Trade financing faces new challenges

Growing challenges in global trade services market is applicable to local market as well. Challenges like trade finance gap, information gap, document rejection, court injunction, disruption in correspondent banking relationship, financial crime, especially trade-based money laundering etc have increased and become more complex over the years. Especially, compliance challenge has become the most critical one, connected with a number of the above mentioned issues. 

Available published data identified significant gap in the provision of trade finance, especially for the growing Small and Medium-sized Enterprises (SME) sectors in emerging markets. The perception of a shortfall of trade finance globally has become evident and an increase in rejection of trade finance proposals or applications has adversely affected SME applicants. Though the situation is improving, it remains a critical challenge. The Asian Development Bank (ADB) estimated demand and rejection rates of different regions and identified that unmet demand is the highest in Asia-Pacific, African and Middle Eastern regions. According to the most recent ICC survey, the global capacity for trade financing is expected to worsen. About 22 per cent of the respondents were optimistic about the increase in unmet demand while 57 per cent said it would be largely unchanged. These responses together suggest that advocacy to address trade finance gap must be stepped up, and that global trade financing capacity. A total of 43 per cent of banks in Africa feared that the gap may further widen.

International trade is vulnerable to abuse and there are several instances of document rejection and court injunctions. Despite improvements, there are several challenging situation concerning documentary compliance and reported instances of refusal of documents on first presentation.  Still, there are practices of offering spurious discrepancies in documents presented under LC to delay payment or creating obstruction. Trade based money laundering is a critical area of malpractice which can be practised through misrepresentation of the price, quantity or quality of imports or exports. The techniques involved are: over and under-invoicing of goods and services; multiple invoicing of goods and services; over and under-shipments of goods and services; falsely declared goods and services etc. In many cases, this can also involve abuse of the financial system through fraudulent transactions involving a range of money transmission instruments, such as wire transfers. Regarding the currency and ongoing approach of addressing trade based money launders, there are observations that 'despite a significant proportion of international trade being conducted on 'open account' terms, firms' trade-based money laundering (TBML) controls typically focus on transactions supported by traditional trade financing such as LC and this is disproportionate and leaves a gap in the industry's response to TBML.' Inter-agency cooperation is crucial to addressing TBML and mis-invoicing practices.  While inter-agency cooperation is possible in most countries, agencies still need to overcome legal, regulatory, cultural, and operational barriers which may prevent the sharing of specialised information with other law enforcement agencies.

Increasing compliance requirement has raised the overall costs of offering trade services in all global economies. The most recent ICC survey identified that, capital adequacy requirements have made trade finance business more expensive and have translated directly into balance sheet constraints on the business, which compound constraints related to risk. Due diligence requirements is a matter of major concern, due to cost and resource needs. What is more, consistency is lacking in regulatory requirements across borders. These fundamental issues must be addressed, in parallel with developing KYC (know your customer) utilities. Despite the challenges of due diligence and KYC, 34 percent of respondents said they did not use a KYC utility, due to cost, operational considerations, and the challenge of complex technical integration. Almost 70 per cent said they work with a specialised service provider of KYC and due diligence, while others use an industry utility. Price verification for financial crime control purposes is another difficult challenge. Banks generally are not in a position to make meaningful determinations about the legitimacy of unit pricing due to lack of relevant business information such as the terms of a business relationship, volume discounting or the specific quality of the goods involved. Further, many products are not traded in public markets and there are no publicly available market prices. Even where goods are publicly traded, the current prices may not reflect the agreed price used in any contract of sale or purchase and these details will not usually be available to the financial institutions involved due to the competitive sensitivity of such information.

The last decade in particular has seen a rise in Fin-Techs entering the market and partnering with some of the arguably more forward-looking traditional financial institutions in a bid to revolutionise traditional finance practices, including trade and supply chain finance. There is a view regarding the potential benefits to non-bank providers of trade finance and supply-chain finance, of having a nascent and far less stringent or mature regulatory framework to deal with. It is argued that current regulatory expectations are not particularly conducive to bank involvement in trade finance. Though non-bank institutions are subject to regulations, including national regulations and sanctions, these do not, however, face the same level of regulatory expectation like banks in the areas of risk asset regulation and capital adequacy, and do have greater flexibility in client onboarding. The entry of non-banks and the rise of 'shadow banking' are indicating towards possible danger of lax regulation. The key advantages of non-banks relate to their not being required to comply with requirements relating to the whole risk asset framework and restrictions on capital requirements.

Sanctions may restrict a bank's ability to perform its role and may confront with different sanction regimes imposed in multiple jurisdictions. Sanctions are imposed by the United Nations, the EU Council or individual countries to achieve political and economic ends. They may prohibit dealings with specific countries, persons or property. Thus, these banks may be subject to conflicting regulatory requirements and legal risks. In several instances, banks have chosen to control these legal risks by use of sanction clauses. Banks should bear in mind that if any transaction falls under applicable sanction hits, it becomes the legal obligation to abstain from its payments.

The number of linkages between banks has been declining in recent years, largely because the industry has been consolidating. The impact of the de-risking has now been rebounded to some extent, as the development institutions like Word Bank, IMF etc are now working almost in the same line to redefine correspondent banking business to bridge the gap between uncertainty in regulator expectation and compliance programme of global correspondent banks. However, the role of certain banks as supportive institutions like advising bank, second advising bank, nominated bank under documentary credit, and collecting bank and presenting bank under documentary collection have changed remarkably. These very important supporting roles were relatively uniform for all the bank counter parties even in the recent past. But now-a-days, it is varies from one bank to another in the name of internal compliance policy. Recently some banks refuse to advise credit through banks (as advising or second advising bank) with which they do not have any RMA (return merchandise authorisation) relationship due to internal policy issue; some banks do not handle bill/documents for presentation, as they do not have RMA with collecting or remitting bank.

Dr Shah Md Ahsan Habib is Professor and Director, Bangladesh Institute of Bank Management (BIBM). [email protected]