Sheetal Soni, CFA, FCA
Partner – Corporate Finance
As governments around the world look to small and mid-size enterprises as engines of growth, trade and job creation, a significant challenge stands in the way: hundreds of billions of dollars of pent-up demand for trade finance. This financing can be used as export working capital that enables a company to purchase labor and inputs to fulfill a specific export order. Or it can be used as supply chain financing that helps the company get paid faster for its export shipment than its foreign buyer wants to pay, and thus get cash flow needed to process the next order.
International trade has been more or less sluggish since the global economic slowdown hit in 2008. World trade grew an average of 3 percent between 2010 and 2015, after 6 percent annual growth between 1983 and 2008. Demand for trade finance is growing fast. According to the International Chamber of Commerce, 63 percent of banks around the world said trade finance activity is growing, 61 percent increased their capacities to meet customer demand for trade finance and 72 percent experienced an increase in trade finance fee income. Requests most frequently came from SMEs, which are both more numerous and cash-strapped than large companies; however, banks rejected about half of all SME requests, as opposed to 21 percent for large corporations.
These findings are indicative of a global trade finance gap, now estimated at $1.4 trillion, $693 billion of which is in developing Asia, including India and China. The gap exists also in advanced economies: In surveys in the U.S., Europe and the OECD region, SMEs unfailingly see a lack of finance as the top obstacle for them to trade across borders.
A story recently in Reuters talked about how the biggest trading houses are filling the traditional banks (and mostly European banks role) of funding traders. Banks such as BNP Paribas and Societe Generale have cut funding of small and mid-sized companies with low credit ratings because of growing regulatory and political pressure, risk aversion and weaker profits. But banks still feel comfortable in providing large trading houses with billions of dollars in credit lines and then often watch this money being re-lent at higher rates to those they chose not to deal with directly.
The 2030 Agenda and Improving Access to Trade Finance – The Role of the WTO and other International Institutions
The availability of trade finance is a significant problem in emerging markets and developing economies. Surveys show that this is especially the case in Africa and Asia. The lack of development of the financial sector means simple, low-cost financing is often not easily available to small companies, which can pose a significant hurdle to developing economies integrating into the global trade system more effectively and taking advantage of the potential benefits of trade for employment and growth.
Trade finance can facilitate SMEs’ integration into global value chains in several specific ways. One promising tool is Supply Chain Finance (SCF). SCF can simplify the manner in which receivables and liabilities are handled, processed and subject to interim financing between suppliers, producers and buyers along a global value chain. Since SCF is based on the binding commitment by the buyer to purchase the primary and intermediary products, the financing conditions are related to the credit rating of the buyer, usually a larger company, which means they can be more beneficial for the supplier than if the supplier requests financing outside this fixed value chain context.
In developing economies, local financial markets are often not in the position to offer such SCF arrangements, making access to factoring and other financial instruments particularly challenging for small-mid enterprises. International institutions like Multilateral Development Banks (MDBs) are putting new programmes in place that can close these gaps. For example, the International Finance Corporation (IFC) has launched a Global Trade Supplier Finance Program to facilitate the integration of smaller manufacturing companies into international value chains. The programme brings together suppliers, buyers and banks, making it feasible for banks to offer pre-payment on claims from suppliers from emerging markets and developing economies through relevant refinancing or acceptance of guarantees. The suppliers, in turn, have to pre-finance less working capital and provide fewer liquid assets, making it easier for them to plan accordingly. It appears that the private sector has also discovered this business model as a promising growth market. According to a survey from the International Chamber of Commerce (ICC), two-thirds of the banks surveyed stated that the importance of SCF is growing and that growth rates in this business line in recent years are above 10%.
International institutions, in particular the WTO, also have a role in supporting trade finance effectively. The WTO is regarded as the initiator of international cooperation in the field of trade finance and serves as a discussion forum for relevant players. Since 2008, the Working Group on Trade, Debt and Finance has been the hub for WTO initiatives in support of trade finance, particularly in developing countries. In this role, the group continuously interacts with the regional development banks, the International Finance Corporation (IFC) and the national export credit agencies.
The WTO and other institutions could do several things to address the difficulties associated with trade finance in developing countries more effectively, including:
(1) Putting a greater focus on trade finance for developing countries and for the integration of SMEs into value chains: IFC and MDB programmes focusing on SMEs could be further strengthened. The WTO’s working group on trade finance could support and evaluate efforts by MDBs in tackling the structural trade finance gap in developing countries.
(2) Improved synergies in cooperation between the actors involved in trade finance: More intensive cooperation between the relevant institutions and actors could help to increase the availability of trade financing. MDBs and their programmes play a leading role here, but increased cooperation between MDBs and export credit agencies, the WTO, the Bank of International Settlements (BIS) and the private sector could improve the effectiveness of trade financing initiatives, for example by institutionalising cooperation between the WTO and BIS and ensuring developing country governments and stakeholders are sufficiently involved in decision-making. A good example is the Trade Finance Institute currently being created by the ICC, which is drawing on existing WTO and MDB e-learning materials.
(3) Keeping trade finance on the public agenda: The WTO Working Group on Trade, Debt and Finance is in a good position to raise international awareness about financing gaps, to discuss whether proposals from stakeholders and institutions live up the demands of trade bankers and trade rules and, when needed, to convene debate among a range of relevant actors, including the G20 and the wider WTO membership.