Economics of Trade Finance
Matrix of trade finance instruments
- Raising working capital for exports: Debt financing; Asset-based financing; Export factoring; and Leasing
- Facilitating payments: Cash-in-advance; Letter of Credit(L/C); Documentary collection; and Open accounts
- Mitigating risks: Export credit guarantee; Export credit insurance; Forfeiting; and Hedging.
Trade Finance is the lubricant in Global Trade. The concentration of banks providing Trade Finance is very high. So are the risks if a bank fails or withdraws credit due to regulations.
- How many Banks provide Trade Finance?
- What happens when Banks withdraw credit due to Financial Crisis?
- What other alternatives are there for Trade Finance ? GTLP?
- What is the role of increased regulations on Trade Finance? BASEL III
From Trade finance around the world
Decline in Trade Finance as a cause of Global Trade Collapse
- Concentration of Banks providing Trade Finance
- De-risking by EU Banks to EMEs due to BASEL III requirement
- Backlash against Trade
From DE-RISKING BY BANKS IN EMERGING MARKETS – EFFECTS AND RESPONSES FOR TRADE / IFC EMCOMPASS
Emerging evidence suggests that de-risking is a reality. Increased capital requirements, coupled with rising Know-Your-Customer, Anti-Money-Laundering, and Combating-the-Financing-of-Terrorism compliance costs have resulted in the exit of several global banks from cross-border relationships with many emerging market clients and markets, particularly in the correspondent banking business. A subset of this business, trade finance, is also at risk, with potential consequences for segments of emerging market trade. The emerging market trade finance gap was significant before the crisis and has since likely expanded. Those involved in addressing the de-risking challenge must focus on compliance consistency and effective adaptation of technological innovations.
From ADB 2016 Trade Finance Gaps, Growth, and Jobs Survey
- The estimated global trade finance gap is $1.6 trillion.
- $692 billion of the gap is in developing Asia (including India and the People’s Republic of China).
- 56% of SME trade finance proposals are rejected, while large corporates face rejection rates of 34% and multinational corporations are rejected only 10% of the time.
- Firms report that 25% more trade finance would enable them to hire 20% more people.
- Woman-owned firms face higher than average rejection rates.
- 70% of surveyed firms are unfamiliar with digital finance, uptake rates highest in peer-to-peer lending.
From ADDRESSING THE GLOBAL SHORTAGE OF TRADE FINANCE
The International Chamber of Commerce (ICC) 2016 Global Survey on Trade Finance reveals that 61 percent of respondents cited a global shortage of trade finance—a figure that is particularly concerning as we continue to observe a period of prolonged sluggishness when it comes to global trade growth. But hope is not lost. Doina Buruiana, Project Manager at ICC Banking Commission, explains the various ways that the trade-finance gap can be filled.
For the fifth consecutive year, trade growth has been reported at below 3 percent and has not recovered to pre-crisis levels—with a global trade-finance shortage estimated to have reached US$1.6 trillion in 2016, according to the Asian Development Bank (ADB). Such figures certainly make for grim reading. And what’s more, the findings from the International Chamber of Commerce’s (ICC) 2016 Global Survey on Trade Finance—an annual report reflecting the issues and trends on the trade-finance landscape—are also providing cause for concern. Sixty-one percent of respondents—national, regional and global banks providing trade finance—reported a global shortage of trade finance.
There are various reasons for this. Ninety percent cited the cost or complexity of compliance requirements relating to anti-money laundering (AML), know your customer (KYC) and sanctions as a chief barrier to the provision of trade finance. Furthermore, 77 percent of respondents to the Global Survey cited Basel III regulatory requirements as a significant impediment to trade finance. Many global banks are withdrawing from several emerging-market regions dependent on trade and trade finance, partly due to pressures to favour domestic clients following some banks’ bailouts by taxpayers.
And the fallout can be severe. A shortage of trade finance impacts the growth of businesses worldwide. In particular, small to medium-sized enterprises (SMEs) are being affected by the shortage of bank liquidity. According to the Global Survey, 58 percent of rejected trade-finance proposals were SME applications, despite the sector submitting 44 percent of all trade-finance proposals.
Yet hope is not lost. There are various ways in which the industry can adapt to not only bridge the gap in unmet demand for finance and help revive global growth, but also to evolve the industry, to drive healthy competition and to remove the focus from being global-bank dependent.
