Blockchain Forces A New Conversation About The Trade Finance Shortage

Trade finance is viewed as essential to businesses, especially smaller firms, that participate in the global economy and expand across borders. Yet there is a $1.5 trillion gap in available trade finance, a staggering figure released last year by the Asian Development Bank (ADB).

As with other forms of financing, alternative lenders have stepped into this space to fill that gap left by traditional banks – and yet, the gap remains, highlighting the limitations of alternative lending’s proliferation in recent years.

“While digitization may lead to more inclusion, its potential impact on the gap is not yet realized,” the ADB’s report concluded. “Even as digitization has opened up new ways to administer the financing of trade, the lack of interoperability limits the ability to scale solutions. Regulators, banks, customs, shipping, logistics and FinTech companies need to work together to inform new regulatory, legal and technical standards.”

Similar warnings about the trade finance shortage were sounded by the International Chamber of Commerce (ICC) when it released its Global Survey on Trade Finance last year. Researchers at the ICC calculated a 9 percent decline in the number of banks that reported an increase in trade finance activity compared to 2015, and 61 percent of financial institutions (FIs) agree there is a global shortage of trade finance.

To understand why the trade finance gap persists, PYMNTS spoke with Krishnan Ramadurai, the ICC Trade Register Project’s new chair and HSBC’s global head of capital management for trade and receivable finance.

“There are a number of reasons behind the shortage in financing, one of them being the impact of regulatory and compliance requirement since the financial crisis,” Ramadurai explained. “While such oversight, responsibilities and requirements have been deemed crucial to the health and maintenance of the financial system, this has inadvertently resulted in ‘derisking’ by banks, resulting in some capacity constraints.”

Part of that derisking process is a pull-back from correspondent banks as FIs instead focus on their home markets.

Separate analysis from the International Monetary Fund (IMF) released in 2017 highlighted that decline in correspondent banking. At the time, IMF CEO Philippe Le Houérou noted he was “concerned” about this trend’s impact on trade finance.

“In emerging markets, the business environment has often been challenging for banks and their customers, but a decline in correspondent banking disrupts the financial connections that countries and businesses need,” he said.

Alt-Fin’s Limited Impact

Alternative lending hasn’t yet been able to make a significant dent in small and medium-sized business (SMB) access to forms of trade finance, though there seems no shortage of players operating in this space to offer various loan products under the trade finance umbrella. One of the newer forms of trade finance is supply chain finance, which, according to Ramadurai, evolved from small businesses’ disproportionate need for financing.

“Arguably one of the more important issues inhibiting global trade and economic growth is a shortage of financing options for parts of the market that need it most: [SMBs], and particularly, suppliers to global supply chains located in emerging and developing economies,” he said. “Supply chain finance is helping this particular segment of the market by improving working capital performance and freeing up liquidity, leading to benefits for buyers, suppliers and banks alike.”

It’s also a sign of the evolution in how companies are financing their global expansions, Ramadurai said.

“We are aware that a global shift in the way trade is conducted is underway, and supply chain finance and receivable finance are at the core of this global shift,” he added.

Unfortunately, as the IMF report highlighted, the alternative finance landscape outside the U.S. and Europe is quite small and unable to meet the needs of SMBs in developing markets. While alternative lending may not have yet addressed the trade finance gap, Ramadurai explained they certainly play a role in expanding access to financing, especially for SMBs.

“[The rise in alternative lending] has not fundamentally impacted banks’ ability to fill the gap,” he said. “Rather, it has meant that banks can increasingly collaborate with these new players in order to innovate and increase trade finance provision. For instance, by partnering with FinTechs and fostering processes of digitalization — such as reducing costs and inefficiencies, improving transparency and reducing risk — this should free up bank capacity for lending. Still, implementing such strategies is a significant operational challenge in itself.”

FinTech Steps In

Alternative finance isn’t the only factor behind the shift in trade finance. As Ramaduri highlighted, technologies that address risk and transparency are increasingly important for both banks and alternative lending players.

On the horizon, too, is blockchain, with trade finance a common use case for innovators when developing new solutions with distributed ledger technology. Ramadurai said it is too early to rely on blockchain to make an impact on the trade finance gap, though.

“While distributed ledger technologies and blockchain technology have rapidly progressed in a reasonably short space of time, these technologies are still at the early stages of global market application,” he said. “In our view, trade finance presents a compelling case for the application of this technology to certain products.”

Ramadurai noted that the ICC’s Banking Commission has formed a task force to examine trade finance’s digital shift, a conversation that, today, cannot happen without including blockchain.

“With with numerous other initiatives aimed at evolving trade finance, there is risk in proceeding without a clear value proposition,” he continued. “The other important question is relating to the regulatory treatment of [disributed ledger technologies (DLT)]-based technologies. It is also worthwhile noting that the practicality of such technologies may also depend on global adoption, given the nature of the business.”

It’s not only up to FinTechs and alternative players to solve these challenges, however. Traditional banks and regulators undoubtedly hold the position of most able to make a sizable impact in the global market on the $1.5 trillion on which companies are missing out to trade globally and expand.

“As the banking environment continues to evolve and respond to the various changes and challenges around globalization, increased competition and heightened regulatory scrutiny, trade finance and export finance — like all other banking products and services — will also need to adapt and evolve,” said Ramadurai. “In this context, it is more critical than ever for banks and regulators to understand the risk profiles of their products and, as these risk profiles change and adapt to the environment, continued dialogue and advocacy between market participants including regulators and policymakers is important necessary.”