Related News

Roundtable: The energy transition speeds up

Making capital work in a challenging environment

Industry Perspectives: Reliable systems – are they really something new?

Industry Perspectives: Procurement’s growing role in the working capital conversation

Industry Perspectives: An inclusive approach to diversifying and strengthening supplier relationships

As the trade finance gap continues to grow, Duarte Pedreira, head of international development organisations and trade finance at Crown Agents Bank, reflects on a decade’s worth of discussion and explores a fresh way of resolving the disparity.

 

We know that the trade finance gap is continuing to widen – colleagues from around the world affirm this consistently across speeches, roundtable discussions and publications. By the trade finance gap, we usually mean the gulf between requests and approvals for financing to support imports and exports. This gap is usually most prominently felt in developing economies. The Asian Development Bank’s (ADB) 2023 Trade Finance Gaps, Growth and Jobs Survey revealed that the gap had widened to US$2.5tn, and that SMEs in developing markets continue to be most affected. Despite the acknowledgement of this huge challenge, proposed solutions and new approaches to closing this gap have been thin on the ground.

I was recently at a trade finance conference, and the trade finance gap was, as ever, clearly acknowledged. The discussion briefly considered the role technology could play in narrowing the gap going forward, especially by making trade finance more accessible through more efficient trading instruments and channels – but that was it. This left me reflecting on how little progress had been made in the 10 years since the ADB identified a US$1.6tn trade finance gap. The discussion increasingly has a sense of déjà vu about it – have we been having similar conversations for a decade now? We seem to be experts at explaining the gap, while failing to overcome it.

So, it is time to come to terms with the fact that whatever we have been “trying” to implement is not working. We all know the positive effect that international trade has on generating growth and inclusive economic development. We all know the benefits of developing a thriving SME community, especially in hard-to-reach markets. So why aren’t we doing it?

If we are to find a starting point to successfully address this challenge, we need to return to the ADB’s landmark survey and dig beyond the headlines that the gap affects SMEs in lower-income economies more markedly.

The very first publication on this topic – from 2013, referencing 2012 data – found that the top three reasons presenting obstacles for international banks in addressing the trade finance gap were (1) a “previous dispute or unsatisfactory performance of issuing banks”, (2) an “issuing bank’s low credit ratings” and (3) “low country credit ratings”.

In comparison, looking at the 2023 report and discounting certain categories, the top three structural reasons it identified that really stop banks from financing SMEs in emerging markets included (1) the “application was from a country perceived to be risky”, (2) the “application was from an SME with no collateral/high credit risk”, and (3) the “application lacked sufficient collateral”. This gives us tremendous insight into these challenges and in particular highlights the risk of non-payment.

From personal experience dealing with hard-to-reach markets, I would dare add that the very nature of the small-scale financing needed by SMEs is also a material impediment, especially for international banks, as this type of funding is commercially not viable – this is where technology can truly step in by creating efficiencies.

Why has the global trade finance industry failed to plug the gap over the last decade? Is it simply that the anxiety of losing money due to non-payment by borrowers (especially with regard to SMEs operating in developing markets) is just too overwhelming, and the value proposition unattractive from a commercial point of view? Perhaps.

I would also strongly argue that the focus of this failure lies with the private sector, which is naturally driven to be risk-averse. As such, we need to depart from this often-pervasive idea that the private sector will be able to solve the problem if we are just patient enough to wait for it to innovate a solution. To unlock this conundrum once and for all, we need to decisively bring the public sector into the conversation.

It is well recognised that most efforts to keep trade finance flowing, even during the hardships of the Covid-19 pandemic, were the output of the work of the global and regional multilateral development financial institutions, which used not just their liquidity, but their political drive and purpose to absorb and underwrite risks and to make available large sums of trade finance, at a time when the private sector had effectively retrenched. This was a natural corollary of the meeting of politically driven growth and development goals, and the normal functioning of markets – the former stimulating the latter.

How can we then generate a level of engagement from the public sector to finally provide the necessary platform to the private sector, so that, together, we can overcome the trade finance gap sustainably and permanently?

The postulate is simple. Every year, the United Nations, major governments, development financial institutions and similar organisations send billions of dollars into developing economies. Most of these funds are used in a way that decisively contributes to mitigating poverty, providing an essential lifeline to those without the means to survive on their own. These aid flows are critical, but are usually awarded on a much-needed basis, effectively being exhausted on consumption by the final beneficiaries.

What if, instead, part of these commitments was re-directed towards the creation of a jumbo non-payment guarantee? This could then be opened for the benefit of those pushing the missing US$2.5tn trade finance funds, especially into SMEs in hard-to-reach markets. It goes without saying that international trade is a key catalyst of growth and development, so the narrowing of the trade finance gap could have a very meaningful impact in the development of local economies, fostering further adherence to the United Nations’ Sustainable Development Goals (SDGs). The guarantee would then be managed for the benefit of pools (special purpose vehicles) of trade finance liquidity directed at developing economy SMEs, with funders including global, regional and local financial institutions, making use of transformative technology solutions.

This could be a win-win all around, as given the proven low probabilities of default and low loss given default statistics of trade finance instruments – found in the International Chamber of Commerce Trade Register Report  – the real impact of credit losses to the donors backing the guarantee could be significantly mitigated.

It will take a large coalition and tremendous amounts of goodwill to make this a reality. At Crown Agents Bank, we are privileged to have developed our position as a conduit into, out of and across hard-to-reach economies; a conduit that is used as widely by the public sector as it is by the private sector. As such, we would always stand ready to be a part of the solution – continuing to live our commitment to the markets we work in, operating in partnership with local governments and financial institutions alongside the global development sector.