October 31, 2019
$1.5 trillion – that’s the value of the global trade finance gap, which is the difference between businesses’ demand for trade finance and the amount lenders are willing to supply. The primary casualties of this disparity: small and medium enterprises (SMEs). According to surveys by the Asian Development Bank, SMEs face rejection rates as high as 45%. By comparison, multinationals have their trade finance applications denied a mere 17% of the time.
This is not a new problem, but it is a stubborn one – the funding gap has remained at around the $1.5-trillion mark for several years now, although it has come down slightly from its all-time high of $1.6 trillion in 2016. And the implications of this problem are dire, especially for SMEs – without the requisite funding, how can they grow their business?
To combat such dampened growth prospects for SMEs, one aspect of trade finance stands out: inventory financing. The most common trade finance solution currently is by far factoring & reverse factoring, which is based on the financing of accounts receivables and payables. In inventory financing, companies can obtain financing to purchase inventory – the financing is then secured and appraised against the liquidation of the value of the acquired inventory.
Inventory financing is thus much more growth-oriented. Since buying and selling additional inventory will directly increase revenue, inventory financing is explicitly linked to a company’s growth. Especially when still in the growth stages, SMEs do not have sufficient assets that can be used to secure a direct loan. But with inventory financing, as long as the lenders are convinced that the additional inventory will be sold, they will be willing to extend financing. For product-oriented SMEs feeling stuck in the growth phase, inventory financing can prove to be an invaluable tool.
Furthermore, inventory financing is still relatively less common when compared to the more traditional trade finance models of invoice and receivables factoring. As such, they present a sizable growth opportunity for FinTech companies looking to break into the trade finance market.
Conventional banks remain the main suppliers of trade finance products. But their stringent capital, compliance, and risk requirements limit the amount of trade financing they can provide, meaning the funding gap remains large and persistent. This presents a clear opportunity for the burgeoning FinTech industry.
The business models of these companies vary, from being simple trade finance lenders (whether from their own balance sheets or crowdsourced from third parties) to providing sophisticated analytics and information to the traditional banks on trade finance prospects.
Inventory financing is another focus area for them, as it is a less-crowded market comparatively. In this space, FinTech companies and other non-bank players are looking to enhance their offerings through high-tech solutions like user-friendly digital platforms, AI-powered data analytics, and blockchain solutions. The integration of blockchain technology, in particular, is a strong value-add to the traditional inventory financing model.
With its ability to create tamper-proof records auditable by all parties, blockchain technology can significantly strengthen supply chain transparency and trackability. After all, one of the primary challenges facing inventory financing companies, aside from the difficulty in appraising inventory value, is in tracking – how can they accurately determine when inventory has been sold and track the payments as well? Blockchain helps solve that issue. Furthermore, smart contracts, encoded on the blockchain, can also be used to create conditional payment scenarios.
Despite these value-adds, challenges remain. A study by the International Chamber of Commerce on supply chain financing in Europe identified four key areas supply chain financing partners (which includes banks) could still improve on: value for money, integration with the companies’ Enterprise Resource Planning (ERP) systems, providing experienced relationship teams, and responsiveness. To snap up more market share, FinTech and non-bank players should direct their focus toward succeeding in these areas.
In Europe, the funding gap is not as stark compared to less-developed regions. A continued loose monetary environment with rock-bottom interest rates, coupled with lower demand from some of the weaker European economies such as Italy and Spain, have combined to reduce the funding gap gradually.
Nonetheless, although relatively low, the European SME funding gap (which includes but is not limited to trade finance) still stands at about 3% of GDP – roughly $440 billion. This is still higher than in the US at 2%. Further, European SMEs are also more dependent on conventional banks for growth. About 70% of their external financing needs are provided by conventional banks, as opposed to only 40% in the US. Thus, although the funding gap is low and improving, the consequences of the said gap on SMEs’ growth prospects are higher in Europe compared to elsewhere.
Keeping in mind the background of Europe’s trade finance gap as well as the opportunities and challenges for non-bank companies looking to increase market share in Europe’s inventory financing space, here are four non-bank players making waves in Europe’s inventory financing market.
As the level of competition in the trade finance space continues to increase – as evidenced by the entry of more and more non-bank companies – the entrenched players will have no choice but to step up their game. And the beneficiaries of all this will be businesses, especially the ones previously marginalized by the conventional banks. The only question is: how long will it take to close the gap, and what will be the consequences for businesses in the meantime?