Africa has a high unmet demand for trade financing with an estimated annual trade finance deficit of USD 91 billion. Africa’s share in the global trade market is miniscule with exports accounting for 2.5% of global trade, and imports at 3% in 2018. Larger enterprises on the continent dominate formal trade as SMEs face unique challenges, including access to trade finance. Although banks currently support one third of Africa’s trade, only 28% of banks’ total trade finance portfolio benefits SMEs, while the bulk of trade finance facilities serve large companies.
What are the key reasons for SMEs struggling to access trade finance even though they comprise 80% of the firms on the continent?
The first key reason is the difficulty of assessing creditworthiness of SMEs on the continent. Creditworthiness is one of the key elements of a bank’s underwriting processes, but it is difficult to ascertain on the continent, where credit ratings are not standard. When it comes to trade financing, in advanced economies, the lender would expect the contract between seller and buyer to be enforced given that reneging on a contract would negatively impact the buyer’s credit rating. In the absence of such safeguards, trade financing for enterprises on the continent has an added element of uncertainty. Banks might be surprised though to learn that trade financing on the continent is less risky than other types of lending. The estimated default rate on trade financing on the continent is 5% as opposed to the 12% for non-performing loans for all bank asset classes.
The second key barrier to trade financing is the inflexibility on the type of collateral required. Collateral requirements on the continent can be as high as 100% of loan value and this is typically limited to traditional collateral i.e. fixed assets, guarantees etc. Most banks are not yet open to considering the goods traded or the receivables of the contracts financed as their collateral on a standalone basis. Hence small companies have often already pledged all their assets to one bank to receive a term-loan or overdraft facility and are then limited when applying for a trade finance or working capital solution as there are no more assets available to pledge. Further some small traders who lease warehouses simply don’t have large assets which they can offer as collateral.
Source: African Development Bank, Trade Finance in Africa 2017 report
*- Original list of questions broke out single obligor limit and bank balance sheet constraints, but they have been merged for the graph under, “single obligor limit*”
The third key factor is the single obligor limit which local banks often face as in trade finance companies, even the smaller ones, often require large amounts of short-term liquidity as they need to be able to buy goods in bulk during a specific time period when prices are low. From a balance sheet perspective, local banks then face restrictions not being able to provide sufficient liquidity to a standalone client.
Other factors that affect both SMEs and larger corporations when it comes to seeking trade financing include political risk – that gets compounded when goods will be moving across borders and also currency risk. The currency risk in trade finance relates to lender’s concerns about their funds getting stuck in a country in which they don’t operate, or the fear of currency devaluation or a shortage of foreign reserves that may result in a lack of payment. Their fears are not unfounded as there are several African countries with highly restrictive policies on the flow of foreign reserves. As an example, in Ethiopia it is extremely difficult for any foreign owned businesses to recover capital brought into the country once it has been converted into local currency. Foreign exchange shortages are extremely common too.
Some of the solutions to address these binding challenges include countries building capacity of local financiers on collateral based financing schemes, building partnerships between international financiers and local banks to set-up dedicated trade finance lines bridging the liquidity / single obligor limits, Development Finance Institutions (DFIs) partnering with traditional lenders to manage some of the risk (e.g. in the form of credit guarantees for trade finance), investing in credit rating mechanisms and also having non-traditional lenders expand their services to companies that might otherwise not get bank financing for trade.
In trying to address the constraints faced by those on the continent trying to obtain trade financing, AATIF recently rolled out its first commodity based financing schemes. In the first investment of this type for the fund, AATIF provided a USD 11m collateral management facility to African Milling Limited (AML) to finance the purchasing of wheat and maize from farmers in the region for further processing and onward selling in the local market. The facility is purely collateralized by the commodities and uses a local bank as agency bank to support in management, but also to build knowledge and comfort around these structures. The second investment was a EUR 20m trade finance facility for Phoenix Commodities, a global agribusiness company. The facility was granted for the local purchasing and exporting of cashew nuts from Ivory Coast and is again secured by the commodities and receivables.
AATIF seeks to further roll-out these financing structures – also trying to target smaller trading companies across Africa. Trade financing, especially for smaller companies on the continent, could go a long way in ensuring that the continent fully realizes benefits from global trade.
AATIF is an investment fund offering debt capital to companies and financial institutions active in the agri/food sector in Africa. AATIF aims to fill gaps identified in this article through investments in small, medium and large-scale businesses along the entire agricultural/food value chain including in agricultural inputs, equipment and machinery, farming, transport and logistics, processing, export, to wholesale and retail trade. To apply for funding for your food/agri-business, access our funding questionnaire at https://www.aatif.lu/funding-application.html