received by him as per the terms mentioned in LC.
To this stage, traditionally, only two documents are used in the transaction, namely i) Purchase Order and ii) LC Application. In Blockchain, both these documents will be replaced by digital documents. So far, this transaction seems simple as the number of participants in the first part of the transaction is very limited.
If the LC needs an amendment at a future date, the same process will be followed. The LC will be amended with the agreement of both the Applicant and the Beneficiary.
How Blockchain Adds Power to Transaction
In this example, where the customer is new to the bank, the time involved in the credit appraisal process gets reduced. The credit reports are transmitted and received through Blockchain, and these are in the most authentic form. The reports can be validated as there is a complete audit trail present behind these reports.
The bank issues the LC based on the data which is fed into the system through Blockchain. There is a field to field mapping, which creates the LC instrument automatically when the data flow in the system. This reduces the time a bank takes to capture the data in the system manually. This is also much safer as the data is tamper-proof and cannot be changed. Also, the chances of errors are eliminated as there is no manual intervention involved in the process.
This completes the first part of the LC Issuance – Powered through Blockchain.
In the second part, we will see how the Presentation of a bill under LC is processed in the blockchain ecosystem and how blockchain enables the transaction cycle to go seamlessly end-to-end.
We will also highlight how BPC (Business Process Consulting) helps in connecting different blocks in a Blockchain. We then explore connecting different Blockchain networks to create a Blockchain ecosystem. Stay tuned for more in Part-2!
To learn more, feel free to message me to explore more, or have a conversation.
For more information, please visit:
Oracle Blockchain: https://www.oracle.com/blockchain/
Oracle Financial Services: oracle.com/financial-services
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