Trade finance needs strong standards, but the cost is high in emerging markets, writes FBN Bank UK.
Since the global financial crisis, world trade has faced many obstacles, as major nations withdraw from trading blocs and unions, such as the United States’ withdrawal from the Transatlantic Trade Agreement and Britain’s potential exit from the EU Customs Union. In addition, new regulations designed to combat terrorism such as AMLD 5 and improve the resilience of the financial system such as the Basel III Accord are making it harder for banks to take on certain business.
Despite these challenges, 2017 saw world merchandise trade record its strongest growth in six years, according to WTO Director-General Robert Azevêdo. While this is excellent news for the global economy, significant challenges remain for trade finance in emerging markets.
One of the consequences of raising regulatory standards has been the increased difficulty for banks to operate in some developing markets. We consider three areas: Anti-Money Laundering Regulations (such as the EU’s new directive, AML 5), Basel III and Modern Slavery.
In order to ascertain precisely how much AML rules are curtailing access to finance in emerging markets, the International Chamber of Commerce (ICC) included a question on this in their Survey 1 of 2017. The results show that almost 80% of respondents agree or strongly agree that the AML/CFT1 rules are a barrier to servicing trade finance needs in developing economies.
Ayodipo Ogunmoyela, Head of Corporate Banking at FBN Bank UK, notes that even the most mundane and basic due diligence processes can become a problem in some markets. “When you’re working in the UK, there is a postcode mechanism. In most parts of Africa, this is simply not available. It may seem like a minor point, but you can see how the lack of this basic mechanism of locating and validating an address makes identifying and knowing your client unduly difficult to demonstrate. You really need to have an in-country presence and have real knowledge of your markets to deliver on even the simplest compliance requirements.”
Along with the need to comply with due diligence requirements, banks must also deal with the need to hold higher levels of capital reserves to offset the risks they take. The Basel III Agreement effectively reduces the amount of capital banks are able to lend. With limits on their capacity to lend, banks are focusing on the most profitable markets. In an IIF/E&Y survey2, banks said that as a result of changes under Basel III, 48% have exited or are planning to exit business lines, and 27% said they are leaving specific countries.
Alongside the issues of CFT and AML, there is also a need to be cautious of the very real risk of human rights abuses, such as slavery, child labour and indentured labour, either directly or through some businesses’ supply chains. In the UK, this is regulated by the Modern Slavery Act, and many nations have equivalent legislation. International standards on human rights are not always fully adopted in developing economies, and FBN Bank UK reports that it spends time educating clients on international standards, trying to bridge local practices and global values.
In summary, the difficulty of compiling sufficient data to meet KYC, AML and CTF requirements, the commitment required to educate and help clients comply with international standards, and the costly risk-capital provisions of Basel III, are forcing many global banks to withdraw from developing markets.
The impact of de-risking on Africa
The scale and impact of this withdrawal in emerging economies is huge. In 2015, a World Bank survey on correspondent banking relationships in Africa and the Caribbean3 found that almost 75% of international banks reported a decline in correspondent banking relationships and 50% of regional banking authorities and local banks reported a similar drop. As a result, tasks such as AML and CFT due diligence are falling to much smaller financial institutions which may be less well-equipped for the task.
For local businesses, the effect is widespread, including the reduced ability to wire cash and carry out foreign currency transactions in key trading currencies such as the US dollar and the euro.
The use of technology
In recognition of all these challenges, a number of banks, often in partnership with fintech or regtech start-ups, are now experimenting with machine learning and analytics to help combat fraud and other crimes related to trade finance. Although this is a new field, it already looks as though it will be helpful in reducing costs and making compliance easier for correspondent and global banks. A report just issued by the Dubai Multi Commodities Centre, describes just how far fintech could disrupt current global trade. The report notes: “Just as the shipping container revolutionised trade in the 1950s, sweeping advances in tech will reshape trade and how we move goods across borders.”4
The issue at the moment is that the fuel that drives all these systems is data, and in emerging markets, data may not be easy to collect. Ogunmoyela notes: “Data and data management is still very much in its infancy in Africa which is a challenge for the whole banking system.”
