Global trade is recognised as a valuable driver of economic growth. Yet, the global trade finance gap, which was last estimated at US$1.5 trillion by the Asian Development Bank (ADB), is presenting a considerable barrier to trade.
Indeed, the availability of trade finance is paramount for a robust, well-functioning trading system, with approximately 80 to 90 percent of world trade relying on trade finance.If businesses are recurringly unable to access funds to support trade activity, this could potentially result in some being cut off from the trading ecosystem—particularly those in certain small countries with limited financial markets—and impact the health of global trade and the world economy.
Worryingly, BNY Mellon’s new global paper, Overcoming the Trade Finance Gap: Root Causes and Remedies, reveals that trade finance rejection rates increased in a third of institutions surveyed.This highlights that the challenges many businesses are facing when it comes to accessing trade finance not only persist but could be getting worse. The gap, therefore, continues to be a grave concern for the finance industry and is an issue that must be addressed with determination and urgency to ensure that trade can flow effectively and efficiently, and realise its full potential.
An industry response
The very real need to implement solutions to help alleviate the gap is clear but, with the chasm so vast—and potentially growing – how can the industry best approach this significant challenge?
A key purpose of BNY Mellon’s survey was to examine not only the causes of the gap but importantly, to move the conversation towards resolution; establishing an understanding of what industry participants—those at the heart of trade finance—believe could most effectively narrow it.
With heightened regulatory requirements and the associated increase in compliance costs already recognised as a primary—albeit, inadvertent—contributor to the trade finance gap (as supported in this survey), it is unsurprising that the solutions identified link directly with addressing regulatory challenges. According to the survey, there are two approaches in particular that the industry should adopt to help bridge the gap: technological innovation and regulatory revision.
The power of technology
Various technologies are already increasingly being applied across the industry, and the possible benefits for trade finance are extensive. These include improving the ease of doing business; helping to enable the adoption of common documentation standards; cost savings; and enhanced efficiency, transparency and security throughout the trade supply chain. This could ultimately help to facilitate operational efficiency, standardisation in terms of the client experience, optimised processes and more frictionless trade—as well as helping to boost trade finance activity and, in turn, economic growth.
Certainly, digital innovation could be a true game-changer in the world of trade, and the industry recognises the value it could bring in addressing compliance challenges linked to the trade finance gap. Current know your customer (KYC) processes involved in verifying the identities of counterparties are often extremely time and resource consuming. Applying technology to help automate these processes could, therefore, have significant implications for trade finance practitioners—and, in turn, help to narrow the gap.
Specifically, according to the survey,sharing data through centralised KYC databases is believed to hold the most value when it comes to digital solutions. Such platforms—accessible by trusted user groups—would remove the need for multiple banks to undertake due diligence processes on the same companies, resulting in increased efficiency, transparency, reduced costs and a far more streamlined, standardised approach to KYC, whilst maintaining data integrity and client security.
Efforts to establish such pools of data are already progressing, with Legal Entity Identifiers (LEIs), for example, being one such initiative. An LEI is a unique code that stores information, such as ownership structure, on registered companies worldwide, enabling banks to access the details needed to automate both KYC and know your customer’s customer (KYCC) checks. Estimates suggest that, were LEIs to achieve critical mass, they could possibly save banks using LEIs in the issuance of letters of credit (LCs) up to US$500 million per annum collectively—savings that could represent 4 percent of existing global trade operations costs. Yet, crucially, for the true extent of the benefits of global directories to be realised, widespread adoption is required.
The BNY Mellon survey indicates that there is an industry consensus regarding the value of KYC data pools (71 percent identified centralised KYC databases, or LEIs specifically, as the most effective technology solution for addressing compliance related issues). With faith in such systems seemingly established, a clear, focused approach to developing their potential could help to ensure such capabilities can be successfully implemented and fully utilised to support global trade.
Engaging with regulators
Alongside technology solutions, revising the regulatory environment was ranked equally as the best way to close the gap. The importance of effective regulation in maintaining a robust, secure global financial ecosystem cannot be overstated, however, and any alterations being sought to the regulatory landscape would need to meet the needs of all parties.
Greater collaboration between banks and regulators was viewed as being particularly effective in helping to drive developments in regulation. By actively engaging with regulators, banks can act as advocates for the industry, including communicating the needs of their clients and the wider market. Certainly, banks have an instrumental role to play in bridging the gap, and the survey highlights not only the value of banks in promoting change but the will of banks to have greater engagement and influence in shaping the development of the regulatory landscape.
Although more coordinated, data-based industry advocacy has already led to regulatory authorities gaining a more comprehensive understanding of trade finance characteristics, more enriched communication between regulators and banks is required to achieve alignment and harmonisation, and for effective regulatory developments to occur.
A time to act
The two solutions identified as holding the most promise for closing the gap are very different, and each presents its own challenges. But a clear theme across both approaches—and throughout the survey—is that of collaboration and cooperation; an industry response to the trade finance gap is needed to ensure it can be addressed as practically and efficiently as possible. Without buy-in from the global market, the full benefits of centralised KYC databases cannot be felt. Equally, without effective communication and understanding between the wider industry and regulators, the challenging compliance landscape will persist.
Banks undoubtedly have a key role to play in the trade formula, and they can use their expertise, established industry positions and extensive client bases to act as advocates for trade, thereby helping to gain traction in terms of achieving the network effect for centralised KYC databases, and driving greater regulatory understanding of the market and its needs—in turn, building greater regulator-bank alignment.
The value of the expertise and the voice of banks was highlighted elsewhere in the BNY Mellon survey, with respondents also stating that the most important roles for correspondent banks specifically in addressing the trade finance gap are lobbying government trade bodies on the value of promoting trade finance, and providing support and guidance to local banks to help facilitate business growth. What’s more, the importance of collaboration in trade finance and narrowing the gap was further reinforced in the survey: risk-sharing partnerships with global banks was ranked overall the most effective way of encouraging additional financing capability. This shows that local-global bank partnerships are still regarded as vital in delivering trade finance solutions and facilitating trade growth.
Many businesses continue to face huge hurdles when it comes to accessing funding support. It is, therefore, paramount that banks are positioned to fulfil their role as facilitators of global trade—and the urgency to find solutions to the gap has been compounded by the new evidence of rejection rate growth in a substantial number of institutions.
With the industry supporting both technology and regulatory strategies, it is important that we establish a collective course of action to enable the delivery of an optimised, efficient response to the trade finance gap. And, with collaboration and the voice of banks also identified as key approaches, it is through dialogue and cooperation that this could most effectively be achieved. Addressing the trade finance gap is undoubtedly a challenge, but if it persists, it could have severe implications for trade and the global economy. The time to act is now.
Author: Joon Kim, Global Head of Trade Finance Product and Portfolio Management, Treasury Services, BNY Mellon
Published by International Banker.com