Report: Review of Trade Finance
RE-FRAMING THE TRADE FINANCE GAP
The global trade finance gap, short-term working capital to fund SME trade, has ballooned from $1.5 trillion to $3-5 trillion during the pandemic, with a £2 billion gap in the UK alone. This issue has been treated for too long as a niche banking and finance problem and as a result not been given the airtime it deserves because those most impacted are trading SMEs.
The issue needs to be re-framed, placing SMEs at the centre of the discussion and looking at the issue through the lens of ensuring economic recovery is got right. If trade is to be at the heart of the recovery, then the working capital has to be available to SMEs to enable them to trade.
50% of trade finance applications are from SMEs, yet over half are rejected despite trade finance having low default rates. If trading SMEs are adversely impacted from market failures in the trade finance sector, and are unable to access working capital, they cannot fund exports overseas. Lack of capital is not the sole issue with less than 8% of SMEs served by traditional forms of trade finance.
*A real opportunity exists to bring many more SMEs into the trading system and to lower the cost of finance if solutions can be found. This should be viewed as an imperative as In the context of month on month exports falling since Q4 2019.
The Cole Commission identified that cumbersome, duplicative, and mostly manual bureaucracy now costs £60,000 for a bank to onboard a SME. This is an inordinately high barrier to overcome for both banks and SMEs. Treating low risk trade finance in the same manner as other forms of higher risk finance is equally ill-advised. This is reinforced by the International Chamber of Commerce having proved through their ICC Trade Register that trade finance is a low-risk activity.
A solution to the first problem is to find more efficient ways to handle the bureaucracy now advanced technology is available that did not exist 20 years ago. The solution to the second is to adjust the risk weighting requirements to reflect actual risk so that there is a more proportionate, evidence-led regulatory regime. Both solutions require action from government and regulators.
The issues stem from two policies dating back to 9/11 and the financial crisis, both of which were designed to stop financial crime and stabilise capital markets, are at the heart of the problem. Neither policy was designed to generate growth and jobs. 20 years on and in a different context, it should not be a surprise that there is a calling for change. Initiatives that accelerate digitisation are part of the solution and will help in time solve some of the £2 billion UK trade finance gap but not enough if taken alone as a policy solution. Technology innovation in the non-bank trade finance, fintech market and skills can be added to the mix, but again they do not form a solution within themselves either.
It is time to address the market failure in the mainstream trade finance sector head on and that means addressing regulatory barriers. We must de-couple the notion that the SME trade finance gap is the price we pay for establishing capital market stability and tackling financial crime. The evidence can demonstrate that trade can be increased without compromising stability or efforts to fight crime.
A more transparent and inclusive debate in the broader setting of trade facilitation is required rather than leaving this in the hands of global financial regulators. They have not addressed the problem partly because of the limited perspectives being applied. More voices are needed at the table and specifically by those representing those who are not able to access finance as a result of policies in which they have little say.
The conversation needs to be reframed, bringing industry to the table to agree solutions that enable the growth of SME trade, and with it more jobs and prosperity across the regions of the UK and overseas.
Lord Waverley, Co-Chair, APPG on Trade and Export Promotion
1. Re-framing the problem - industry should re-frame the challenge of the trade finance gap in the context of the post Covid, economic recovery, enabling more SMEs to trade, generate jobs and improve livelihoods across the towns and cities of the UK, and importantly in the high growth markets with which we need to trade.
2. Government-Industry Working Group – A joint government/industry working group should investigate the issues raised in more detail. It should comprise HM Treasury, DIT and the International Chamber of Commerce should form.
This should include a review of SME capital weighting requirements on banks as well as smart solutions to remove excessive manual activity and unnecessary duplication and cumbersome bureaucracy to help bring down the cost of onboarding. The working group should look for best practice outside of trade finance to see what lessons can be drawn between what is an acceptable versus making life easier for SMEs to trade, for instance in the use of credit cards and tackling consumer fraud.
Building on these recommendations, a formal response to the APPG including practical solutions would be helpful.
3. Cross departmental working group - DIT should be more actively engaged on trade finance across the board, beyond solely export finance and help to foster dialogue across departments, most particularly with Treasury. We recommend DIT build on successful approaches elsewhere and set up a joint Treasury / DIT working group as they have done for the trade and development agenda.
4. Skills – DIT should review the curriculum for its plans for a nationwide trade academy and ensure that trade finance and trade enabled financial crime are incorporated into the programme. This should cover key topics such as sanctioned markets and tackling illicit forms of finance.