The Potential of Trade Finance in East Africa

Nairobi’s Central Business District - Suppliers face challenges such as high interest rates.

Nairobi’s Central Business District - Suppliers face challenges such as high interest rates.

Trade Finance in East Africa

East Africa is a diverse region that includes countries such as Kenya, Ethiopia, Tanzania and Rwanda. Despite rapid economic growth, the region has the lowest annual export trade value in Africa with trade volumes totalling $75m compared to $187m for North Africa. The region possesses a solid foundation to exploit trade volumes due to the underexploited cross border transport opportunities, investments in the energy sector, the discovery of natural resources, and a high proportion of shared language and cultural similarities which ease doing business. Natural gas discoveries in Ethiopia, Tanzania, and existing oil deposits in South Sudan (and potentially Uganda) mean that there is a role to play for trade finance in supporting key industries, particularly with the implementation of the AfCfta, and the potential admission of the Democratic Republic of Congo to the East African Community which would greatly boost trade volumes.

Trade Finance Options

1. Documentary Trade Finance

This covers Letters of Credit (LOCs), Guarantees and other documents historically used in the trade finance sphere. A Letter of Credit is a promise by a financial institution to honour the financial obligations of the buyer due to the risk of the buyers' failure to pay the seller. It is often used in a transaction to mitigate the risk of not getting paid post-delivery of the products. Although 91% of Banks in East Africa issued LOCs, the average value of these was only 0.6million USD, which is far lower than Southern Africa which had an average value of 7million USD. Raising this value will require a concerted effort to reduce the high costs of lending and sourcing logistics which suppliers in nations such as Kenya suffer from.

2. Structured Commodity Finance

This would involve the cash flows of an underlying asset or commodity being leveraged as security for providing financing. For large corporates, revolving credit facilities are often essential to plugging funding gaps. With the region rich in commodities and other assets, there would be ample opportunity to rely on this form of financing.

3. Trade Credit Insurance

Companies would rely on this in the event of credit risks such as bankruptcy. Political Risk Insurance would also fall under this bracket, this would guard against unforeseeable political risk, particularly in East Africa where political instability has threatened investments in regions such as Ethiopia which is currently in the midst of violence in the Tigray region.

4. Supply Chain Finance

Supply chain finance, also known as supplier finance or reverse factoring, is a set of solutions that optimizes cash flow by allowing businesses to lengthen their payment terms to their suppliers while providing the option for their large and SME suppliers to get paid early. Alternatively, loans could also be offered to supply chains backed against their receivables. African banks such as Absa, Nedbank and Standard Chartered have begun to offer this form of financing in markets such as Tanzania and Mozambique. The introduction of the AfCfta means that suppliers will need working capital to be able to supply more products across the continent.

5. Export and Credit Agency Finance

This is provided by agencies who seek to promote trade and exports. Finance can be provided in the form of guarantees, loans and trade risk insurance. ECA funding can play an integral part in funding infrastructure investments. For large project finance transactions, in order for the countries to attract liquidity both from local, regional and international banks, support from Export Credit Agencies plays a key role in attracting liquidity. Therefore, credit agencies such as UKEF can help plug the liquidity and infrastructure gap. The Total LNG Project in Mozambique is the most recent deal which had significant ECA backing with eight agencies taking part in the project.

Total’s $20bn LNG Project in Mozambique received significant ECA funding.

Total’s $20bn LNG Project in Mozambique received significant ECA funding.

Trade Finance Funds

Although the services sector dominates the region’s GDP composition at 59%, this is followed by the Agriculture sector at 25%. For instance, Rwanda and Uganda rely on rain-fed agriculture for a bulk of their primary commodity exports, while in the rural communities agriculture is often the most important economic activity to alleviate poverty and inequality. To support SMEs operating in the sector, a regional revolving fund could be created to drive exports, this regional fund would be overseen by agriculture associations and key compliance operators. Organisations such as ECOWAS, the African Development Bank or the World Bank could provide financial backing or play a role in drafting a regulatory framework that is acceptable to key exporters.

The development of a fund would also apply to other industries such as construction which accounts for 15% of the GDP composition of the region. The creation of the fund would no doubt increase the need for due diligence exercises, therefore, there is an opportunity to draw on technological innovation to aid in setting up and running the fund. For example, FinTech organizations could create an online platform that allows SMEs and supply chain providers to trade and process their invoices, trade finance providers would then have access to this and provide credit facilities based on the platform’s information. Finastra is a global FinTech company that specialises in providing FinTech solutions to banks to process trade and open up their trade solutions. The company processes 6% of global trade every day and has a presence in East Africa. This is an example of an existing company that could drive trade finance solutions by working with existing local FinTech companies to deliver an end-to-end service that spans all areas of the relevant East African community.

Areas of focus

Collaboration

To mitigate the risks of trade finance in East Africa, public and private insurers could seek to collaborate through co-insurance or re-insurance packages. Providers could also seek to provide solutions to more local providers and SMEs rather than corporate investors.

Technology

Technology can be used to drive the uptake of Trade Finance initiatives. The rise of FinTech and Blockchain organisations presents an opportunity for providers to partner with them to reduce operational costs of providing trade finance solutions due to automation in areas such as due diligence.

Regulatory

Legal frameworks in the region can be developed to increase the uptake of trade finance by SMEs, improve compliance and enforcement. With intra-regional trade being so low, there is an opportunity to draft legislation that can facilitate cross-border trade such as special economic zones.

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