The importance of short-term financing of international trade, known as trade finance, is explicitly recognized in the Addis Ababa Action Agenda as an important means of implementation of the SDGs.
The Addis Agenda specifically:
- Commits to explore use of market-oriented incentives to expand WTO-compatible trade finance and the availability of trade credit, guarantees, insurance, factoring, letters of credit and innovative financial instruments, including for MSMEs in developing countries
- Calls on development banks to provide and increase market-oriented trade finance and to examine ways to address market failures associated with trade finance
The lack of local access to trade finance was cited as an obstacle to economic diversification by 60 developing WTO members and by 14 donor respondents in a recent survey. Trade finance is normally a high-volume and low-cost source of finance. The risk of default is small, with a global average of 0.2 per cent, and with little difference across countries. However, underdeveloped financial sectors in some countries have not been able to provide sufficient and affordable trade finance services. As a result, there are significant gaps between supply and demand, estimated at $1.5 trillion in 2018 (stable compared to 2017) in an industry survey led by the Asian Development Bank (ADB). SMEs are particularly affected, since 45 per cent of their trade finance proposals were rejected by surveyed banks. Half of the rejected SMEs abandoned trade transactions, as they were unable to find appropriate alternative financing. Rejections are explained by a variety of factors, including lack of collateral, lack of proper information available during the application process, and lack of profitability for banks. Trade finance gaps have also been compounded by the decline in correspondent banking.
Given the large gaps in commercial trade finance for SMEs, especially in the poorest countries, MDBs are an important source of trade finance in developing countries, under so-called trade finance facilitation programmes. For example, in the last two years, ADB doubled the number of trade transactions it supported involving SMEs, with 3,500 SMEs supported in 2018. Capacity-building is key to helping local banks comply with new financial regulations, as well as for adopting new technologies. The WTO, International Finance Corporation, and Financial Stability Board (FSB) are working together to inform trade finance providers about relevant regulatory requirements, promote tools to make compliance more effective and less costly for local banks, and help them attract new correspondents. For example, the WTO and FSB have been encouraging the development of synergies between legal identifiers provided by the Global Legal Entity Identifier Foundation and the World Customs Organization.
Read more on trade finance gaps and instruments here.