;

Dynamic trade finance in the presence of information frictions and FinTech

Subject

Management Science and Operations

Publishing details

Social Sciences Research Network

Authors / Editors

Lee H L; Tang C S; Yang S A; Zhang Y

Biographies

Publication Year

2020

Abstract

We study the value of a type of innovative bank-intermediated trade finance contract, which we call dynamic trade finance (DTF, under which banks dynamically adjust loan interest rates as an order passes through different steps in the trade process) in the presence of information frictions related to process uncertainties, and its strategic interaction with FinTech. As more than one third of global trade involves bank-intermediated trade finance (IMF 2009), examining the value of DTF as a contract innovation and its strategic interaction with FinTech is of practical importance. Also, analyzing trade finance in the presence of process dynamics and information frictions complements the existing academic literature. We construct a parsimonious model of a supply chain process consisting of two steps: the duration of each step is uncertain, and the process may fail at either step. The seller borrows from a bank to finance this 2-step process either through uniform financing (the interest rate remains constant over the process) or DTF (the interest rates are adjusted as the process passes each step). While lending, the bank faces either ex-post information opacity (the bank may experience a time delay to verify information about the order's passing of a step) or ex-ante information asymmetry (the seller possesses more accurate information about the trade process than the bank). FinTech may alleviate such information frictions. We find that the value of DTF increases as the trade process becomes more reliable or lengthier. The severity of ex-post information opacity hurts the value of DTF convexly. FinTech that enables speedy information verification and automatic execution complements DTF. In the presence of ex-ante information asymmetry, DTF enables separating the more reliable sellers from the less so ones, and hence, substitutes FinTech that alleviates information asymmetry. Our results shed light on how the underlying trade process dynamics and the type of information frictions involved affect the optimal deployment of contract innovations (DTF) and FinTech in trade finance.

Keywords

Trade finance; Supply chain finance; Structured trade finance; Information friction; Information asymmetry; FinTech; Blockchain; Smart contracts

Series Number

3632563

Series

Social Sciences Research Network