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Mind the gap: The role of credit insurance in facilitating trade finance

Global trade shapes economic opportunities by facilitating the movement of goods and services. Between 80-90% of this trade requires financing, yet a huge gap exists between what lenders are prepared to provide and what borrowers need.

03/08/2023 · 7 minute read

Global trade shapes economic opportunities by facilitating the movement of goods and services. Between 80-90% of this trade requires financing, yet a huge gap exists between what lenders are prepared to provide and what borrowers need. This finance gap is impeding the ability of trade to fully support economic growth, especially for SMEs.

Depending on which methodology is used, the size of the global trade finance gap is estimated to be anywhere between US$2 trillion to US$30 trillion. By any standards, it is an alarming situation. To discuss the reasons why the trade finance gap exists and what can be done to close it, Marsh and Allianz Trade convened a panel in London on February 23, 2022, chaired by Vincent McCue of Marsh. This article is a summary of insights from the discussion.
 

The scale of the trade finance gap

Based on a sample number of financing application rejections, the Asian Development Bank estimates that the trade finance gap reached US$2 trillion in 2022. This estimate is far too conservative for some, including Ludovic Subran of Allianz. Using data from companies’ turnover, working capital needs, and margins, Ludovic and Allianz’s own estimates suggest that the trade finance gap could be as much as US$30 trillion. “We have an opportunity to reinvent trade finance – it’s all hands on deck,” he said, adding “we need banks and credit insurers to invest in solutions.”

Closing the gap for SMEs

Globally, small and medium-sized enterprises (SMEs) are disproportionally affected by the trade finance gap. To put this into context, Sinan Ozcan of DP World Trade Finance shared the statistic that almost 50% of trade handled comes from SMEs, but between them, SMEs only have access to about 10% of financing. To compound matters, it’s estimated that over 50% of the total financing rejections are for SMEs. There are several reasons for the challenges SMEs face with the traditional banking system. For instance, SMEs often do not have the skills and time to source the best financiers, and for lenders, there is a perceived high risk of lending to SMEs. 

According to Bhriguraj Singh of HSBC, traditional lenders continue to use conventional methods of risk assessment, including solid financial statements, large amounts of capital, and collateral ꟷ criteria that SMEs often do not have in abundance. Bhriguraj believes a move towards transactional performance methods of assessment would be beneficial to SMEs. Lenders should assess SMEs based on their performance, not just traditional methodologies; this will go some way to tackling the trade finance gap. Özlem Özüner of Allianz Trade made the point that it was a mistake for lenders and the insurance market to only “look at past performance and not the future.”

In addition, the traditional banking system cannot provide all the capital to fill the gap of US$2 trillion (or more), so alternative lenders must be found, said Bhriguraj.

Opportunities for greater participation

There was a consensus among the panel that solutions to close the trade finance gap will come from multiple sources and require collaboration among traditional lenders, private sector players, financial institutions, governments, and more.

Edgard Carneiro Vieira of the World Economic Forum (WEF) described a four-pronged approach to closing the trade finance gap with greater collaboration. This includes:

  1. Innovation. The insurance industry should think about solutions in a fully digitalized way to increase efficiencies and reach scale.
  2. New niches. Go beyond business as usual; find new markets and new needs. For this, there is a need for “more data to make better decisions.”
  3. Interoperability. New solutions and technologies must be interoperable.
  4. Better regulation. Data and opportunities will only flow where there is an enabling framework.

Adding to the theme of collaboration when it comes to data, Oren Bass of Pemberton Asset Management noted that fund managers should work with banks and other platforms to get “the right access to the right data” in order to make informed decisions.

Leveraging digital

From big data to the blockchain to e-commerce, and more, the panel agreed that digitalization holds transformative potential for the global trade finance industry. Digitalization can help address inefficiencies, regulatory compliance, and information asymmetry in trade and financial transactions. Digitalization “will make it simpler, faster, and safer to trade,” said Bhriguraj, adding that it is crucial to help bridge the trade finance gap by “reducing friction and reducing costs.” For instance, the digitalization of data can help lenders assess a company’s performance from trusted sources.

