Why trade finance is vital in fostering intra-African trade

02Nov 2017
Correpondent
The Guardian
Why trade finance is vital in fostering intra-African trade
  • • Trade finance is a relatively low-risk activity in Africa with an average default rate of five per cent, while a high proportion (87 per cent) of banks on the continent are engaged in trade finance activities

East and southern Africa leads in intra-African trade with the highest share of between 18 and 19 per cent, which reflects Common Market for Eastern and Southern Africa (COMESA) and Southern African Development Community’s (SADC) effective agenda in consolidating trade and development in Africa.

According to the Trade Finance in Africa Survey Report by the African Development Bank Group published in September 2017, North Africa and Central Africa have the lowest share of intra-African trade of 5.3 and 2.1 per cent, respectively.

 

The survey tracks the changes that have occurred in the trade finance market in Africa during the period 2013-2014.

 

Among other things, it reveals that compared to other regions of the world, Africa’s trade is still dominated by international trade, where the European Union accounted for 63 per cent of total trade, 50 per cent for North America and 52 per cent for Asia in 2014.

 

Intra-African trade only accounted for 15 per cent of overall trade in the same year.

 

The report also reveals that significant challenges lie ahead in meeting the demand for trade finance by African firms, of which the majority is composed of SMEs.

 

Trade finance is a relatively low-risk activity in Africa with an average default rate of five per cent, while a high proportion (87 per cent) of banks on the continent are engaged in trade finance activities.

 

The survey disclosed that banks in West Africa have more significant exposure to trade finance with a 31 per cent share of their total assets devoted to that activity, followed by Central and East Africa at 28 and 25 per cent, respectively.

 

“This regional disparity could be explained primarily by the risk profiles of countries in the sub-regions, in addition to their income levels and their economies’ reliance on natural resources,” said the report.

Commercial banks in fragile states are also highly engaged in trade finance activities with trade assets representing 50 per cent of their total assets, compared to banks in non-fragile states where trade finance exposure averages 14 per cent.

“Thus, funding trade, which is a relatively less risky short-term activity, appears to be one of the core activities of commercial banks in fragile states. Indeed, banks’ assets in these markets are more skewed towards short term activities (such as trade finance) given the relatively higher risk associated with providing longer term finance in such economies,” the report premised.

However, banks in North and Southern Africa recorded the lowest exposure to trade finance with 15 and eight per cent, respectively, of total bank assets devoted to trade finance.

“This could be a reflection of a more developed financial sector where banks in such markets are able to hold a diversified portfolio of assets under a wider range of banking activities. For instance, bank assets in such markets are not necessarily dedicated to short term activities such as trade finance but go beyond that to finance much longer tenures and higher volumes as required for infrastructure and housing projects,” stated the report.

 

Trade is an important catalyst for economic growth and poverty reduction, but Africa has yet to fully capture the growth-enhancing benefits of trade.

 

Africa’s shares of global GDP and trade currently stand at only three per cent, yet it accounts for 11 per cent of the world’s population.

“A correction of this anomaly is possible if we work to remove the constraints to trade. And there are quite a number. The infrastructure deficit that has for long inhibited regional and international trade is well known,” said Akinwumi Adesina, the president of African Development Bank Group.

He added that another major impediment is the lack of availability of trade finance – the lubricant of trade without which opportunities for growth and development are missed.

“The African Development Bank has always recognised the importance of access to trade finance for businesses,” added Adesina, saying that while significant efforts have been made in reducing barriers to trade finance in the recent past, not much is known about the dynamics of the trade finance market in Africa and bridging this knowledge gap has become a critical element.

The major findings of the Trade Finance in Africa Survey Report uphold that two major reasons for banks’ rejection of trade finance facility applications are weak client creditworthiness and insufficient collateral.

Banks are also facing several challenges hampering the growth of their trade finance portfolios and mention competition, lack of sufficient risk capital and limits with correspondent banks as the main constraints.

The survey concludes that a win-win partnership and a collaborative approach involving development partners is needed to overcome the challenges of access to trade finance faced by financial institutions and the private sector in Africa.

The findings of the report also show that trade finance is a powerful instrument which, if well designed, could go a long way to foster intra-African trade and regional integration, calling for closer collaboration among the different suppliers of liquidity and risk mitigation on the continent in order to create the necessary synergy and to better complement one another.

“For Africa to improve its competitiveness, raise productivity, and achieve robust and inclusive growth, it is essential that African countries become more integrated into the global economy and have a strong and well diversified export base. For this to happen, trade finance must be genuinely accessible and affordable to those who need it,” noted Adesina.

Looking ahead, there is still a lot to be done to bridge the trade finance gap in Africa.

Meanwhile, the Common Market for Eastern and Southern Africa (Comesa) has announced cutting of its 2018 budget by US$10 million to US$32 million.

The announcement was made recently at the 37th meeting of the Committee on Administration in Lusaka, the eastafrican reported this week. The 19-member states are expected to contribute a total of US$16.7 million while partners are expected to provide US15.6 million.

Comesa secretary general Sindiso Ngwenya said the funding from partners may increase for 2018 if the programming processes of the 11th European Development Fund funds are completed early and grant agreements signed.

The EU funds about 61 per cent of Comesa's budget as several member countries either fail to pay up or remit the payment past the deadline. Other partners include USAid, TradeMark Southern Africa, Rockefeller Foundation, Norway and the African Development Bank.

Among the Comesa agencies that will be affected are the Regional Investment Agency, the Federation of Women in Business and the Comesa Competition Commission.

The funding from development partners is directed towards programmes such as climate change, human security support programme and regional integration support mechanism.

"At some point, our partners will expect us to assume a greater share of funding of Comesa's programme," said Sindiso, adding that member states should find ways to increase their contributions.