Problems with Trade Finance
That foreign trade should be fair rather than free. — Lyn Nofziger
By now, you can probably see for yourself what’s wrong with the existing model of trade finance. What was once a simple process of exchange has been replaced with a process that is dependent upon layer upon layer of intermediaries, each with its own idiosyncratic bureaucratic procedures, rules, and costs. These processes have led banks and middlemen to become fiercely protective in order to maintain the status quo which only serves their own interests and makes it difficult for real businesses to secure the trade finance that they need.
So how does this affect you? Well, think about the last time that you went to a store and wanted a specific product, but could only find one option. Maybe broadening the availability of trade finance would allow other manufacturers to produce and sell their products which would give you more, or higher quality, or less expensive options. The lack of trade finance acts as a bottleneck to limit consumer options.
KYC & Trading Histories
One of the simplest barriers to entry for availability of finance is basic KYC. Thousands, if not millions, of SMEs and startups face tremendous difficulties with banks because their KYC packages and trading histories are “insufficient”. This is a catch-22 situation because those SMEs who need finance can’t establish a trade history or build a credit profile without that finance. SMEs that do have a positive credit risk profile typically don’t struggle to find finance.
Intermediaries
Assuming you can get finance, the next hurdle in financing is the associated paperwork. As we touched upon in Part 2, there are multiple people and organizations involved in every step of the trade process. Insurance companies, shipping companies, surveyors, and brokers (to name a few) all play an integral part in trade. Each of these entities have their own procedures and documentation that are deemed “necessary” in order to appease the banks involved. Each document is almost exclusively paper-based and must be processed manually with original copies physically being shipped everywhere needed. This latency creates a ripple effect as each additional document adds to the delay before a buyer and seller can actually conclude their business.
Costs
The biggest hurdle of all tends to be cost. Each intermediary involved in trade will want a piece of the action and charge fees for their services. While there’s nothing inherently wrong with this practice, fees can quickly add up and become a significant burden on the profitability of trade. Banks, too, charge large fees to a transaction and create their own hurdle by requiring yet more paperwork, almost as if trying to justify their fee structure.
SMEs who are able to pass the first two hurdles quickly realize that what was once a profitable trade may not be so attractive once banks get involved. The overall scarcity of trade finance as created by banks leads to much higher financing costs. The situation has become untenable and SMEs are literally “damned if they do (get trade finance) and damned if they don’t”.
This blog post is the fifth in a mini-series looking at Global Trade Finance. For more posts on trade finance and the Bonorum Platform:
Part 1 — Introduction
Part 2 — What Is Trade?
Part 3 — Trade Finance Instruments
Part 4 — Why Trade?
Part 5 — Problems With Trade Finance
Part 6 — An Example
Part 7 — Digitizing Trade
Part 8 — Show Me The Yield!
Part 9 — What’s Bonorum?
Part 10 — Meet The Team
All articles and posts have been written and produced by team members of the Bonorum Platform. Click here to learn more about Bonorum and how it can help you as business or as an individual.
