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WTO Report on Trade Finance for Small and Medium Enterprises
Practical Law Legal Update w-002-2494 (Approx. 3 pages)
WTO Report on Trade Finance for Small and Medium Enterprises
by Practical Law Finance
| Published on 12 May 2016 • USA (National/Federal) |
The World Trade Organization (WTO) issued a report calling attention to the difficulties faced by small and medium enterprises in obtaining trade financing. These difficulties are especially detrimental for the economies of developing countries. The report analyzes the causes of these difficulties and makes recommendations for improvement, including taking greater care in crafting financial regulations.
On May 4, 2016, the World Trade Organization (WTO) issued a report, "Trade finance and SMEs: Bridging the gaps in provision," calling attention to the difficulties faced by small and medium enterprises in obtaining trade financing. These difficulties adversely affect trade worldwide, but are especially detrimental for the economies of developing countries. The report contains a list of recommendations that include relaxing some restrictions in the trade finance programs of multilateral development banks, increasing the funding for these programs and ensuring that tighter financial regulations do not inadvertently exacerbate the problem.
The WTO report notes that finance is essential to trade, with up to 80% of global trade supported by credit or credit insurance. In 2014, out of roughly US $18 trillion of international trade, more than $12 trillion involved trade finance of some sort. It also notes that trade finance is an unusually safe form of finance with a default rate of 0.021% during the period 2008-11. This is a fraction of the default rate of 0.14% for Aa-rated corporate customers.
Small and medium enterprises (SMEs), defined as companies employing 250 or fewer workers, are responsible for 60% of employment in developed countries and 80% in developing countries. But they account for a much smaller share of global trade – 40% of exports from OECD (Organisation for Economic Co-operation and Development) countries and 30% from developing countries. According to the report, this shortfall is largely due to SMEs' difficulty in accessing trade finance.
Globally, more than half of trade finance requests by SMEs are rejected, compared to just 7% for large companies. Trade finance itself is scarce for SMEs. The process of obtaining trade finance is more burdensome than for large companies, with higher transactional and informational costs. And the cost of trade finance is higher for SMEs. Bank deleveraging in the wake of the 2008-09 financial crisis has made these problems worse. Indeed, the report notes that compliance and regulatory burdens are among the main obstacles limiting SME access to trade finance.
These difficulties are especially acute for SMEs in developing countries. In 2012, the unmet demand for trade finance in Africa was $120 billion, and was $700 billion in developing countries in Asia. Bridging these gaps would allow thousands of SMEs to participate in the global marketplace and would benefit the economies of developing countries in particular.
The WTO report concludes with six recommendations:
- Multilateral development banks (MDBs) should try to reduce restrictions in existing trade finance programs. For example, many MDBs do not permit state-owned entities to participate in their programs. But in many developing countries the lion's share of trade finance is provided by state-owned banks.
- MDBs should increase the size of their trade finance programs to the extent possible.
- In expanding their trade finance programs, MDBs should set realistic goals. MDBs currently provide $30 billion of trade finance per annum. Although the unmet demand is closer to $1 trillion, the WTO proposes $50 billion per annum as a more achievable goal for MDB programs.
- MDBs and private sector financial institutions should increase their technical assistance to the trade finance sector in developing countries. For example, training trade finance specialists and increasing awareness of the trade finance products that are available would allow developing countries to build their own trade finance capacity.
- Trade finance providers should maintain an open dialogue with financial regulators. For example, tighter know-your-customer requirements can have the unintended consequence of reducing SME access to trade finance in developing countries. The WTO proposes a dialogue with the Group of 7 Financial Action Task Force, which coordinates regulatory efforts to combat financing for terrorism and money laundering.
- The international financial community should improve its capacity to read markets and predict problems. Since 2009, MDBs and other international financial institutions have undertaken many efforts to gather and pool financial information, to identify gaps in the global financial system and to better prepare for the next financial crisis. The WTO recommends that these efforts be enhanced and harmonized.