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The $2.5 trillion trade finance gap is the elephant in the room for the trade finance industry.
Trade Finance Global (TFG) surveyed 20 trade finance experts to start the year, and every single one predicted that the trade finance gap would grow in 2024.
Part of their reasoning is that general economic conditions would lead to a decline in liquidity and economic growth, decreasing access to capital. But, other factors include the implementation of new capital constraints such as Basel 3.1.
As the world of international trade finance adapts to the changing macroeconomic environment and the ever-increasing trade finance gap, there has been a clear shift to the originate-to-distribute model.
To help break down this fresh approach, TFG’s Brian Canup spoke with Oladapo Adeigbe, Head of Financial Institutions Trade Sales – (Africa) at Absa and Boitumelo Thoka, Head of Pan Africa Trade Working Capital Distribution, Syndication and Insurance Product at Absa.
Origins of the originate-to-distribute model
The shift towards an originate-to-distribute model in the banking sector reflects a strategic evolution in how banks approach trade finance.
Initially, banks prioritised originating loans and retaining them on their balance sheets, aiming for balance sheet growth and market share expansion. This approach was attractive because trade finance, as a low-default asset class, bolstered the banks’ financial profiles.
However, several factors have contributed to the shift towards distribution.
The globalisation of markets expanded opportunities for banks but also introduced new challenges, such as the need for optimal capital utilisation and higher return on equity. Banks now tend to focus more on originating deals while limiting their capital commitment, mitigating risk and improving capital efficiency.
This shift was facilitated by the increased interest from various new investors, including non-bank financial institutions, insurers, export credit agencies, and fintech companies. These entities, attracted by the diversified portfolio opportunities presented by trade finance, have become critical players in the distribution model.
Advancements in data transparency have also made risk mitigation more effective, particularly in managing trade finance risks like commercial contracts, currency, and country risks.
Ageigbe said, “The clarity this has brought has introduced more investors to trade as an asset class and to distribution as an option.”
For Absa, this shift has had significant strategic impacts.
Thoka added, “It has allowed us to be bold and flexible in how we service our clients, and it helps alleviate both internal and external constraints imposed by factors such as a tightening regulatory framework, unknown markets, scarcity in foreign currency liquidity, and risk appetite.”
Distribution has facilitated better management of returns, exploration of new markets, efficient recycling of liquidity, and judicious use of limited capital, ultimately enabling more dynamic client service, improved risk and liquidity management, and strategic capital utilisation.
Challenge begets collaboration
The current macroeconomic landscape – characterised by rising interest rates, global supply chain disruptions, and political instability – has significantly impacted the trade distribution sector.
These factors have increased commodity and energy prices, fueling inflation and prompting central banks worldwide to raise interest rates, which has resulted in higher borrowing costs. As a result, trade finance is becoming more expensive, decreasing capital supply, especially for corporates and SMEs involved in cross-border trade.
The heightened political risks, particularly prevalent in Africa, and concerns over sovereigns’ ability to repay in foreign currencies have further exacerbated the challenges, reducing trade volumes and heightened default risks.
According to Afreximbank’s 2022 Africa Trade Report, about 40% of African SMEs struggled to secure funding in 2022, primarily due to the lack of bank-acceptable collateral.
This gap creates an opportunity for non-bank liquidity providers and private credit entities to step in. These entities can distribute trade finance risks more broadly, relieving pressure on banks’ balance sheets and increasing their capacity to service SME clients.
The role of non-bank liquidity providers in the originate-to-distribute space is increasingly important. These providers, including development financial institutions (DFIs), insurers, and other financial institutions, can offer alternative financing solutions that banks may be unable to provide.
By partnering with banks, these non-bank entities can help bridge the SME funding gap, leveraging their different risk profiles and capital sources.
Adeigbe said, “This would bring inclusivity and reduce the financing gap and will create much more room for collaboration among willing investors in the distribution space.”
Distribution in trade finance needs to be more inclusive, focusing on direct corporate risk alongside the traditional focus on financial institution risk.
Technological advancements may be able to help.
Technology addressing challenges
To tackle the challenges that exist in facilitating an originate-to-distribute approach, Absa is exploring various technology-oriented solutions.
One significant stride has been in automating manual processes, creating efficiencies in internal operations, and streamlining previously cumbersome and time-consuming processes. By reducing the time and effort required for these processes, the bank can focus more on strategic aspects of trade finance distribution, such as expanding its reach and improving service delivery.
Thoka said, “For where we are right now as a business and our level of maturity where distribution is concerned, we are progressing well and have managed to leverage the various options in the market quite adequately.”
But it’s not just internally that the bank is leveraging technology; Absa is also exploring marketplace opportunities through networked platforms to offer new ways to connect with partners, clients, and investors.
Absa hopes to broaden its distribution network by engaging more actively on these platforms, enhancing its ability to reach different markets and client segments.
The substantial $2.5 trillion trade finance gap might not be going away soon, but the industry is set in motion to try and do something about it with a strategic shift towards an originate-to-distribute model.
This evolution, shown by insights from Absa and other trade finance experts, reflects a response to global economic changes and the need for efficient capital utilisation.
Embracing technological innovations and engaging non-bank liquidity providers, the industry is actively working to bridge this gap. These efforts aim to streamline trade finance, particularly for SMEs, indicating a proactive stride towards a more inclusive and dynamic trade finance landscape.