The developmental narratives for each country is different, shaped by their policy priorities of the past and defined by their vision of future. Nevertheless, there remain intertwined challenges to growth across countries which cannot be delinked. One such encumbrance is access to trade finance, a feature which bears remarkable concurrence in the policy agenda of developing countries,especially in the aftermath of the Global Financial Crisis.
The Financial Crisis highlighted the fault lines in financial architecture across countries.
The Financial Crisis highlighted the fault lines in financial architecture across countries. The multi-layered disruptions adversely impacted the international trade flows, with deteriorating credit conditions emerging as one of the key transmission channels. In fact, the adverse effect on trade finance, which was more pronounced in the case of emerging economies, still lingers on. The constraints to trade finance have not only emerged from the crisis itself, but also from the response to the crisis, in particular, from the general regulatory tightening.
The constraints to trade finance have not only emerged from the crisis itself, but also from the response to the crisis, in particular, from the general regulatory tightening.
Financial regulations have witnessed unprecedented strengthening since the crisis, but not necessarily for the most efficient outcomes. Re-calibration of capital charges have led to low-risk trade finance products being treated at par with much more complex financial products. Such regulatory treatment has impacted bank-intermediated trade finance, and as a corollary, global trade and economic growth.
In case of developing countries, structural snags in the financial systems, typically characterized by a frail trade finance architecture, further compound the vulnerabilities and risks. Veritably, the financial sector of several developing economies is still at an early stage of development, and needs capacity building to support trade. Lack of access to international financial system further restricts trade finance availability in these countries.
In case of developing countries, structural snags in the financial systems, typically characterised by a frail trade finance architecture, further compound the vulnerabilities and risks.
In a world of deeply integrated economies, solutions to such intrinsic and extrinsic challenges lie in mutual cooperation. The interconnectedness of trade finance markets necessitates development of effective, cooperative partnerships in the financial sphere, to foster resilience and support growth in international trade. Trade finance has been an important conduit for the expansion of international trade during the past century. As the centre of global demand gradually inclines towards the South,substantive upgrade in trade finance architecture will be required to support the increase in South-South trade.
In a world of deeply integrated economies, solutions to such intrinsic and extrinsic challenges lie in mutual cooperation.
The overwhelming role of trade in the multi-faceted interactions among developing countries, and the role of trade finance in harmoniously welding the South-South trade links, behoves developing countries to adopt collective, concerted and coherent initiatives for developing an efficient trade financing framework.
TRADE FINANCE AND DFI
Trade finance encompasses credit, guarantees and insurance needed to facilitate the payment for the merchandise or service on terms that satisfy both the exporter and the importer. Trade finance mechanism provides support primarily in the following four areas:
Trade finance encompasses credit, guarantees and insurance needed to facilitate the payment for the merchandise or service on terms that satisfy both the exporter and the importer.
Payment facilitation, enabling secure and timely payment across borders, for example through proven communication methods such as SWIFT
Financing to one or more parties in a trade transaction, whether it is the importer, exporter, or one of the banks
Risk mitigation, either directly through the features available in a trade financing mechanism,or indirectly through insurance or guarantee products designed to meet the needs of importers and exporters
Providing information on the movement of goods and/or the status of the related financial flow
Trade finance assistance is generally provided by commercial banks and Development Finance Institutions (DFIs). Banks are the major providers of trade finance and act as a means to reduce payment risks. Alongside, the role of DFIs, including export credit agencies as providers of long term loans, project finance, guarantees/insurance, and other risk mitigating products is also crucial.
A well-functioning trade finance market enables firms which would otherwise be considered too risky, to link into expanding global value chains and thus contributes to employment and productivity growth. According to estimates, an increase in access to trade finance by 5% increases the production by 15% and induces the firms to hire 12% more staff. Cleary, trade finance can help revive the faltering trade and output growth being currently faced by many countries, and thus needs to be one of the key instruments under any DFI’s suite of finance programs.
A well-functioning trade finance market enables firms which would otherwise be considered too risky, to link into expanding global value chains and thus contributes to employment and productivity growth.
Since 1990, real GDP in the Asia-Pacific region has grown by 80%, with increase in exports contributing to nearly half of this growth3. For the long term growth prospects for the region to remain resolutely positive, revival of exports will be a sine qua non. Micro, Small and Medium Enterprises (MSMEs),which account for nearly 90% of all enterprises in most Asia-Pacific economies, have substantial latent potential to export as, at present, less than 15% of MSMEs in most of these economies are currently engaged in exports.
