68 Finance & economics The EconomistOctober 26th 2019
2 And they are safe. Annual default rates on
letters of credit averaged 0.08% of transac-
tions in 2008-17, compared with 1.6% for
corporate lending. When loans do sour, re-
covery is quick.
The work is as unspeakably tedious—
thousands of small, similar deals—as it is
steady. Annual returns on trade-finance in-
struments have an average volatility of less
than 0.30%, compared with 4.44% for in-
vestment-grade bonds. Four-fifths of glo-
bal transactions are processed by just ten
banks, mostly in London, New York or Sin-
gapore. Borrowers rarely switch providers.
Graduates would rather work on initial
public offerings or multi-billion mergers.
Business cards change, but not the cast.
“It’s very incestuous,” says a senior banker.
All this explains why an industry that is
global by definition is parochial and anti-
quated. From banks and insurers to ware-
houses and customs, processing trade
credit requires the exchange of 36 original
documents and 240 copies, on average;
each of the 27 parties involved spends
hours if not days fact-finding and form-
filling. Less than a quarter of banks use
electronic documentation. It is not, as An-
drew Colgan of Mizuho, a bank, notes, “a
screen-based market”. Standards and ter-
minologies vary across the industry, and
even within banks.
Since the financial crisis, regulators
have made banks set aside more capital
against risky or exotic lending. As a result
trade finance is punished, because it often
serves small firms in poor countries.
Watchdogs also want lenders to stop dodgy
flows of cash, and the cost of scrutinising
customers makes small trade-finance
deals unprofitable. So most lenders com-
pete for big clients, says Joon Kim of bny
Mellon, a bank. Low interest rates have also
crushed margins, which have shrunk by a
third since 2014.
In response, banks have retreated. The
top ten earned 19% of their transaction-
banking revenue from trade finance last
year, down from 27% in 2010, according to
Coalition, a data provider. The Asian Devel-
opment Bank (adb) reckons $1.5trn of fi-
nancing proposals were rejected in 2018.
“Country risk” was cited as a reason by 52%
of banks. Nearly half of applications by
small firms got nowhere. As supply chains
move from China to poorer countries, re-
jections could rise to $2.5trn by 2025, says
the World Economic Forum. That hurts
even big multinationals: many rely on the
niche suppliers shunned by banks.
Luckily transformation is coming—on
three fronts. First, thanks to the internet
and easier international travel, buyers and
suppliers know more about each other,
which boosts trust. Many blue-chip im-
porters are also keen to lengthen payment
terms beyond what exporters can bear.
This has fed the rise of “supply-chain fi-nance” (scf). It usually involves cutting out
several steps in the chain, with exporters
filing their invoices directly with the im-
porter’s bank, which pays them promptly
minus a fee. Suppliers need not waste time
and money amassing documents. They
benefit from their patrons’ stronger credit
rating (as it is the buyer who eventually
pays the bank). Last year banks earned
$21bn from scf, a 12% rise over 2017. It now
represents 18% of trade-finance deals.
Second, banks are starting to sell
tranches of the loans they originate to third
parties, while also acquiring slices of debt
from others. That helps to diversify portfo-
lios and increase lending capacity. Surath
Sengupta of hsbc, a bank, says it will sell
over $30bn-worth of trade assets in 2019,
up from $2bn three years ago.A profitable trade
Banks still account for over 95% of buyers
in this secondary market. But institutional
investors are starting to be lured in—
thanks to technology, the revolution’s third
prong. With its many transactions, trade fi-
nance is an ideal training ground for mach-
ine learning. Platforms like Tradeteq, a
startup, allow banks to repackage short-
dated invoices into rolling debt products.
Algorithms crunch data to predict credit
risks, so investors know what they buy.
More transparency and liquidity could
lead data providers like Bloomberg to re-
cognise trade finance as an asset class,
bringing it onto the radar of big money
managers. Fasanara Capital, a hedge fund
with €750m ($835m) of assets under man-
agement, has already invested in over
16,000 trade deals. Stenn International, an-
other firm, aims to quadruple its trade-fi-
nance assets to $2bn within 18 months.
Yet danger looms. Impeded by protec-tionism and an economic slowdown, the
imf predicts global trade will grow by just
1.1% in 2019, down from 3.6% in 2018. So far
that has put only a minor dent in finan-
ciers’ revenues, in part because supply
chains are being reshuffled, bringing glo-
bal banks new business. But smaller lend-
ers are more exposed. And competition for
a shrinking volume of deals could push all
lenders to lower interest rates.
That pool may shrink further as the
credit standing of borrowers worsens. This
year corporate defaults are expected to rise.
Meanwhile trade-credit insurance claims
are picking up, says Alexis Garatti of Euler
Hermes, a firm that insures payments to
exporters. This will probably mean rising
premiums and more lenders fleeing to the
safest borrowers, hurting margins further.
“We should expect a mild version of a credit
crunch,” says Francesco Filia of Fasanara.
The trade war between America and
China threatens to erase other gains. Rising
uncertainty in 2019, for instance, has led
both traders and lenders to demand more
paperwork. That feeds a resurgence in let-
ters of credit, at the expense of supply-
chain finance. The shift could accelerate as
the trade war leads importers to source
their wares from riskier markets, says Su-
kand Ramachandran of bcg, a consultancy.
Technological progress, at least, cannot
be undone. But it can harden emerging di-
vides. The birth of a single global stan-
dard—the 20ft container—revolutionised
shipping. But partly because of tariffs,
partly because fleeting consumer tastes re-
quire shorter supply chains, commerce is
splintering into regional blocs. If digital
standards also develop in silos, rather than
as part of a global effort, that may prove im-
possible to reverse. Trade finance may yet
see its container moment float away. 7Globally sourced