It is widely acknowledged and accepted that access to finance remains one of the biggest constraints for the survival and growth of MSMEs. Given that they are the drivers of broad-based economic growth in developing economies, solving this problem is crucial if we are to address the ever-increasing trade finance gap, write George Wilson, head of institutional trade finance, and Derryn Faure, institutional trade finance, at Investec Bank Limited.

 

Notwithstanding that MSMEs are the focus of many multilaterals and development finance institutions (DFIs) across the globe, who genuinely want to help, the trade finance gap in developing markets continues to worsen. In our view, an on-the-ground understanding of developing market MSMEs and their constraints, obtaining practical legal and IT help, liquidity, capital, grants and international collaboration are key to solving the problem. Unfortunately, this will also require an unprecedented level of communication and partnership between MSMEs, African non-bank financial institutions (NBFIs), local banks and governments, international banks, fintechs, funds and multilaterals. Some deeply held shibboleths will also have to be discarded along the way.

 

Endogenous cost barriers to entry

In previous articles, we have discussed at length how inappropriate regulation has negatively impacted African trade finance, particularly by making it unprofitable for trade financiers. What we have not focused on are the additional prohibitive cost barriers to entry for local African MSME financiers and MSMEs themselves.

African MSME financiers tend not to offer technical open account, structured or commodity trade financing products as their product development, implementation, systems, controls and operations require expensive capex and investment, and these banks sensibly won’t invest in unprofitable business.

This puts ‘real’ trade finance products, which use self-liquidation and the underlying transactional flows as credit mitigation, beyond the reach of most MSMEs and relegates them to overdrafts and mortgage loans to fund their working capital cycles. Unfortunately, however, most MSME traders just don’t have enough tangible security to offer their financiers as collateral. Once small businesses have pledged their fixed property, which most small businesses must do to raise initial capital, they have nothing else to mortgage beyond their underlying inventory and invoices – the very trade products that their banks are deterred from financing.

In order to lend to MSMEs, financiers need to take a credit view on those MSMEs’ track records by assessing their books and records. Here again, unfortunately, many MSMEs don’t maintain usable financial accounting or IT systems as they are not core to their business, and their cost and implementation are prohibitively expensive.

However, without serviceable accounting information or systems, the availability of any credit will be negligible and/or prohibitively expensive – we have seen margins north of 25% for dollar funding.

As is already evident in the rest of the world, the future of trade finance is open account and digital. Some excellent digital open account trade and accounting systems are already available for this type of African trade finance, but the implementation and testing costs for lower-tier MSME financiers are not financially viable, and the MSMEs can’t afford the associated costs, either.

Even where open account or structured commodity trade products are available, the standard Loan Market Association-style legal documentation required by financiers is too complicated and overwhelming for most MSME traders, especially since the associated costs (including registration of local law security) are prohibitively expensive for short-term MSME trade facilities. What is needed are simpler and shorter, standardised MSME trade loan agreements and regional security templates – much like the BAFT (Bankers Association for Finance and Trade) Master Trade Loan Agreement – for MSME traders and their financiers.

 

International collaboration

As mentioned, DFIs, multilaterals, governments and local and international banks are genuinely desperate to address the trade finance gap and have each independently proposed solutions in the form of guarantee and risk-sharing programmes, implementing policies through MSME ministries as well as supply chain finance (SCF) facilities, for example. However, no material impact has been made as there has been little coordination in implementation, no practical African input and no understanding or consideration of the actual root causes of the problem. Solutions have generally focused on corporate-anchored, digital SCF programmes because they fit the non-African pre-requisites.

Critically, the only entities that have the resources and mandate to have a material impact are the DFIs but they insist on crippling extraneous philosophical tenets:

  1. They harbour an aversion to leveraging their trade programme resources for working capital as they interpret it as not ‘real trade’. But MSMEs often can’t access ‘real’ trade finance products for the reasons mentioned previously;
  2. They insist that their assistance is not concessional and must be limited to mobilising private capital to amplify commercial risk takers who have some ‘skin in the game’. This is reasonable for corporate trade, but the problem is that no one is taking MSME risk in the first place;
  3. Their guarantee and refinance programmes demand all the details of the underlying transactions. Unfortunately, this is impossible for MSME trade finance where there are millions of small, randomly timed MSME invoices, which disqualify international banks due to the regulatory obligation of intolerable risks associated with sanctions and AML screening of millions of underlying past, present and future MSME transactions; and
  4. Their requirement for evidence of and adherence to the goals of the Paris Agreement and northern hemisphere ESG sensibilities that they require as a prerequisite of their support. Fragile developing economies seeking a ‘just transition’ question why they must shoulder the burden of climate action for first-world governments and multilaterals where it’s clearly evident that these developing economies only contribute 2/3% to overall global carbon emissions.

 

If solving the African MSME trade gap is really the priority, then all of these tenets must be abandoned. New solutions must be designed, and mandates and terms of reference need to be recommissioned, taking into account MSME-specific challenges and obstacles to successfully support African MSME trade programmes in order to achieve sustainable economic growth in developing markets.

 

Proposed solutions

Crucially, the solution to the regulatory challenges depends on the deliberate expansion of DFI and multilateral guarantee programmes to cover aggregated trade portfolios to neutralise their capital and liquidity cost aversion. The guarantees can be made 50% transferable to cover not just the African FIs in the traditional way but also the risk and, therefore, capital costs of the underlying MSMEs, converting trade and working capital into profitable, good business for the African banks.

The DFIs will also need to adopt a ‘trade not aid’ approach by developing ‘technical assistance’ funds for grants to offset the endogenous legal, accounting, logistics and IT costs for the African MSMEs, NBFIs and banks in addition to its provision of finance/guarantees. This needs to be practical grant funding, not theoretical training. It will be important to give this kind of financial assistance to foster the wellspring of factors, impact funds, microfinance houses, freight forwarders and other NBFIs to develop trade products alongside working capital facilities into the segment. Together with technical assistance grants, DFIs, FIs and impact investors need to develop private equity-funded limited partners to invest directly into these NBFIs, as the first-order trade financiers of MSMEs in Africa.

Africa’s US$120bn trade gap problem can then be addressed by applying four scaling factors:

  1. The aggregation of these trade facilities into African NBFIs and lower-tier African banks’ revolving trade portfolios;
  2. The aggregation of these aggregators into African top-tier, regional and central banks and international FIs with African FI trade risk appetite;
  3. The application of DFI guarantees to leverage tens of millions into hundreds of millions; and
  4. The packaging up and securitisation of these DFI-wrapped facilities into revolving programmes of notes, which are then sold to global alternative funds and impact investors as high-yielding, truly sustainable finance investments with their DFI and developmental halos. This transports the risk to international markets, enabling the second aggregation layer of financiers to recycle their African credit limits and multiply the scale of the solutions into billions of dollars.

 

Conclusion

The importance of MSMEs and their contribution to inclusive and sustainable economic growth, particularly in developing markets, cannot be ignored. We also cannot keep talking about the problem and not produce scalable, practical, sustainable solutions that strike at the root causes of a problem of this scale and complexity.

All of the multilateral and developmental capital, technology, products and relationships required for this manifesto already exist. All that is required is collaboration between all parties to overcome the obstacles. For us to deliver on SDG 17 (partnerships for the goals), it is time we all work together on these practical solutions to reduce the trade finance gap and enable Africans to sustainably trade themselves out of poverty.