International trade is associated with positive impacts on growth, and acts as a particularly important channel of positive spill-overs for SMEs, including in the area of managerial skills, technology and innovation.
Access to trade finance can facilitate SME engagement in international trade by addressing two major challenges. First, both exporters and importers are exposed to significant counterparty risks, in particular when exploring new markets and dealing with new customers and suppliers. This is especially challenging for SMEs that have limited capacities and resources to engage in a sound due diligence process.
Second, SMEs are often constrained in working capital. In a trade deal, both parties however have diverging preferences in respect to the ideal point of time for making the payment. The exporting SME would prefer payment before shipment, or ideally even earlier to buy raw materials, etc., for the production of the good or service. The importer, on the other hand, prefers to hold back payment until the proper delivery of the ordered goods and services. Access to trade finance hence can enhance the cash constraints on the SME side. While this is true for transactions in general, payment delays for cross-border transactions tend to be longer, information asymmetries more pronounced, and disputes harder to resolve.
Across all countries, SMEs have a disproportionately smaller share of direct international trade than they do of economic activity in general, and the gaps between the two measures typically increase as firm size decreases. For example, in most OECD countries, between 10 to 25% SMEs in manufacturing export, compared to more than 90% for their large counterparts1. However the contribution that SMEs make to overall trade is much more important when taking account of their role in indirect exports as suppliers to internationally operating larger firms, as well as when considering other sectors beyond manufacturing.
The coronavirus pandemic is affecting exports and international trade significantly; merchandise trade was expected to drop by an estimated 9.2% in 2020 (WTO, 2020), though the actual decrease may be less pronounced according to more recent estimates (WTO, 2021). As supply chains, both domestic and international, have come under strain, trade finance instruments appear increasingly likely to come under pressure. The scope to rely more on inter-firm lending to cushion the blow of the economic impact is also severely reduced in the current crisis, given its synchronised nature across countries and sectors (Boissay, Patel and Song Shin, 2020[3]). Governments and development banks are therefore ramping up their trade finance programmes to compensate for shortfalls in commercially provided trade finance that may undermine global trade, and allow smaller firms to be part of global value chains. Across the world, countries have expanded the support of export credit agencies and working capital programmes, introduced new facilities, and eased the modalities of existing support schemes (OECD, 2020), (OECD, 2020). These policy instruments are often complemented by other measures to ease SME access to finance more generally (OECD, 2020).
Indeed, traditional bank-intermediated trade finance instruments can be a factor in driving trade performance of SMEs. These include short-term trade loans, letters of credit (L/C), documentary collection and guarantees. However, in particular after the financial crisis of 2008, the relevance of traditional trade finance has diminished significantly. The share of global trade using documentary credit, for example, has declined from about 50% in the 1970s to an estimated 15% in 2018 (Ganesh et al., 2018). In 2017, the volume of letters of credits continued its negative growth trend since 2014 and fell by 2.7% year-on-year.
At the same time, the global trade finance gap was estimated to be USD 1.5 trillion in 2018, difficulties in measuring this gap notwithstanding (Kim et al., 2019). SMEs struggle to access bank-intermediated trade finance instruments for a variety of reasons that vary by instrument, reflecting differences in barriers and complexities, such as high cost, high complexity and HR resource-intensive workflows on the SME side. On the supply side, information asymmetries and related resource-intensive due diligence processes generate high transaction costs but low transaction volumes, which work to disincentivise banks.
However, Supply chain finance (SCF) instruments, which bring in new providers of finance, by leveraging on players within global value chains, have opened up new possibilities for SMEs to manage working capital and payment risk associated with international trade. Supply chain finance refers to instruments such as factoring, forfaiting or payables finance – also known as reverse factoring – enable SMEs to better manage their cash situation in trade transactions, benefit from larger and well-known buyers or suppliers, and help costs and complexities for SMEs.
Digitalisation has the potential to increase SME access to trade finance3 by: (1) Improving how trade finance is done, i.e. in respect to process efficiency and quality, (2) enhancing the portfolio of trade finance instruments, and (3) expanding the field of dedicated trade finance and SCF supplier.
