Banks are missing out on a major opportunity in trade finance

By Patrick Manasse, Chief Compliance Officer, MonetaGo

As the nature of trade evolves, how it is financed needs to also change. Trade finance is about securing an asset, such as a contract for payment or an invoice, and lending against that asset. Lenders have a multitude of products that help exporters get paid for goods but ensuring that an asset has been pledged to only one lender remains a key industry challenge. The integrity of the trade finance landscape is vital for the flow of trade finance, especially since 80% to 90%[1] of the world trade market relies on trade finance.

As crucial providers of trade finance, banks need to take action toward reducing the trade finance gap. Pre-pandemic, the Asian Development Bank estimated the trade finance gap at an astounding $1.5 trillion – recently figures show this number to have more than doubled due to COVID. Research from the International Chamber of Commerce (ICC) estimates that as much as $5 trillion in trade financing is needed for the global trade flow to return to pre-pandemic levels. Considering the potential for trade growth, the onus is on banks to step up their digitization efforts, accessibility, and operating models to de-risk trade finance transactions.

Accessibility for organizations of all sizes

While the gap in trade finance is global, it is not evenly distributed. Small to mid-sized suppliers often bear the brunt, especially those based in developing markets where export-oriented goods are the engine of economic growth and prosperity. These suppliers cannot get access to credit to fund new deals and many are waiting weeks, sometimes months, to get paid for the goods or services they have already delivered.

International trade has long been viewed as a hard-to-lend-to sector which has resulted in many banks and financial institutions sitting on the sidelines, funding only the bluest of blue-chip clients and deals. However, a strategy focused solely on companies at the top tier results in high-margin lucrative trade opportunities going unfunded. Much of the trade finance gap hits small to mid-sized enterprises (SMEs) despite the fact that SMEs represent 90 percent of businesses and 50 percent of employment worldwide. SMEs also contribute up to 40 percent of GDP in emerging economies according to the World Bank.[2] Despite SMEs’ enormous contributions to the global economy, financing remains largely unavailable to many of these businesses and banks need to change their previously conceived notions.

Global banks and insurers have previously found themselves in unfortunate situations where the business loses billions of dollars because there are no global standards for commodity and trade finance. These types of instances have caused banks and other institutions unable to lend to a large segment of the market as there is a relatively high associated risk. The goal for all parties in the trade finance ecosystem should be the ability to look at an exporters business through an array of secure data points to confirm that the business is legitimate, and the company’s trade transactions are bankable.

Digitization and security is key

There is already an industry-wide push toward digitization and the pandemic has pushed efforts even further along. Trade is historically and notoriously analog. The biggest threat to transformation being the existing paper. Efforts at reducing the mountains of typed documents have been ongoing and trading partners are investing heavily in streamlining their own processes. Despite these efforts, the fax machine is still how many invoices get presented and many deals are done. This legacy of paper is one of the reasons there is still a heavy burden upon exporters and their financial partners. Banks would be wise to invest in the digitization of trade to remove friction from paper-intensive global trade.

The recent “Dear CEO letter” from Britain’s Financial Conduct Authority (“FCA”) is a reminder that due diligence, transaction monitoring, and suspicious activity reporting, while complex and time-consuming, are in service of protecting the financial industry and the global economy. Trade finance currently lacks standards for trading partners which results in a higher propensity for risk and outright fraud. Digital technologies combined with standards and networks of counterparties have the potential to reduce and even eliminate trade finance fraud by ensuring that an asset cannot be stacked against multiple lenders. While security is not always top of mind for organizations, banks and other institutions need to deploy technology that has a full view of activities between the two parties to ensure fraud is combatted.

As many banks have learned the hard way, trade finance can be extremely challenging due to the complexities of credit, collateral, and currency fluctuations. Many of these financial risks can be managed already, but there are also significant untapped opportunities. Despite being a challenging sector, trade finance represents an arena for tremendous opportunity for bank institutions seeking new growth.

[1] https://www.wto.org/english/thewto_e/coher_e/tr_finance_e.htm

[2] https://www.worldbank.org/en/topic/smefinance