Alternative lenders are stepping into the gaps as banks scale back from trade ﬁnance lending
In late 2017, the Asian Development Bank estimated a $1.5trn shortfall between the demand and supply of trade finance, leaving deals undone and economies worse off . This gap is approximately 10% to 20% of the trade finance market, which is valued at over $9trn annually. Fast forward to today, and this figure is set to increase in the wake of full Basel III implementation and the impending realities of Basel IV. If global economies, emerging or developed, are to thrive, alternative private credit lenders must innovate and partner with trade finance banks to bridge this gap.
Owing to the complicated nature of trade finance, this issue has not been given much attention by those outside the industry, despite its effect on global trade. Not only does the funding gap result in trillions of dollars of lost potential economic value, but it also specifically hinders the development of emerging markets, which ultimately stalls economies, small and large.
A combination of forces has driven down trade finance activity over the past decade, but this issue, like many, has its roots in the latest financial crisis. In response to the banking crisis, new regulations, such as Basel III and more recently Basel IV, were introduced to improve regulation and risk management within the financial sector. These new frameworks required banks to meet strict minimum capital requirements, essentially reducing the amount of capital banks are able to lend.
These regulations, which were designed to curb excessive risk-taking, unintentionally penalised the trade finance banks whose credit ratings had always been stable, and had measurable implications within the trade finance sector. In an effort to avoid costly risk-capital provisions, global banks rapidly withdrew from developing markets and focused their funding into more profitable ones.
A collateral gap seemed to appear overnight in emerging markets and for small and medium sized companies. Today, there is a stark difference in access to funding, with banks granting more trade capital to larger firms in developed countries. The perception that trade in emerging markets is inherently high-risk continues to drive this shortfall.
This funding gap must be addressed because it represents trillions of dollars of untapped trade potential and unrealised economic value. Trade finance drives global economic growth and is relevant to all participants of trade, not just SMEs. In fact 80% of global trade is supported by some aspect of trade financing, credit, and guarantees.
However, SMEs do represent the majority of the world’s companies, so when they cannot access funding, it not only limits their opportunities, it damages the entire global economy. Consequently, the SME funding issue hits emerging markets the hardest. Alternatives to bank financing are scarce for many countries in South America, Africa and Asia. After funding requests are rejected by trade finance banks, the majority of transactions are abandoned. This loss of capital hinders development impact as well as the economic inclusion of developing economies.
In order to begin to bridge the trade finance gap and provide liquidity for SMEs, new players must enter the space. Many trade finance banks and large companies are betting on fintech and blockchain as the solution. Indeed, technology has a part to play, but it is only a tool, not a solution. Digitalisation will improve access to information, increase the speed of transactions and make them more secure, but it will not address the underlying issues contributing to the lack of funding.
Instead, there is opportunity for new participants, such as alternative lenders, to work within the banking system to deliver innovative solutions. The creation of new sources of capital that can facilitate funding between institutional investors and physical producers by working alongside bank-originated transactions, will optimise transactions beyond current trade finance banks’ capabilities.
If alternative lenders can provide the collateral required under new regulations, transactions that would have otherwise not have happened can finally begin to go and pave the way towards a more prosperous and growing global economy.
First published in April 2019 by Alt-Credit Magazine, Page 14
By Fasil Nasim, co-founder and CIO, Audentia Global