Financing Gaps are Squeezing Trade in Asia Just When it is Most Needed

By Steven Beck, Kijin Kim

The pandemic laid bare the fragility of global supply chains and the need to increase access to trade finance to spur economic growth and create jobs.

Trade finance – the financial backing importers and exporters need to keep global trade going — is vital to economic growth and development. Trade finance is low risk for providers yet still often difficult to obtain for many businesses in Asia. And this was even more the case in 2020, when the pandemic caused global trade to contract by 7.5%.

This devastation may have been less severe had there been more finance available to support trade. But that’s history. As we move forward, trade-led growth will play a critical role in rebuilding economies and rebuilding lives. But without sufficient trade finance, that recovery won’t be able to reach its full potential.

A lack of finance, particularly for small and medium-sized enterprises (SMEs) has meant that some companies find it difficult to join supply chains, missing out on contributions that would add to much-needed growth and employment.

To better understand the size of the trade finance shortfall and the pandemic’s impact on access to trade finance, we surveyed the latest gap, the reasons for it, and suggested a path toward closing those gaps. Perhaps unsurprisingly, the survey found that the situation has worsened.

It showed that the estimated global trade finance gap rose by about $200 billion dollars (from $1.5 trillion to $1.7 trillion) between 2018 and 2020. As a percentage of global goods trade, the gap increased to 10% in 2020 from 8% in 2018.

Trade finance is essential, supporting 80%-90% of the world’s trade in goods, but the survey showed that the likelihood of trade finance applications being rejected rose significantly between 2018 and 2020. The pandemic led to an increase in trade- and finance-related transactions costs for firms because of lockdowns, supply disruptions, and related economic and financial risk.

Half of the surveyed banks expect trade finance defaults to increase because of the pandemic. Yet the latest data from the International Chamber of Commerce confirms marginal increases in defaults in trade finance transactions in 2020.

One persistent factor that remains a barrier to banks expanding their trade finance operations is the difficulty navigating the complicated regulatory regime surrounding anti-money-laundering (AML) and know-your-customer (KYC) concerns.

The pandemic highlighted the urgent need for trade to move from a paper-based system to a digital one.

Simplifying that system and ensuring that trade takes place under the same set of rules across borders would be a major step forward, improving data collection for law enforcement and other authorities while making it easier for trade to flourish.

The gap in trade finance is mostly a smaller company issue. The survey indicated that while SMEs account for only about 20% of trade finance proposals received by banks, compared with 54% for large corporations, they account for 40% of trade finance rejections.

The additional collateral required by banks to mitigate the risk of SME lending has persistently remained one of the major obstacles causing the rejection of many SME trade finance applications. Access is even more difficult for women-owned SMEs. Among the women-owned firms surveyed, about 70% of their applications were totally or partially rejected.

Greater access to finance and public sector support is key to the post-pandemic recovery. Many of the surveyed SMEs believe their business will recover in the first half of 2022 or later. On the path to recovery, one-third of firms noted that lack of access to finance is one of the major barriers that should be addressed over the next year.

One-fifth of firms believe more public-sector support is warranted. Nearly all banks surveyed echoed that the provision of trade finance is essential for post-COVID-19 trade growth and economic recovery.

The pandemic also highlighted the urgent need for trade to move from a paper-based system to a digital one. In addition to making global supply chains more robust, the digitalization of trade can help close the financing gaps–think meta data on risk and performance–and could have a huge impact on global productivity. But there are a few hurdles to be addressed.

First, most banks and firms surveyed confirmed that the pandemic has accelerated and will continued to propel the use of digital processes in their operations. Yet the use of fintech and digital solutions remains limited and concentrated on such areas as digital filing/transmission, accounting, and electronic signature platform purposes.

Major constraints include the high cost of technology and insufficient inter-operability for banks, and the lack of information and expertise for firms. Second, global standards are needed to drive inter-operability; and third, governments need to adopt model laws developed by the UN that recognize electronic documents. 

During the pandemic, the trade finance programs of multilateral development banks significantly increased the number of transactions they supported, demonstrating high market demand for public sector involvement at a time when private sector capacity retrenched, as demonstrated in the higher rejection rates due to elevated risk concerns.

Even so, public sector support is relatively small against the size of the market gap and won’t go nearly far enough to narrowing it. What is needed is more private sector involvement, including alongside the public sector by co-financing transactions, for example. More granular data including default and loss statistics by country would also help the private sector gain a better understanding of the needs, opportunities, and risks of trade finance.  

The pandemic helped highlight the relative fragility of global supply chains. Improving access to trade finance would bring growth and jobs to the world when it needs them most.

This article was originally published on Asian Development Blog.