Digital tech can help narrow trade finance gap | The Daily Star
12:00 AM, October 13, 2019 / LAST MODIFIED: 12:31 AM, October 13, 2019

Digital tech can help narrow trade finance gap

Digital, or financial technology – including mobile  internet access, blockchain, artificial intelligence, and big data – can  make international trade more efficient and support financing options.

Trade  finance provides exporters and importers with effective tools to manage  working capital and reduce risks related to trading across borders.  Around 40 percent of global international trade is financed by banks through  trade finance transactions such as letters of credit, loans, and  guarantees. There are around $1.5 trillion of rejected trade finance  applications globally in 2018, which is as much as 8 percent of global goods  trade, according to the recent report, Trade Finance Gaps, Jobs, and Growth Survey. The Asia-Pacific region accounts for 40 percent of the total rejection.

The lack of financing acts as a significant barrier to trade,  particularly for small and medium-sized enterprises in developing  economies. These businesses are most affected as they tend to have  higher rejection rates relative to larger firms. Around half of the  rejections originate from small and medium sized enterprises. The survey  shows that around 44% of the firms with rejected trade finance  applications were unable to find appropriate alternative financing.

Here are three major challenges in meeting the unmet need for trade finance:

INEFFICIENCIES FROM PAPER-BASED TRANSACTIONS

A significant number of  trade finance transactions still rely on paper-based documentation  which is prone to delays and human error. Manual processing and handling  can cause many payment errors, thus lead to delays in payment or even  non-payment of transactions. For example, letter of credit transactions  which are often paper-based may lead to multiple potential risk points  including delays, additional costs incurred by manual labor, and  financial fraud.

REGULATORY COMPLIANCE REQUIREMENTS

Compliance with anti-money  laundering and know-your-customer regulations is an intensive process  for both banks and firms. A majority of banks identify these  requirements as one of the largest challenges for the industry to grow,  although they are necessary to ensure sound cross-border transactions.  Also, the new Basel III standards require banks to have more regulatory  capital and liquidity.

INFORMATION ASYMMETRY

The third challenge is related to the fact  that the amounts of information that lenders and borrowers have are  different—so-called information asymmetry. Lenders usually require  collateral or information on borrowers such as credit history to  mitigate risks. Such requirements may not be available for some small  businesses. Or it could be costly for banks to obtain, especially when  dealing with small and medium-sized enterprises where the loan amounts  and profits are small relative to the needs of bigger firms. Ironically,  requirements to reduce information asymmetry may add more challenges to  access to trade financing.

Fintech or financial technology makes use of mobile internet access,  blockchain, artificial intelligence, and big data to improve access to  information with fewer security concerns. These technologies can help  improve efficiencies substantially at various stages of international  trade. They help address the three challenges previously mentioned, and  therefore draw more small and medium-sized enterprises into global  trade.

For example, electronic bills of lading and other e-documents can  greatly enhance process efficiency by reducing paperwork and  facilitating transactions with customs. Blockchain and artificial  intelligence can facilitate due diligence and payments for small  businesses that have difficulty finding representative banks. Fintech  firms using big data coupled with artificial intelligence can ease the  costs of asymmetric information by providing alternate (non-bank) credit  information.

We should note that digitalization is far from complete. High  implementation costs are one reason it is not happening right now. A  recent survey by the International Chamber Commerce shows that roughly  40% of responding banks said that digitalization was not part of their  immediate agenda. Banks also find that the high cost of technology  adoption is the biggest impediment in technology adoption, followed by  lack of global standards, laws and rules for digital finance.

How can we strengthen our support for small and medium-sized  enterprise trade finance through digital technology? It is important to  create an environment in the medium to long term that can facilitate the  adoption of digital technologies in trade finance. International  standards in technology should also be encouraged to ensure  interoperability and compatibility of various systems.

Three global initiatives are worth receiving support. First, the  Digital Standards for Trade initiative aims to develop digital standards  so different systems can be interoperable in the trade ecosystem. Next,  the Global Legal Entity Identifier system can provide a global  harmonized identity for all companies, large and small. It promotes  transparency and security by enabling firms to have a unique identity.  Thirdly, there has been little recognition or adoption of a legal  framework nationally. E-title documents, e-promissory notes, and e-bills  of lading are not yet recognized as legally equivalent to paper-based  trade documents. Therefore, model laws created by the United Nations  Commission on International Trade Law can help implement legislation  toward paperless trade.

In parallel, national government and regional institutions should  increase their support for trade finance, for example, through export  credit agencies and trade finance programs. Knowledge gaps should be  reduced since small and medium-sized enterprises often lack awareness of  trade finance products and public assistance programs.

 

The writer is an economist of the Economic Research and Regional Cooperation Department of the Asian Development Bank.

 

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