Since 1990, real GDP in the Asia-Pacific region has grown by 80%, with increase in exports contributing to nearly half of this growth
Exports growth in the region will hinge critically on a well-functioning trade finance market. The increasing regulatory constraints on commercial banks, and the need to enhance access to trade finance for MSMEs presents a case for DFIs in the region to join hands to fill the financing gaps. The credit and risk mitigation mechanisms provided by DFIs and ECAs in the region will be pivotal in infusing a new vitality to exports and economic growth.
Exports growth in the region will hinge critically on a well-functioning trade finance market.
TRADE FINANCE INFRASTRUCTURE: THE CURRENT LANDSCAPE
Almost 80-90% of world trade today relies on trade finance. It is one of the safest forms of financing with less than 1% of transactions facing default. In spite of such low default rates, the global trade finance gap was estimated at US$ 1.6 trillion in 2016. For Asian developing economies alone, the estimated shortage is US$ 692 billion. The access to trade finance is further constrained in case of MSMEs. According to a survey by the Asian Development Bank (ADB), rejection rates for trade finance applications are as high as 56% in case of small and medium sized companies5. As MSMEs account for the majority of firms in most countries (95% on average6), and for the vast majority of jobs, these rejections have far reaching outcomes for the overall economy. According to WTO, trade financing gaps arise due to a mix of structural and development factors. The disinclination of the global financial sector to invest in developing countries after the 2008-09 financial crisis compounds this problem as local banking sectors are often not equipped to fill the market gap.
Almost 80-90% of world trade today relies on trade finance. It is one of the safest forms of financing with less than 1% of transactions facing default.
A region-wise analysis of the rejection rates in trade finance transactions indicates that the rate is the highest at 29% in case of Asia-Pacific, indicative of higher level of risk perception for such transactions. Europe and America, on the other hand, had a rejection rate of 12% and 8%, respectively. Ironically, the actual level of risk, as reflected in the default rates, was substantially lower at 0.29% for Asia Pacific as compared to 0.38% in case of Europe (Figure 1). This gap between actual and perceived risks tends to increase in periods of crisis, even though the payment record does not differ much7.
These high risk perceptions in the end translate into lost opportunities for firms in developing countries. According to a survey, nearly 71% of firms facing rejection reported that when a bank declines to finance a trade transaction, they do not seek alternative financing for that transaction8. While some of these transactions are then self-financed, it can be assumed that some proportion of them do not go forward. This has repercussions on the trade flows and consequently on the overall growth and development.
Apart from high risk perceptions, trade finance markets in emerging and developing economies are also characterised by lack of regulations needed to offer different instruments, limited capacity of local markets, and the inability of banks to establish correspondent relations globally. Low profits and demand in some of the countries also contribute towards low level of market development.
Cost and complexity of compliance with regulatory requirements such as Basel III and financial crimes is also a major impediment for trade finance. In fact, according to ADB’s 2016 Trade Finance Gaps, Growth and Jobs Survey, the major impediments to trade finance fall into two categories: regulatory (including Anti-Money Laundering (AML): 90% of respondents cited having impediments and Basel III: 77%) and risk-related (including credit rating of country: 82%, or issuing bank: 85%). The implementation of Basel III puts higher margin requirements on trade finance business and induces banks to either raise new capital or reduce trade finance business. The underdeveloped credit market in developing countries impacts the scope and cost of raising new capital. Borrowing from the international market may also not be a feasible option for local banks as they have to compete with borrowings from advance country financial institutions and governments. These regulatory challenges therefore exacerbate the already precarious position of trade finance in many countries.
BRIDGING THE TRADE FINANCE GAP: SEARCHING FOR SOLUTIONS
Collaboration among Development Finance Institutions
There is a need to address the mix of structural and developmental factors which are hindering the growth in trade finance, and in turn international trade. An essential first step will be to coalesce the efforts of development partners to enhance the existing trade facilitation programs. This includes Multilateral Development Bank (MDBs) such as the International Financial Corporation (IFC), the ADB, the African Development Bank (AfDB), the Inter-American Development Bank, Islamic Development Bank and the European Bank for Reconstruction and Development, ECAs, as well as the national Development Finance Institutions (DFIs).
