All You Need To Know About Trade Finance Gap: Find Effects on SMEs
The pandemic has hurt trade and highlighted a requirement to make productive changes in international trade finance services to bridge the gap in the number of those who need it and those receiving it.
Recently, the USD 1.5 trade finance gap was reported by the Asian Development Bank in 2019 during the Covid pandemic. Besides this, the Manila-based multilateral institution’s latest Trade Finance Gaps, Growth, and Jobs Survey, included 79 banks from 43 countries and 469 firms from 72 nations. Its findings reveal the extent to which this trade finance gap is disrupting the full utilization of trade to facilitate growth, employment, and poverty reduction during the sudden outbreak of the global pandemic.
All this data efficiently demonstrates the lack of accessibility of global trade finance instruments and the disproportionate impact of a lack of funds on emerging markets businesses, especially SMEs (small- and medium-sized enterprises). However, what trade finance gap exactly, why does it matter, and how can it be decreased or controlled?
What is the Trade Finance Gap?The trade finance gap is the difference between the trade finance requests made by businesses around the world to empower sales of their goods & services and the actual amount of financial assistance that banks are willing to grant or able to provide. In other words, it is the difference between the supply & demand of trade finance services.
Why Is Trade Finance Important?Trade finance provides financial instruments to overseas importers & exporters to help them reduce foreign payment risks and move goods to the markets. It is essential for economic growth, employment, and other purposes. As per facts, trade finance supports almost 80% of global trade by providing a variety of international trade finance instruments, including letters of credit, documentary collection, Bank guarantees, insurance, and many more. Without trade finance, international trade would collapse.
As stated by the United Nations and the International Chamber of Commerce, in the absence of trade finance, it is difficult for businesses & economy to reach sustainable development goals. For SMEs, trade finance helps ensure that the buyers receive the goods on time and the sellers get paid for what they have delivered. The trade finance gap hits hardest the SMEs and least developed countries which are the most important factors in the growth & development of the economy. These SMEs make up 90% of companies, while as per facts, they generated 41% of trade finance requests, and they made up 52% of rejections in 2020. This gap is even bigger in the case of women-led businesses, with 70% of their applications either partially or fully rejected.
Trade Finance Gap ReportsUnfortunately, the trade finance gap is growing. The ADB estimated a $1.5 trillion gap in 2018 which had increased to $1.7 trillion by 2020. Further, it has been reported to have increased to $2 trillion due to rising risk aversion guidelines of banks and inflation. In the past years, ADB facilitated increased support by over 40%, from $5 billion in 2019 to over $8 billion in 2021.
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Why are SMEs adversely affected by the trade finance gap?Financial institutions are not generally unwilling or resistant to provide global trade finance services to SMEs. Rather, the banks cannot fulfill the growing trade finance demand as higher risk aversion, compliance constraints, poor financial background or quality of the candidates, and regulatory guidelines obstruct them.
Combining these issues with other foreign trade risks such as cost, the difference in regulations, and anti-money laundering compliance requirements against relatively low returns, banks often keep themselves away from providing finance to small-scale businesses.
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Why is International Trade Finance Important to SMEs?Small and Mid-sized Enterprises (SMEs) represent about 95% of the global economy. But they generally have limited access to financial services due to a small balance sheet and strict compliance requirements of banks. Here, international trade finance services help SMEs execute overseas transactions.
They need trade finance:
1. As the banks are rigid in providing financial assistance
2. To reduce patent risks
3. To get access to working capital
4. And spread business into new markets
What’s Next?Various institutional investors are showing interest in trade finance asset classes. The World Trade Organization (WTO) has also released recommendations for providing alternatives to bank funding, such as factoring and credit insurance. Moreover, associating with institutions resolves the issue and decreases the trade finance gap.
Multilateral development banks have also increased access to trade financing in less developed countries. Clearing the difficulties of access between global markets and SMEs will help trade boost around the world.