Why banks should embrace structured trade finance

Why banks should embrace structured trade finance
Photo credit: New Times

29 Oct 2014

A number of developments have taken place in the banking industry globally and in Rwanda, in particular, with regard to the way conducting of business.

We have recently witnessed mergers and acquisitions in Rwanda’s financial sector and opening shop of new banks on the market.

These developments imply growing competition in local banking industry and call for a lot of innovation on the part of the banks, especially in aggressively rolling out of the existing trade products and developing of new ones.

Structured financing of commodity trade could be one of the measures banks should consider. These techniques of financing and the different applicable trade finance tools originated from the Latin American financial crisis in the mid-1980s. During that period banks were involved in international commodity finance and relied on balance sheet analysis and government guarantees for ascertaining the credit worthiness of borrowers. Security was at times enhanced by tangible assets such as real estate offered as collateral.

However, the international environment for commodity finance has continued to evolve, driven especially by the development of information technology, consolidation of commodity trading and processing industries and increasing liberalisation.

With the consolidation of the commodity industry, only a small number of large creditworthy traders are actively involved in trade, in addition to an increasing number of niche players that are difficult to finance. These niche players if they come for finance, they want the money almost at zero cost.

Due to the effect of consolidation, companies have become much large, with increased credit requirements (compared with own equity), modest capital base and limited access to government guarantees. However, given the high default rate of commodity traders, banks have become hesitant to advance unsecured credit.

Due to privatisation, commodity-trading activities are now controlled by private companies, which has seen the previous government-to-government business backed by state bank letters of credit being replaced by commercial bank funding.

These developments have increased economic and political risks in emerging markets; and the traditional tools are no longer sufficient to dealing with the growing risks and are, therefore, less viable. Producers, processors, traders and banks that fail to adapt to the new realities of international commodity and financial markets risk losing out.

That’s why financial institutions need to adapt the basics of using the new trade finance tools.

The future will see various structured finance tools like pre-shipment or pre-export financing, post-shipment financing, warehouse receipt financing, and structured trade and commodity financing utilised by a number of banks. Large continental and regional banks have already moved in this direction, but most local banks in the market in are yet to embrace it.

All these fundamental tools rotate around identifying the probable risks at whatever level, and the best possible mitigation measures. As banks take on the credit risk, independent collateral managers take on the performance risks on ground.

Commercial banks can make better use of increasingly common external tools that ease the risks, like collateral management services while extending pre or post shipment finance, not just to control goods at one point in the marketing chain (inventory or stock financing), but to control trade flows in the value chain from farm gate to final destination expecting reimbursements through export receivables.

Collateral management services are available locally and globally. In Rwanda, commodities being handled under these highbred services include maize, fertilisers, sugar, rice, petroleum products and pharmaceuticals, among others.

The benefits of these new trade finance services go both ways; for banks, these services provide the ability to lend out more than it would been possible if only physical assets were considered; they reduce the number of non-performing loans as these are transactional based financing and the banks have a constant flow of information through the independent third party. For the trader, the ability to borrow more than what their physical collateral permits is second to none, plus a certain level of proper business management through the collateral manager’s reports.

These services provide comfort to both the financing and borrowing parties that a collateral manager is willing and able to take on the performance risk on ground.

Importantly, there banks need to build their capacity and improve skills in structured finance to be able to apply the tools effectively.

Greater skills in structured finance will, among other things, enable bankers to identify new revenue streams that can be used to underwrite medium and long-term financing.

The writer is the ACE Global Depository Rwanda country manager.

Author Richard Manzi
Source The New Times
Website Visit website
Date 29 Oct 2014
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