A survey and subsequent report, ‘Survey of Impact of Covid-19 on African Trade Finance’, by the Africa Export-Import bank (Afreximbank), shows that outflows from emerging market economies in the first quarter of 2020 accounted for more than $100-billion.
The report was a joint production between the Afreximbank, the African Development Bank, Making Finance Work for Africa and the United Nations Economic Commission for Africa, to look into the impacts of the Covid-19 pandemic on the health, economic and financial systems globally.
Covering the first four months of 2020, including April, the survey took place during the height of the pandemic downturn, when global trade contracted by over 5%, and surveyed commercial banks across the continent about the impact of the pandemic on their trade finance activities.
Global output, which had been forecast to expand by 3.3% in 2020 before the pandemic hit, instead contracted by 3.5%. As a result, Africa entered its first recession in 25 years.
Similarly, global trade, which had been forecast to expand by 2.7%, contracted by 9.2% for the year.
The survey targeted more than 370 commercial banks (58% of the $1.5-trillion in total assets held by commercial banks in Africa) involved in trade finance across Africa and achieved a response rate of more than 50%, with balanced geographical coverage.
A key finding of the survey, showing the adverse impact of the pandemic downturn on trade finance across the region, reflects increased rejection of letters of credit (LCs).
Afreximbank reports that LC business, and correspondent banking operations, witnessed a significant slump which could exacerbate Africa’s trade financing gap, while reversing gains in the expansion of the continent’s trade during the preceding few years.
In this regard, the survey reveals a substantial increase in LC request rejections in the first four months of 2020 compared with the first four months of 2019 – with 30% of respondents indicating an increase in rejection rates.
The survey results show that insufficient collateral and client creditworthiness were the primary reasons for bank rejections of trade finance applications in Africa during the first four months of 2020.
The reduction in global growth and trade was particularly significant in the second quarter of 2020, resulting in capital outflows from Africa exceeding $5-billion in the same period, with about $400-million exiting the Egyptian market and $3.1-billion leaving the South African market.
These massive outflows strained African banks, many of which recorded sharp drops in their net foreign assets, thereby also exacerbating banks’ existing liquidity constraints and undermining their capacity to finance the growth of African trade, according to Afreximbank.
The survey also finds that demand for trade finance increased during the first quarter of 2020, with about 37% of banks reporting increased demand from their export clients, of which smaller banks in the Southern and Western regions of Africa recording the largest increases.
However, Afreximbank notes that, while demand for more financing may not necessarily reflect more new businesses, it may instead reflect the challenges faced by small and medium-sized enterprises in concluding existing trade transactions, as a result of difficulties with cash flow or working capital.
RISK APPETITE
The survey highlights that government-owned financial institutions appeared to have more appetite for risk and were making significant contributions to address liquidity flows during the crisis. This contributed to creating the necessary conditions for a swift recovery as the pandemic subsides.
The sharp contrast in risk perception between domestic privately-owned and domestic majority government-owned banks, according to Afreximbank, suggests that other factors could be driving credit allocation and trade finance.
Further, since most LC cancellations and correspondent banking services withdrawals appear to be informed by perceived high risk, the bank says a lot more must be done to address this “perennial canker” of risk mis-estimation, which leads to high-risk premiums.
Meanwhile, Afreximbank posits that creating an environment conducive to the expansion of trade and trade finance in Africa will require broad cross-sectoral reforms across the continent.
Reforms to the banking and financial services sectors, as well as to the regulatory environment, could contribute to strengthening existing infrastructure, including technical infrastructure such as Internet connectivity.
In addition, the availability of data is also key to establish an environment that favours positive linkages between trade finance and trade in Africa.
The Afreximbank’s Mansa Repository Platform – which provides a single source of primary data required for the conduct of customer due diligence on African entities – is an important step, the bank says.
However, it is a step that requires broad-based support at an African continental level to have a greater impact on the financing of continental trade.