Backlash against trade
Improving understanding and attitudes toward trade, and awareness around trade finance, would be a good place to start. Across the world, many have attacked trade and globalisation for threatening jobs and benefitting only big businesses—sentiments that have been evident across the European Union (EU) during Transatlantic Trade and Investment Partnership (TTIP) negotiations, and also during the recent US presidential election campaigns.
Indeed, we’ve seen a clear rise in protectionist and populist policies—a recent World Trade Organization (WTO) report cited that between mid-October 2015 and mid-May 2016, G20 economies had introduced new protectionist trade measures at the fastest pace since 2008. To address this, we need to first make the case for trade itself in order to highlight the importance of trade finance. It is therefore crucial that businesses and trade-finance industry stakeholders reinvigorate the narrative around global trade, relaying its significance to the public and ensuring that trade is on the agenda of policymakers worldwide.
Understanding trade finance.
Next, enhancing awareness around trade finance should also remain a top priority. While there has already been significant progress in the dialogue between trade-finance practitioners and regulators, and a noticeable shift towards a more suitable risk-aligned treatment of trade finance, it is crucial that we continue to emphasise the low risk nature of trade-finance instruments.
Indeed, ICC’s 2015 Trade Register report highlights the low risk nature of trade-finance products—with favourable credit and default-risk experience. For instance, the Trade Register shows that there is a low default rate across all short-term trade-finance products, with the average expected loss for short-term trade finance lower than typical corporate exposures. In particular, traditional documentary trade-finance products such as letters of credit (LC) are low risk. Remarkably, the transaction default rate for export LCs between 2008 and 2014 was 0.01 percent. Medium- to long-term products also fare well, with a low loss nature due to the export credit agency’s (ECA) guarantee—normally with investment-grade ratings and backed by high-income Organisation for Economic Co-operation and Development (OECD) governments.
The need for increased awareness around trade finance extends well beyond traditional trade finance and also includes newer techniques and instruments under the supply-chain finance umbrella. We also need to raise industry understanding around compliance measures—differentiating between client KYC and non-client KYC, for instance, in order to ease processes. In addition, enhanced awareness and understanding in relatively unsettled areas in trade finance, such as trade-based money laundering, would help direct compliance measures. Despite common belief, for instance, only a small proportion of trade-based money laundering actually occurs in trade-finance transactions.
Yet while progress has certainly been made with regulation and compliance proposals, the Global Survey suggests that the costs associated with such measures are still, and will perhaps continue to be, prohibitive. As such, if we want to close the trade-finance gap, we need to move slightly away from a global bank-dominated financial landscape and embrace collaboration.
Financial-technology firms (fintechs) are increasingly shaping the future of trade finance, and make an obvious banking partner, with both parties bringing strengths and expertise to such arrangements. Indeed, many fintechs are looking to partner with—rather than compete with—banks due to balance-sheet requirements, the regulatory framework to navigate, and the industry expertise required to bring new concepts to fruition. Certainly, partnerships between the two players could drive additional efficiencies and the capacity of banks to conduct business—perhaps eventually reducing the trade-finance shortage.
Fintechs aren’t the only players that could potentially collaborate with banks—or even fill the trade-finance gap independently. The Global Survey found that export credit agencies (ECAs) are increasingly supporting export finance, with alternative liquidity flowing into the ECA space. Thirty-seven percent of respondents reported that they had successfully concluded business with institutional investors in ECA finance, up from 30 percent in the previous survey in 2015, reflective of the growing role of alternative investors.
The Global Survey also highlighted the important role of multilateral development banks (MDBs), with 75 percent of respondents agreeing that MDBs (and ECAs) help reduce trade-finance gaps. In particular, MDBs provide financial assistance to emerging markets for investment projects and policy-based loans. This can prove crucial for enabling access to trade finance in general, and for SMEs.
The ADB’s Trade Finance Program (TFP), for instance, fills market gaps for trade finance by providing guarantees and loans through more than 200 banks. The TFP has supported more than 12,000 transactions across Asia, valued at over US$23.1 billion—of which more than 7,700 involved SMEs. What’s more, the TFP focuses on markets in which the private sector has less capacity to provide trade finance, and where there are large trade-finance gaps.
However, the Global Survey also indicated that MDB and ECA support varies by region—with respondents deeming it most effective in advanced Asia, Russia and sub-Saharan Africa, and less effective in Commonwealth of Independent States (CIS) countries, India and Central America and the Caribbean. Clearly, an increase in the envelope and effectiveness of MDB trade-finance provision in these regions will help further reduce the gap. In order to counter geographical disparities, the next step for MDBs is to consider any structural limitations in existing trade-finance programmes—or contextual difficulties in particular markets.