One way of mitigating the poor data in many Emerging Markets is to pool resources. KYC registers, such as the one established by SWIFT, are designed to allow banks to share factual KYC data with each other in a pre-defined format, which other banks can use to augment and support their own due diligence. With banks withdrawing from the market, the solution will take time to become fully populated, but it is an investment that should eventually help banks to undertake more effective due diligence programmes in markets where data is currently scarce.
Does the business case make sense?
Many encouraging signs reinforce the business case for emerging markets in general, and Africa in particular. Exports from emerging economies increased 13% in 2017.5 However, emerging economies still represent less than 1% of all global trade.6 The growth is encouraging, but the fact that these markets represent so little of the total global trade value shows just how much upside still remains.
Looking at it from another perspective, the Asian Development Bank reports that the world is facing an unmet global trade finance demand of US$1.5tn.7 The ADB has been monitoring this gap for several years and whilst it seems to have stabilised (US$1.6tn reported the year before), it is not getting significantly better.
The ADB report goes on to say that this is a problem faced by 74% of SMEs and mid-cap firms, predominantly in emerging markets. Not all of that trade gap is addressable; there are valid credit and compliance issues which prevent the banks from lending – but according to the report, there are opportunities too, noting at least 36% of rejected trade finance may be fundable by other financial institutions.
Ogunmoyela is positive that the business case for Africa does make sense, pointing to recent figures published by the African Development Bank (AfDB). “There is still a lot of business in Africa, which has not become evident yet. Investment that will help Africa catch up with the rest of the world, for example in developing better infrastructure, will pay back handsomely.”
According to AfDB’s President, Akinwumi Adesina, the continent has an infrastructure funding gap of US$87bn to US$112bn annually.8 The African Economic Outlook Report goes on to say that this restricts economic growth in a region that is one of the world’s poorest, despite having vast mineral resources. Sub-standard roads, ports and airports alongside power generation and distribution problems add to the cost of exporting commodities and hamper intra-regional trade.9
Numerous opportunities therefore remain for the public sector and private investors to finance local and international businesses to build new infrastructure easing the passage of goods and services to other countries within and outside the continent.
One of the most critical factors for the future African prosperity is the African marketplace itself. The share of Africa’s merchandise exports within the continent has nearly doubled, jumping from 10.3% of total exports (by value) in 2010 to 19.6% in 201710. According to a recent UNCTAD conference, the long-term gains for Africa are estimated to be around US$16bn annually once all tariffs have been eliminated. Whilst there are some protectionist fears in certain countries, overall this is a strikingly different approach to that of many advanced economies at the moment.
This, in turn, is expected to lead to increased production of products with higher technological content, higher returns on investments because of the economies of scale that could be realised and significant increases in employment.
Ogunmoyela sums it up: “Not everybody is prepared to go the extra mile, especially in markets which they don’t really know. That’s completely understandable. We at FBN Bank UK see the risks as they actually are, not as others perceive them, and we understand the potential of the markets too. There is plenty to do to educate, promote and implement international standards here. It’s a bit of a ‘roll up your sleeves’ kind of banking. That’s what we at FBN Bank are good at.”
1. Counter terrorism financing
2. IIF and E&Y, 2016. Seventh Annual Global Bank Risk Management Survey
3. Withdrawal From Correspondent Banking Where, Why, And What To Do About It – November 2015
4. The Future Of Trade – DMCC – 2018
5. World Trade Statistical Review 2018.
6. World Trade Statistical Review op cit
7. 2017 Trade Finance Gaps, Growth, and Jobs Survey
8. African Economic Outlook 2018 – AfDB
9. African Economic Outlook op. cit.
10. World Trade Statistical Review 2018.op.cit