Why Is The Trade Finance Gap A Great Deal For Exporters?

Nov 23, 2021 - 07:34 AMAuthor - Kenneth Jackson

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Finance for international trade has a vital role for exporters all over the world when it comes to completing global foreign trade deals. Due to the associated overseas risks, exporters want to eliminate the payment risk, and thereby demand to be paid upon shipment, while importers are willing to pay only after receiving the ordered goods or services. Here, import/export finance narrows this time gap among parties through various financing options such as Letters of Credit, Bank Guarantee or Documentary Collections, etc. 

A suitable & wide range of access to global financial services provides them with the instant & required short-term working capital to complete the trade-deal-related tasks, that have been stuck due to lack of funds. It makes it one of the most important pillars of international trade & transactions among global traders. 

For many years, different banks & financial institutions have been minimizing the global trade finance gap and covering the risk of non-payment. The estimated risk is 0.2% on average worldwide with a little bit of variation across nations, highlighting international finance as an economic source of funding for SMEs. Currently, various credit & short-term payment guarantees cover around 80% of global trade with over $10 trillion in yearly flows, as shown by the Bank of International Settlements.

But some nations are witnessing a tremendous gap between supply & demand. As calculated by the Asian Development Bank, the current trade finance gap, or the amount of applied finance for trade that is rejected, is estimated at around $1.5 trillion globally. Developing nations in Asia & Africa, with small & medium-sized enterprises (SMEs), are facing a hard hit from half of this figure. As per WEF, this gap could reach up to $2.5 trillion by 2025, followed by shifting of China’s supply chains to poorly developing nations, followed by an obstructive barrier between international markets and SMEs. Plus, it will also lead to the least use of trade’s potential necessary for growth and employment opportunities.

What Is The Finance Gap In Trade Exactly?

The global finance gap is simply the difference between the number of requests made by businesses globally for financial services so they can sell their goods & provide their services and the actual amount of financing the banks provide. In other words, it is the difference between the supply & demand for finance in conducting trade.

Reasons Behind Finance Gap In Developing Nations

Generally, banks or financial institutions are not reluctant to provide global financial services to businesses, but they cannot cater to the growing finance demand due to several reasons. For example, they are hindered by regulatory requirements, the poor creditworthiness of the applicant, and compliance constraints. Here is how it works. 

The global finance sector often favors the industrialized nations, as the global importers & exporters have established financial industries, while in developing nations, the requests for finance often get abandoned because of the above-mentioned reasons. Neither SMEs can provide any collateral or strengthened financial statements nor do they have sufficient knowledge to handle trade finance instruments. In addition to this, the financial systems have also become rigid & more focused, followed by the adoption of new guidelines to curb money laundering & other illegal activities. 

Least Developed Nations Are At More Risks 

When it comes to poorly or least developed nations, the rejection rate for requests of global finance in Africa surpasses 50%, while the global finance gap is estimated to be over $100 billion yearly - one-third of the total market value. Plus, the fear of regulatory fines prevents international banks from initiating cross-continent trade transactions with Africa, leaving local banks with a dilemma of finding US dollars to complete trade deals. 

SMEs represent around 90% of the exports but the unavailability of funding & lack of other financing alternatives ultimately leads to the elimination of trade transactions by them once the request is rejected. As a result, they need to pay for their inputs in advance and go for local lending that is focused on collateralizing land and doesn’t invite businesses that don’t have lands or sufficient cash flow from global financial services. 

Recommended Read: Reasons Why SMEs Opt For Import-Export Finance

What’s Next?

USD1.5 trillion is such a vast amount of money that needs to be tackled promptly as it is a continuous roadblock to growth and development. Undoubtedly, a large part of this gap results from SMEs with poor creditworthiness in developing nations. As such, it is quite complex to narrow this finance gap through additional lending or credit. However, the distribution of trade finance instruments to other banks and capital markets can be a contributory step.

Recently, the World Trade Organization (WTO) has created recommendations for bank financing alternatives such as Factoring and Credit insurance. Moreover, banks are adopting new models for their trade books to open up additional sources of funding.  

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