Global trade finance gap is a lost opportunity – both for banks, and their customers

Banking

Published 04 Sep 2024
6 min reading
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Global trade finance gap is a lost opportunity – both for banks, and their customers

The unmet global demand for trade finance amounts to $1.5 trillion a year. That’s how much companies struggle to access the capital they need.

The data presented by WTO shows that the issue particularly affects SMEs, which are crucial for cross-border trade. According to the organisation, over half of trade finance requests made by SMEs are rejected.

Over the years, the financing of trade contracts has been principally reserved for large companies. Banks tend to evaluate the company standing by looking at the balance sheet, turnover or profit. SMEs are by default at a disadvantage compared with big firms. The risk of lending to smaller business entities is also clearly higher.

Additionally, banks are facing increasing compliance restrictions. The cost of KYC procedures on a large number of small and medium businesses is clearly a heavy factor. Costly onboarding processes on top of that, becoming stricter and stricter each year, simply do not make it cost-effective for banks to meet SMEs’ needs.

Understanding the Trade Finance Gap

The global trade finance gap has become a pressing concern for businesses, economies, and policymakers worldwide. This gap, which refers to the difference between the demand for trade finance and the supply available to support international trade, has significant implications for global trade, economic growth, and job creation.

Currently, the trade finance gap is estimated to be around $2.5 trillion, with the Asian Development Bank (ADB) reporting a record high in 2022. Several factors contribute to this widening gap, including heightened economic risks, rising interest rates, dwindling economic prospects, high inflation, and geopolitical instability. These challenges make it increasingly difficult for businesses, especially micro, small, and medium-sized enterprises (MSMEs) and women-led businesses, to secure the necessary trade finance.

The impact of the trade finance gap extends beyond individual businesses to entire economies. International trade is a critical driver of economic growth, and without adequate access to trade finance, countries struggle to participate fully in global trade. The World Trade Organization (WTO) has underscored the importance of trade finance in facilitating international trade and promoting economic development.

Multilateral development banks, such as the ADB and the International Finance Corporation (IFC), are actively working to address this issue. These institutions offer trade finance solutions, including guarantees, loans, and risk management products, to support imports and exports. However, more efforts are needed to deliver trade financing to those who need it most.

Trade Finance Gap

Addressing the trade finance gap requires a comprehensive approach. This involves understanding the trade finance ecosystem, identifying the gaps, and developing innovative solutions to bridge them. The ADB’s Trade Finance Gaps, Growth, and Jobs Survey provides valuable insights into the trade finance gap and its impact on businesses and economies.

To bridge the trade finance gap, it is essential to provide trade finance assets that are attractive to investors. These assets have gained popularity due to their relative stability, low default rates, and intrinsic link to real-world trade flows. However, the complexity of trade finance transactions poses a unique challenge, necessitating innovative solutions to make trade assets more accessible to investors.

Technology plays a crucial role in addressing the trade finance gap. Digital platforms can facilitate the distribution of trade finance assets, making it easier for investors to access trade finance data and for banks to free up capital for further lending or investment activities. The Trade Finance Distribution (TFD) initiative exemplifies a collective effort to tackle the trade finance gap by deploying digital platforms that aggregate trade finance data and make it available for sale to investors.

In conclusion, understanding the trade finance gap is crucial for developing effective solutions to this pressing issue. A comprehensive approach that involves understanding the trade finance ecosystem, identifying the gaps, and developing innovative solutions is essential. By providing trade finance assets that are attractive to investors, leveraging technology, and promoting collaboration among stakeholders, we can work towards bridging the trade finance gap and promoting global trade, economic growth, and job creation.

universal solution

A somewhat problematic customer

Growing costs or fear of thin profits are not the only reason, though. Banks’ legacy software solutions often do not provide the means to be competitive for SMEs and quickly react to their needs. Especially, with SMEs being a somewhat problematic customer – straddled somewhere between retail and corporate sectors, often escaping categorisation and demanding services that go way beyond old-school corporate banking products.

This growing gap makes a significant issue for global trade and markets, contributing to the inhibition of SMEs development. But isn’t it also a huge loss of profit for banks?

Eating the bank’s lunch

When a bank refuses service, it does not mean nobody earns a commission for it. SMEs just go look elsewhere. This is fertile ground for alternative financing via start-ups and FinTechs or other more flexible institutions. Cloud-based ecosystems have been gaining ground tremendously fast in the last few years: The Xero Platform, QuickBooks, FinSync and many more. There are platforms which grew form simple accounting systems or ERPs, other are focusing on lending or financing like factoring services.

But trade finance is not just about lending. Its major role is also to manage trade risk. That is why SMEs are particularly in need of trade finance; they cannot buffer the risk with their small capital. Banks, operating based on established trust, seem to be in the best position to provide this risk mitigation and create safer environment for trade development.

Digitisation to the rescue

So, how to make it more cost-effective for banks to tip the scales in favour of SMEs? No one should be surprised that digitisation is the answer. In 2017 the ICC Banking Commission assessed that the elimination of paper from trade transactions could decrease compliance costs by as much as 30%.

Digitisation to the rescue

Automation in anti-money laundering investigations can drive banking costs down by reducing the growing need for headcount. A typical AML process is rigorous and mostly manual, even if facilitated by software. Leveraging AI and RPA in these processes seems inevitable, otherwise costs may be skyrocketing.

Digital sales channel that is cost-effective and flexible to serve corporates and SMEs can help increase bank’s margin and business volumes. But the issue that often prolongs or postpones the digitisation process of SME banking is the clash of expectations and complexities.

In search of the universal solution

Banks have to decide which system to invest in. On one hand, the systems dedicated to corporate banking are quite rigid and not easily updated with novelties – they don’t satisfy SMEs’ appetite for innovation. On the other hand, attempts at servicing SMEs with retail banking systems may limit the product portfolio offered. Hence, finding a sales channel that is easily expandable and can universally address the needs of corporates and SMEs gives a chance at a serious profitability increase.

System architecture that breaks with the monolithic applications and allows for a quick plug-in of new services can help banks compete or coexist with cloud-based ecosystems. Why is that an issue at all?

Monoliths must go

The legacy applications which exist as single monolithic entities and have often been heavily customised to a particular bank needs are very difficult to upgrade. Even small changes can result in the need of complete regression tests and new deployment. This makes adjusting to regulatory changes or international standards (i.e. SWIFT changes to MT7XX in 2018) quite painful, let alone trying to keep up with innovations in the sales channels on regular basis.

Monoliths must go

Parting ways with monolithic approach should make it easier to keep up. At the moment it seems that microservices architecture may help fixing this problem. It lowers the barrier of adopting new technologies and enables independent implementation of single services. As a result, it makes microservices applications much faster to develop and easier to maintain.

Survival of the fittest

These are some of the ways to make addressing SMEs needs profitable, though they obviously require investment. While SME trade finance seems to be somewhat neglected by banks, it is quite a market judging by the size of unmet demand. Having in mind that SMEs have huge innovation potential, which means positive disruption on the local and global markets, it seems a safe bet that they have great money-making potential for banks. In order not to lose this market entirely to other financial institutions, banks should look into adjusting their offer and sales channels to meet the clearly huge demand for trade financing. The time to actively start filling in the trade finance gap is now.

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