By Dr. Gyan Pathak
Increasing trade finance gap has been impeding growth, jobs, and poverty reduction across the globe. The COVID-19 impact widened the gap by 15 per cent in 2020 in comparison to 2018. Moreover, despite various measures to support the Small and Medium Sized Enterprises (SMEs), the sector that employs the majority of workforce, during the pandemic, 40 per cent of trade finance applications rejected by banks were from SMEs.
The latest ADB brief titled ‘2021 Traded Finance Gaps, Growth, and Jobs Survey’ also found that as a percentage of global goods trade, the gap increased to 10 per cent from 8 per cent during the period under consideration. Firms’ demand for trade finance declined as the COVID-19 pandemic dampened world trade and disrupted global value chains.
However, the matter of concern is that the likelihood of trade finance applications being rejected rose significantly as the pandemic heightened economic and financial uncertainties while trade- and finance-related transactions costs increased because of supply disruptions. As the availability of trade finance is essential to trade, its shortage could have contributed to the global trade contraction during the pandemic.
Despite the widened trade finance gap, the responses from banks indicate that 79 per cent of them did not reduce capital availability and 73 per cent of them did not reduce limits to support trade during the pandemic. However, 50 per cent of banks expect trade finance defaults to increase because the pandemic. On the expected impacts of the pandemic, nearly 60 per cent of the surveyed banks viewed that trade finance support for SMEs and current and new clients was maintained while 14-23 per cent of the banks agreed that the pandemic reduced trade finance availability. It suggests that even if trade finance continued to be available to a certain extent, clients’ weaker balance sheets coupled with macroeconomic uncertainty may have intensified banks’ perceptions of increased default risk, resulting in higher rejection rates.
Heightened economic uncertainties due to the pandemic constitute one of the top barriers for banks to serve global trade finance needs felt 61 per cent of the banks participated in the survey, while 31 per cent of the responding banks noted that the pandemic raised risks faced by banks. Other major barriers are quite persistent—of the top five factors identified in the current survey, four have been included in the 2019 survey. These include Basel capital regulatory requirements (62 per cent); low credit ratings of applying firms (62 per cent); and banks’ low credit ratings (59 per cent).
Requirements on anti-money laundering (AML) and know your customer (KYC) remain the top barriers to expanding trade finance operations according to 72 per cent of the banks. The complexity and costs involved in the conduct of AML/KYC due diligence alongside measures to combat the financing of terrorism (CFT) often override correspondent relationships that are essential for SMEs and clients in developing economies to continue to access finance to support their trade transactions.
More than half of the surveyed SMEs believe their business will recover in the first half of 2022 or later. On the path to recovery, the firms noted that lack of access to finance (31 per cent) is one of the major barriers that should be addressed over the next year. About 22 per cent of them see that more public sector support is warranted.
Under the prolonged restrictive mobility measures, continued disruptions of production and supply chains (18 per cent) and weak consumer demand (17 per cent) are also major concerns. Nearly all banks surveyed echoed that the provision of trade finance is essential for post-COVID-19 trade growth and economic recovery.
As to areas of public sector support, responding firms agreed on the key roles of regional and international organizations in SME trade-financing guarantee schemes (25 per cent), collaborating with national and multilateral institutions to expand technology-based financing platforms to vulnerable groups (24 per cent), and providing SMEs with finance education and related knowledge-sharing campaigns (20 per cent).
National governments as well as regional and global institutions have executed various measures which included easing of terms, working capital and liquidity support, bank-charge waives, tax relief etc. Banks have also introduced various measures to support SMEs impacted by the pandemic – 27 per cent of them offered a moratorium on debt repayments; 23 per cent have increased capital availability and limits to SMEs; 23 per cent created pandemic-related products for affected clients; 13 per cent made compliance procedures easier, quicker, and cheaper; and 8 per cent reduced the rejection rate of SME proposal. However, the survey reveals that many SMEs expressed a lack of available support or did not know about available support, which could be indicative of the lack of coordination in disseminating information about the help available to them.
The ADB brief says that access to trade finance continued to be favourable towards large firms. SMEs account for only 23 per cent of trade finance demand compared with 54 per cent for large corporations. SMEs account for 40 per cent of trade finance rejections, much higher for its share of trade finance applications. Additional collateral is generally required by banks to mitigate the risk of SME lending under the traditional banking system, and this has been persistently one of the major obstacles that caused many SMEs to fail to secure approvals on their trade finance applications.
Limited access to finance could also push SMEs into financial difficulties, constrain their businesses, and make them more vulnerable to crisis, the report emphasized. Women-owned SMEs still face considerable difficulties in accessing trade finance. Among the women-owned firms surveyed, about 70 per cent of their applications were totally or partially rejected.
Among SMEs who were initially rejected and sought alternative financing, 40 per cent used their own funds. A slightly higher percentage of firms used informal (17 per cent) rather than formal financing alternatives (14 per cent) successfully.
The take-up of digital finance remains low at 1 per cent. Around 18 per cent of companies were unable to find an appropriate financing alternative, which is suggestive of either a knowledge gap or a financing product gap. Firms who sought informal finance resorted mostly to business partners (33 per cent) and family members and relatives (22 per cent) before seeking out other informal sources.
As for the fintech and digital solutions, usage of purchase order advances is 38 per cent, invoice financing 19 per cent, and peer-to-peer financing 15 per cent, which are too low. The majority of the firms (52 per cent) are not aware of crowdfunding while 57 per cent are not aware of debt-based securities. It suggests that more financial education and literacy would be needed to broaden the reach of fintech products and services for SMEs.
The survey points out that increasing trade costs and supply chain disruptions are causing inflation to creep into commodities, including food and agriculture products, which is particularly hard on the poor. Rising prices could even erode the limited support and exacerbate the gap, the report has warned.
Public sector support is vital to close trade finance market gaps but the private sector must play a larger role, ADB brief suggests. Realizing the potential of digitalization, more inclusion of women entrepreneurs, and greater transparency are among other recommendation to close the trade financing gap. (IPA Service)