Özlem agreed and said that machine-learning methods can predict performance and patterns of behavior. With more data, “we can take risks and enable companies to grow,” she said. Özlem pointed to Allianz’s Global Digital Factory, which is developing digital models and products to support trade finance. The market needs to be prepared for digital transformation. For example, the strong uptake in e-commerce is only likely to continue and will change how companies and countries trade.

Vincent asked the panel for their predictions on how the trade finance gap will change in the next 5-10 years. Several speakers expect new legislation on digital ownership to support faster, more efficient, and fairer global trade. A regulatory framework would be “a massive boost,” noted Bhriguraj, citing the Basel IV framework and adding that “standardization can help [the digital transformation] scale and deliver value.” Sinan agreed, saying that there are many hidden costs in the trade finance gap and that improved regulation will improve the lack of transparency.

For Edgard, the reality of geopolitics means “we are going to re-globalize and go to new markets, and this comes back to regulation; there needs to be an enabling regulatory environment to penetrate new markets.” How ready is the insurance market for this? For Özlem, proving authenticity is critical in the digitalization of trade. Authentication can help prevent risk in the first place, she said. Compared to other sectors, “innovation in our world is much smaller,” Ludovic added. “We need to move, but move nimbly to reach simplicity and scale.”

For Oren, credit insurance is critical if non-banking entities offer alternative types of capital to close the trade finance gap. A “good credit insurer” will “create a wedge between stabilizing the risk approach and allocating risk where there is still some resilience,” said Ludovic. 

Long-term trends are supportive, but risks remain

According to Ludovic, we are in a period of “hyper-interventionist” policies, with the US Inflation Reduction Act (IRA) cited as an example. Increased political interference, friction within the global trade market, the pressing crises of climate change, the Russia-Ukraine conflict, and the aging pyramid (not to mention the COVID-19 pandemic) have all led to higher costs of trade, market and political volatility, and hardening of financial conditions ꟷ factors that are all widening the trade finance gap. Ludovic added that three sectors, in particular, will be negatively impacted: construction, retail, and transport. There are opportunities – China’s reopening could boost global growth and trade – but “resilience is the name of the game for 2023,” reported the speakers.

Marcus Miller of Marsh closed the event by reminding the audience why the trade finance gap is so important. “In practical terms, the trade finance gap has financial and humanitarian consequences; it has a real effect on people’s lives,” Marcus said. Trade finance is inherently low risk (as shown in the International Chamber of Commerce’s (ICC) Trade Register). This low risk is further evidenced by global default rates across all trade finance asset classes declining in 2021, compared to 2020 ꟷ stubbornly defying the economic turbulence caused by the pandemic and supply chain disruptions. Today, up to 80% of global trade is supported by finance and or credit insurance. Marcus added: “as an industry, we all have a role to play in global trade.” The trade finance gap is growing, but with help and support from the insurance industry and other financial institutions, “we can help close the gap.”

About Allianz Trade

We predict trade and credit risk today, so companies can have confidence in tomorrow

Allianz Trade is the global leader in trade credit insurance and a recognized specialist in the areas of surety, collections, structured trade credit and political risk. Our proprietary intelligence network analyses daily changes in +80 million corporates solvency. We give companies the confidence to trade by securing their payments. We compensate your company in the event of a bad debt, but more importantly, we help you avoid bad debt in the first place. Whenever we provide trade credit insurance or other finance solutions, our priority is predictive protection. But, when the unexpected arrives, our AA credit rating means we have the resources, backed by Allianz to provide compensation to maintain your business. Allianz Trade is present in 52 countries with 5,500 employees. In 2022, our consolidated turnover was € 3.3 billion and insured global business transactions represented € 1,057 billion in exposure. 

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