An easy access to working capital is critical for companies, especially small- and medium-sized enterprises (SMEs), to explore new markets globally. International trade in turn is dependent on the success of SMEs, which represent around 95 percent of the world’s companies and provide 60 percent of private sector jobs. To ensure companies are in good health and add significantly to the global economy, easy availability of trade finance is vital.
The global trade finance ecosystem is worth $5.2 trillion in which bank-intermediated transactions represent more than a third of global commerce. Besides providing specialised supply chain finance facilities, trade finance agencies help companies mitigate the risks associated with importing or exporting goods and services.
Mitigating financial risks involved
So how does trade finance exactly help companies? Simply put, trade finance takes care of payment to suppliers for the products and shipping with the provision to pay back the financer once the goods are sold. The borrower can also choose to pay 5 to 10 percent of the total loan amount, either monthly or at a mutually agreed fixed interval.
This kind of mechanism gives companies the financial cushion against high-value shipments and a long delay in payments. For companies with limited cash flow and working capital, trade financing wards off the constraints resulting from global freight costs, customs, fulfilment costs, fees for Amazon and other related costs. This allows importers and exporters to engage in global trade with the availability of more funds for expanding inventory and improved profit margins without any fear of financial uncertainty.
In the case of high-value shipments, there’s a greater risk involved for both exporters and importers. While an exporter may not know the trustworthiness of the party receiving the shipment, an importer, too, may not be sure of the complete fulfillment of the deal and successful delivery. Herein a trade financing firm (a bank in most cases) pitches in to bring a sense of security and makes the payment upfront to keep the international trade ticking.
Any sort of trade finance involves an agreement between a company and the financing agency, which can be a private firm or bank. A letter of credit is issued by the buyer’s bank, which guarantees the seller of payment at a later date, of course, with interest.
Options galore, but challenges too
From financing start-ups to established institutions like Wells Fargo, HSBC, and several others, today companies have a number of options to choose from. However, it is important to be absolutely clear of payment terms, interest rates, securities and guarantees if any, and penalties in case of default.
Even though there are plenty of financing options, a recent Asian Development Bank study estimated that the gap in trade finance availability reached $1.7 trillion in 2020, representing 10 percent of global trade. Financing options remain limited for MSMEs, with rejection rates up to 40 percent; a 2017 World Bank study indicates that 65 million MSMEs were credit constrained.
If the future world economy has to grow to the desired level, the global trade finance ecosystem has to become all the more inclusive. Improved access of working capital to SMEs can add 600 million new jobs by 2030 and give the much-needed impetus to international trade.
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