Addressing the Trade Finance Gap

Small and medium-sized enterprises (SMEs)  play a significant role in economic growth particularly in emerging economies where they can contribute up to 45% of total employment and 33% of GDP³. In the UAE, the impact of SMEs on the local economy is even greater – SMEs account for nearly 95% of all companies operating in the country and contribute more than 60% to the country’s GDP⁴.

Although SMEs have an outsized role in driving the economies in Africa, Asia and the UAE, they also face the greatest challenges in accessing the services and financial instruments necessary to finance trade and grow their business. Closing the trade finance gap is a pressing issue that requires urgent attention.

Mind the gap

The trade finance gap represents an unmet financing need. It is the difference between the money available to finance trade transactions and what businesses receive through letters of credit, trade loans, and other trade-related financial instruments.

In Africa, Asia, and the UAE, the trade finance gap can be attributed to several factors, including limited access to trade finance, weak regulatory environments, and compliance-related measures such anti-money laundering (AML) regulations, sanctions screening and export controls.

Limited access to trade finance is a twofold issue. Many financial institutions in these regions lack the infrastructure and expertise needed to provide trade finance services to their clients. 
And since SMEs make up a significant portion of the trade finance market, they are hit the hardest.

SMEs are considered higher risk as they typically lack the resources, collateral, and credit history necessary to obtain trade financing. As a result, SMEs account for a disproportionate share of trade finance rejections, particularly for women-led businesses where as much as 70%⁵ of trade finance applications are either partially of fully rejected.

Weak regulatory environments are another issue that exacerbate access to financial services, further contributing to the trade finance gap. Inadequate legal frameworks and enforcement mechanisms can create a lack of trust and transparency in the financial sector, increasing perceived risk and making it difficult for financial institutions to establish correspondent banking relationships, operate effectively and provide trade services to clients.

The heavy hand of compliance

Compliance-related measures also impact the trade finance gap. In addition to meeting AML and countering the financing of terrorism (CFT) regulations, financial institutions are under increased pressure to ensure compliance with ever-changing sanctions and export controls. Failure to comply can result in severe penalties and potential reputational damage.

Sanctions are measures imposed by governments to restrict trade with specific countries, individuals, or entities in order to achieve foreign policy objectives. Export controls are measures that regulate the export of sensitive goods and technologies to prevent them from falling into the wrong hands.

While these measures can be effective in achieving their intended goals, they can also have unintended consequences on trade finance in Africa, Asia, and the UAE. Additional compliance steps introduce delays and add to trade-related costs – making it even more challenging for SMEs to finance trade activity, manage cash flow and compete effectively.

Nonetheless, toeing the line on compliance is critical. Countries with a weak regulatory infrastructure and compliance gaps are likely to be placed on the Financial Action Task Force (FATF) grey list, which can create a range of challenges that further widen the trade finance gap in affected countries.

FATF grey listing

The FATF is an intergovernmental organization that sets international standards for AML/ CFT measures. When a country is placed on the FATF grey list, it means that the country is considered to have significant deficiencies in its AML/CFT regime and is subject to increased monitoring and scrutiny. Being place on the grey can be a “kiss of death” to affected countries already wrestling with delicate economies and large trade finance gaps.

Financial institutions are often hesitant to provide trade finance services to clients in countries that have been placed on the grey list due to the higher risk, making it more difficult for SMEs to access financing. In addition, countries placed on the FATF grey list are likely to face:

• Increased compliance costs: Banks in grey-listed countries will may experience a compliance cost increase due to the infrastructure upgrades and staff training needed to implement AML/CFT due diligence measures to comply with FATF regulations as a result.
• Reduced access to correspondent banking relationships: International banks may be hesitant to do business with banks in grey-listed countries due to the perceived increased risk as a result of their weaker AML/CFT regulatory controls.
• A negative impact on economy: A report by the International Monetary Fund (IMF) found that grey-listed countries experienced a decline in foreign direct investment, increased borrowing costs, and decreased trade activity. In fact, capital inflows were reduced by over 7.5%⁶ in countries that were greylisted.
• Increased scrutiny from regulators: Banks in grey-listed countries are likely to face increased scrutiny from regulators as they implement measures to comply with FATF regulations. 

Driving growth and inclusion

Although compliance measures can create barriers that increase costs and make it more difficult for SMEs to access the financial instruments needed for trade finance, meeting compliance obligations can also have a positive impact.

Adhering to international standards for compliance facilitates cross-border trade by providing a framework for conducting business in a safe and secure manner. Compliance measures can help reduce the risk associated with trade finance transactions, making it easier for financial institutions to operate across borders and provide trade finance services to a broader audience.

Know-your-customer (KYC) and other compliance requirements enable financial institutions to better understand their clients and their client’s business activities, further reducing the risk of fraud and other illicit activities. By implementing simplified KYC requirements and other compliance measures tailored to SMEs, financial institutions can drive financial inclusion, paving the way for these businesses to access the credit they need to finance their trade activities.

In Africa, Asia, and the UAE, trust is an essential component of doing business. By implementing robust AML/CFT measures as well as dependable sanctions and export controls, financial institutions build trust, which strengthens the relationship between the institution and its clients. This in turn can drive additional business.

Closing the gap

Limited access to financial services, weak regulatory environments, compliance-related measures, and sanctions and export controls are key factors that contribute to the trade finance gap in Africa, Asia and the UAE.

Closing this gap is a complex issue that requires a multifaceted approach to address the diverse challenges. By adopting robust compliance programs, financial institutions can help to support trade finance for SMEs, which is essential for economic growth and development.

At the same time, compliance measures help to strengthen relationships with clients and build trust – the bedrock of business in these regions.

¹International Chamber of Commerce. (n.d.). International Chamber of Commerce and Finastra team up to tackle the trade finance gap. Retrieved June 18, 2023, from https://iccwbo.org/news-publications/news/international-chamber-of-commerce-and-finastra-team-up-to-tackle-the-trade-finance-gap/
²African Development Bank. (n.d.). Africa needs urgent trade finance boost in wake of COVID-19, report finds. Retrieved June 18, 2023, from https://www.afdb.org/en/news-and-events/press-releases/africa-needs-urgent-trade-finance-boost-wake-covid-19-report-finds-37925
³Organisation for Economic Co-operation and Development. (n.d.). SMEs are key for more inclusive growth. Retrieved June 18, 2023, from https://www.oecd-ilibrary.org/economics/smes-are-key-for-more-inclusive-growth_25aa3d56-en;jsessionid=HDe6kZkTyv_S1yq3DfNHF2YblWwOniBckem9PRFr.ip-10-240-5-97
⁴AGBI. (n.d.). DP World & SMEs: Trade finance gap. Retrieved Jaune 18, 2023, from https://www.agbi.com/articles/dp-world-smes-trade-finance-gap/
⁵Asian Development Bank. (n.d.). Your questions answered: What is the trade finance gap and why does it matter? Retrieved June 18, 2023, from https://blogs.adb.org/blog/your-questions-answered-what-trade-finance-gap-and-why-does-it-matter
⁶Deloitte. (n.d.). Greylisting: Understanding its implications for financial institutions. Retrieved June 18, 2023, from https://www2.deloitte.com/content/dam/Deloitte/za/Documents/risk/za_Greylisting.pdf