Trade finance industry in the Covid-19 era: Inclusive and green is the way to go

Optimism on the prospects for a rapid recovery in world trade received a boost as merchandise trade recorded a strong 15 percent increase in the first quarter of 2021. According to an estimate from the World Trade Organisation, the volume of world merchandise trade is expected to increase by 8 percent overall in 2021.

Trends for 2020 and 2021 clearly reveal massive downturns and fluctuations in response to the multiple waves of Covid-19 and the associated economic and logistic challenges. 

Therefore, recent trends in trade recovery have notable implications for trade financing activities by banks and financial institutions. However, certain key factors need to be addressed meticulously to achieve sustainable trade financing in this new business and economic environment.

Access to trade finance can enable Small and Mid-size Enterprises (SMEs) to take part in international activities through export and participation in global value chains. However, it is well-known that SMEs have several inherent challenges or barriers pertaining to their access to finance.

In the context of trade financing, SME exporters and importers are exposed to significant risks as most SMEs have limited capacities and resources to engage in a sound "due diligence" process. SMEs are also often constrained in working capital and prefer payment before shipment or purchase of raw materials to meet the expenses of production of goods or services.

Practically, SMEs need special treatment from policymakers and financial institutions to address fund constraints and ensure adequate access to trade finance. 

The SME trade finance gap widened in the face of the Covid-19 challenges. Before the coronavirus pandemic, the trade finance gap facing SMEs was estimated at $1.5 trillion; and this gap might reach $2.5 trillion by 2025, according to an estimate of the World Economic Forum. 

The SME trade finance gap in the developing countries drastically widened, where women-owned firms fared the worst.

In the context of Bangladesh, import volume was substantially low during the first lockdown (April to May 2020). After that, import volume rebounded slowly from June 2020. The country has observed substantial growth in import volume since the beginning of 2021. 

However, the lion's share of imports was made by the big corporations of the country. SME participation was relatively low.

The export volume shows positive growth as exporters were timely supported by the stimulus packages. Geopolitics between China and the US also played a supportive role in favour of our exporters. But it is the big exporters that appear to be the primary beneficiaries. Small traders were already struggling, and Covid-19 created a further trade service gap for them.

Greening Strategy

The Greening Strategy in trade finance has received renewed focus in the context of the Covid-19 crisis. As a result, banks are required to support sustainable trade and integrate sustainability into their trade finance policies that broadly include environmental, social and governance issues. Several European banks are leading this area, with three-quarters of them having a sustainability strategy.

The most recent International Chamber of Commerce (ICC) survey on trade finance finds that green and sustainability strategies were primarily adopted due to credit and reputational risk (38 percent ), client expectations (35 percent ) and regulatory requirements (24 percent ).

The ICC survey also reported on sustainability priorities and interventions of different forms taken up by a considerable number of global banking institutions. 63 percent  of surveyed institutions focused on  climate change feature in their finance products, 58 percent  on environment, waste management and pollution, 45 percent  on supporting sustainable supply chains, 39 percent  on financial inclusion ventures, 36 percent  on social issues, 31 percent  on raising awareness on trade finance sustainability, and 14 percent  on related sustainability reporting. 

In line with the broad policy framework, trade financing activities must integrate environmental risks in their operations. Therefore, it is not only about loan instruments to finance green projects but also about sustainability-linked trade finance products: international bank guaranteed, letter of credit, and supply chain products.

In the context of Bangladesh, Green Transformation Fund is a relevant initiative taken by Bangladesh Bank in 2016. In April 2020, Bangladesh Bank expanded the facility by adding 200 million EURO to the fund. This long-term financing is admired by all manufacturing and industrial enterprises for importing environment-friendly and energy-efficient/green capital machinery and accessories (including Buyer's Credit).

Digitisation efforts

When accomplished, the benefits of digitisation efforts will be numerous. Digitisation and technology adoption is expected to bring incredible changes in the trade financing approaches of banks with remarkable implications for their sustainability approaches.

According to a recent survey on major banks, there are common expectations of over 10 percent  in cost savings from digitisation in the next five years. The survey also observed that digitisation could enhance the quality of customer services and ensure superior risk mitigation benefits that could improve the future of trade finance. This means that banks that can implement digital solutions would control higher market share and have competitive advantage.

It is also estimated that the global trade finance gap could be reduced by $1 trillion, if Digital Ledger Technology is used efficiently in the near future. Furthermore, digitalisation can increase SMEs' access to trade finance by improving process efficiency and quality of trade finance. 

Moreover, digitalisation efforts might be a significant force to solve Know-your customer (KYC) related difficulty and associated costs. Replacing the current paper-based model with an automated, quick and secured process can substantially reduce costs. 

Innovative solutions based on distributed ledger technologies can play an important role in this transition. As in several other global economies, banks in Bangladesh are experimenting with blockchain in facilitating trade services.  

In August 2020, Standard Chartered Bank issued a letter of credit (LC) for a ready-made garment exporter over a blockchain network. In November 2020, HSBC Bangladesh executed the first-ever cross-border blockchain LC transaction in Bangladesh - a development that would reduce LC processing time from the standard 5-10 days to under 24 hours. In addition, Prime Bank becomes the first Bangladeshi Bank to execute inter-bank blockchain LC transaction partners with HSBC Bangladesh.

Addressing the trade finance gap and handling environmental and sustainability concerns should be the upcoming agendas for the trade finance providing banks. To attain that, adopting relevant policy and operational strategies is the need of time. Embracing appropriate technology might be the most crucial vehicle for ensuring inclusivity and addressing sustainability concerns of the trade finance industry.

 The author is a Professor of the Bangladesh Institute of Bank Management (BIBM)