In respect to process efficiency of trade finance, recent digitalisation efforts focus on solving Know-YourCustomer (KYC) frictions. The legal requirements to on-board clients for trade finance deals are often resource intensive, especially for SMEs. Ongoing efforts focus on the centralisation of KYC databases, in order to provide client information to a larger group of finance providers, thereby reducing redundancies and costs. In addition, decentralised blockchain-based efforts that have similar goals are also being explored. Some large multinationals (e.g. IBM, Microsoft, Walmart, Maersk), are building the infrastructure needed to offer this service on the market or directly to integrate more SMEs in their global supply chains and to offer better services to the ones that are already part of them (Chang, Iakovou and Shi, 2020[9]). Replacing the current paper-based model with an automated, tamper-proof, data storing process can result in strong cost reductions (Morabito, 2017[10]). Moreover, e-documentation is increasingly applied, which, in particular in the context of document-heavy traditional trade finance instruments, can reduce the cost and complexity for all parties involved. Innovative solutions based on distributed ledger technologies can play an important role in this transition in global supply chains, and are becoming more widespread in the market (Chang, Iakovou and Shi, 2020[9]).
Digitalisation can also impact the quality of trade finance credit assessments. New tools building on big data and artificial intelligence, such as machine learning, can support the credit assessment of smaller firms, which are often opaque if a long-standing relationship with a financial intermediary is absent. Thanks to new tools, a variety of different data and information sources can be meaningfully interpreted, which go beyond simple balance sheet statements.
In line with increasing e-documentation, new products such as the bank payment obligation (BPO) are being introduced in the trade finance market. The BPO is subject to standardised regulation and enables the exchange of electronic documentation between banks that engage in the provision of trade finance.
Beyond traditional trade finance players, such as banks, and supply chain finance actors, such as factors and forfaitors, more new vehicles and actors are emerging from the process of ongoing digitalisation. Trade finance platforms for example are often consortia of large institutional banks that centre around the idea of digitising the trade finance process, for instance by digitising documentary credit, electronic issuances, exchange and documentation. Fintechs are also entering the space by either cooperating with banks or operating on a stand-alone basis, in particular in the supply chain finance sector, including through the provision of accounting software or invoice management tools and access to finance.
The COVID-19 pandemic has had significant implications for digitalisation and trade, with secondary effects on trade finance. The traditional reliance on paper-based processes represents a key weakness under current circumstances. Banks, for instance, face mounting difficulties to process transactions that require substantial in-person back office staffing (ICC, 2020[11]). Early assessments have shown that trade between businesses (as well as with consumers) is increasingly taking place online given the limitations and restrictions imposed when combatting the crisis. Surveys from across the globe show that SMEs are increasingly using online trading.4 Moreover, large industry players advocate the wider acceptance of electronic trade documentation, which is a prerequisite for mainstreaming digital trade.
However, in order to fully realise the potential of digitalisation for SME access to trade finance, a variety of challenges has to be addressed. A major issue is that only parts of the trade and trade finance process are subject to digital innovation, whereas the end-to-end digitalisation across the trade value chain remains fragmented. Hence, solutions presented in this paper are often not interoperable, and efforts in this area remain nascent. Similarly, banks remain reluctant to view technology as the solution to the trade finance gap. In addition, SMEs have to ramp up internal digitisation efforts to adapt and adopt to the new landscape of trade finance instruments.
Current policy efforts have four different entry points: focusing on trade, the use of technology; a focus on SME skills, and access to finance. The trade dimension includes policies such as the adaptation of national export strategies to facilitate SME exports. With a focus on mainstreaming technologies in finance related fields but also beyond, many countries are using so-called regulatory sandbox approaches to test new products, services or business models. Several on-going policy efforts aim at improving the skills of SMEs. These entry points are also very much inter-related. For example, financing policy measures include financial support for SME access to training. Policy approaches also aim at improving access to finance to stimulate the exposure of SMEs to international trade or investments in digitalisation.
However, policy approaches remain as fragmented as the digitalisation process itself. Moreover, the acceptance and coherent regulation of new products and players in the field is limited. This report suggests a number of preliminary options for policy makers to leverage digitalisation to enhance SME access to trade finance:
- establish a conducive regulatory environment that fosters the adoption of innovative solutions, in particular to foster the wider acceptance of electronic documents,
- facilitate coherent industry-wide solutions that can operate at scale and are interoperable,
- develop tailor-made policy approaches to enable SMEs to harness the potential of digitalisation to improve access to trade finance, and
- support efforts to generate a sound evidence base to better understand the benefits of digitalisation for SMEs’ access to trade finance, and also challenges impeding uptake.
Source: OECD