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Rejection rates for trade finance applications for SMEs in Africa are rising, with bank participation in activities decreasing. The continent’s trade finance gap, estimated to be more than US$81bn, is also growing, finds a new report by the African Development Bank (AfDB) and the African Export-Import Bank (Afreximbank).

Conducted over 2011-19, the report titled Trade Finance in Africa: Trends Over the Past Decade and Opportunities Ahead, is based on a survey of more than 600 commercial banks across 49 African markets.

The research reveals that over the eight years leading up to 2019, the average size of the trade finance gap in Africa was estimated to be US$91bn. It decreased slowly 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.

At the same time, participation in trade finance by banks has been decreasing. In 2019, 71% of banks surveyed engaged in trade finance activities, compared with 92% in 2014.

Competition, know your customer (KYC) and anti-money laundering (AML) regulations, as well as stricter capital requirements introduced after the global financial crisis, have increased due diligence costs and eaten into margins, making smaller transactions unprofitable for banks operating across the continent, reveals the report.

The share of SME trade finance applications rejected by banks has increased by 20% from 2013 to 2019. The Central Africa region experienced the highest rate of rejections last year, with almost half (47%) of applications not approved. This is followed by North Africa at 37%, Southern Africa at 33%, West Africa (30%) and East Africa, which has the lowest SME rejection rate of the sub regions, at 23%.

Banks surveyed listed weak client creditworthiness (30%) and insufficient collateral (25%) as the main reasons for rejections. 16% of banks engaged in trade finance list KYC/AML compliance as the key motive for not approving trade finance applications in the period from 2015-19, compared with less than 1% in 2013-14. “As regulatory requirements related to KYC/AML have become stringent, banks have become more selective too, moving away from clients that present significant risks for less reward,” reads the report.

 

LCs popular, bank income down

In 2015-19, a quarter of trade finance assets in Africa related to capital goods such as machinery and equipment. A fifth of all transactions were associated with trade in agricultural goods, and about 11% of deals took place in the energy sector.

On average, over that period, half of banks’ trade finance portfolios were associated with letters of credit (LCs) and documentary collections. Import loans and pre and post-export finance instruments accounted for 45% of banks’ trade finance portfolios, with the remaining 5% of transactions associated with other instruments.

Trade finance activities in Africa contributed an average of 10% to total bank income in 2015-19, down from 15% in 2014. The report says this decrease could partly be the result of more competition and higher transaction costs for banks.

It adds: “Trade finance earnings also depend on the volume of transactions and overall trade growth. Hence, as African trade fell below 2013 levels largely due to falling commodity prices, so did bank earnings from associated trade finance activities.”

When it comes to correspondent banking, Citi, Commerzbank, Deutsche Bank, Standard Chartered and UBAF were the top confirming banks for African issuing banks between 2015-19.

Citi had confirmation relations with 9% of African banks, the highest on the list. Aside from Citi, the report reveals that all confirming banks had lower shares of correspondent relationships with African issuing banks during 2015-19 than in 2011-14, showing a general move away from correspondent relationships with African issuing banks.

The report also highlights the critical role of development finance institutions (DFIs) in supporting trade and trade finance in Africa. More than half (60%) of the banks surveyed that engaged in trade finance activities between 2015 and 2019 received support from DFIs to boost their transactions. However, support from DFIs is concentrated amongst banks based in West and Southern Africa and foreign-owned private banks throughout the continent.

 

Covid-19 chaos

Already facing a growing trade finance gap and higher rejection rates for SMEs seeking trade finance, African trade must now navigate the Covid-19 pandemic, which has caused social and economic chaos around the globe.

A few months before the pandemic hit in March, the International Monetary Fund (IMF) warned of debt distress in low-income developing countries, revealing that two-fifths of them were at high risk of debt distress. Countries in Africa are now tasked with overcoming a deep global recession in a vulnerable position.

Across Africa, more than 1.3 million cases of Covid-19 have been confirmed, almost half of which were recorded in South Africa. However, the World Health Organization (WHO) has warned about the reliability of testing in Africa, meaning numbers could be far higher, and that it could be facing a “silent pandemic”.

“Increasingly, it is becoming clear that the ongoing Covid-19 pandemic could add to the burden of risks facing African trade and trade finance. The pandemic has already resulted in sharp falls in the prices of most of Africa’s top export commodities,” reads the report.

As export revenues fall and firms and banks’ balance sheets deteriorate, access to foreign exchange liquidity and banks’ willingness to engage in trade finance transactions could be reduced.

In a bid to free up liquidity, the AfDB approved a US$10bn Covid-19 Response Facility (CRF) in April 2020. The bank is also providing up to US$1bn in trade finance liquidity and risk mitigation support to local banks in all member countries. Meanwhile, Afreximbank announced a US$3bn facility in March for its member countries.

The report adds: “Covid-19 is impacting global supply chains and the region’s trade with the rest of the world, while limiting the availability of dollar liquidity to support trade. Thus, once the crisis recedes, the need for financing to re-energise the region’s trade will be higher and more urgent.”