Trade Financing Challenges 2018: Global Context

April 25, 2020

Trade Financing Challenges 2018: Global Context

(Published in the Financial Express in 2018)

Dr. Shah Md Ahsan Habib[1]

Global trade finance markets and participants are also facing some newer challenges with the growing business complexities, changing global political scenario and decelerating confidence amongst parties and market players. For banks, these geopolitical shifts came up at a time when regulation – including more rigorous anti-money laundering (AML) and know your customer (KYC) obligations – are dominating the landscape. Too many regulations and too many regulators became a cause of concern to many banks as they need to follow domestic regulation, the recipient bank’s foreign regulation or international regulation. As a result of the regulatory burden and uncertainty, there are instances, when banks avoid entering into some transactions altogether.

Available published data identified significant gap in the provision of trade services in the context of global economy, especially for the growing SME sectors in emerging markets. The perception of a shortfall of trade finance globally has become evident and an increase in rejection of trade finance proposals or applications has hit SME applicants. Though situation is improving, it remains a critical challenge. According to a recent estimation of ADB, the global trade finance gap is notable in developing countries, and the unmet demand is highest in Asia and the Pacific. The most recent ICC Survey observed that the trade finance proposal was rejected by a considerable number of instances in 2016: 58 percent of SMEs, 33 percent of large corporates and 9 percent of multinational companies.

 A large-scale withdrawal of correspondent banking relationships is occurring in many regions and jurisdictions that affecting trade facilitation remarkably.  The correspondent banking is being threatened by an overzealous interpretation and enforcement of rules aimed at preventing money-laundering and starving terrorists of funds. The number of linkages between banks has been declining in recent years, largely because the industry has been consolidating. According to the most recent ICC Survey, 40 percent of banks terminated correspondent banking relationships because of increased cost and the complexity of the regulatory requirements. In terms of decrease in correspondent banking relationship, Middle East and North Africa are most affected.

There are indications of upsurge of document rejection and court injunction in some instances in recent time. There are several reports of increase in allegations of fraud, increase in court injunctions barring payment of bank undertakings and increase in claims under bank guarantees. Still there are several challenging situation concerning documentary compliance with the increase in refusal rates of documents on first presentation.  Still there are practices of offering spurious discrepancies in documents presented under LC in many instances.

Trade finance involves a wide range of instruments and is undergoing a period of innovation. New products, such as supply chain finance and Bank Payment Obligation (BPO) are intended to reduce financial frictions. The reach and uptake of these instruments has been slow. One reason appears to be information asymmetries. Current available published data reflect lack of familiarity with financial products. In the case of nontraditional products such as factoring, forfaiting, BPO and supply chain finance, only limited number of companies report familiarity. Even within traditional bank products, companies reported limited familiarity with relatively established products, as observed by an ADB study.

It is recognized that international trade and the processes and systems that support it, are vulnerable to abuse for the purposes of financial crime. In recent years, there has been an increasing focus on these risks for a variety of reasons, including the continued growth in world trade. Among the risks, malpractices in trade services, broadly take the form of irregularities or non-compliance of regulation and fraudulent activities. Though the malpractices (especially fraudulent activities) in trade services are not very frequent however these could prove to be very costly for banks and the concerned parties. Of the different types of crimes in the financial sector, some are directly related to international trade and cross border service facilitation. In recent time, concerns on money laundering, cybercrime and violation of sanctions became very apparent in connection with both developed and developing countries. Especially, trade based money laundering is a critical area of malpractice which can be practiced through the misrepresentation of the price, quantity or quality of imports or exports, and the techniques involved are: over- and under-invoicing of goods and services; multiple invoicing of goods and services; over- and under-shipments of goods and services; falsely described goods and services etc. In many cases, this can also involve abuse of the financial system through fraudulent transactions involving a range of money transmission instruments, such as wire transfers.

Regulatory requirements designed to mitigate the risk of financial crimes have resulted in unintended consequences particularly in emerging markets. In many instances, AML and Know Your Client (KYC) due diligence requirements were significant impediments to their provision of lines of credit. Globally, Asia and Africa were said to be most negatively impacted regions. In the context of trade services,sanctions may restrict a bank’s ability to perform its role and may confront with different sanctions regimes imposed in the multiple jurisdictions. Sanctions are imposed by the United Nations, the EU Council or individual countries to achieve political and economic ends. They may prohibit dealings with specific countries, persons or property. Thus, these banks may be subject to conflicting regulatory requirements and handling of legal risks.

Price verification for financial crime control purposes is difficult for Financial Institutions. FIs generally are not in a position to make meaningful determinations about the legitimacy of unit pricing due to the lack of relevant business information, such as the terms of a business relationship, volume discounting or the specific quality of the goods involved. Further, many products are not traded in public markets and there are no publicly available market prices. Even where goods are publicly traded, the current prices may not reflect the agreed price used in any contract of sale or purchase and these details will not usually be available to the FIs involved due to the competitive sensitivity of such information.

Offshore banking activities are causes of concern in several instances,where the political and financial elite are trying to hide from the public view. While imposing austerity measures on hard working citizens, they are well aware that astronomical amounts of money are secretly held in offshore banks, thus lost in taxes. In the second half of 2015, there were several cases that revealed how the world’s wealthy elite are and can avoid paying taxes. The ‘Panama Papers’ database showed the largest ever release of secret offshore companies and the people behind them. The leaked documents illustrate how wealthy individuals, including public officials, are able to keep personal financial information private. While offshore business entities are often not illegal, reporters found that some of the corporations used the channel for illegal purposes, including fraud, tax evasion, and evading international sanctions.

In connection with Bangladesh, most of the cases of malpractices are related to non-compliance of regulation or guidelines. Some of these are intentional, and many of these are due to knowledge gap of the service providers. There are also instances when fraudulent activities or undue legal steps by the clients resulted in difficulties. Behavior on the part of clients and other external steps also affect country risk, and thus trade services as well. Of the different trade related frauds, trade based money laundering, compliance and sanction issues are very concerning to the policy makers of the country, as also true for other trading economies at this moment.

[1] Professor and Director (Training), BIBM ([email protected]).

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