Digitalization and Technology to Help Fill the US$1.7 Trillion Global Trade Finance Gap

Digitalization and Technology to Help Fill the US$1.7 Trillion Global Trade Finance Gap

by October 31, 2022

Micro, small and medium-sized enterprises (MSMEs) have historically faced severe financing difficulties, especially when trying to expand internationally. However, technological advances and innovative fintech solutions have emerged over the past years to help reduce this financing gap and provide MSMEs with greater 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 so by introducing a third party to the transaction, like a bank or a financial institution, to remove the payment risk and the supply risk.

During a trade, an exporter would ideally prefer the importer to pay upfront for an export shipment to avoid the risk that the importer takes the shipment but refuses to pay for the goods. However, if the importer pays the exporter upfront, the exporter may accept the payment but refuse to ship the goods.

Trade finance aims to address this issue by providing solutions like 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 made by the importer’s bank to the exporter’s bank that payment will be made once the exporter presents documents that prove the shipment occurred, like a bill of lading.

Supply chain finance, on the other hand, refers to a form of financial transaction where a third party facilitates a trade by financing the supplier on the customer’s behalf. Practically speaking, this means that the supplier accesses immediate payment for their goods, while the buyer receives an extension of the payment period and get more time to pay off their balances to their bank.

These instruments are used by many large corporations to address trade-related challenges, including counterparty- and liquidity-related issues, mitigate the risks associated with the trade counterpart’s default or unwillingness to pay, as well as to manage liquidity and working capital.

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

Trade finance rejections

MSMEs’ difficulties to access trade finance can be explained by a combination of factors including their opacity. A 2019 survey on trade finance by the Bank of New York (BNY) Mellon revealed that the lack of creditworthiness and lack of ability to provide financial statements were among the most important reasons to reject requests from business seeking trade finance. In addition, most MSMEs are often unable to provide collateral, which raises rejection rates.

At the same time, rapid digitalization in the finance and banking sector has introduced new modalities and opportunities to finance MSMEs, offering the potential to alter existing trade finance patterns and help fill the trade finance gap which the World Economic Forum estimates to be currently standing at US$1.7 trillion.

Digitalization and technology to fill the trade finance gap

Distributed ledger technology (DLT) and blockchain, for example, are technologies that are being explored to digitize traditional documentary credit, enable greater transparency and increase efficiencies. Applied to trade finance, DLT has been said to enable trust in digital documents by certifying their provenience and correctness, trust in digital trade and trade finance transactions, and digital identification of trade stakeholders, among other key benefits.

Several DLT solutions and platforms focusing on trade finance are currently in the market. The Komgo platform, for example, brings together commodity trading partners, including banks, trading companies and oil and gas corporates. 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, carriers, traders and other trade-related entities, and allows importers and exporters to exchange bills of lading easily, securely and transparently.

Beyond operational benefits, digitalization is also proving to help reduce asymmetric information issues. German company Compeon, for example, is a financing portal for SMEs that connects data and financing request from SMEs with large companies, banks, equity investors, guarantors, innovation support agencies, and public and private databases. Compeon works with more than 220 banks, leasing companies and special providers.

In Hong Kong, the DLT-based eTradeConnect platform was launched in 2018 to improve trade efficiency, build better trust among trade participants, reduce risks and facilitate trade counterparties to obtain financing. The platform allows buyers and sellers to create, exchange and confirm purchase orders and invoices in real-time, share information and submit applications for financing on one single interface. Participants of eTradeConnect benefit from enhanced transparency and potential access to multiple banks for trade loans.

Finally, new fintech companies and tech firms are entering the field with innovative solutions to trade and supply chain finance. For example, Amazon Lending is providing eligible sellers with financing solutions to purchase additional inventory. In the UK, Ebay is cooperating 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 microfinancing for food kiosk owners. The lending platform, which is powered by blockchain technology, calculates the creditworthiness of a borrower using machine learning (ML) and by processing mobile data as well as looking at historic transaction payment behavior.

 

Featured image credit: Edited from freepik here and here