Interview with Ghazi Ben Ahmed, Lead Trade Finance Officer at the AfDB
What was the motivation of the Bank to start a trade finance program?
The adverse impacts of the financial crisis that hit the world in 2008 became evident in Africa towards the end of the same year. Its severity and detrimental impact on investment and trade required urgent, collective countercyclical actions by the international financial community, using creative and pragmatic approaches that would support the recovery of trade flows as soon as possible. In particular, as many African commercial banks were experiencing severe liquidity constraints, the African Development Bank (AfDB) had an important role to play in helping the continent through the financial crisis.
African exporters are very dependent on external trade finance, without the Bank intervention to infuse liquidity and crowd in other financial institutions, the real cost of the global crisis on Africa would have been probably higher.
How is the situation 19 months after the onset of the global financial crisis?
The severe global recession seems to be bottoming out and the global economic outlook is turning cautiously optimistic. A gradual recovery of African economies is expected with average growth reaching 4.5% in 2010 and 5.2% in 2011. All African regions will achieve higher growth although the recession will leave its mark. Southern Africa, which was hardest hit in 2009, will recover more slowly than other regions. East Africa, which best weathered the global crisis, is likely to again achieve the highest average growth in 2010/11.
Budget spending cuts, increased unemployment, high consumer prices and reduced remittance flows remain sources of concern in the immediate future.
Through the end of 2008, the general consensus was that Africa would remain relatively insulated from the effects of the global financial crisis. Since the onset of the crisis, growth on the continent fell well below the 2006-2008 trend line of 6% but remained positive overall. The African Economic Outlook 2010 is optimistic about Africa's economic prospects which have been strengthened by "good policies that had given Africa's governments the fiscal space to cope with the crisis." The global economic crisis has given a new impetus on domestic resource mobilisation in Africa.
However, the crisis has underlined Africa's undiversified exports i.e. the continued primary commodity dependence: This implies that growth in the medium term will largely depend on the recovery of global demand. Last year, import demand remained low in Africa, but as demand picks up, the problem of import financing will materialize fully, and if not addressed adequately, it may hamper the economic growth.
Beyond short-term economic recovery African countries still have to deal with structural constraints to growth. In particular, the continent faces severe infrastructure deficiency, inadequate access to long term financing, shortage of skilled labor, and weak industrial base, which hamper high and sustained long-term growth.
The market situation for trade finance has, by and large, been gradually improving - although that assessment should be put in context, particularly regarding the diversity of African countries. What are the main constraints?
In the first half of 2009, African commercial banks surveyed generally reported constrained access to trade finance facilities characterized by shortening tenors and increased prices. There were significant differences among financial institutions, across products and across markets.
While the largest, pan-African banks have been able to support their clients during the crisis (although at a higher cost and for a lower level of transactions), particularly on the financing of exports, the smaller banks and banks in countries whose rating has been downgraded have suffered from a loss of access to domestic and international inter-bank resources at acceptable terms. In addition, the smaller banks are suffering, like everywhere in the world, from the general re-assessment of "counterparty" risk.
With the recovery of consumer demand, on the one hand, and on the other the increase in collateral requirements (cash collateral) for importers, the increasing prices for the confirmation of letters of credit, and the lack of local trade insurance capacity, there is a concern from international commercial banks still present in the African market that the gap for trade finance can only increase. Hence leaving imports to be paid only in advance.
Beside the trade finance gap, the cost of Know Your Client (KYC), i.e. collecting information on counterparty risk, is high and coupled with relatively low profitability of small operations in the Africa, make trade financing unattractive, particularly on the import side.
The situation could be compounded by more stringent regulatory issues, as Basel II significantly overstated the risk associated with trade transactions. In fact, the Basel II accord, finalized in June 2004, sets out a framework for banks to determine their minimum capital set-aside requirements in order to ensure that sufficient capital is on hand in times of stress. The agreement sets different weightings for various forms of credit risk, with riskier forms of exposure subject to higher set-aside requirements. In the case of trade finance, the credit conversion factor was set at 20%, the same as in the Basel I framework.
The difference, though, is in the application of such ratios. The Basel II framework is a risk-based, asset-weighted system of capitalization. Should the inherent risk of doing cross-border business increase with the instability of the international financial environment, the capitalization requirements are also set to increase - both with the re-assessment of the banks' internal ratings, but also with the assessment of the counter-party risk. This double weighting tends to increase capitalization for cross-border lending relative to domestic lending, a disincentive to trade financing.
Another issue comes from the application of maturity floors for letters of credit. The Basel II framework applies a one-year maturity floor for all lending facilities, even though trade finance lending in Africa is usually short-term in nature, between zero to 180 days maturity. Since capital requirements increase with maturity length, the capital costs of trade financing are thus artificially inflated as a result.
SME access to finance is indirectly affected by Basel II as most international credit flows are to large established firms.
What are the next steps for the Bank in Trade Finance?
Programs like the GTLP and other emergency liquidity facilities have reversed the financial crisis negative trend to some extent. Although no statistics are available, regional commercial banks and international financial institutions report that the secondary market is strong.
According to local and international commercial banks active in Africa as well as development finance institutions, there is still an important role for the AfDB to play in supporting trade finance in the immediate post-crisis period.
First, several commercial banks indicate that the crisis is not over and the AfDB should continue to maintain its Trade Finance Initiative. Hence, the GTLP will continue to provide needed support and is expected to cease operations only once the markets have normalized and demand for its products is no longer sufficient to justify continuation of the program.
Second, access to trade finance facilities continues to be constrained by the small size of many African financial institutions. The liquidity problem has become a capital allocation problem; we have a problem of risk appetite. In the short term, the Bank should therefore assess the additionality and the impact of a guarantee program in partnership with a key trade finance player. This outsourcing would allow major partners active in trade finance to increase the scope of their program (i.e. include more banks) and to complement the existing program so existing banks can access increased trade lines.
Third, the impact of Basel II is unknown and preoccupying the market. Risk ratings attached to trade finance transactions in Africa will default to the highest requirements as there is no verifiable data on which to base expected losses. The lack of consistent, portable data will translate into overly conservative risk weightings for trade finance products.
Consequently, the AfDB should lead the development of a data archive documenting trade experience in Africa to allow market participants to model expected losses. This could be a useful starting point for a more comprehensive mapping exercise aimed at quantifying the extent of trade financing gaps, identifying the institutions involved in trade financing in Africa, their strengths and weaknesses, the constraints faced by these institutions, and how the Bank can assist and work with these institutions.
We had recently a useful meeting internally at the AfDB to discuss the mapping issue, and the discussion will continue internally in the light of the G-20 Toronto Summit Declaration (26, 27 June 2010), which asked "multilateral agencies, including the World Bank and other Multilateral Development Banks to step up their capacity and support trade facilitation which will boost world trade".
Finally, African commercial banks reported increasing demand for facilities with importers and exporters in emerging Asia. However, banks report trade transactions are constrained by Asian banks unfamiliarity with the continent and its financial institutions. Asian firms require letters of credit and transactions are slow and difficult. African commercial banks suggested that the AfDB could facilitate trade transactions by working with its counterpart financial institutions in Asian markets, especially India, China, Korea and Thailand.
Contacts
Yvan Cliche
