Letter of credit (LC) business and correspondent banking relationships “slumped substantially” across Africa in the initial months of the Covid-19 pandemic, according to a new report from the African Export-Import Bank (Afreximbank) and the African Development Bank (AfDB).

The Africa Trade Finance Survey Report garnered responses from 185 commercial banks – representing 58% of total assets across the continent – to better understand the impact of Covid-19 on African lenders of trade finance for the period January to April 2020.

It reveals that, as previously suspected, the pandemic “affected the trade finance activities of banks across the continent and led to material disruptions to trade”.

While a “significant range of respondents” from different subregions and types of bank reported increased demand for trade finance – with 37% experiencing rising demand from export clients, for instance – the study highlights how local and foreign banks also quickly became risk averse in the initial phase of Covid-19.

The most notable example of the adverse impact of the pandemic on African trade finance was the “substantial increase” in LC request rejections in Q1 2020, in comparison to the year prior, with 30% of respondents indicating an increase in rejection rates.

Results varied drastically based on factors such as geography, the size of the bank, or its ownership structure.

Lenders in Anglophone West Africa and Southern Africa reported some of the highest LC rejection rates – 50% and 48% respectively – while respondents in North Africa displayed “strong consistency” in LC issuance, the report says, with 92% stating there was no change in rejection rates in Q1 2020 when compared with 2019.

“The profile of LC rejections during the period was most evident in small banks,” the report adds, with 50% reporting an increase in rejection rates. Rejection rates were 32.1% for medium banks and 20% for larger lenders.

“This appears to reflect the asymmetric impact of Covid-19 on small and medium-sized businesses on the continent,” the report says.

Fears had already been growing over constrained trade financing for SMEs. A September report from Afreximbank and the AfDB detailed how rejection rates for SME trade finance applications have been rising since 2011, with bank participation in activities decreasing.


LC rejection causes

In terms of systemic factors driving this trend, roughly 59% of survey respondents identified access to foreign exchange as a reason for increasing rejection of LC applications.

US dollar liquidity, still the dominant currency in international trade transactions, was strained in emerging markets last year as a result of the pandemic, as remittance money fell, companies began to hoard cash, or were exporting less.

In explaining rising LC rejections, 40% of banks laid blame at the door of international lenders for decreasing credit lines.

More broadly, the study suggests that Covid-19 exacerbated existing frailties in correspondent banking relationships.

According to the report, the pandemic only served to amplify the effects of a “massive exodus” of international banks from the African correspondent banking space in recent years due to “increasingly stringent” KYC/AML and regulatory environments.

Survey results shows that 125 banks experienced correspondent banking relationship cancellations during Q1 2020, with Europe accounting for more than 50% of terminations in that time. Africa accounted for 15%, Asia Pacific 13%, Middle East 11%, and North America 10%.

The reasons for this include increased risk perception associated with Africa’s customer base as a result of Covid-19; decreased profitability or lower transaction volume due to the pandemic; and changes in sovereign credit risk rating.


Plugging the gap

The authors of the report warn that challenges posed by correspondent banking relationship issues, FX concerns and other Covid-19-related complications could see an increase in Africa’s trade finance gap.

A previous study from Afreximbank and the AfDB found that the chasm between Africa’s trade finance need and capacity has risen over the course of the past decade, and estimates the size of the gap to be US$91bn from 2011 to 2019.

It grew smaller from US$120bn in 2011 to US$70bn at the end of 2016. However, it has since increased, with the latest data putting it around US$81bn.

Against this backdrop and the wider Covid-19 disruption to trade finance, the latest survey report says that local and regional banks across Africa should enter domestic correspondent banking relationships to “take advantage of growth opportunities created by the exodus of large international banks from the continent’s trade finance landscape”.

With the launch of the African Continental Free Trade Area this year, Afreximbank has previously talked up the prospects of boosting intra-African trade in the coming years. The report also suggests countries could seek to boost intra-African trade through the involvement of alternative lenders.

“Covid-19 and related challenges provide an impetus for central bank and capital market regulators to engage with industry, to explore the viability of creating new trade financing capacity via the participation of asset managers and private equity in directing capital to the financing of international trade – including South-South trade and African trade,” it says.

Meanwhile, the report notes that greater dialogue between development finance institutions (DFIs) and governments could help bolster trade finance support.

Multilateral development banks (MDBs) and DFIs have rolled out billions of support across the continent, with Afreximbank signing off on its US$3bn Pandemic Trade Impact Mitigation Facility (PATIMFA) in late March.

In late 2020, the bank also announced a separate US$1.5bn pandemic response facility with backing from the International Islamic Trade Finance Corporation and the Arab Bank for Economic Development in Africa.

According to the report, improved dialogue between DFIs and governments in Africa will allows DFIs to continue to play a “vital role of a front line in the fight against the pandemic”.

This role includes taking more risks, easing credit access criteria, and using government guarantee schemes to scale up liquidity to struggling banks, in efforts to protect small and medium enterprises and save jobs.