Finally, non-bank capital provides another useful source of trade finance, particularly from private-sector sources of finance—such as specialist financiers or alternative-finance providers. Since the financial crisis, these players have played an increasingly crucial role in meeting unmet demand, and have experienced considerable growth. What’s more, specialist financing is growing increasingly popular among companies in emerging markets, in which trade-finance demand is most acute.
Revamping trade finance.
Of course, one way to possibly boost the provision of trade finance is to make it more efficient and attractive. Certainly, the digitisation of trade finance holds huge potential. Automating trade finance can make overall processes more effective and reliable, increasing capacity for banks, corporates and other stakeholders along the supply chain. For instance, eDocs (paperless documents) streamline processes, with the ability for multiple parties to access, review and collaborate at any one time. The resulting operational improvements in turn reduce errors, maintain data integrity and accelerate the completion of agreements.
Despite the clear benefits, the Global Survey shows that there has been a slow uptake of digitisation. In fact, one-fifth of respondents reported that there is no evident digitisation at all, two-thirds saw very little impact of technology on trade finance, and just over 7 percent saw digitisation as being widespread. The slow uptake is likely due to the challenges of digitising trade—including the considerable scale and complexity of the task at hand, for instance. Banks should play a key role in advocating the benefits of digitisation and help their corporate clients adapt to new systems.
We cannot let the trade-finance gap incapacitate trade. Clearly, there are steps that the trade-finance industry can take to help meet unmet demand. Looking ahead, improving attitudes and raising understanding, encouraging collaboration and making progress towards innovation in the industry will support the growth of businesses of all sizes—and the economy—worldwide.
From Global Trade Liquidity Program /IFC
The Global Trade Liquidity Program (GTLP) is a unique, coordinated global initiative that brings together governments, development finance institutions (DFIs), and private sector banks to support trade in developing markets and address the shortage of trade finance resulting from the global financial crisis.
With targeted commitments of $4 billion from public sector sources, the program has supported nearly $20 billion of trade since its inception. It raises funds from international finance and development institutions, governments, and banks, and it works through global and regional banks to extend trade finance to importers and exporters in developing countries. IFC’s commitment to the program is $1 billion.
GTLP began its operations in May 2009, channeling much-needed funds to back trade in developing countries. Phase 2 was launched in January 2010 with an unfunded solution, based on the existing GTLP platform, to support trade finance directed at the food and agribusiness sectors. The program was extended in January 2012 to continue to stabilize and foster trade and commodity finance to emerging markets.
Since its launch, GTLP has been acknowledged in the financial industry as an innovative structure to help infuse much needed liquidity into the trade finance market, thereby catalyzing global trade growth. The solution also represents a win-win proposition: for the banks it provides an opportunity to continue supporting clients through these difficult times; for IFC and its partners, it affords the ability to channel liquidity and credit into markets to help revitalize trade flows by leveraging on the banks’ vast networks across emerging markets in Asia, Africa, Middle East, Europe, and Latin America.
The program is already benefiting thousands of importers and exporters and small- and medium-sized enterprises.
From ADB Trade Finance Program
ADB’s Trade Finance Program (TFP) fills market gaps for trade finance by providing guarantees and loans to banks to support trade.
Backed by its AAA credit rating, ADB’s TFP works with over 200 partner banks to provide companies with the financial support they need to engage in import and export activities in Asia’s most challenging markets. With dedicated trade finance specialists and a response time of 24 hours, the TFP has established itself as a key player in the international trade community, providing fast, reliable, and responsive trade finance support to fill market gaps.
A substantial portion of TFP’s portfolio supports small and medium-sized enterprises (SMEs), and many transactions occur either intra-regionally or between ADB’s developing member countries. The program supports a wide range of transactions, from commodities and capital goods to medical supplies and consumer goods.
The TFP continues to grow, supporting billions of dollars of trade throughout the region, which in turn helps create sustainable jobs and economic growth in Asia’s developing countries.
