Trade Based Money Laundering: Payment

April 21, 2020
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Trade Payment Methods and Trade Based Money Laundering Vulnerabilities

(Published in the Financial Express in 2019)

Dr. Shah Md Ahsan Habib[1]

In today’s connected global economy, banks are working to increase their market share in trade services by linking importers and exporters though several payments and financing products. In the coming years, banks should expect to increase their share of trade related transactions and services and, as a by-product, their exposure to potential fraud and Trade Based Money Laundering (TBML). Trade services by banks mainly include trade payment and financing products/services that may not have same implications for the TBML risks. Practically, TBML risks may vary from country to country; and different trade payment techniques may offer different level of vulnerabilities in different countries.  

In the global context, most trade is conducted on open account terms, and therefore enabled through techniques of Supply Chain Finance (SCF). Open account is an arrangement between the buyer and seller whereby the goods are manufactured and delivered before payment is required. Supply Chain Financing like factoring, forfaiting, invoice financing etc. are particularly relevant for open account transactions. Using SCF, banks provide technology and other services to facilitate payments and financing within supply chain of enterprises. There are also some instances of cash in advance where sellers enjoy notable bargaining power. In case of cash in advance and open account, involvements of banks are generally insignificant, and traders have relatively greater freedom in handling the process in reasonably low cost.

In considerable cases, international trades are facilitated by trade services by banks and financial institutions covering documentary credit (LC), documentary collection, standby LC or other bank guarantees. Involvements of banks are significantly higher in the trade services techniques like LC, bank guarantee, standby LC and documentary collection. Especially through LC, banks offer payment, financing and risk management services to their clients. It is a classic form of trade facilitation technique that substantially reduces risks for both exporter and importer. It is an undertaking or commitment issued generally by a bank to pay the exporter a certain amount provided that the documentary conditions of the LC are complied with. A standby LC is functionally equivalent to demand guarantee or international bank guarantee, but differs in terms of structure. International guarantees may serve several purposes from indefinite range of payment, performance or non-performance obligation. Documentary collection is basically a payment tool having ‘documents against payment’ and ‘documents against acceptance’ techniques that provides a means of payment whereby the exporter can ensure that the buyer should not be able to take possession of the goods until it has paid or given a payment under­taking.

According to the most recent ICC survey, of the different trade financing techniques, traditional trade services products i.e. (LC, documentary collection and bank guarantees) have been at the focus. It is interesting to observe that while 47 percent of respondents report their traditional trade finance and supply chain finance businesses were in the same business unit, survey findings show a clear focus on traditional trade finance, with 85 percent of respondent activities in this area, versus 15 percent in SCF. This is in contrast to the market: roughly 80 percent of trade takes place on open account – better suited to SCF solutions than traditional mechanisms.  

There is no doubt that of the traditional trade financing techniques commercial LC is the most widely used. Of the different regions, Asian markets have been the key markets for trade finance businesses by banks. The recent availability of SWIFT data (published in the ICC survey) demonstrate that in terms of LC business Asia-Pacific accounted significant market share for export messaging as a proportion of world LC traffic. Growth in trade finance transactions both in volume and value terms are no longer predominantly driven by China. Countries using SWIFT LCs the most for imports include: Bangladesh, South Korea, China, India and Pakistan; and countries using SWIFT LCs the most for exports cover: China, Hong Kong, India, Singapore and Japan.

Trade payments and financing techniques involve different risks and regulatory issues that may be linked to the TBML. Regulatory issues for the trade services products are critical from the point of view of compliance and addressing trade-based money laundering challenges. Of the methods of payment, cash in advance and open account are the simplest and cheapest, but they create the greatest possibility for opportunistic misconduct by the trading partners. Involvements of banks are insignificant in these transactions and generally, regulatory authority enjoys lesser controls over these dealings. Contract or purchase/sale agreement is the guiding document for cash in advance and open account transactions, and thus sound and legally enforceable purchase/sale contracts are crucial for ensuring responsible behavior on the part of traders.  

Generally, greater involvements of banks help regulatory authority to exercise greater control and thus help minimizing risks of trade-based money laundering.  Banks involvements are higher in documentary collection than that of cash in advance and open account methods; and it is costlier to the traders as well. Documentary collection is cheaper than LC to the traders; however, regulatory authority may have relatively less control over the transactions as compared to that of LC. LC is the costliest form of trade payment method where regulatory authority may exercise significant control. Banks have significant involvement in the LC or documentary credit operation and the processes are formally regulated or guided by a classic ICC publication. Practically bank is amongst the main parties of the transaction. This is a very good risk minimization tool for the traders and the best of the trade payment methods from the perspective of country risk.

Practically, LC is considered as the best trade payment method from the TBML vulnerability perspective. Regarding the ongoing approach of addressing trade based money launderers, Global Banking and Finance Review observed ‘despite a significant proportion of international trade being conducted on ‘open account’ terms, trade-based money laundering controls typically focus on transactions supported by traditional trade financing, such as LC; and this is disproportionate and leaves a gap in the industry’s response to TBML.’ Of the different trade payment methods, the existing global regulatory approach for handling TBML is the most effective for LC or documentary credit followed by the documentary collection. It is the greater control which is helping the most.  There is no doubt that ‘open account’ as a payment method and the technology driven and relatively recent supply chain trade finance products have their own advantages. However, several of these cannot be brought under comprehensive regulatory and control framework. Thus, for many developing countries greater use of LC offers better protection, monitoring and control and so better circumstance to address TBML challenges.


[1] Professor and Director (Training), BIBM ([email protected]).

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