The role of MDBs and ECAs has been crucial in ensuring that trade-finance gap does not incapacitate trade. According to the International Chamber of Commerce (ICC) 2016 Global Survey on Trade Finance, nearly 75 percent of respondents reported that MDBs and ECAs help narrow trade finance gaps. Going forward, the support from these entities will remain critical for supporting trade finance transactions till the time alternative local capacity can be augmented.
There is a need to address the mix of structural and developmental factors which are hindering the growth in trade finance, and in turn international trade.
Collaboration among MDBs, ECAs and national DFIs can substantially enhance the trade financing capabilities, while concomitantly meeting the growing infrastructure requirements. There has been substantial increase in such transactions by MDBs, ECAs, and national DFIs. An example of such collaboration is the financing of Itezhi - Tezhi Hydro Power Project in Zambia. The project involved the development, construction, operation and maintenance of a 120 MW base load hydro power plant, and was a first-of-a-kind public private partnership in the power sector of Zambia. The project was co-financed by several lenders including multilateral banks such as the AfDB and the European Investment Bank; DFIs such as the Development Bank of Southern Africa, Dutch development bank FMO, and French development financial institution PROPARCO; and ECAs such as the Export-Import Bank of India (Exim India).
Collaboration among MDBs, ECAs and national DFIs can substantially enhance the trade financing capabilities, while concomitantly meeting the growing infrastructure requirements.
There have also been cases, where co-financing has enabled ECAs to finance transactions and support domestic companies which it otherwise could not. For example, on account of lack of sufficient scale, the Hungarian Export-Import Bank (Exim Hungary) could not support many Hungarian companies in large-scale transactions on a standalone basis. However, a collaborative approach by Exim Hungary opened up large-scale project opportunities for the domestic companies. Exim Hungary entered into an international deal with the General Electric, Indonesian Power Utility ‘Perusahaan Listik Negara’, and the Export Development Canada (EDC). The project involved installation of mobile power plants in Indonesia, and the total project value was more than US$ 575 million, of which nearly US$ 453 million was co-financed by the two ECAs—Exim Hungary and EDC in a 50:50 ratio. The project had substantial cross- country benefits. Not only did the project generate exports worth more than US$ 276 million from the Hungarian economy, it also provided nearly 4 million Indonesian homes with electricity9. Clearly, smaller ECAs can benefit substantially by networking with other ECAs, DFIs, and MDBs.
There is also substantial evidence of collaboration among ECAs and MDBs. One way through which some of them are already collaborating is through insuring of loan exposures and reinsuring of guarantee exposure. Multilateral Investment Guarantee Agency (MIGA) reinsures approximately 40 percent of its gross exposure with ECAs and Political Risk Insurers. Paul Mudde in his article estimates that if leading MDBs follow MIGA’s practice, US$ 169 billion of additional finance can be made available for development10.
Another way in which ECAs, MDBs and national DFIs can collaborate is through information sharing and creation of an enabling environment for financing. All institutions face challenges in terms of financing projects which may originate on account of regulatory issues, structural challenges, public sector inefficiencies, etc. Structural exchange of information can reap substantial benefits for these institutions. These institutions can also collaborate in the sphere of creation of bankable projects through initiatives such as project preparation facilities. Exim India has made an attempt in this direction, and along with the African Development Bank, Infrastructure Leasing and Financial Services Ltd. and State Bank of India, has floated the Kukuza Project Development Company to facilitate private sector participation in infrastructure projects in Africa.
Another way in which ECAs, MDBs and national DFIs can collaborate is through information sharing and creation of an enabling environment for financing.
Region-specific collaboration can also be encouraged among these development institutions. The Asian region has been particularly active in establishing such frameworks. The Asian Exim Banks Forum (AEBF) is one such platform which has facilitated interactions among the ECAs in the Asian region. At the initiative of Exim India, the AEBF was formed with the purpose of developing and enhancing regional cooperation, forging stronger links among member institutions, and exchanging information and sharing ideas in a structured manner. The AEBF members have signed Memorandum of Understanding to utilize credit line, enhance cooperation in cofinancing, and local currency loans, amongst others. The AEBF platform serves as a remarkable example of cooperation among ECAs at a regional level.
Region-specific collaboration can also be encouraged among these development institutions.
