TRADE FINANCE GAP - ECONOMY
News: India urges G20 to find ways to shrink widening trade finance gap
What's in the news?
● The
first G20 Trade and Investment Working Group (TIWG) meeting under India’s
Presidency started in Mumbai with Sunil Barthwal, Secretary, Department of
Commerce emphasizing the need for trade finance cooperation among member
countries to help reduce the widening trade finance gap.
Status of Trade finance Gap:
As
estimated by ADB, the gap which was $1.5 trillion in 2018 has now increased to
$2 trillion,
What is Trade Finance?
● Trade
finance provides financing and risk
mitigation that helps produce and move goods to markets.
● This
is critical for the economic growth that creates jobs, delivers medical
technology and other goods, and improves peoples lives.
What is the Trade Finance Gap?
● The
trade finance gap is the unmet demand
for trade finance and is calculated based on rejected applications for
trade finance funding.
● From
the perspective of global banking, trade finance is a low-risk form of finance with very low default rates, which makes
the sizable gap difficult to understand.
● Trade
finance supports about 80% of global
trade through a variety of financial instruments including letters of
credit, trade loans, guarantees, and insurance.
Importance of Trade Finance:
1. To Realize SDG goals:
● As
stated by the United Nations and the International Chamber of Commerce, without
sufficient levels of trade finance, the world will not be able to realize many Sustainable
Development Goals.
2. Trade finance underpins economic growth:
● On
a more micro level, trade finance helps ensure that buyers get what they paid
for and sellers get paid for the goods they produce.
3. For MSME:
● The
trade finance gap hits hardest on small and medium-sized enterprises, which are
the top drivers of growth and jobs,
especially in developing countries. These businesses make up about 90% of
companies.
● While
they accounted for 41% of applications for trade finance, SMEs made up 52% of
rejections in 2020.
4. For Women led Business:
● The
gap is also particularly difficult for women-led businesses with 70% of their
applications either partially or fully rejected.
Steps to be taken to reduce the trade finance gap:
1. Direct Participation of Multilateral development
banks:
● Multilateral
development banks need to actively participate in global trade finance markets
to reduce gaps.
● Billions
of dollars worth of trade and development take place because of that support.
● But
multilaterals need to work themselves out of a job, and replace themselves with
private-sector counterparts.
● Direct
participation in the markets is only a stopgap measure.
2. Role of Banks and other financial Institutions:
● To
address core issues that could materially close the gap, the banking sector
needs to take the Trade Finance Register that ADB started 10 years ago to the
next level.
● The
default and loss statistics provided by the register prove that, even in the
most challenging markets during a crisis, trade finance is a relatively
low-risk business.
● Banks,
financial institutions, development finance institutions, and export credit
agencies could play to identify the gaps and address the challenges in the
trade finance arena amidst the uncertain global trade landscape.
● By
cooperating to inject more robust and granular data, banks could demonstrate to
risk managers and regulators that capital allocations to trade finance should
increase and capital costs should decrease. This would help close the gap
materially.
3. Digitization:
● There
is an urgent need to digitize trade. A range of issues could be addressed by
bringing trade into the digital world.
● Through
digitization comes transparency and a flow of data.
● This
data can provide the information required to bring more financing to SMEs,
enhance financial crimes detection, and help verify environmental standards
through the supply chain
● The
need to accelerate digitalization as well as the adoption of fintech solutions
for improving access to trade finance.
4. International Cooperation:
● The
challenges to be addressed in digitalizing trade were identified as
international cooperation in harmonizing definitions, standards and data
sharing across the borders digitally.