COMCEC Trade Outlook 2016
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diversify the exports of the country. UNESCAP (2005) classified the trade finance methods and
instruments into the following three categories:
1) Methods and Instruments to raise capital,
2) Methods and Instruments to mitigate risk,
3) Methods and instruments to effect payment.
With regards to raising capital, firms need financing to ensure adequate production to meet the
orders of the commercial transactions on time. They may need to import inputs, hire more
workers and etc. In this context pre-shipment and post-shipment financings provide the
exporting firms with the ability to cover their expenses until they get the payments from the
importers.
There are various risks faced during the international trade such as political and commercial
risks. These risks are covered by export credit insurance and export guarantee programs. While
export credit insurance protects exporters, guarantees protect banks offering the loans
(UNESCAP 2002: 61).
Another issue in trade financing is the type of
payment. There are several types of payments in
international trade such as open account, Letters of
Credit (L/C), payment in advance and documentary
collection. Most common type is L/C, which is the
most secure way for both exporters and importers.
This instrument is particularly suitable for
international contracts that are difficult to enforce and
riskier than domestic contracts because the
creditworthiness of the foreign counterparty is hard to evaluate (Contessi and de Nicola 2012).
L/C’s are commonly used in trade among the developing countries including the LDCs. Another
instrument, namely open account is mostly used in trade among the developed countries and in
exports of SMEs to large firms. Malouche (2009) cites SMEs weaker bargaining power position
versus large firms as the reason for their use of open account in exports.
Trade finance, provided by commercial banks, export credit agencies, multilateral development
banks, suppliers and purchasers, has grown by about 11 per cent annually over the last two
decades (UNESCAP 2002: 4). However, in many developing countries, firms still face difficulties
in getting trade finance. The trade financing gap is especially noticeable in the least developed
countries, where the financial sector tends to be heavily transnationalized and strongly risk-
averse, and where a significant share of deposits are invested in very low-risk instruments,
including short-term liquid assets and foreign government bonds (UNCTAD 2012).
The situation worsens during the crisis periods. For example during the global economic crisis
in 2008, getting trade finance for exporters in the developing countries became more expensive
and harder. The results of the survey conducted by the World Bank in 2009 on 14 developing
countries demonstrated how difficult the situation was. Overall trends from the survey indicate
that trade finance has been noticeably constrained post-September 2008 as illustrated by the
increased pricing of the trade loans and short-term financing, shortened payment terms,
requests for more guarantees, and tightened counterparty bank requirements. (Malouche 2009:
22).
“Firms face difficulties in
getting trade finance in
many developing
countries”