- IFC GTFP (Global Trade Finance Program)
- IFC GTLP (Global Trade Liquidity Program)
- IFC GTSF (Global Trade Supplier Finance)
- IFC GWFP (Global Warehouse Finance Program)
- SME ( Small and Medium Enterprises)
- LC (Letter of Credit)
- DC (Documentary Collections)
- IFC ( International Finance Corporation)
- WTO (World Trade Organization)
- ADB (Asian Development Bank)
- WB (World Bank)
- MDB ( Multilateral Development Banks)
- ECA (Export Credit Agency)
- Structured Trade
- Aid for Trade
- BRICS NDB (New Development Bank)
- ADB TFP (Trade Finance Program)
Key Sources of Research:
Global Trade Liquidity Program
Trade Finance Program
EXPORTS AND FINANCIAL SHOCKS
Mary Amiti David E. Weinstein
Why Boosting the Availability of Trade Finance Became a Priority during the 2008–09 Crisis
International Trade, Risk, and the Role of Banks
Friederike Niepmann Tim Schmidt-Eisenlohr
Revised November 2014
International Trade Risk and the Role of Banks
Niepmann, Friederike and Tim Schmidt-Eisenlohr
Trade finance: developments and issues
Report submitted by a Study Group established by the Committee on the Global Financial System
The Group was chaired by John J Clark, Federal Reserve Bank of New York
Trade finance and SMEs
Improving the Availability of Trade Finance during Financial Crises
Trade Finance in Financial Crises: Assessment of Key Issues
December 9, 2003
US Trade Finance Guide 2008
ADDRESSING THE GLOBAL SHORTAGE OF TRADE FINANCE
Doina Buruiana, Project Manager at ICC Banking Commission
December 15, 2016
Trade finance around the world
Friederike Niepmann, Tim Schmidt-Eisenlohr
11 June 2016
The challenges of trade financing
28 January 2009
The role of trade credit financing in international trade
Katharina Eck, Martina Engemann, Monika Schnitzer
20 April 2015
The global financial crisis: A wake-up call for trade finance capacity building in emerging Asia
Wei Liu, Yann Duval
19 June 2009
The role of bank guarantees in international trade
Tim Schmidt-Eisenlohr, Friederike Niepmann
26 November 2014
Why does finance matter for trade? Evidence from new data
Marc Auboin, Martina Engemann
03 December 2012
Trade and Trade Finance in the 2008-09 Financial Crisis
Prepared by Irena Asmundson, Thomas Dorsey, Armine Khachatryan, Ioana Niculcea,
and Mika Saito
Enhanced Attention for Trade Finance
Trade finance: The landscape is changing— are you?
RETHINKING TRADE & FINANCE 2016
ICC Global Survey on Trade Finance
2016 TRaDE FINaNCE GaPS, GROwTh, aND JObS SURvEY
alisa Di Caprio Ying Yao Steven beck Fahad Khan
Articles on Trade Finance
2016 State of Supply Chain Finance Industry
ICC Global Survey on Trade Finance
DE-RISKING BY BANKS IN EMERGING MARKETS – EFFECTS AND RESPONSES FOR TRADE
TRADE AND DEVELOPMENT REPORT, 2016
No Guarantees, No Trade: How Banks Affect Export Patterns
Friederike Niepmann Tim Schmidt-Eisenlohr
Understanding Trade Finance: Theory and Evidence from Transaction-level Data
Jae Bin Ahn
International Monetary Fund
Off the Cliff and Back? Credit Conditions and International Trade during the Global Financial Crisis
Davin Chor Kalina Manova
Trade Finance during the Great Trade Collapse
Jean-Pierre Chauffour and Mariem Malouche
Why Trade Finance matters for Trade
TRADE FINANCE IN PERIODS OF CRISIS: WHAT HAVE WE LEARNED IN RECENT YEARS?
Marc Auboin and Martina Engemann
Global Finance Names The World’s Best Trade Finance Providers 2016
The Trade Finance Business of U.S. Banks
Friederike Niepmann and Tim Schmidt-Eisenlohr
MAY 19, 2014
Why U.S. Exporters Use Letters of Credit
Friederike Niepmann and Tim Schmidt-Eisenlohr
WHAT DRIVES BANK-INTERMEDIATED TRADE FINANCE? EVIDENCE FROM CROSS-COUNTRY ANALYSIS
José María Serena Garralda
The impact of Basel III on trade finance
Author: Bc. Jana Malešová
The Withdrawal of Correspondent Banking Relationships: A Case for Policy Action
Prepared by Michaela Erbenová, Yan Liu, Nadim Kyriakos-Saad, Alejandro López-Mejía, Giancarlo Gasha, Emmanuel Mathias, Mohamed Norat, Francisca Fernando, and Yasmin Almeida1
Leveraging Supply Chain Finance for Development
Alexander R. Malaket
Trade Finance: A Catalyst for Asian Growth
Trade Flows in Developing Countries: What is the Role of Trade Finance?
Clara Brandi Birgit Schmitz
Financing Global Development: The Potential of Trade Finance