Trade finance and the impact on global financial inclusion

The Financial Stability Board (FSB) said in May that the ongoing decline in correspondent banking relationships is “a source of concern for the international community” and that “should the situation deteriorate further” it will look at taking action. The number of active correspondent banks has fallen by 19.3% since 2011.

The issue at stake is whether all countries – particularly in the developing world – have access to global financial markets, or, as Mark Carney, Governor of the Bank of England, said in a recent speech, face “financial abandonment”. One of the major worries that the FSB has with regard to correspondent bank relationships is the need to support remittances.

The burden of bank regulation on SME trade finance

Banks have cut correspondent banking relationships because of the cost of meeting stiffer regulatory requirements – particularly those designed to prevent money-laundering and the financing of terrorism. At The London Institute of Banking & Finance’s Annual Trade Finance Compliance Conference in mid-May, delegates highlighted that a correspondent banking relationship can cost a bank between £40,000 and £100,000 a year – something that may make little sense in smaller developing markets.

At the same time, banks are very aware of the urgency of the problems that shutting down such relationships can cause. Making remittances difficult is one, but there are others that are at least as serious.

At the conference, delegates discussed how the burdens of complying with regulation could mean the end of trade for SMEs if the trade finance gap is not closed. Speakers noted that European regulations do give some capital relief to banks providing funding to SMEs and that there are currently a number of studies of SME financing (see: www.fsb.org/wp-content/uploads/P250219.pdf). However, it was also pointed out that 87% of world trade is in US dollars and that using a different currency for one leg of a deal is not enough to avoid triggering US rules (and the associated regulatory burdens).

Big corporates to the SME rescue?

Supply chain finance from big corporates might help close some of the trade finance gap for smaller firms – after all, they know their suppliers well (and often the suppliers of their suppliers) and have an interest in seeing that their businesses are funded – as well as having the capital to support them.

However, one of the main problems, some conference delegates argued, was the risk that the smaller players would be at the mercy of the larger corporates – forced to use their solutions, at the price they set. Others countered that both sides need one another and that supply chains overall were becoming much more transparent thanks to technology, which should help mitigate against abuse.

The overall view was that while technology and an increase in non-bank funding can help boost funding to smaller countries and firms, many of the regulatory demands that stymie correspondent banking in emerging economies will need a regulatory fix.