Breaking down barriers to trade finance in Africa

Africa’s share of global trade has fallen to less than 3% - down from around 4% in 1980 and 5% post-independence. This fall has happened despite a rapid increase in Africa’s share of the global population.

More and better financing for trade is part of the answer. Soha Abou Zikry, head of global corporate relations at CIB, says it is easy to sum up the current state of trade finance in Africa: “challenging, but with a lot of potential.” Financing trade is a complex endeavour with different players and many moving parts.

At the national level, there are governments and regulators. Operating within these national regulatory environments are local banks providing trade finance to local SMEs and corporates. Local banks are in turn reliant on relationships with larger international banks. At each level, there are challenges that require private or public sector solutions - and frequently both.

The larger corporations often find themselves comparatively well provisioned. “If you're a large business or a multinational you can get credit lines, you can get guarantees from a parent company, you can source FX from different places - the banks are happy to provide support,” says Segun Adeyemi, the CEO and co-founder of Anchor, which provides digital infrastructure for banking and payment products. For SMEs, the vast majority of businesses in every single African market, it is a different story.

Currency headaches

Access to funding and banking services in general have been perennial bugbears for Africa’s small firms. This is starting to change. Nimble neobanks increasingly offer low-fee financial services and lending options designed for the small entrepreneur. But trade finance is a different animal with additional layers of complexity. Currency shifts are a prime example. “The major barrier to trade finance is FX,” says one former Nigerian banking executive. “You started a business when the naira was at 900 to the dollar, now it's trading at 1600. You don’t know where it's going to go next and so you can’t plan.”

Economic volatility - whether around exchange rates, inflation or other factors - makes life especially hard for trade-focussed SMEs. They can put all the effort into becoming part of the registered formal financial sector - only to have whipsaw currency moves kill their business. What progress there has been on financing trade - and there has been some - has occurred against a backdrop of economic shocks. In just the last few years, the pandemic, associated stimulus measures and then Russia’s war in Ukraine have created colossal volatility across food and energy prices, interest rates and commodity exports.

Even in parts of Africa that are experiencing more economic stability and increasing trade, the trade finance gap is severe. A recent IFC report on trade finance in West Africa found that the four largest members of the Economic Community of West African States (ECOWAS) - Côte d’Ivoire, Ghana, Nigeria, and Senegal - were making progress on international trade. “The number of firms participating in international markets is growing, and exporters in some countries are becoming more competitive, expanding into new products, and reaching new destinations,” the report said.

But when it looked at financial institutions in the ECOWAS4, the IFC found that trade finance supported only 25% of goods trade in these countries. This was well below the African average of 40% and the global average of 60%–80%. Just over 20% of all trade finance requests to banks were rejected. Measured by the value of trade finance requests, the rejection rate was 25%. These rejections fell disproportionately on SMEs and led the IFC to estimate the annual unmet demand for trade finance across the ECOWAS4 at US $14bn.

Building relationships

The continent’s financial sector has changed hugely over the last decade. Many of the major banks are better regulated and on firmer financial footing than they used to be. At the same time many non-African banking groups have withdrawn from the continent.

African lenders and a new generation of fintechs are stepping up to fill the space. Zikry says CIB’s recent move to establish a presence in Kenya aims to enhance the trade relationship not just between Egypt and Kenya, but with the wider East Africa region. Pan-African firms like Ecobank and Attijariwafa are focused on financing trade in a way that the old generation of national banks were not. “They tend to be more willing to support transactions in most of the African countries because they understand the risk,” says Mohamadou Ba, chief trade finance investment officer at the African Development Bank (AfDB).

But relationships with global lenders are still a crucial part of trade finance. “And global banks perceive local banks as risky due to their jurisdiction,” says Ba. There is some differentiation here. Banks in the West Africa region enjoy more support from global lenders - as do those in key markets in the North and East. But for the lower income nations, help from international banks is virtually nil. Even in bigger, more attractive, African markets, global banks tend to only support what Ba calls “tier one” local banks. “When it comes to the tier two and tier three banks, they are really left out,” he says.

Global banks’ reluctance relates to perceived sovereign and country risk. This spans everything from macroeconomic stability to security and KYC concerns. The IFC study on the ECOWAS4 found that 90% of local banks reported difficulties meeting the requirements of foreign correspondent banks. This is where multinational institutions like the AfDB and IFC play a critical role. Ba notes the AfDB is focused on helping global banks collaborate more with Africa’s tier two and tier three banks, bolstering capacity at these smaller lenders, and using risk sharing mechanisms to address their limited equity base. The risks are rarely credit risks, says Ba. There is almost never a default on a transaction. The issue is delays - often due to shifts in FX rates or commodity prices.

Like the AfDB, the IFC helps African banks form relationships with international lenders. Beyond this match making, the IFC is also helping train African banks across various markets on how to improve their trade finance businesses. “In the last fiscal year, we did around 12 courses in 14 countries,” says Sérgio Pimenta, IFC’s vice president for Africa.

There seems to be increasing awareness - across the public and private sector - of how important it is to drive trade growth across the continent. “Everyone is realising this and we see a lot of our clients in the private sector saying: let's do more trade in Africa and among African countries, and that's a really positive development.”

Another key part of what the IFC does is take risk off banks' books, covering a significant chunk of a given trade finance transaction. In its ECOWAS4 report, the IFC said 77% of banks cited a shortage of low-cost funding as a barrier to trade finance. The ability of the IFC to take some of the transaction risk does not come at the expense of innovation. There is no prescription as to how banks should structure a transaction. The IFC’s priority is to play a counter cyclical role, providing support when wider market support is declining.

The IFC also has a large team in Africa that spends a lot of time with regulators. This includes helping develop collateral markets, expanding the range of assets that can be counted as collateral for the purposes of trade finance. Banks surveyed for the ECOWAS4 report listed “insufficient collateral for the high perceived risk of borrowers” as a more common problem than the lack of short-term funding. More than 80% of banks said collateral issues were a common barrier to trade finance. The IFC is working with the regulators to promote international best practice in collateral recognition.

“If you change the regulations on that front, then suddenly you create a space where companies, including particularly small companies, can really bring collaterals to the market and then can get access to trade finance,” says Pimenta. “That's a very important dimension. We've done it in a number of countries in Africa and the impact that it has is very large.”

Breaking down barriers to trade finance is a slow yet progressing battle. Multilateral assistance is helping African lenders form correspondent relationships and build internal capacity. Rejection rates for trade finance applications will fall. But there is a clear need for innovation and adaptation.

The IFC study found that African trade finance remains focussed on “well-established bulk exporters and importers using traditional trade finance products such as pre-export financing for commodities and letters of credit for trusted importers”. Crude oil is a key export for Nigeria, as cocoa is for Ghana and rubber for Côte d’Ivoire.

For African growth to reach its true potential, however, trade finance needs to expand to intermediate and capital goods. The good news is that multilateral and national governments have made real progress at identifying specific challenges and the necessary solutions. Rolling these solutions out will be the hard part.