TFG heard from Iain MacLennan, VP Trade & Supply Chain Finance, Finastra on how blockchain and DLT can close in the trade finance gap experienced by SMEs.
The trade finance gap facing SMEs is an estimated $1.5 trillion, according to the Asian Development Bank, with the majority of these SMEs being in the developing world. This was prior to the uncertainty caused by the Covid pandemic. The World Economic Forum estimates this gap could reach $2.5 trillion by 2025, preventing trade and growth. Since the 2008–09 global financial crisis, international banks have been reducing the banking relationships used to clear cross-border payments and guarantees.
From over a million such relationships before the crisis, 200,000 have disappeared, affecting trade finance flows to Africa, the Caribbean, Central and Eastern Europe and the Pacific Islands. The trade finance gap particularly affects microbusinesses: the MSME finance gap in developing countries is estimated to be approximately $5 trillion – 1.3 times the current level of MSME lending. Significantly impacted are female entrepreneurs, according to research from the Asian Development Bank, women-owned firms fared the worst when accessing trade finance, with 44% of requests for financial backing to support their exporting or importing needs rejected. Once rejected, these firms are less likely to seek alternative finance. This is troubling when you consider that women lead 6.6 million SMEs and 39 million micro-businesses in emerging markets. Quite simply, the trade finance gap debilitates those communities we most need to flourish.
Post the 2008 banking crisis, procedures were put in place to make trading and transacting safer, with more robust customer authentication for example. Ironically this has led to financial institutions being far more restrictive with how they do business. A major operational complexity for financial institutions is regulation: more than three-quarters (76%) of the Asia Development Bank’s surveyed banks reported that anti-money laundering (AML) and know-your-customer (KYC) regulations are major obstacles to expanding their trade financing operations.
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These regulations put in place for the best of reasons, have inadvertently made it harder for SMEs, particularly in emerging markets to access funds. This can be because many SMEs lack the organisational roles that are required to address these regulations to the satisfaction of potential financing bodies. In addition, financial institutions may find that protracted regulations do not justify the time invested into managing relatively small transactions delivered by SMEs in the developing world. Particularly as we are now entering a global recession.
A Finastra survey of over 700 financial institutions and banks around the world underscores the problem of regulatory barriers to growth. Almost half of respondents believe regulations are holding back innovation. Accordingly, there is now an urgent call for harmonisation: 83% of financial institutions and banks agree that regulations regarding fintech innovation should be harmonised across different geographies to promote growth.
Can technology help the industry respond to the trade finance gap? Over 40% of the UK respondents to the survey thought paperwork, and not enough automation, hampered trade finance and 54% of our survey respondents in the UK thought a better use of technology would improve trade finance with over 30% thinking cloud-based solutions would aid collaboration. Looking further ahead, machine-learning and AI are effective for operational processing, data analysis, document checking and anti-fraud. Blockchain and distributed ledger technology can address immutability, verifying data across a disparate supply chain, but are yet to operate at scale. What they need to address is adoption and interoperability, this is where the concept of networks of networks could help drive scale. To scale blockchain networks must be interoperable, across the flows (Physical, Documentary and Financial) associated with global trade.
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Technology innovation, irrespective of sector is associated with speed and efficiency, the removal of friction from processes and interactions. This is where fintechs can be effective, enabling faster and frictionless improvements across processes, for instance by allowing access to working capital finance for your business in a seamless manner. Fintechs are unhampered by legacy technology and protracted governance processes and hierarchies. This allows them to move quicker than other organisations, such as financial institutions that could for instance, have a significant legacy infrastructure.
Fintechs can also specifically target those processes that are manually intensive such as trade services or commercial lending, with their high reliance on physical documentation. In addition to addressing in-house manual processing, they can build solutions that would allow banks to take assets off their balance sheet to facilitate further trade, via distribution and syndication. Another advantage, is that “local” fintechs, can understand their market and be more sensitive to the needs of local end-users. Whereas other multi-country organisations could adopt a one size fits all approach.
Some financial institutions are responsive, and can meet the needs of their market, but there is a growing concern with regards to the potential for the current trade finance gap to widen. Fintechs can play a key role in helping the market address systemic inefficiencies to enable the funding of key businesses. Speed of response is critical when we look to support the most vulnerable in society, and never forget SMEs are often the strongest drivers of employment and innovation within their societies.
Access to finance is a significant barrier to growth for SMEs, themselves critical companies for their communities across the world. It has never been more important to ensure we support global trade and all parties involved in it. The challenge was significant prior to the current pandemic, but to quote Alan Turing:
‘Those who can imagine anything, can create the impossible’.
In the current situation, we must innovate to ensure the future of finance is open and available to all.
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Now launched! Summer Edition 2020
Trade Finance Global’s latest edition of Trade Finance Talks is now out!
This summer 2020 edition, entitled ‘Coronavirus & The Fourth Industrial Revolution’, is available for free online, covering the latest in trade, export credit insurance, receivables and supply chain, with special features on fintech and digitisation.