Small and medium-sized enterprises make up about 90% of businesses in the world, however, many struggle to access trade finance. When it comes to closing the trade finance gap, banks—specifically those with deep understanding of their local business communities, can be the missing piece of the puzzle.
Trade finance is about risk and providing working capital. This is typically done by finding the party in the transaction with the lowest risk and using their access to capital to fund the transaction. For established supply chains, this process can be quite simple. Supply chain finance as a product leverages the cheap financing available to large buyers (think Walmart, Nike, etc.), and they use that financing access to their supply chains across the globe. Banks are eager to participate, and traditional paper-based products like letters of credit (LC) are rarely used.
Further down the supply chain, it becomes more complicated and the need for traditional trade finance products like letters of credit becomes much greater.
Small and medium-sized enterprises (SMEs) are the heart of most economies as major contributors to jobs creation and economic development. According to the World Bank, SMEs make up about 90% of businesses and over half of employment worldwide. In emerging economies, formal SMEs contribute up to 40% of GDP.
However, SMEs have a hard time accessing trade finance, and addressing this is an important piece of the puzzle when it comes to closing the trade finance gap.
Banks: The missing piece of the trade finance puzzle
The reason SMEs struggle to access working capital is that they do not sell directly to such large companies as Nike or Walmart and therefore are ineligible for supply chain early payment programs. Supply chains have many layers, and it gets harder the further you are away from the top layer. Their customers may be SMEs themselves, or they might be even smaller B2C companies who need to manage large inventories to meet consumer demand.
Banks can be the missing piece—and specifically banks with a deep understanding of their local business community and with support from organisations like the IFC.
“As a fintech, companies like Contour can level the playing field with flexible and cost-effective Software as a Service (SaaS) solutions and bring together banks of all sizes on a common network. Only with this diversity of inter-bank collaboration on a common network can we start to reach all types of corporates and reduce this finance gap growth.”
– Joshua Kroeker, CPO, Contour
If an SME has a trade finance facility, they can ask their bank to lend them money to pay their supplier, or even arrange the bank to pay the supplier directly through an LC. In this case, the supplier needs only to accept the risk of the bank, not the risk of their SME. This, in turn, allows them to obtain financing for their own business from their local bank. These types of loans are transactional, and repayment schedules are designed to match their working capital cycle (i.e., the time it takes to turn an input such as a raw material into cash). The result is a virtuous cycle of banks having low risk, short-term loans that are self-liquidating, and buyers and sellers receiving both the finance and risk management they need.
However, it is expensive for a bank to provide transaction-based financing tailored to the working capital cycle of an individual company. It costs roughly the same to process a $50,000 loan on a $500,000 facility as it does to process a $10 million loan on a $100 million facility. Because of this, smaller banks may not invest in a trade finance offering, and large banks may not be inclined to provide their services to smaller clients. It can also be hard for smaller clients to manage the paperwork and process of these types of facilities, and errors in paperwork can destroy the protections these products provide.
Technology plays a major role in reducing this cost-to-serve and improve the accessibility of these products.
It is now possible to significantly simplify, streamline, and digitise the process of providing trade finance—even for products like the LC. The LC is one of the most traditional trade finance products, but one that may be best suited to creating the aforementioned ‘virtuous cycle’.
Levelling the playing field
Large global banks have been investing in technology for decades to reduce their costs to serve, but global trade is not just global banks, and they cannot digitise trade alone. Trade finance requires a network of banks large and small, each with varied mandates to support both MNCs and SMEs in the regions where they operate.
As a fintech, companies like Contour can level the playing field with flexible and cost-effective Software as a Service (SaaS) solutions and bring together banks of all sizes on a common network. Only with this diversity of inter-bank collaboration on a common network can we start to reach all types of corporates and reduce this finance gap growth.
Founded by eight banks of diverse sizes and geographies, Contour’s platform was conceptualised through industry collaboration. The purpose is to build more intuitive, digital, and cost-effective trade finance solutions. Contour does not invent new products and legal standards, instead improving processes for existing products and leveraging tested legal standards common around the world.
Contour is not just accessible software for banks; it’s also an offering for a bank’s corporate customers, including SMEs. This combination allows a bank with a fledgeling trade finance offering to deliver a world-class experience to both their staff and their customers without significant upfront investment.
Connecting local banks globally
Beyond the software offering, Contour also offers the industry another key to growth—a network. By joining Contour, local banks are automatically connected to all other banks and corporates in the network, including some of the largest banks in the world.
This interconnection is important as it becomes increasingly difficult for local banks to find global banks willing to accept their payment obligations. In an LC transaction, it is common for the seller to ask their bank to accept the risk of the overseas issuing bank. This ‘confirmation’ of risk is subject to the confirming bank having risk appetite, KYC, and other information on the overseas issuing bank. If they don’t, the whole transaction could be at risk.
This is where the global trade finance community, on a network like Contour, can provide a very useful service. If the network is strong enough, someone will have interest in this risk and the revenue that comes along with it—but the key is finding that someone in a timely manner. By connecting the world’s banks, large and small, on a common network, the probability of saving this transaction and putting together the right participants is greatly increased. This not only saves a transaction, but it also makes a once impossible business possible. This community-based approach to risk distribution is currently being explored in Contour’s Future of Finance lab, and we are very excited about the early results.
Building the future of trade finance is indeed a puzzle, but ensuring SME and local bank inclusion may turn out to be that crucial piece of the puzzle that has been missing so far. As the world prioritises Environmental, Social and Governance (ESG) issues, we are focusing on the “S” at Contour and making a difference in our societal impact.
If you would like to learn more about Contour and how we are changing the face of trade finance, contact us here.