Article

by Steven Beck

The Asian Development Bank (ADB) published a study in Q1 this year indicating that there is a $1.6 trillion global gap, meaning unmet demand, for trade finance, $425 billion of which is in developing Asia. These are big numbers. To give them some meaning, ADB surveyed over 300 companies to ask: "If you had more trade finance available, would you increase production and hire more people?" In response, companies said that if they had access to 5% more trade finance, they would increase production by 2% and hire 2% more staff. They also said that if they had access to 10% more trade finance, production and staffing would go up by 5%. If one extrapolates these numbers over the global economy, or just developing Asia, the impact on economic growth and job creation would be huge. (The study is available on the ADB website at www.adb. org/tfp)

Hopefully, this information will help governments get concerned about growth and jobs and address issues that impede trade finance, including unintended consequences associated with regulatory requirements, and a lack of harmonization on KYC (know your client) and AML (anti-money laundering) requirements.

Statistics

ADB's other "non-transactional" work was to create first-ever statistics in trade finance. The pilot ICC-ADB Trade Finance Register gives statistical weight to the argument that trade finance carries a relatively low probability of default and loss. Three years and two more Register reports later, the conclusion is the same: defaults on trade finance tend to be about 0.02% to 0.04%, which is very low. These statistics have been discussed with the Basel Committee, and we believe they are helping Basel consider the possibility of treating trade finance differently, perhaps even as a unique asset class. The Register now needs to go in a couple of additional directions: to develop country-by-country stats and special reports on how trade finance assets have performed during the crisis.

TFP and the financial gap

In addition to closing "knowledge gaps"' about trade finance, ADB's Trade Finance Program (TFP) is helping close financial gaps. TFP does this by providing guarantees and loans through partner banks, over 200 of them, to support trade in the most challenging Asian developing countries.

In 2012, TFP supported $4 billion in trade through over 2,000 transactions. There was a more than 23% growth in TFP volumes in Q1 2013. This level of growth is unlikely to continue throughout the year, but the overall trend is clearly one of growth, as gaps in some of TFP's markets seem to get larger and ADB's role in filling those gaps has become more prominent, as represented by the exponential growth of the TFP over the past few years.

About 75% of companies supported by TFP in 2012 were small- and mediumsized enterprises (SMEs). Given the importance of this market segment in job creation, and the fact that gaps disproportionately involve SMEs, ADB is pleased to see this kind of support flowing through the program.

Importance of co-finance

Another important element to TFP is its ability to generate ($2.3 billion in 2012) private sector capital into the most challenging markets. Through the program's partnerships with insurance and commercial banks that assume risk in TFP transactions, the Bank has been able to leverage what financial capacity it has, and more importantly to introduce the private sector to frontier markets where they may never have operated. Over time, once a credit history is established under TFP's guarantees, and because TFP charges market rates for guarantees, the private sector has a natural incentive to fill market gaps without using the program.

This is the perfect scenario - the private sector filling market gaps without requiring ADB guarantees and funding - and in an ideal world, TFP would render itself redundant over time. In fact, that's one of its objectives. But with trade finance gaps enlarging - fueled by political, economic and regulatory uncertainties - this doesn't seem likely any time soon.

TFP does not assume risk in relatively developed markets such as the PRC, India, Thailand, Korea and Malaysia, but focuses on countries where the gap is proportionally greatest, such as Bangladesh, Pakistan, Sri Lanka, Nepal, Mongolia and Viet Nam, among others.

Expansion to Myanmar

Myanmar's banking system and commercial regulatory infrastructure is at an early stage of development, which makes it a real challenge for TFP to expand there. The country is a perfect market for TFP; it's an extreme example of why ADB and TFP exist: to be first-movers into new and uncertain markets: to fill financing gaps for economic growth, to provide technical assistance to upgrade skills of Myanmar's public and private sectors and to create structures (including the provision of guarantees) through which partnerships are formed with international investors and banks.

Because the Bank plans to have expanded in Myanmar by end Q3 this year, it's been very busy there over the past six months, having done due diligence (DD) on nine banks in the country. The banks have never been through this kind of DD, so what they learned in the process is very valuable and hopefully will help them understand what potential correspondent banks, international investors and (over time) rating agencies will require. ADB's open and frank feedback to the banks about its assessment will enhance this learning process, which is important at this stage of Myanmar's development.

In addition, the Bank will be talking with the Central Bank of Myanmar about its DD methodology, which should provide some important information and learning opportunities for the Bank's personnel. And finally the DD process was critical for ADB to gain a better understanding of the banking system and individual banks in that market. Equally important, the Bank is now able to share what its learned from the process with its partners around the world.

Most active markets

Outside of Myanmar, TFP continues to be very active in Bangladesh and Pakistan, monitoring risks and disseminating knowledge about these markets to its partner banks around the world.

Viet Nam is another very active market for TFP, where there is more demand than capacity, and the TFP has been expanding in a number of central Asian countries, including Kazakhstan, the Kyrgyz Republic, Uzbekistan and Tajikistan.

South-South trade

It has become trendy to talk about the promise of South-South trade in creating economic growth and jobs. There's no question the opportunities are enormous, but to realize its full potential there need to be more points of contact and more relationships among banks to underpin more trade. With the exception of a few global banks with a presence in most corners of the world, there are no bank relationships between Latin America and Asia outside of Japan, China, India, Korea and Singapore. That means there are no direct relationships between banks anywhere in Latin America and Indonesia, Viet Nam, Philippines, Sri Lanka, Pakistan, Bangladesh, etc. And the links between African and Asian banks are even more sparse.

In an effort to change this situation, TFP has been working with the African Development Bank (AfDB) and the Inter- American Development Bank (IDB). TFP has been actively introducing IDB's trade finance program to Asian banks to encourage them to sign up to IDB's trade finance program as confirming banks. In turn, IDB has helped ADB do the same, to encourage Latin American banks to join TFP as confirming banks so that ADB can provide guarantees to these banks covering payment obligations from Asian banks to support South-South trade. In addition to covering transactions, by having banks from both continents in our respective trade finance programs, ADB will facilitate the establishment of direct relationships between banks on both continents.

The AfDB is in the process of implementing a trade finance program, and it has decided to model the program after the TFP. ADB has been working closely to support the implementation of this program and have provided its operations manual, legal documentation and training. Once the AfDB trade finance program is fully implemented, ADB plans on "swapping banks" as it has started doing with IDB.

Steven Beck is Head of Trade Finance at the Asian Development Bank. His e-mail is sbeck@adb.org Other ADB staffers engaged in TFP programs are Janet Hyde (jhyde@adb.org), who handles Myanmar and other Asian countries and Victoria Tyo (vtyo@adb.org), who manages Viet Nam and several central Asian countries.