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Closing the trade finance gap is essential for global trade

The USD 1.5 trade finance gap, as calculated by the Asian Development Bank in 2019, is a much-cited figure that casts a long shadow over the global trading environment. It has become a go-to statistic when lamenting inaccessibility of trade finance and the disproportionate impact of a lack of funds on emerging markets businesses, in particular SMEs. However, what is this gap really, how can we better understand it and – most importantly – what solutions are available in order to close it?

What is the trade finance gap?

The trade finance gap is the difference between how much trade finance is requested by businesses around the world so they can sell their goods and provide their services, and the actual amount of funding that banks are willing or able to provide. In other words, it’s the difference between the supply of, and the demand for, trade finance. 

It is important to recognise that financial institutions are not generally reluctant to provide trade finance to businesses. Rather, banks do not have the capacity to absorb the growing trade finance demand and they are hampered by compliance constraints, the poor credit quality of the applicants, and regulatory demands. 

The World Economic Forum estimates that the trade finance gap may widen even more and that it could reach 2.5 trillion dollars by 2025. To put these numbers into perspective in terms of monetary value, USD1.5 trillion represents about half of the UK’s GDP for 2019 and more than the entire 2019 GDP of either Spain or Australia. These comparisons make it clear how significant the trade finance gap is, showcasing the huge rift between what businesses need and what banks can lend. 

Tech-led trade finance distribution

By any comparison USD1.5 trillion is a vast amount of money and the existence of this gap is a persistent inhibitor to growth and development. It is worth noting that a large part of the trade finance gap results from SMEs with low creditworthiness in remote regions of emerging markets. As such it will be difficult to fill the gap through additional lending or credit. One strategy adopted by banks that, however, shows promise in narrowing the gap is the distribution of trade finance instruments to other banks and the capital markets. 

Banks are increasingly recognising that by adopting an originate and distribute model for their trade books they can open up additional sources of funding. This benefits not only the banks but also their investors and the businesses and communities that depend on trade finance. By distributing trade finance, banks can increase their Net Interest Income (NII), boost Return on Equity (RoE), and generally do more with less. 

While the distribution of trade finance sounds attractive in principle, transactional friction costs can, however, substantially reduce this attractiveness. Efficient and scalable distribution to other banks, credit insurers, and capital market participants requires a factory-like approach and it needs automation and standardisation to reduce friction costs. 

The answer to all of these issues lies in purpose-built technology that significantly improves the way banks distribute trade finance instruments and that reduces barriers which result from high costs and time and labour intensive manual processes. Trade finance assets can be packaged into an investable format, allowing investors to invest across the entire trade finance universe. 

Trade finance distribution is no panacea and no quick fix to closing the trade finance gap. But when done right and on an automated, technology-driven basis, trade finance distribution presents a highly attractive strategy for banks to make their balance sheet work harder, create economic and social opportunities, and offer a highly attractive asset class to of investors.

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