Rejection rates for trade finance hit new heights during the Covid-19 pandemic in 2020, according to research by the Asian Development Bank (ADB), with the gap between demand and supply now standing at a towering US$1.7tn – a 15% increase over the previous estimate of US$1.5tn in 2018.
The Manila-based multilateral institution’s latest Trade Finance Gaps, Growth, and Jobs Survey, now in its seventh cycle, polled 79 banks from 43 countries and 469 from 72 countries. Its findings lay bare the extent to which shortfalls in finance are impeding the full potential of trade to deliver growth, jobs and poverty reduction in the wake of the pandemic.
Fully 57% of survey respondents said that the pandemic had worsened the shortage of trade finance support, with 14% of banks saying that they reduced capital availability to support trade, and almost a third – 27% – saying that they reduced limits available to support trade.
The fact that trade contracted during 2020 likely masks the extent of the issue. According to data from the World Trade Organization (WTO), global trade shrank by 7.5% last year, and with less trade comes less need for trade finance.
“There was a 9% drop in trade finance applications – broadly in line with the drop in trade in 2020 – so the US$200bn increase in relation to the drop in applications is understated,” Steven Beck, head of trade and supply chain finance at the ADB, tells GTR.
Indeed, according to the ADB study, as a percentage of global goods trade, the gap increased to 10% in 2020 from 8% in 2018.
However, the converse is also true, the report says, demonstrating just how closely connected the supply of trade finance is to the performance of global trade.
“Firms’ demand for trade finance declined as the Covid-19 pandemic dampened world trade and disrupted global value chains,” the ADB says, adding that the “panic and uncertainty” induced by the rapid global spread of the virus aggravated the trade finance access issue.
“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.”
SMEs and women-owned firms the hardest hit
As in previous years, it is small and medium-sized enterprises (SMEs) that are the hardest hit. Despite accounting for just 23% of all trade finance applications, fully 40% of trade finance requests rejected by banks were from this segment.
This comes despite various measures to support SMEs during the pandemic, such as moratoria on debt repayments – offered by 27% of the banks that responded to the survey; increased capital availability and limits – offered by 23% of banks; and simplified compliance procedures – offered by 13% of banks.
The data also suggest that there are few options available once an initial application for trade finance has been rejected, with almost a fifth of SMEs saying that they were unable to find an appropriate financing alternative.
“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,” the report says. “Limited access to finance could also push SMEs into financial difficulties, constrain their businesses, and make them more vulnerable to crisis.”
For those SMEs owned by women, the picture is bleaker still. Among the women-owned firms surveyed, about 70% of their applications were totally or partially rejected.
Among barriers to servicing global trade finance needs, anti-money laundering (AML) and know your customer requirements were by far and away the top issue cited, with 72.4% of responses, followed by Basel capital regulatory requirements at 62.1%.
The ADB also found that the potential for digitalisation to close the trade finance gap – either via streamlining onboarding processes for SMEs or opening up the sector to new sources of liquidity – is yet to be fully realised. While most banks and firms surveyed believe the pandemic has accelerated and will continue to propel the use of digital processes in their operations, the report says that the use of fintech and digital solutions is “limited and concentrated on certain areas only”.
Worryingly, the indications are that the trade finance gap will get worse before it gets better.
“The data for this study was accumulated nine months ago, before the huge spike in energy and food prices,” Beck tells GTR. “The spike in prices will exacerbate the gap significantly – each deal will use up more of what country and counterparty limits exist to support trade, reducing the capacity to support other deals. Importantly, energy and food consume a lot of the poor’s income and this has to be a major concern.”
To close the widening trade finance gap, the development bank has come up with a number of policy recommendations. The first is for greater partnerships between the public and private sectors. “During the pandemic, the trade finance programmes of multilateral development banks significantly increased transaction numbers, demonstrating high market demand for public sector involvement at a time when private sector capacity has retrenched, as demonstrated in the higher rejection rates, against elevated risk concerns,” the ADB says. However, it adds, public sector support is relatively small against the size of the market gap, and so public-private partnerships including co-financing can help fill the gap further.
The second policy recommendation is around digitalisation, and in this, the ADB echoes the International Chamber of Commerce’s Digital Standard Initiative’s calls for global standards and protocols to be implemented in order to drive interoperability between various platforms and between components of the trade ecosystem.
“Beyond the expected productivity gains and lower barriers to entry for SMEs, the metadata generated could expose and help address impediments to closing financing gaps, while making global trade and supply chains more robust and less susceptible to shock,” says the bank.
The ADB’s third recommendation to policymakers is to focus on greater inclusion of women throughout the global financial system. “The Trade Finance Gaps, Growth and Jobs Survey shows that underrepresented groups including women-led businesses are likely to face higher rejection rates and therefore greater financing gaps than businesses led by well-represented groups,” it says. “Attracting, retaining, and promoting more women in finance is important to closing the gap. Banks need to adopt and advance practical gender- and diversity-inclusive human resource policies and practices to increase women’s participation in banking, which should help translate to more understanding about the challenges faced by women entrepreneurs and higher trade finance support for women-owned businesses.”
Finally, the ADB calls for greater transparency throughout global trade and supply chains, in order to tackle issues such as the unintended consequences of AML requirements. To achieve this, it continues to push for global adoption of the Legal Entity Identifier (LEI) – a unique, electronic, 20-digit standard identifier for legal entities – as well as detailed maps of supply chains, including all companies involved in each component part of production and distribution.
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