Taking the learnings from the AEBF experience, Exim India, along with the United Nations Conference on Trade and Development (UNCTAD) launched a Global Network of Exim Banks and Development Finance Institutions (G-NEXID) in March 2006 in Geneva. The Annual Meetings of G-NEXID provide an opportunity to deliberate upon measures to foster long-term relationship, share experience and strengthen financial cooperation to promote trade and investment relations among developing countries. Apart from this, the Association of Development Financing Institutions in Asia and the Pacific has also been an important platform for the DFIs in Asia- Pacific to voice their inputs and share their insights, and benefit from the experience of other institutions.
Taking the learnings from the AEBF experience, Exim India, along with the United Nations Conference on Trade and Development (UNCTAD) launched a Global Network of Exim Banks and Development Finance Institutions (G-NEXID) in March 2006 in Geneva.
The BRICS countries have also made an attempt to enhance collaboration among their ECAs and DFIs. Five export credit agencies of BRICS countries, namely the ABGF (Brazilian Fund and Guarantee Management Agency), EXIAR (Export Insurance Agency of Russia), ECGC (formerly Export Credit Guarantee Corporation of India Ltd), SINOSURE (China Export and Credit Insurance Corporation) and ECIC (Export Credit Insurance Corporation of South Africa Ltd) have signed a Memorandum of Understanding to strengthen collaboration among ECAs of BRICS countries by establishing a framework of co-operation among them to support and encourage international trade among the BRICS countries, and wherever appropriate, to facilitate the supply of goods and services from their respective countries as part of a project in any of the BRICS countries. The countries are also collaborating under the BRICS Inter-Bank Cooperation Mechanism (BICM). The BICM serves as a platform for multi-faceted engagement between member development banks — Brazilian Development Bank, Vnesheconombank, Exim India, China Development Bank, and Development Bank of Southern Africa. In less than eight years of its existence, the Mechanism has concluded more than ten agreements, and formed five Working Groups in key cooperation areas such as innovation, training, and financing in local currencies.
Another way in which the development finance institutions can collaborate is through creation of liquidity pools. The Global Financial Crisis saw a drying up of liquidity with the impact being particularly adverse in case of small firms and smaller geographies. Establishment of targeted liquidity pool by MDBs, national DFIs and ECAs can help ensure that adequate funds are available to SMEs, new exporters and firms in smaller geographies during times of contraction in liquidity and credit.
Capacity Building of Domestic Financial Sector
Capacity building of the local financial sector will form the cornerstone of initiatives for improving trade financing infrastructure in developing countries. The growing role and influence of emerging market firms in international trade need to be supported through multi-faceted intervention. To begin with, a reform of the domestic institutions will be required. Financial markets in several developing economies remain risk averse, and a large proportion of bank deposits in these economies are invested in low-risk low-yield instruments. Companies that are creditworthy but do not have strong banking relations face higher interest rates, fees and capital requirements, which in turn restricts their prospects for growth and diversification. Technical assistance, aid, and policy advice will be required to equip developing countries with the necessary tools to counter the existing challenges and risks to trade finance. Greater adoption of technology will also be essential for removing the frictions in the domestic financial sector.
Capacity building of the local financial sector will form the cornerstone of initiatives for improving trade financing infrastructure in developing countries.
The constraints in developing countries are not only with respect to the knowledge gap, but also in relation to the growing technology gap which results from innovations in advanced economies. The increasing usage of technology is making it an important competitiveness factor. According to Auboin (2007), technology gaps can increase the risk of marginalization of poor countries in trade transactions, and technology networks will have an important role in determining the access to liquidity by developing countries11.
The constraints in developing countries are not only with respect to the knowledge gap, but also in relation to the growing technology gap which results from innovations in advanced economies.
The way of conducting trade finance business needs to undergo an overhaul, with digitalisation and automation forming the linchpin of this transformation. This shall ensure that the processes are streamlined, and become more effective and reliable. This shall also accelerate the process of providing trade finance, thereby leading to overall operational improvements. Currently, the technology uptake in developing countries has been slow due to considerable scale and complexity of digitalisation.
Automation of key processes such as due diligence processes can significantly reduce the costs and complexity of trade finance. Compliance related costs can be substantially reduced through technological intervention. According to the ICC Global Survey 2017, appropriate application of technology to compliance-related processes and procedures could reduce the compliance costs by 30% or more12.
Automation of key processes such as due diligence processes can significantly reduce the costs and complexity of trade finance.
