Duarte Pedreira, head of trade finance at Crown Agents Bank, discusses the drivers of, and solutions to, the continent’s trade finance deficit.

Given that Africa’s resilience to external shocks is still somewhat limited, one would think that the resulting business sentiment around the financial sector in Africa would be rather pessimistic, with local banks facing significant difficulties to sustain their business levels. However, African banks continue to develop, with growing business supported by ever-expanding technological platforms materialising in increasing numbers of individuals and institutions having access to bank accounts and facilities. In fact, according to the World Bank’s Financial Inclusion Database, the percentage of adults with bank accounts in Sub-Saharan Africa grew by 10% to 34% between 2011 and 2014 alone. One can of course argue that the overall profile of the African banking system is still not pristine, but the strengthening of local financial institutions and the rise of a significant number of solid regional players are an obvious cause for optimism.

A more in-depth analysis of African financial institutions shows that it wasn’t just business volumes and market penetration that grew significantly over the last few years. In fact, Africa has been catching up rapidly on key factors such as capital adequacy and prudential policies, alongside compliance, anti-money laundering and know-your-client standards. In line with these items, a key driver of change has been the transformation around the way African financial institutions approach their market, operational and credit risks.

Despite the above-mentioned growth levels around both business volumes and sophistication, African banks and their international counterparts have increasingly been put in the spotlight due to the existence of a sizeable gap in available finance facilities to enable international trade in the continent versus existing demand. Recently quoted figures place this gap as high as US$120bn. The African trade finance gap leaves a bitter persistent impression that significant business volumes are being left undone, with a negative impact on the development of African countries.

What are the main drivers of this African trade finance gap? Different studies and surveys have been undertaken on this topic, yielding a somewhat consistent set of drivers. According to the IFC DOTS Survey of 2016, the main barriers to trade finance business growth of African banks were foreign exchange (liquidity and availability), macro-climate factors/trade flows, internal capacity issues/internal priorities, and product unfamiliarity of local firms.

To better understand the scope of the African trade finance gap, one should link the above factors and the structure of the local economies, as both are inter-dependent. With the passage of time, the African corporate structure has evolved significantly and is now markedly different from where it was decades ago.

As such, now we can not only identify and recognise a myriad of African corporate conglomerates by name, but we also know that many global and multinational companies have opened subsidiaries in Africa. Interestingly – and certainly justified by the need to create practical assessment tools rather than excessively detailed ones which could breakdown in terms of relevance – the existing studies on the African trade finance gap focused on the overall picture rather than a breakdown in terms of the different users of the product. Empirical evidence, however, suggests that larger companies are not at the genesis of the gap, as they tend to be very well served in terms of facilities, which are normally readily available in size and often offered under tailor-made structures and at appealing pricing levels. In fact, if one focuses only on this top slice of large corporates and multinationals in Africa, even more advanced enhancement tools become available, such as credit risk insurance. Also, these larger entities are not only served by local and regional banks, but global banks are also often seen making available state-of-the-art trade finance facilities to them.

The interesting take-away is that, as seems to be happening throughout the rest of the world, the concentration of trade financiers’ attention in the top slice of the corporate pyramid is also creating a wider split between those who have all the attention, and those who have none, or very little, in Africa.

The issue is that in Africa, despite the considerable growth of that top slice of the corporate pyramid, local economies are still heavily dominated by (i) the informal market and (ii) small and medium-sized businesses, which are either altogether overlooked by local and international financial institutions due to their challenging characteristics, or are given credit in terms (size, cost, security) that simply make the underlying deals untenable. As such, one may argue that the African trade finance gap is not necessarily spread in a uniform manner throughout the local economies, but is specific to very significant economic sectors. And it is precisely in understanding these specific segments, how they are structured and how they operate, that the solutions to bridging the gap may lie.

So, what drives the problem when the counterparty is, for example, a smaller trader involved in importing grains and re-selling them on the informal market in a given African country? Let’s assume this grain trader needs her bank’s support for a US$1mn revolving import finance facility, which will allow her to bridge the 90 days cash flow cycle between placing an order from an international grains trader, to receiving the monies from her last sale of grains from that order at one of her local warehouses. The owner of the trading company will visit the manager of her local bank branch and discuss the deal, only to find out that her counterparty will pull out a sheet of paper with standard security requirements for a company of her size and for the loan amount in question. Invariably the security requirements on this sheet will be made of so-called real assets, which will normally mean real estate. What if the trader doesn’t have real estate to give as collateral? Two things normally happen – the transaction may collapse entirely, or, the pricing levels offered to reflect the higher perceived risk will make it uneconomical. As such, acknowledging that the aforementioned surveys on the African trade finance gap reflect the opinions of the bankers, perhaps one would get a different set of factors by interviewing local business owners in Africa, whose answers could also include other things such as the lack of flexibility of collateral structures proposed by the bankers, and the sometimes prohibitive cost of borrowing, mainly when facilities are offered in local currency.

Are African SMEs and informal market players un-bankable from a trade finance perspective? Numbers seem to suggest that may often be the case, but there are certainly alternatives that can be explored which may be suitable from a risk mitigation and cost reduction point of view, and scalable to target bundles of smaller players such as those previously mentioned. In our specific example, rather than force the trader to adopt a security structure that does not suit her, or to pay a price that makes the transaction uneconomical, the local bank might consider exploring ways to finance several similar clients using shared common warehouse space to keep goods financed as security, while simultaneously developing a cash collection system that gathers daily cash flows and uses part of the funds to amortise the facility on a regular basis.

In a world where the word “de-risking” has become an integral part of the lexicon, particularly around emerging markets banks’ relationships with their correspondents, it is precisely in the strengthening of the support received by local banks from their foreign counterparts that one can potentially find part of the answers to the questions around solving the African trade finance gap. Not only must foreign correspondents invest in positioning themselves as a reliable source of structuring knowledge, where they add value to their African counterparts through the application of their own relevant experience in driving a mid-market agenda, but also in becoming a reliable source of trade finance credit to enable that same agenda. Interestingly, this process seems to already be under way to a certain degree, causing the exclusion of those foreign correspondents less willing to invest in the African banking scene, and the retention of those institutions that are serious in their pledge to deliver credible and long lasting support to the local banking sectors.

Our focus at Crown Agents Bank is precisely to create opportunities that allow our partner banks in Africa to enable their clients’ businesses. We take this a step further by channelling our efforts into smaller banking sectors, which tend to be off the radar of foreign correspondents. Combining traditional trade finance products and a hand-holding relationship-focused approach, with a significant commitment towards understanding our clients’ needs (and thus those of their clients), we focus on facilitating trade, allowing our clients to have access not only to customised trade finance solutions at competitive cost levels, but also to our significant experience in closing gaps to enable trade.