By Karen Lynch
Lack of credit propagated around the world, freezing business and consumer demand in one country after another. Cross-border lending and trade financing were particularly hard hit everywhere, with small and midsize enterprises (SMEs) and developing countries feeling the brunt of it. Ten years later, though international trade has largely rebounded, trade finance hasn't fully recovered. But it has irrevocably changed, including the rise of open account trade and supply chain finance.
Up to 80 percent of trade is financed by some form of credit, guarantee, or insurance, as World Trade Organization (WTO) Director-General Roberto Azevêdo recently noted. "For many years access to this finance was taken for granted, but the financial crisis changed all that," he said,2 as major global banks pulled back from cross-border and small business lending.
And since then, "some financial regulations governing banks have had the unintended consequence of widening the trade finance gap," the International Chamber of Commerce (ICC) wrote in a 2018 report.3 For example, regulations designed to stop banks from taking excessive risk have pushed them toward lower-risk lending, which has meant reductions in small business loans, cross-border lending, and loans to private (versus public) companies.4 In addition, complicated, time-consuming "know your customer" rules to combat money laundering and terrorist financing are effectively blocking many SMEs from getting trade finance.
"Businesses of all sizes continue to struggle to access sufficient credit, resulting in a global trade finance gap of $1.5 trillion in 2016," the Asian Development Bank reported late last year. "While the global trade finance gap stabilized in 2016 compared to the 2015 record high of $1.6 trillion, it still translated to missed growth opportunities and job creation."5
Businesses conducting international trade are particularly susceptible to credit crunches and higher credit costs – not only because of the higher risk in cross-border business but also because the way cash flows in import-export businesses leads to greater dependence on external capital. "Most firms rely on external capital (as opposed to their own capital, internal cash flows, and reinvested earnings) to finance fixed costs – such as research and development, advertising, fixed capital equipment – and also to finance intermediate input purchases, inventories, payments to workers, and other frequent costs before sales and payments of their output take place," according to a report from the Federal Reserve.6
Exporting requires extra upfront spending, the report said – not only to ship, pay customs duties, and insure freight, but to research the profitability of new export markets; make market-specific investments in capacity, product customization, and regulatory compliance; and set up and maintain foreign distribution networks. And, because cross-border delivery can take longer than completing and getting paid for domestic orders, working capital requirements can be higher, the Fed said.
The Fed defines trade financing in its broadest sense, including trade credit extended directly between cross-border buyers and sellers, bank loans for working capital to produce for export, "traditional" letters of credit, insurance, and other financial products that mitigate the risks of international trade.
It is hard to say exactly how far trade finance dropped during the global financial crisis. "Much of trade finance is not distinguishable in official statistics," the World Bank said. "Trade finance is dependent on both domestic and cross-border funding. … both fell substantially in 2008."7
During the global financial crisis, "while exporters everywhere were confronted with higher trade finance costs, the decline in trade finance availability occurred primarily in the emerging markets," according to a second Fed report. In the early days, more than 70 percent of banks surveyed said that prices for letters of credit had risen from the previous year, while over 90 percent reported higher rates for short- and medium-term lending facilities in which exports served as collateral. And, when export financing in South Asia, South Korea, and China decreased sharply, for instance, that disrupted the supply chains of U.S. companies importing from these countries.8
"Efforts [were] deployed in 2008 and 2009 by various players – governments, multilateral financial institutions, regional development banks, export credit agencies – to mobilize sufficient flows of trade finance to offset some of the ‘pullback' by commercial institutions in the period of acute crisis," the WTO reported. As the market situation deteriorated, G20 leaders in April 2009 decided to inject additional liquidity and make public guarantees available to support $250 billion of trade transactions in the coming months. But it was not enough to bridge the gap between supply and demand of trade finance worldwide.9
Meanwhile, tensions were also increasing between big importers and small exporters – the buyers and suppliers in global supply chains. For example, one major multinational began requesting up to 120 days to pay suppliers, and smaller farmers and manufacturers were in no position to refuse, according to an account by Flowcast, a data analytics company specializing in trade finance. "The practice soon caught on almost everywhere, giving big companies breathing room in the aftermath of the 2008 financial crisis. But it led to cash flow problems for the small, captive suppliers with little financial cushion, and the tactic still affects them today."10
However, some multinationals saw extended payments as "a zero-sum game or worse," and instead began arranging supply chain financing programs to help suppliers. When goods are shipped on open account, which requires payment only a month or more after delivery, these programs give suppliers easier, cheaper access to bank-facilitated financing to buffer their cash flow, according to The Power of Resilience, a 2015 book by Yossi Sheffi, professor of engineering systems at the Massachusetts Institute of Technology.11 In fact, the current growth of this type of supply chain financing is considered an outcome of the global financial crisis.
