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Trade finance gap grows to record levels

by Paul Morgan

The global trade finance gap has reached a record high of $2.5 trillion in 2022, according to the Asian Development Bank’s (ADB) recent survey. This gap represents the difference between requests and approvals for financing to support imports and exports. Despite the strong rebound after the Covid-19 pandemic, the demand for trade finance has surged, making it more difficult for businesses to secure financing due to heightened economic risks.

The survey conducted by the ADB included data from 137 banks and 185 companies from around 50 countries. It revealed that firms are facing challenges accessing financing for trade, with insufficient financing being cited as the top supply chain obstacle. Access to adequate financing, reliable logistics, and the use of digital technology were identified as the three most important components in building resilient supply chains.

Maurice Benisty, Chief Commercial Officer at Demica, identified the increase in the cost of capital as the “single biggest driver” of the widening trade finance gap. Higher inflation leads to higher trade requirements, while higher interest rates raise concerns from a credit and risk perspective. The majority of the trade gap is likely between and within Asia, Europe, and the US, where the focus of banks lies due to the small size of trade finance markets elsewhere.

Based on the current financial environment of low growth, high interest rates, high inflation, and a large demand for capital investment, the trade finance gap is expected to continue growing. Moreover, pressures on firms to meet environmental, social, and governance (ESG) targets may further hinder the reduction of the trade finance gap.

For the first time, the ADB’s survey focused on ESG issues and digitalization to assess their impact on supply chains and the trade finance gap. While most surveyed firms believe aligning with ESG measures may help reduce the gap, Maurice Benisty suggests that ESG financing pressures may initially widen the gap due to banks and investors reducing exposure to carbon-intensive industries. He emphasizes the need for countervailing initiatives and greater digitalization to catch up, as pressures to transition to net-zero emissions and reshore supply chains have increased the demand for investment.

Steven Beck, head of the ADB’s Trade and Supply Chain Finance Program, acknowledges that ESG pressures may negatively affect the trade finance gap in the short term but refers to the ADB’s brief on deep-tier supply chain finance (DTSCF). This provides a solution to fill the financing gap for small and medium-sized enterprises while aligning ESG efforts with the reduction of the trade finance gap. The ADB’s DTSCF brief recommends better utilization of supply chain linkages to achieve ESG targets by ensuring transparency and traceability throughout the chain.

Digitalization is seen as a crucial factor in closing the trade finance gap. Surveyed banks reported that the lack of harmonized standards and data collection impedes sustainability progress in trade. The digitalization and standardization of trade documentation processes, including increasing rates of paperless trade, were identified as significant boosts to productivity and efficiency. Modernizing systems and processes within banks is also crucial, as traditional trade finance has been described as document-heavy and process-intensive.

However, the trade industry as a whole is still considered antiquated and ripe for disruption. Less than 2% of global trade used electronic bills of lading in the previous year. The digitalization of global trade requires agreement among exporters, shipping ports, customs, warehouses, logistics importers, and banks on the electronic forms of the 35 paper documents used in trade. The ADB’s Digital Standards Initiative (DSI) aims to achieve this agreement and is composed of policymakers from governments and international organizations.

In addition to digitalization, governments must align their domestic legislation with model laws, such as the Model Law on Electronic Transferable Records, to create a harmonized global framework for digitalizing trade documentation. Once the transition from paper to digital forms is completed, it is expected to have a transformative impact on trade, enhancing transparency, anti-money laundering efforts, ESG alignment, and overall understanding of supply chains.

Although legislative changes may take time due to reliance on various jurisdictions, the ADB believes that global trade can be successfully digitalized by 2026, with completion of the process by 2028. This transformation will help address the trade finance gap and contribute to the resilience and efficiency of supply chains worldwide.

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