The Covid-19 pandemic profoundly harmed global trade and supply chains. Covid-19 also slowed the growth of companies and economies everywhere.
Small- and medium-sized enterprises (SMEs) in emerging markets were hit particularly hard. These firms had already found secure trade finance from banks difficult enough to obtain, yet working capital is essential for these businesses to run effectively.
Many SMEs found that their banks rejected them for finance. The reasons varied. Some banks cited external policies while others cited a lack of credit history. In 2020, finance rejection rates reached all-time highs, adding to the estimated $1.5 trillion (USD) trade finance gap.
These developments spelt disaster for some SMEs. However, Covid-19 paved the way for significant digital advances in cross-border trade. In response to supply chain disruption, many existing financiers digitised their business models.
FinTech start-ups emerged to help Exporters and Importers secure global partnerships. Through non-recourse factoring (explained later) financing became more accessible for SMEs. Most of all, the solutions have delivered real tangible value.
This shift in consumer demand and the emergence of technology have affected the trade finance industry. Banks are no longer seen as the go-to trade finance providers. Instead, FinTechs are being recognised as facilitators for SMEs in developing markets.
These ‘non-banks’ provide digital trade finance in areas that banks have been reluctant to service. SMEs will often find obtaining finance quicker from a non-bank these days. These financiers are digitally-minded, while banks remain stuck in their ways. FinTechs can use cloud technology and secure documentation that serves a broader range of clients (and at a lower cost). There is no longer a need for paper-based applications, and cross-border trade deals are growing thanks to the advanced technology that supports them. FinTechs have an excellent opportunity for global expansion as they can operate in many countries.
Bain & Co - a global consultancy firm - predicts FinTechs could generate an extra $2 billion (USD) annually in trade finance fees. Much of this will come from SMEs in areas under-served by banks. These trade volumes are expected to top $1 trillion (USD) by 2026.
Banks active in trade finance have many regulatory boxes to tick. In Europe, the Basel III framework introduced stricter compliance rules. Regulatory needs vary across countries and regions, so many banks can only finance SMEs in the same country. Also, numerous SMEs have been refused loans by their banks due to having limited or no credit history. In addition, banks often cited Know Your Customer (KYC) risks as reasons not to provide finance. This doesn't help the perception of banks in the eyes of many SMEs.
FinTechs are not bound by the same level of regulations as banks. This is why they can serve a broader client base more quickly. FinTechs benefit from this flexibility and remain legally compliant and dependable. They take an elegant approach and make the application process easy and quick.
The non-bank model is attracting more interest from SMEs around the world. Non-bank financiers can foster strong feelings of trust within customers, which can be attributed largely to the technology they use.
Another appealing aspect of FinTech trade finance is the lower default risks. Non-recourse financing ensures that the financier remains responsible for chasing payments from Importers.
FinTechs are willing to serve as many international customers as possible. Only 15% operate in a handful of countries, while over 50% plan to be in five or more countries in five years.*
In an attempt to stay competitive, bank initiatives like 'we.trade', 'Trade Finance Gate' and the 'Trade Information Network' have been introduced. According to the Boston Consulting Group (2017) banks hope to use these networks to attract clients to multi-bank trade finance. These participating banks hope these networks will save them up to $6 billion (USD) by 2022. They hope this additional cash will provide room for more international trade finance activities.
However, it might be too late for banks to be agile competitors in the trade finance space. FinTechs have solidified their places and it will be hard for banks to bring many SMEs back on board. These non-banks have a positive reputation in the eyes of many international customers. They are becoming crucial for the financial supply chain.
*Roland Berger Consultants – FinTech in Europe: Challenger and Partner (2016)
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