Access to finance for small businesses is essential for a full recovery, writes the secretary general of the International Chamber of Commerce.

John Denton

John WH Denton

With the outlook for the global economy increasingly uncertain, governments and financial institutions must prioritise interventions that address the trade financing needs of small and medium-sized enterprises (SMEs).

Small businesses around the world continue to suffer from uncertain economic conditions caused by the Covid-19 pandemic. While governments and development banks have taken steps to support these businesses, more proactive interventions are required to ensure their survival.

Morale among SMEs in emerging markets has deteriorated in recent months, corresponding with warnings of a growing stimulus gap in many low- and middle-income countries. In Colombia, business failure rates in August were 60% higher than levels recorded during the same month in 2019. According to International Chamber of Commerce (ICC) data collected in September 2020, 53% of small business owners in the least developed economies fear that their firms will close permanently unless there is a significant improvement in their cashflow over the next six months.

SMEs operating in advanced economies are not immune to this worrying trend. The UK’s Office for National Statistics reported in November that nearly 19% of UK small business had either temporarily or permanently closed their doors since the start of the pandemic. As SMEs prepare for an uncertain future, they are expected to remain highly reliant on short-term loans and working capital facilities to remain solvent in 2021. Yet, with credit conditions tightening as default risks increase, it is increasingly likely that the supply of bank finance will be insufficient to meet the liquidity needs of SMEs in the coming months. From a global perspective, this is particularly troubling given that short-term finance underpins 80% of all global trade transactions.

Unless governments and international financial institutions intervene to backstop the supply of credit from commercial banks, SMEs will suffer from shortages of credit that could starve them of essential liquidity and halt commercial opportunities. This is not just a theoretical risk: available data already points to a widespread reduction in the supply of trade credit to SMEs – particularly in emerging markets – mirroring trends seen in previous economic shocks of recent decades.

To avoid this worst-case scenario for the global economy, governments need to prioritise interventions that will unlock trade finance for SMEs and keep the global economy moving forward.

Why trade finance?

SMEs desperately need liquidity to survive the ongoing economic crisis and, moreover, most mainstream economists seem to agree that international trade will be a vital form of relief for cash-strapped firms in 2021. Set in this context, securing the supply of trade finance must be a high priority for governments looking to stem the economic damage wrought by the pandemic and power a recovery capable of restoring growth and productive employment.

The size of that challenge should not be underestimated: modelling by ICC estimates that at least $2tn of ‘fresh’ capital will be required to restore cross-border trade to pre-pandemic levels. But the good news is that trade finance offers national governments and financial institutions with a targeted, low-cost, short-term solution to provide SMEs with the immediate capital required to carry out cross-border transactions.

Trade assets present a generally lower risk to national treasuries compared to other forms of stimulus funding, given their securitised nature and low default rates, as evidenced by ICC data collected over the past decade. The tenor of trade finance transactions, typically between 60 to 120 days, should put to rest any concerns held by policy-makers of implementing long-tail Covid-19 stimulus measures.

What is more, for those worried about the risk of public money being misspent on businesses that would have failed even in sound economic circumstances, trade finance also provides a channel to targeted future stimulus funding to viable firms, for example, by connecting stimulus support directly to confirmed commercial invoices.

There are several readily available, concrete measures that governments can take to prime the supply of trade financing to SMEs. But in recognition of the cross-border nature of international trade, it is essential that national governments coordinate their interventions globally: after all, a trade finance shortage on just one side of a transaction can kill an otherwise promising trade deal. In this context, the most essential intervention is for the G20 to expand the provision of credit guarantees by government agencies and development banks at a scale capable of backstopping demand throughout the world.

Coordinated response

Some promising steps have already been taken in this regard. As the Covid-19 pandemic began to severely disrupt supply chains and global trade flows, the European Bank for Reconstruction and Development raised the limit on its trade finance guarantee facility to €3bn. The International Finance Corporation also received $4bn in additional capacity for its Global Trade Finance Programme and Global Trade Liquidity Programme.

Since the onset of the crisis, development banks have implemented several policies to keep trade flowing, such as extending online training schemes for banks to underpin support for SMEs in global supply chains. The Asian Development Bank, the Inter-American Development Bank and the Islamic Development Bank incorporated trade lines in emergency Covid-19 response funds, including priority allocations for trade in essential medical products. These interventions have already played an important role in stabilising market confidence, avoiding delays in processing transactions and providing additional coverage for trade lines.

In short, the foundations of a coordinated response are in place. All that is needed is a political commitment from the world’s largest economies to put the capital in place to scale the capacity of these existing programmes and emergency interventions.

Governments can also apply regulatory flexibilities – mirroring actions many have already taken to safeguard the supply of consumer credit – to protect the supply of trade financing to the real economy. In particular, policy-makers should revisit the Basel III reforms adopted by the Basel Committee on Banking Supervision in the wake of the recession of 2007-09. As proposed by Basel III, governments and central banks can reduce weights for exposures to SMEs from 100% to between 75% and 80%. By ensuring full application of this flexibility to trade financing, governments and central banks can mitigate capital constraints that might hinder the deployment of essential trade finance for SMEs.

Large-scale government or central bank purchases of trade assets, such as through securitised vehicles, should also be used to free up bank balance sheets to finance new SME-focused transactions. By taking these measures, governments can prime trade finance and advance a resilient and sustainable global recovery for all; better still if they make these interventions proactively, rather than scrambling to respond in the face of a frozen credit market.

Building back by going digital

The Covid-19 pandemic has exposed an additional vulnerability in the provision of bank-intermediated trade financing: an over-reliance on paper-based processes. Due to necessary public health measures taken in response to the pandemic, such as social distancing and teleworking, banks have faced growing difficulties in processing paper-based transactions.

As the global economy continues to build back, governments should work toward a rapid transition to paperless trade by removing legal requirements to be in hard-copy paper format. Following the lead set by India, Oman, Peru and the UK – all of which introduced emergency reforms in the second quarter of 2020 – governments need to phase out outdated requirements for trade documents to be presented in paper copy.

At the international level, there is scope for the G20 to fast-track the adoption of the United Nations Commission on International Trade Law Model Law on Electronic Transferable Records to provide a sound legal basis for the use of electronic documents in the processing of trade finance transactions, which is already being championed by the ICC’s newly-created Digital Standards Initiative.

Advisory group on trade finance

In recognition of the central role that access to trade finance will play in the global recovery, ICC has formed a high-level Advisory Group on Trade Finance (ATF) to develop recommendations for policy reforms that will mitigate credit shortages and fill persistent trade finance gaps. The ATF will provide thought leadership, data and strategic guidance to help bridge trade finance gaps, particularly in emerging economies. In collaboration with policy-makers, the ATF will inform interventions from governments and multilateral institutions to mitigate risks of short-term credit shortages affecting SMEs.

The group is led by former ICC chairs Victor Fung and Marcus Wallenburg. ATF members will formally convene for a limited period of 15 months and work closely with other relevant bodies, including the ICC Banking Commission.

There is a clear business case for governments, development banks and regulators to prioritise interventions that guarantee SMEs with access to trade finance.

SMEs have long been considered the backbone of the global economy, representing as much as 80% employment in many economies. But that spine will be severely weakened without effective intervention to prevent an existing liquidity crunch turning into a widespread solvency crisis. Now is the time for governments, development banks and regulators to take measures to keep the lifeline provided by trade finance in place, before it is too late. 

John WH Denton is secretary general of the International Chamber of Commerce.

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