Trade financing is evolving because of changing global trade patterns as well as shifts in supply and demand, according to a new report from financial research and consulting firm Celnet. The emergence of Asia and growth prospects in Latin America and Africa have had a significant impact on banks’ trade financing techniques.
Key findings of the report, “Trade Finance: Servicing an Evolving Global Economy” from Boston-based Celent, include:
*World trade growth decelerated to 4.5% in the first half of 2008, down from 5% in the third quarter of 2007, and is likely to be still lower by the end of 2008. The US saw a weakening of domestic demand. Growth in the US will be around 1.3% in 2008, and the economy will be further affected by rising energy prices, rising food prices, and tighter credit conditions. Japan experienced a similar situation. Europe grew at 2.8%, while Russia had the best year since 2000, with a GDP growth of 8%, driven by rising oil and gas prices. Developing countries’ growth rate is around 7%, contributing more than 40% of the global output growth in 2007.
*South-South trade, the trade between developing countries, is playing an increasingly important role in international trade. South-South intraregional trade, especially within Asia, is growing much faster than the growth of world trade. In 2006, total exports from the South reached $4.5 trillion, accounting for 37% of world trade.
*Asia is the world’s most important trade hub, with intra-Asian trade accounting for about 90% of total South-South trade. By 2008, the developing countries (including China) already have a share of around 40% of world exports. By 2030, it is estimated that 45% of the international trade will be developing countries, while the high income countries will see a 13% drop to a 55% share.
*Intra-firm trade comprises 45% of international trade and is a major driver of open account transactions. In the United States, 40% of trade is touted as intra-firm trade. The Netherlands (50%) and Sweden (60%) have high intra-firm trade, while in Japan it fell to 20%. With the data available, it is estimated that in most of the OECD countries, the share of intra-firm exports is 40-60% of total exports.
*The trend continues towards open account trading, but with the rapid growth in South-South trade, traditional trade finance tools like L/Cs and guarantees are finding a new area of growth (the majority of L/Cs issued are for Asian trade). L/Cs are the still the most frequently used trade finance tool, with more than 80% of firms still using them. On average, 65% of trade activity is through open accounts, though only 50% of firms use them, whereas 20% is through L/Cs, even though 83% of the firms use them. Even in firms where L/Cs are used, most of the transactions are done via open accounts.
*The growth of open accounts increased the use of various insurance products. 50% of organizations have buyer’s insurance, while 25% use political risk insurance, and 22% utilize factoring techniques to mitigate the risk.
*Another trend is the ever increasing contribution of SMEs to merchandise trade, ranging from 20% to 60% in various countries, and the opportunities for trade finance in this sector. SMEs in trade are affected by the tariff and non-tariff barriers and they have a constraint on liquidity. With these barriers coming down, financial institutions have a huge role to play in enabling SMEs. The trade financing requirements for SMEs are radically different from the bigger players, and this opens up a huge opportunity for the trade finance banks to provide innovative solutions for SMEs.
*Factoring is a $2.15 trillion business. It has grown by more than 70% in the last five years, and its year-on-year growth for the next couple of years will be around 13-14%. By 2010, factoring will be a US $2.75 trillion business. Even by conservative estimates, factoring worldwide is more than 40-50% of the size of the L/C market.
*Europe, in particular, is showing double-digit growth and is driving the global growth for factoring. In Asia, Japan has always been a factoring hub. But in the past five years, China and Taiwan have embraced factoring very well and both of them show tremendous growth year-on-year. Factoring in China is now a $14 billion business. The Indian factoring business is at $7 bn today and will touch $12 billion by 2010. With SMEs driving the exports in India, factoring will sustain a growth rate of 20% for the next few years.
*Basel II regulations have forced banks to assign higher risk weights to trade finance, thereby affecting capital flow to trade. The higher risk capital has resulted in lower financing for trade as well as a move away from plain vanilla working capital loans to factoring and supply chain financing options.