Digitization and technology are helping to close the $1.7 trillion global trade finance gap

Micro, small and medium-sized enterprises (MSMEs) have historically faced serious funding difficulties, particularly when trying to expand internationally. However, in recent years technological advances and innovative fintech solutions have emerged to bridge this financing gap and give MSMEs better access to trade finance.

Trade finance refers to financial solutions used to facilitate domestic and international trade and payments between exporters and importers. Trade finance does this by involving a third party in the transaction, such as a bank or financial institution, to remove payment risk and delivery risk.

During a trade, an exporter would ideally prefer that the importer prepay for an export shipment to avoid the risk of the importer accepting the shipment but refusing to pay for the goods. However, if the importer pays the exporter in advance, the exporter can accept the payment but refuse to ship the goods.

Reuters

Trade Finance aims to address this issue by offering solutions such as Letters of Credit (LOC), Guarantees, Insurance and Supply Chain Finance. A LOC, a well-known and widely used trade finance instrument, is essentially a promise from the importer’s bank to the exporter’s bank that payment will be made once the exporter provides documentation proving the shipment has taken place, such as a bill of lading.

Supply chain finance, on the other hand, refers to a form of financial transaction in which a third party facilitates a trade by funding the supplier on behalf of the customer. In practical terms, this means that the supplier can pay for his goods immediately, while the buyer gets an extension of the payment term and more time to pay off his balances with his bank.

These tools are used by many large companies to address trading-related challenges, including counterparty and liquidity-related issues, to mitigate risks associated with trading partner default or default, and to manage liquidity and working capital.

In contrast, despite their strong presence and important economic contribution, MSMEs face difficulties in accessing trade finance in many countries. According to a 2021 Asian Development Bank (ADB) survey, MSMEs accounted for just 37% of global trade finance demand in terms of number of contracts and experienced a 45% rejection rate (compared to just 17% for multinationals).

Trade finance denials

MSMEs’ difficulties in accessing trade finance can be explained by a combination of factors, including their lack of transparency. A 2019 survey of trade finance by the Bank of New York (BNY) Mellon found that poor creditworthiness and the inability to produce financial statements were among the top reasons for denial of applications from companies seeking trade finance. In addition, most MSMEs are often unable to provide collateral, which increases rejection rates.

At the same time, rapid digitization in the financial and banking sectors has introduced new modalities and ways of financing MSMEs that offer the potential to transform existing trade finance patterns and help close the trade finance gap, which the World Economic Forum estimates currently stands at US$1.7 trillion -Dollar.

Digitization and technology to bridge the trade finance gap

For example, distributed ledger technology (DLT) and blockchain are technologies being explored to digitize traditional documentary credits, enable greater transparency and increase efficiency. Applied to trade finance, DLT aims to enable trust in digital documents by certifying their origin and correctness, trust in digital trade and trade finance transactions, and digital identification of trade actors, among other key benefits.

Several DLT solutions and platforms with a focus on trade finance are currently on the market. For example, the Komgo platform brings together commodity trading partners, including banks, trading companies and oil and gas companies. It uses the Ethereum blockchain to enable encrypted exchange of documents on a need-to-know basis.

Similarly, Wave BL offers a document exchange network to facilitate international trade. The platform connects banks, freight forwarders, traders and other trade-related entities and enables importers and exporters to exchange bills of lading easily, securely and transparently.

In addition to the operational benefits, digitization also helps to reduce asymmetric information problems. For example, the German company Compeon is a financing portal for SMEs that connects data and financing requests from SMEs with large companies, banks, financiers, guarantors, innovation support agencies and public and private databases. Compeon works with more than 220 banks, leasing companies and specialist providers.

In Hong Kong, the DLT-based eTradeConnect platform was launched in 2018 to improve trading efficiency, build more trust between trading participants, reduce risk and facilitate access to financing for trading partners. The platform allows buyers and sellers to create, exchange and confirm orders and invoices in real time, share information and submit financing requests through a single interface. eTradeConnect participants will benefit from increased transparency and potential access to multiple banks for trade credit.

Finally, new fintech and technology firms are entering the field with innovative trade and supply chain finance solutions. For example, Amazon Lending offers eligible sellers financing solutions to purchase additional inventory. In the UK, Ebay is partnering with Santander-backed fintech startup Asto to disburse loans to SMEs. And in Kenya, business-to-business (B2B) supply platform Twiga Foods is working with IBM to provide microfinance to grocery kiosk owners. The lending platform, based on blockchain technology, calculates a borrower’s creditworthiness using machine learning (ML) and mobile data processing, as well as looking at historical transaction payment behavior.

Selected image credit: Edited by Freepik here and here

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