Recognizing the benefits of technology and automation, several initiatives have been taken in this regard. For example, in 2015, commodity exporter Cargill along with Wells Fargo made an attempt to digitalise its trade finance processes. The two companies collaborated on the first electronic L/C along the US-Taiwan shipping route, using the essDOCS digital platform. Under this, Cargill tied up with shipping line and its agents to create the electronic bill of landing. Cargill then presented the documents to Wells Fargo electronically. Wells Fargo upon necessary examination forwarded the documents to issuing bank in Taiwan, which retrieved and reviewed the documents from the essDOCS platform for final processing and payment13. As a result of this, the process time was reduced from more than 10 days to five days or less.
Several fin-tech companies have also made an attempt to ease the regulatory burden on banks through technology and automation. One of the fin-tech firms, Traydstream, has launched a trade digitalization and compliance screening solution. The Optical Character Recognition engine of Traydstream scans and extracts paper-based information digitally, and serves as the initial step towards conversion of trade documents into a digital format. The second part of Traydstream’s solution is a compliance engine, which uses machine learning algorithms to quickly scrutinize the digital transaction data for wide array of issues, such as blank fields, inconsistency of names, industry-specific legislation, sanctions and country restrictions. This helps banks and corporations to better handle AML and compliance issues.
Several fin-tech companies have also made an attempt to ease the regulatory burden on banks through technology and automation.
Blockchain technology is also set to revolutionize trade finance businesses. It is a decentralized software system which enables a public distributed ledger system. The system allows for tracking and recording of assets and transactions without the presence of a central trust authority such as bank. The system enables peer-to-peer exchange of data, assets and currencies through rules based smart contracts in a more efficient, transparent and cost-effective manner14. There are several advantages of blockchain technology which can help ease the trade finance process:
Blockchain technology is also set to revolutionize trade finance businesses. It is a decentralized software system which enables a public distributed ledger system.
The technology allows for greater transparency, and helps lower the cost of Letter of Credit (L/C) transactions as third party verification is not required;
In absence of any intermediary, transaction time is substantially reduced;
There is no need for manual processing or authentication through intermediaries. This enhances the process time, and also offers the possibility of self-executing contracts;
Internet of Things can allow monitoring and tracking of physical assets across countries.
Going forward, it will be important for governments in developing countries, development finance institutions and commercial banks and other financial institutions to collaborate with technology firms for leveraging technologies for trade finance. These stakeholders also need to develop common standards and systems which can allow efficient integration of information and allow seamless operations. The World Trade Board’s Digital Standards in Trade Initiative aims to create a common set of standards for digital trade by filtering existing standards and merging those which overlap. Stakeholders should pursue such initiatives to ensure that technology interventions in trade transactions become actionable and contribute towards reduction of the trade financing gaps.
Bridging Knowledge Gaps
Technical assistance for strengthening schemes and mechanisms offered by financial institutions in both private and public sector will be pivotal for enhancing trade finance. Bulk of the trade finance is provided by commercial banks, necessitating capacity building of these institutions for better cross-border transaction risk assessment and lower trade finance costs. The role of MDBs, ECAs and national DFIs will be crucial in such institutional capacity building. Many of them are already engaged in providing such technical assistance. Technical training for issuing banks constitutes an integral part of the trade finance programs of MDBs. Global Trade Finance Program of IFC, for example, has technical assistance modules comprising basic and intermediate courses on trade finance. At times, IFC also places experienced trade finance bankers with issuing banks to help enhance their expertise. Going forward, the role of MDBs through their trade finance program will remain crucial in capacity building activities.
Alongside commercial banks, which are the prime agents of trade finance, technical assistance to ECAs will also be important for effectively bridging knowledge gaps. Institutional capacity building of ECAs will be important in order to position them as key drivers of export growth, especially in scenarios where the commercial sector is unable to efficiently meet the demand for trade finance.
Technical assistance for strengthening schemes and mechanisms offered by financial institutions in both private and public sector will be pivotal for enhancing trade finance.
Already, ECAs in several countries are proactive in rendering technical assistance for institutional capacity building to other ECAs in developing countries. Exim India, for example, has provided consulting services for institution capacity building in several countries. This, inter alia, includes consulting services for institution capacity building for export credit and insurance to enhance trade competitiveness in Ghana and Rwanda; establishing an Export Credit Guarantee Company in Zimbabwe; feasibility study to establish an Exim Bank in Malaysia; blueprint for setting up an Exim Bank in Zimbabwe; and technical assistance for creation of international financial products for Industrial Development Corporation of South Africa. The Italian ECA, Servizi Assicurativi del Commercio Estero (SACE), has also been active in extending capacity-building support. SACE has provided assistance to Serbia and Montenegro ECA, Russian Agency for Export Credit and Investment Insurance, and Georgian ECA.
