Despite the pervasive digitisation reshaping the landscapes of commerce and finance—trade finance has been relatively slow to join the race and modernise its decades-old processes.
In 2022, the global trade finance gap grew to a record $2.5tn from $1.7 trillion in 2020, and $1.5 trillion in 2018, according to the Asian Development Bank (ADB).
While factors like inflation and geopolitical turbulence contribute to the widening gap, the rising cost of capital takes centre stage as the predominant driving factor, expanding the trade financing gap.
Following a robust post-pandemic recovery, the demand for trade finance has surged. However, heightened economic risks have simultaneously increased the difficulty of securing trade finance, leading to a 3 per cent decline in global trade exports' value year-to-date in April 2023.
Over the past decade, the challenges confronting Micro, Small, and Medium Enterprises (MSMEs) in the global trade arena have become more pronounced. While the current environment poses challenges, it also opens avenues for banks and fintechs to offer innovative trade financing solutions to address SMEs' underfinancing pain points.
Trade finance roadblocks for MSMEs
Currently, financial instruments like letters of credit, trade loans, bills of lading, and guarantees form the backbone of global trade finance, providing support to approximately 80-90 per cent of worldwide trade. A majority of the trade finance deficit can be attributed to the culmination of recent events, marked by a deteriorating economic outlook and an increase in interest rates.
These developments have adversely affected banks, diminishing their capacity to sufficiently extend trade financing to MSMEs. With the surge in interest rates, the increased affordability of repayments becomes a source of concern, amplifying credit risks for financial institutions.
With MSMEs holding a prominent position in global economies, facilitating increased involvement of MSMEs in global value chains has become imperative for unlocking new pathways to productivity and nurturing inclusive growth.
However, these businesses commonly confront barriers to obtaining trade finance loans, attributable to their limited resources and collateral. Furthermore, many MSMEs lack the necessary expertise to navigate the fragmented trade finance system.
The ADB's survey revealed that 20 per cent of banks faced trade finance application rejections due to reasons such as insufficient collateral, inadequately presented documentation, and issues related to KYC compliance. Among the hurdles faced by SMEs, lack of collateral is a significant barrier, coupled with challenges like limited transaction history, absence of long-term relationships with bankers, and unfavourable market conditions.
Given that MSMEs often serve as robust catalysts for employment and innovation, their timely financial support is paramount. Banks and FinTechs, by rectifying systemic inefficiencies, play a crucial role in enabling access to financing for key businesses and establishing a responsive support framework for MSMEs.
Closing the trade financing gap
Presently, a significant 30 per cent of banks’ trade operations capacity is currently being taken up by manual reviews for compliance. Detailed monitoring is essential to assess the creditworthiness of MSMEs.
As a result, the focus must be to replace manual processes with automated and digital reporting capabilities. Digitising the credit risk process becomes crucial to enable greater transparency and give banks greater control over risk management,
By embracing technological advancements and fostering strategic collaborations with fintechs, banks today have the opportunity to navigate trade financing complexities effectively and offer MSMEs tailored solutions as seamlessly as new-age counterparts.
Here are some of the key ways in which banks and fintechs can join forces to enable faster and frictionless access to trade finance:
Embedded finance and operational efficiency enhancement:
The challenges in offering MSMEs innovative lending choices are overcome with the rise of embedded finance, allowing traditional banks to incorporate financing solutions at the point of need seamlessly.
Utilising artificial intelligence, data-driven decision-making, and purpose-built FinTech solutions enhances operational efficiency, leading to improved and faster trade financing solutions for MSMEs.
Data utilisation for informed decision-making:
Banks have a significant opportunity to offer personalised solutions to MSME clients by leveraging the extensive data generated from digital customer touchpoints.
Considering a broader range of MSME data across multiple channels leads to more precise insights into the borrower’s financial stability, increasing the chances for MSMEs with limited credit histories to obtain loans.
Leveraging alternative credit data for comprehensive underwriting:
Traditional financial institutions can enhance their underwriting systems by leveraging alternative credit data, including digital footprints and full-file public records.
AI and machine learning capabilities enable the deployment of 'robo-advisors' and advanced algorithms for a more accurate assessment of MSME credit risk.
The Way Forward
Reducing the trade financing gap for MSMEs calls for improvements within the trade ecosystem.
Banks and fintechs need to address the nuanced needs of MSMEs across their business lifecycle, from seed and start-up to growth and maturity, which requires a tailored suite of financial instruments, including both debt and equity. Comprehensive digital financing and invoice management solutions emerge as a pivotal avenue for expanding financial accessibility in the trade financing sector.
Taking personalised approaches in MSME lending is crucial for banks, ensuring quick alignment with the unique needs of these businesses. Collaborations within the financial services ecosystem are pivotal, serving as a cornerstone for increased awareness and promoting inclusive access to trade finance.
This dynamic interplay of collaborative synergy, customised financial solutions, and proactive digitisation will drive MSMEs toward a more resilient and accessible trade financing landscape.
- Nirav Choksi, founder and CEO of CredAble
