Trade finance in start-up banks: barriers and solutions
Trade finance consultant Igor Roussine looks at the challenges of setting up trade finance departments in new banks in the economies where the EBRD invests
No one would disagree that trade finance is one of the most important products for start-up banks in countries with transitional economies. Or that it is an important factor in the formation and development of such new banks.
But trade finance is also important for the clients of start-up banks as it enables them to mitigate risks associated with international trade, to receive financing for their contracts from foreign sources on attractive terms, and to improve the terms and conditions of trade transactions.
So what difficulties do trade finance departments face when establishing and developing such operations in new banks in economies in which the EBRD invests?
Over the years of working as an EBRD adviser on trade finance in many countries and in many new banks, I have encountered a number of generic issues that tend to impede the development of trade finance.
Credit policy in trade finance
Do all banks have an internal trade finance policy paper, or at least a provision, stating what transactions are eligible for trade finance products? Is trade finance a service or a credit operation? What methods of structuring transactions and requirements for borrowers are preferable for banks under trade finance instruments? Are target markets, target product groups and target customers for trade finance determined properly? For example, should the trade finance department spend time on small trade finance transactions for small and medium-sized enterprises and how should it approach a letter of credit application for a small amount of €1,000?
As a rule, the absence of a specific trade finance policy slows down sales and development of trade finance and does not allow the bank to focus on key business areas and key trade finance clients.
Definition of trade finance products in the bank
Is there a definition of trade finance products in every start-up bank, and is it exactly the same everywhere and in all banks? Is there a common understanding of these products among all employees and management, and what tools are included in this concept? For example, are loans to finance foreign trade contracts and related domestic trade transactions considered as trade finance transactions or only as working capital loans? Or if a start-up bank does not have foreign trade finance limits and has not yet started to work with documentary transactions and international guarantees, does it mean that there is no trade finance business in that bank at all?
Internal organisation of credit and trade finance departments
Where is the trade finance department of a start-up bank located and what functions are included? Is it only a technical back office unit dealing with documentary transactions and guarantees, or does it also have a credit responsibility and authorisation to initiate credit applications and respective trade finance transactions?
Very often in start-up banks there are no clear solutions to these questions. Obviously the processing of trade finance instruments is a back office function. At the same time, there should be a commercial front office unit, free from technical responsibilities but targeted on developing a trade finance portfolio, dealing with the structuring of transactions and being responsible for origination and initiation of trade finance limits and transactions for clients.
These functions, or rather the trade finance product responsibility, is very often lost between the documentary trade departments, credit departments, corporate client units and risk management in the start-up banks.
Internal competition between credit and trade finance
Structuring trade finance transactions is often more time-consuming than structuring regular loans. Accordingly, in many cases, when start-up banks have enough liquidity and are pushed by customers to proceed quickly, selling working capital loans prevails instead of arranging more complex trade finance deals.
As a result, the client’s foreign trade contract is very often financed by the bank with the working capital loan. Under such a contract the bank doesn’t insist on improvement of forms of settlements, and it often accepts the risks of advance payments under import contracts, relying on the borrower’s sufficient collateral. However, this does not help to improve the terms of trade for its customer.
Therefore by setting up a specialised trade finance unit in the bank’s corporate and credit area as a fully equal component with allocated responsibilities and dedicated customers, mainly using trade finance products, allows many of these contradictions to be resolved, and brings trade finance into the mainstream of the bank’s activities, alongside other loan products. Trade finance should be treated as a fully fledged credit product of the bank, the same as project finance, construction finance, energy finance, and so on.
The role of risk management in trade finance
Are the risk management departments of start-up banks always fully involved in the execution of trade finance transactions? Are the risk managers always well informed of the rules of processing documentary credits and demand guarantees? It is vital that risk management specialists are involved in credit decisions and the technical implementation of trade finance transactions.
Training in trade finance
Lastly, training staff in the processes of trade finance is essential. Nowadays there are many training opportunities available, such as the EBRD Trade Finance e-Learning Programme, trade finance weeks and seminars, and online sources of published professional materials. But the coaching and support that bank staff receive from professional consultants in the daily structuring of transactions and trade finance product development remains indispensable.
Under the TFP the EBRD supports start-up banks by providing technical assistance through trade finance advisory projects. Between 2004 and 2019, in my capacity as a consultant, I worked with 41 banks from 6 countries on a medium-term basis. Separate training has been arranged by the EBRD to advise banks on the use of short-term revolving cash advances for trade finance. In the same period, 81 banks from 21 countries benefited from such additional training on the use of trade finance loans.
Such consulting projects deliver results. Not only did the number and volume of trade finance transactions increase, but also in many cases trade finance departments were reorganised or restructured, necessary internal procedures and credit policies were prepared, risk management became more involved in trade finance operations, customer service improved and new trade finance products were introduced.
Structuring trade finance transactions is often more time-consuming than structuring regular loans.