There remains substantial scope for further collaboration among ECAs for development of new lines of business and increasing market coverage. ECAs can also increase cooperation for enhancing staff knowledge and expertise. Existing ECAs can also assist other countries in conducting feasibility studies and setting up ECAs. The utility of these institutions in times of crisis when market is not functioning efficiently is now well documented, and it shall be important for countries to undertake feasibility studies for establishing government-backed, self-sustainable organizations focusing exclusively on promoting international trade of their respective countries.
Capacity building will be essential at the level of regulators as well. To begin with, greater dialogues among the financial institutions and regulators will be required to help ensure that trade and development considerations are prioritized and adequately reflected in the regulatory changes in the countries. Greater interactions among regulators is also needed to build a resilient trade finance architecture. To reap the full benefits from regional mechanisms for trade financing, harmonization of regulatory frameworks will be an essential first step.
Remedying the knowledge and technology gaps, while simultaneously addressing the regulatory aspects related to cross-border financial services can significantly reduce the risk of marginalization of developing countries in trade transactions. While North-South knowledge sharing has been the norm, the growth of South-South sharing of knowledge has exponentially grown over the past several years. South-South cooperation can play an important role in equipping local banks with basic to complex trade finance solutions and adopting international best practices, establishing self-sustainable ECAs, and regional regulatory cooperation, thereby making the trade finance architecture more resilient.
Collection and sharing of credit information is a critical component for enabling accurate risk assessment of trade finance providers. Correct and reliable information on creditworthiness of importers and exporters can improve the risk assessment process and allow the banks and the financial institutions to offer affordable products. The scope, accessibility and quality of credit information available through public or private credit registries is especially restricted in the regions of East Asia and Pacific, South Asia, and Sub-Saharan Africa. The depth of credit information index, which measures rules and practices affecting the coverage, scope and accessibility of credit information available through either a credit bureau or a credit registry, stands at 4.0 for South Asia and 3.0 for Sub-Saharan Africa — significantly lower than the 4.75 global average.
There are several ways through which MDBs, ECAs and national DFIs can provide support to countries and institutions for creating a robust credit information system. A favourable environment can be created by advising and supporting government authorities, regulators, etc. Direct support can also be provided to countries for developing new credit bureaus and credit registries. Support can also be provided to enhance existing bureaus. IFC is already providing such assistance under its Global Credit Reporting Program.
Information gaps also arise in cross-border financial services. Correspondent banking relationships have declined following the Global Financial Crisis. While re-evaluation of business models has contributed towards such decline, withdrawal of such relationships has also arisen where regulatory expectations are unclear, risks cannot be mitigated, or there are legal impediments to cross-border information sharing15.
Collaborative partnerships can help mitigate the market information gaps. Partnerships among countries for developing and disseminating trade finance data can help in better understanding of the markets, and an accurate pricing of risks. This shall also help understand the disruptions in trade finance markets during periods of shock and crisis, and help devise responsive solutions.
While durable solutions may take time to be established, interim solutions can help improve information flows between correspondent and respondent banks. This includes use of “Know Your Customer” software utilities which store customer due-diligence information in a single repository and allows easy access to bank customer information. Legal and contractual issues can also be streamlined to facilitate information sharing across institutions and countries.
MDBs have also made an attempt to bridge the information gap from the end of exporters and importers. World Bank, for example, has engaged in trade finance clinics which provide capacity building for trade finance in Africa. The clinics provide information about innovative products and mechanisms for trade finance, as also the best practices of institutions.
Alternative Trade Financing
Bank-intermediated transactions represent more than a third of world trade, equal to trillions of dollars each year. However, non-bank capital is also emerging as an important source of trade finance. Since the time of financial crisis, these players have played an increasingly crucial role in meeting unmet demand, and have experienced considerable growth.
Bank-intermediated transactions represent more than a third of world trade, equal to trillions of dollars each year.
Going forward, the role of fin-techs and alternative-finance providers will be crucial in bridging the trade-finance gaps. Alternative finance players are increasingly providing direct matching mechanism between borrowers and lenders through platforms such as peer-to-peer lending, crowdfunding and invoice trading for trade finance. Fin-tech companies also seek to supplement the existing pool of bank-intermediated trade finance. Hedge funds have also been active in trade financing. Partnerships among DFIs, banks and fin-techs can help drive efficiency and improve the capacity of financial systems to extend trade finance.