"The product mix within the global market of trade finance is shifting," according to another ICC report. Traditional trade finance products are declining as supply chain finance and lower-cost open account transactions see increased market share.12
The rise of cloud-based supply chain finance platforms has made this option available to a far wider range of companies.13 "Yet, these alternative techniques require costly or complicated risk management by SMEs," such as trade credit insurance, the WTO has warned.14 And supply chain finance is still the subject of considerable marketplace confusion.
"Trade finance has never stood still – but in the last decade its most fundamental rules have changed," according to one financial services provider. "Cultural, geographic, and communication barriers are dissolving, facilitating a significant increase in international trade. In this hyper-connected world, even the smallest companies can use technology to sell their products overseas. And shipments that once took weeks or months now happen in a matter of days."15
From a technological perspective, digital innovations such as big data analytics and blockchain are also transforming the trade finance industry, the ICC said, bringing in a new generation of financial services providers, business models, and paperless efficiencies.16
The global financial crisis undermined trade finance, which is still seen to be on the road to recovery. Post-crisis growth has skewed toward open account trade and supply chain finance, as international trade has picked up steam.
Karen Lynch is a journalist who has covered global business, technology and policy in New York, Paris and Washington, DC, for more than 30 years. Karen also is a principal at Content Marketing Partners.
1. “Credit Markets Frozen as Banks Hoard Cash,” The Telegraph; https://www.telegraph.co.uk/finance/financialcrisis/3109892/Credit-market-frozen-as-banks-refuse-to-lend.html
2. Global Trade – Securing Future Growth, International Chamber of Commerce; https://iccwbo.org/media-wall/news-speeches/new-icc-survey-shows-pace-trade-finance-digitalisation/
4. “How Did Foreign Bank Lending Change during the Recent Financial Crisis?” University of South Carolina; https://www.sc.edu/study/colleges_schools/moore/documents/finance/berger/berger-makaew-turk-ariss-foreign-bank-lending.pdf
5. $1.5 Trillion Trade Finance Gap Persists Despite Fintech Breakthroughs,” Asian Development Bank; https://www.adb.org/news/15-trillion-trade-finance-gap-persists-despite-fintech-breakthroughs
6. “The Role of Financing in International Trade during Good Times and Bad,” Federal Reserve Bank of St. Louis; https://www.stlouisfed.org/publications/regional-economist/january-2012/the-role-of-financing-in-international-trade-during-good-times-and-bad
7. “Global Perspectives in the Decline of Trade Finance,” World Bank; http://siteresources.worldbank.org/INTRANETTRADE/Resources/TradeFinancech06.pdf
8. “The Financial Crisis, Trade Finance, and the Collapse of World Trade,” Federal Reserve Bank of Dallas; https://www.dallasfed.org/~/media/documents/institute/annual/2009/annual09b.pdf
9. “Restoring Trade Finance During a Period of Financial Crisis: Stock-taking of Recent Initiatives,” World Trade Organization; https://www.wto.org/english/res_e/reser_e/ersd200916_e.htm
10. “5 Reasons Why Obama’s SupplierPay Isn’t Working,” Trade Financing Matters; http://spendmatters.com/tfmatters/5-reaasons-why-obamas-supplierpay-isnt-working/
11. The Power of Resilience, MIT Press; http://www.supplychainquarterly.com/topics/finance/20151223-the-financial-crisis-and-the-money-supply-chain/
12. 2017 ICC Trade Register Report, International Chamber of Commerce; https://cdn.iccwbo.org/content/uploads/sites/3/2018/02/icc-trade-register-report-2017.pdf
13. “How Supply Chain Finance is Offering Companies a New Cash Source,” Forbes; https://www.forbes.com/sites/forbesbusinessdevelopmentcouncil/2018/04/09/how-supply-chain-finance-is-offering-companies-a-new-cash-source/#25106dcb22f1
14. Trade Finance and SMEs,” World Trade Organization; https://www.wto.org/english/res_e/booksp_e/tradefinsme_e.pdf
15. “Trade Finance is Going Open Account,” Nordea; https://insights.nordea.com/trade-finance-going-open-account
16. Global Trade – Securing Future Growth, International Chamber of Commerce; https://iccwbo.org/media-wall/news-speeches/new-icc-survey-shows-pace-trade-finance-digitalisation/