FX International Payments
By Bill Camarda
Especially in international transactions, short-term trade financing can be indispensable. It helps SMEs “bridge” the weeks or months between when they spend money to manufacture and ship goods and when they receive payments for those goods. According to one recent estimate, up to 80 percent of global trade is supported by some sort of trade financing, credit, insurance, and/or guarantees.1 When SMEs can’t access these, this not only limits their opportunities: it may damage the entire global economy.
Conversely, the Organization for Economic Cooperation and Development (OECD) suggests that improving SME access to trade finance could be a powerful way to create and sustain more inclusive global prosperity.2
As the OECD points out, SMEs have long been at a disadvantage when accessing finance, “owing to opacity, under-collateralization, high transaction costs” and weaker financial expertise.3 But the obstacles they face seem to have grown in recent years.
In its 2016 global survey, the Asian Development Bank found that SMEs had submitted 44 percent of proposed trade finance applications in the preceding year, but accounted for 58 percent of rejections.4 According to World Trade Organization (WTO) researchers Marc Auboin and Alisa DiCaprio, these rejections are especially troubling “given that trade finance is one of the safest forms of finance, in which less than 1 percent of transactions go into default.”5 Auboin and DiCaprio argue that lenders often treat developing market trade finance applications as inherently high risk, even where their default rates are virtually identical to mature markets.6
According to an International Chamber of Commerce (ICC) survey, one key reason for the growing difficulties many SMEs face in accessing trade finance are stricter compliance rules aimed at preventing money laundering and other financial crimes, often called Know Your Customer (KYC) rules. Some 90 percent of respondents to the 2016 ICC survey say compliance requirements are now a significant impediment to SME trade finance, and 83 percent expect the rules to keep toughening, at least in the short-term.7 As leading Nordic bank Nordea recently observed, “KYC is likely to broaden out into new areas, such as know your goods (KYG).”8
In ADB’s survey, compliance-related obstacles were viewed as highest in the Middle East, North Africa, Sub-Saharan Africa, and Russian Federation/Commonwealth of Independent States (CIS).9 ADB called special attention to the bank-to-bank correspondent relationships that often underpin trade finance, noting that many correspondent banking relationship were terminated during 2014 and 2015 “due to the cost or complexity of antifinancial crimes regulatory compliance.” In 2016, International Monetary Fund (IMF) staffers raised the issue, observing that the withdrawal of commercial banking relationships had reached a "critical level” that could "disrupt financial services and cross‐border flows, including trade finance and remittances, potentially undermining financial stability, inclusion, growth and development goals.”10
Given these realities, the United Nations Economic and Social Council recently noted in May 2017 that “many micro, small and medium-sized enterprises are not benefiting sufficiently from the international trading system, and have difficulties integrating into global value chains.”11 It then committed to promoting “policies that encourage access by micro, small and medium-sized enterprises to adequate and affordable trade finance at all levels,” and asked its Inter-Agency Task Force to review SME trade financing during the coming year.
To help focus countries and trade organizations on how to ameliorate the problem, the G20 and OECD have established high-level principles. To begin, they propose “strengthening financial market infrastructure for SMEs,” including credit reporting frameworks, collateral registries, and insolvency rules,” and requiring the international Financial Stability Board to pay closer attention to SMEs in assessing the impact of proposed rules.12
Second, recognizing that SMEs may benefit from drawing on diverse financing sources, they recommend that member states “improve access to various forms of financing and take specific and targeted measures to boost the financial literacy of SMEs by encouraging the establishment of mentorship and financing networks.”13
Finally, the G20 and OECD recommended aggressively promoting “SME awareness of and ability to engage in digital finance, including electronic invoicing and settlement, as well as digital trade and supply chain finance.” Given that digital tools can increase transparency throughout a transaction’s lifespan, SMEs might be able to reduce the perception of risk associated with financing their international trade, thereby leveling the playing field with larger suppliers.14
Recognizing that SMEs face unique and growing challenges in accessing crucial trade finance, global economic and political organizations are mobilizing to address the problem – and thereby promote more inclusive economic growth.
Bill Camarda is a professional writer with more than 30 years’ experience focusing on business and technology. He is author or co-author of 19 books on information technology and has written for clients including American Express Private Bank, Ernst & Young, Financial Times Knowledge and IBM.
1.“The challenge of the trade finance funding gap,” TXF News; http://www.txfnews.com/News/Article/5818/The-challenge-of-the-trade-finance-funding-gap
2.Financing SMEs and Entrepreneurs 2017: An OECD Scorecard, Organization for Economic Cooperation and Development; https://www.oecd.org/cfe/smes/Financing SMEs and Entrepreneurs 2017_Highlights.pdf
3.G20/OECD High-Level Principles on SME Financing, Organization for Economic Cooperation and Development; https://www.gpfi.org/sites/default/files/G20-OECD-High-Level- Principles-on-SME-Financing.pdf
4.“2016 Trade Finance Gaps, Growth, and Jobs Survey,” Asian Development Bank; https://www.adb.org/sites/default/files/publication/190631/trade-finance-gaps.pdf
5.“Why Do Trade Finance Gaps Persist: And does it Matter for Trade and Development?” World Trade Organization Working Paper; https://www.wto.org/english/res_e/reser_e/ersd201701_e.pdf
7.2016 Rethinking Trade & Finance, International Chamber of Commerce; https://cdn.iccwbo.org/content/uploads/sites/3/2016/10/ICC-Global-Trade-and-Finance-Survey-2016.pdf
8.“Trade finance: five trends to watch out for in 2017,” Nordea; https://insights.nordea.com/trade-finance-five-trends-watch-out-2017
9.2016 Rethinking Trade & Finance, International Chamber of Commerce; https://cdn.iccwbo.org/content/uploads/sites/3/2016/10/ICC-Global-Trade-and-Finance-Survey-2016.pdf
10.The Withdrawal of Correspondent Banking Relationships: A Case for Policy Action, International Monetary Fund Staff Discussion Note; https://www.imf.org/external/pubs/ft/sdn/2016/sdn1606.pdf
11.“Economic and Social Council forum on financing for development follow-up,” United Nations Economic and Social Council; http://www.un.org/esa/ffd/ffdforum/wp-content/uploads/sites/3/2017/05/E-FFDF-2017-L.1_Draft-Outcome.pdf
12.Think Big for Small: Small and Medium Enterprises as Pillar for Future-oriented, Sustainable Growth, G20 Germany 2017 Business 20 Dialogue; https://www.b20germany.org/fileadmin/user_upload/documents/B20/B20_CTG_SMES_Final_Policy_Paper_2017-04-11.pdf