Trade Finance Facility
In spite of the relatively low default rates and high recovery rates, commercial banks across the world consider trade finance business to be fraught with wide array of risks viz., payment risk, political risk, commodity risk, currency risk and production risk. Under such circumstances, risk mitigation instruments are crucial for catalysing private finance from commercial banks and non-bank financial institutions.
National DFIs and ECAs from developing countries, with support from MDBs can explore the prospects for a trade finance facility to enhance the access to trade finance by companies and banks from participating countries. While many MDBs already have risk mitigation instruments, the scope and reach of such instruments can be significantly enhanced with the involvement of national developmental agencies. These facilities can be established at the regional level, and can provide non-funded guarantee to enhance the international confirming banks’ appetite for dealing with local issuing banks by substitution of risk from the local bank to the facility. The facility can also extend trade finance loans, structured around a company’s trade cycle period—starting from the import/ purchase of raw materials to the receipt of sale proceeds. Loans can be provided against evidence of invoices/ trade activity. For example, payment obligations in intermediation instruments such as L/Cs and bills may take time to discharge. Banks may discharge such obligations ahead of time based on a straight discount basis, with discount rate based on the market price of the obligation party. The facility can also provide training and capacity building support to banks. Further, a subsidy can be provided by the respective Governments to cover the cost of compliances which may be associated with on boarding of banks.
National DFIs and ECAs from developing countries, with support from MDBs can explore the prospects for a trade finance facility to enhance the access to trade finance by companies and banks from participating countries.
Several trade finance facility such as the OPEC Fund for International Development’s (OFID) Trade Finance Facility, already provide a host of such funded and non-funded trade finance products for developing countries. OFID’s Trade Finance Facility aims at facilitating trade activities and addressing working capital requirements of firms in developing countries. Under the facility, products such as import-, export- and pre-export financing, warehouse receipt financing, working capital finance and non-funded risk participation are available to Governments, private entities, commercial banks, regional DFIs and any other institution which is active in OFID partner country.
To further enhance the availability of trade finance products in key regions such as Asia-Pacific, Africa, and Latin America and Caribbean, such dedicated trade finance facilities can be formed through mutual cooperation amongst the countries. The facility will be especially beneficial in case of regions such as the Caribbean and the small island states of the Pacific, which have seen a precipitous decline in correspondent banking relationships.
Trade Enhancement Facility for Small States
A special Trade Enhancement Facility can also be set up for Small States, which have been disproportionately impacted in the post-crisis period. These countries cannot get L/C, opened by them on behalf of their importer customers, confirmed by exporters’ banks at reasonable prices as the perceived risks of the L/C opening banks is considered high by the exporters’ banks. This denies importers in these countries access to trade finance through L/C and other instruments, which form the backbone of current international trade architecture. This in turn impacts the competitiveness of businesses in these countries.
A special Trade Enhancement Facility can also be set up for Small States, which have been disproportionately impacted in the post-crisis period.
In such a scenario, a Trade Enhancement Facility for such small countries can be set up. The proposed facility for Small States could comprise a credit enhancement mechanism which enables confirmation of L/C opened on behalf of importers by banks in the countries participating in the facility. The confirmations would be enabled by guaranteeing the credit risk of L/C opening banks in these countries. The guarantee may be backed by pool of cash collateral contributed by member states into a Fund, which can be managed by an independent Facility Manager, who, inter alia, can identify banks in the member countries who would be interested in participating in the program, and assign credit limits to these banks depending on parameters such as credit profile, potential usage, etc.
The Fund can receive revolving grant contributions from member states which can form the core capital of the Fund. These contributions may be invested in high quality liquid assets which can be drawn in the event of defaults to honour the claims. Support from bilateral and multilateral development finance agencies, and private sources of capital may also be considered for contributions to the Fund.
Regional Financing Mechanism for Asia
In value terms, global merchandise imports registered second consecutive year of decline in 2016. However, Asian exports have witnessed a remarkable rebound since the second quarter of 2016. While the overall exports have increased during this period, intra-regional trade in Asia has continued to decline. Intra-regional exports registered third consecutive year of decline in 2016, accounting for only 59.6% of Asia's total trade.
