Trade is the lifeline for practically every national economy. Despite their heavy presence and share of employment, small and medium-sized enterprises are strikingly underrepresented in cross-border trade. A study of the Organization for Economic Cooperation and Development’s member countries shows that SMEs, or small- to mid-size enterprises, account for 95% of all firms, two-thirds of total employment, and over half the business sector’s value added. However, their annual contributions to the external sector are significantly lower – between 20-40%. This difference is even more pronounced in emerging markets. For many countries, particularly those in Africa and South America, agricultural and natural resource sectors dominate the economy. For these countries, the diversification and expansion of exports will be crucial for future industrial growth. The U.S. International Trade Commission found that exporting SMEs outperform their non-exporting counterparts in several measures including higher total revenues, faster revenue growth, and higher labor productivity. By expanding their involvement in international markets, SMEs have the potential to experience immense economic growth.
However, it’s fairly difficult for SMEs to export. One main problem for SMEs is their struggle to access adequate trade financing. With limited cash flow and liquidity, small companies, especially those in emerging markets, must rely on lending institutions to supplement their transactions. However, large credit institutions require strong historical financials, hard collateral, and high volume transactions. Without significant guarantees, many banks in emerging markets are ill-equipped to manage the operational risks associated with SMEs. When it comes to extending short-duration credit lines, factoring, or debt financing to micro-enterprises and SMEs, the hypothetical juice is not worth the squeeze.
The Asian Development Bank (ABD) found that over 40% of SMEs faced rejections on their trade finance applications. Cited impediments to obtaining financing include Anti-Money Laundering (AML) & Know Your Customer (KYC) terms, low credit ratings, and Basel regulatory capital requirements. Due to this, financial institutions willing to risk lending to SMEs charge exorbitant interest rates and fees because they face little competition from other firms. They are able to monopolize the system and face little consequence at the expense of the SMEs that are consequently unable to export.
In 2019, the ADB found that the global trade finance gap, the amount of trade finance rejected, totaled over $1.5 trillion USD with developing economies in South America, Asia, and Africa accounting for the vast majority of the gap. It is estimated that over $350 billion of trade finance applications are rejected by major lending institutions in Latin America alone. The trade finance gap is a significant impediment to reducing poverty and improving global living standards. If SMEs are able to expand and diversify their involvement in international markets, the resulting growth will generate employment opportunities for millions of individuals. Diminishing the gap would help achieve many of the UN’s Sustainable Development Goals including minimizing inequality and promoting sustainable economic growth for all.
The fallout from the COVID-19 pandemic has only exacerbated the situation. The WTO estimates global merchandise trade decreased between 13-32% during 2020. Using these calculations, the International Chamber of Commerce (ICC) found that an additional $1.9-5.0 trillion USD will be required to restore global trade to 2019 levels. Factoring in setbacks from the pandemic, the current trade finance gap lies between $3.4 and $6.5 trillion.
Technology will play a key role in helping SMEs overcome barriers in the financing process. Using the power of machine learning and data analytics, lenders can restructure their risk models to better fit the needs of smaller clients. By crafting data-intensive risk models, institutions can consider operational data, industry verticals, and regional trends when determining financing options. Access to these measures helps firms better accommodate KYC guidelines and mitigate risk wherever possible.
Blockchain can accelerate the financing process by eliminating inefficient paper-based processes while still maintaining data security. Many fintechs are currently using AI and Blockchain to help market their financing solutions. By offering speed and flexibility, these smaller specialty lenders are able to compete with traditional institutions. The playing field is leveled. For instance, Marco Financial, a Miami-based online financing platform, shortens the loan origination process from 2-3 months to 1-2 weeks. Rather than manual underwriting methods, Marco uses advanced data analytics and AI to continuously update and expedite the process.
In addition to technology, SMEs from emerging markets may look towards accounts receivable factoring as a substitution for traditional bank loans. This type of transaction occurs when a firm sells invoices for receivables at a discounted price to a third-party “factor,” who goes on to collect payments from the company’s buyers. Factoring allows firms to immediately replenish their cash balance to pay any outstanding debts, buy new equipment, or expand operations. This service is especially enticing to SMEs exporting their products under 60-90 day payment terms. By freeing up capital tied to accounts receivables, businesses can stay afloat and even begin to grow their operations. If financial institutions can provide factoring services at a reasonable rate, SMEs will be able to improve their exporting productivity.
International trade is a major engine of economic growth and poverty reduction within developing countries. Increasing presence in global markets helps create jobs, mitigate inequality, and raise living standards. In order to internationalize their operations, many SMEs require trade finance to supplement their expansion, and there are many obstacles to that. Along with fallout from the pandemic, this reluctance to lend widened the trade finance gap. SMEs in developing countries, especially those in South America and Africa, are overrepresented in loan rejection rates. Technology may help bridge the gap within global trade finance: AI and machine learning utilize advanced data analytics to eliminate inefficiencies and create new models for managing risk. Ultimately though, the financial future of many emerging markets lies in the hands of technological advancements and our ability to effectively implement them. It is therefore paramount that for the most efficient and optimal economy, developing countries must adopt these technological advancements.