In value terms, global merchandise imports registered second consecutive year of decline in 2016.
Intra-regional trade in Asia can serve as an important avenue for shielding against decline in exports to developed country. Asian economies, especially in East and Southeast Asia, are already fairly dependent on each other and have strong product value chains. Adequate availability of trade finance will be critical to maintain the existing value chain linkages and extend them further to other geographies within the region.
In much of the developing Asia, the financing mechanisms, which are taken for granted in industrial nations, are rudimentary and sub-optimal. Information networks and policy environments required for banks to carry out international transactions with a fair deal of confidence are also yet to stabilise.
A regional mechanism which pools funds and risks across countries can benefit the intra-regional trade in Asia. In this context, an Asian Exim Bank can be set up as the principal agency in Asia for re-financing trade and investment and may operate on business principles. The basic objective of the Asian Exim Bank would be to improve the access to trade finance for Asian economies through credit enhancement and risk mitigation measures and thereby, contribute to enhance intra-regional trade and investment.
With a view to achieve this purpose, the Asian Exim Bank may provide refinance/ rediscounting / reinsurance facilities to ECAs / commercial banks in the region to enable them to extend financial assistance to the exporters and importers of the region, at both pre and post-shipment stages as also to enable banks in the region to extend short and medium / long term credit through a variety of instruments / programmes to promote intra-regional and industrial development.
The establishment of the Asian Exim Bank to facilitate trade and investment flows in the Asian region, and address financial and institutional gaps in trade finance and insurance may be expected to confer several advantages for the member countries :-
The Asian Exim Bank would serve to facilitate intra-regional trade through credit enhancement and risk mitigation measures;
The Asian Exim Bank, by virtue of being a quasi-multilateral body would be able to access international finance at lower cost and provide refinance / reinsurance to ensure availability of trade finance at acceptable cost to developing member countries;
For developing member countries, access to international trade finance at reasonable cost, would ensure adequate finance for exports and export diversification into new markets and new products;
For developed and emerging member economies, expansion of markets for export of capital goods, technology, manufactures and assurance of payment with a view to promoting trade and developing infrastructure in frontier countries;
The Asian Exim Bank would also provide support to ECAs / commercial banks in the region with a view to developing the small and medium exporters, who contribute significantly to the development of a country;
The Asian Exim Bank would complement rather than duplicate or supplant existing multilateral, regional, sub-regional and national institutions, which would increase the level of intra and extra Asian trade and investment;
The Asian Exim Bank would also seek to provide information and advisory services, generally on pay-as-you-use basis in collaboration with existing institutions, national and international;
The Asian Exim Bank would provide a common forum for its members, the Asian shareholder governments, for coordinating their trade financing and trade promotion activities in a more efficient manner;
The Asian Exim Bank would encourage a local currency programme that will foster greater use of local currencies, thereby further reducing the foreign exchange cost of intra-Asian trade transactions.
1ITC (2009), How to Access Trade Finance: A Guide For Exporting SMEs, International Trade Centre
2DiCaprio, A., Beck, S., and J. Daquis (2014), ADB Trade Finance Gap, Growth, and Jobs Survey,
3Tammy L. Hredzak and Quynh Le (2013), Trends in Trade Finance across the APEC Region, APEC Policy Support Unit
52016 Trade Finance Gaps, Growth, and Jobs Survey, ADB
7Marc Auboin and Alisa DiCaprio (2017), Why Trade Finance Gaps Persist: Does it Matter for Trade and Development? Asian Development Bank Institute
8Asian Development Bank
9Berne Union Yearbook 2017
10Berne Union Yearbook 2016
11Auboin, Marc (2007), Boosting trade finance in developing countries: What link with the WTO?, WTO Staff Working Paper, No. ERSD-2007-04
12ICC (2017), Rethinking Trade and Finance
13Cargill and Wells Fargo in trade digitisation first, Global Trade Review
14Demystifying Blockchain, Cognizant
15Michaela Erbenová, Yan Liu, Nadim Kyriakos-Saad, Alejandro López-Mejía, Giancarlo Gasha, Emmanuel Mathius, Mohamed Norat, Francisca Fernando, and Yasmin Almeida, The Withdrawal of Correspondent Banking Relationships: A Case for Policy Action, International Monetary Fund, June 2016
Long Term Minimum Lending Rate (LTMLR) for the month of March 2017 is 9.45 % p.a.
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