Why the evolution of financial institution trade finance holds the key to closing Africa’s development gap. A shift toward inclusion, sustainability and SME access could unlock transformative impact, write Derryn Faure of Investec International Trade Finance and George Wilson, CEO of ARM African Trade Finance Fund.
In keeping with Charles Dickens’ cautionary seasonal tale of how informed foresight can offer the power to effect change to everyone’s benefit, we can understand three distinct progressions of financial institution (FI) trade: from its traditional financing origins, through its current ‘refinancing’ model, to a yet-to-come, more inclusive and sustainable product that is crucial for sustainable development in developing markets.
This progression is inextricably linked with sustainable socio-economic development in African countries. As such, it should be of paramount importance for global OECD banks, African banks and traders if we hope to close the trade finance gap. However, this can only work if there is an enlightened mindset shift in global policymakers and stewards of product management in trade finance.
Trade finance defined
FI trade finance is where an FI takes credit or payment risk on another FI, referencing a specified, underlying trade transaction. The guaranteeing FI must pay at maturity, irrespective of the underlying transaction performance. As such, the financing FI takes the pure FI risk of the guaranteeing FI.
To the uninitiated, FI trade finance may seem unduly technical and abstruse. However, it is the key component to international banking and economic progress for industrialised and developing economies alike.
The ghost of FI trade 1.0: The past
FI trade origins were born from cross-border trading necessities. Using banks as intermediaries mitigated counterparty risks in international trade.
In export letters of credit (LCs), the importer’s bank issues an LC on behalf of its client. The exporter’s bank, as confirming bank, takes the risk of the importer’s bank and confirms payment on presentation of compliant documents.
The ‘old guard’ only regard this documentary trade as ‘real trade’, and many traditional banks will only do this banking where they ‘follow their clients’ into taking foreign bank risk in developing markets. They won’t consider anything outside traditional documentary trade as ‘trade finance’ and relegate it to bank debt or working capital.
This traditional approach, while foundational, was inherently limited in scope and accessibility, serving established corporates but leaving significant gaps for smaller enterprises.
The ghost of FI trade 2.0: The present
FI trade is the framework for international transactional banking and developmental trade finance. All infrastructure developed for FI trade formed the framework for international and multilateral development finance institutions’ trade programmes, like the IFC’s Global Trade Finance Programme.
Over recent decades, FI trade has evolved to incorporate trade ‘refinance’. This emerged because trade flows between developed and developing markets were almost exclusively founded on FI trade instruments like LCs, mostly denominated in US dollars, which were in short supply in developing markets.
To ease this liquidity constraint, international FIs offered trade refinance loans to developing market banks. This provided dollar liquidity to enable payment of obligations at maturity without suffering shortages at central banks’ FX windows.
After the financial crisis and African bank derisking, DFI trade programmes were designed to support trade by entirely neutralising African issuing bank risk. These programmes depend entirely on FI trade infrastructure.
Although contributing billions to developing market trade finance, this support is limited to large-scale, longer tenor, cross-border trade assets through global transactional banks and top-tier African correspondent banks.
Merchant clients of non-bank FIs, alternative trade financiers and lower-tier African banks cannot benefit because they lack correspondent banking relationships, and international FIs cannot assess unregulated non-bank financier risk.
Consequently, these programmes have a minimal impact on SMEs and a limited impact on reducing Africa’s trade finance gap.
The proposed ghost of FI trade 3.0: The future
A new FI trade finance form is necessary to have any impact on Africa’s trade finance gap. We propose that international FIs invest in African SME trade portfolios through African bank aggregators. These international FIs take the aggregators’ risk, consequently injecting additional liquidity into SME trade portfolios to incentivise additionality. Aggregators’ treasuries can manage FX through the self-liquidation of portfolio assets and liabilities.
Combining the work being done by the International Trade and Forfaiting Association (ITFA) SME trade working group, BAFT (Bankers Association for Finance and Trade) sustainable trade finance working groups, the International Chamber of Commerce’s Trade Register and ITFA’s Trade Finance Conference of Parties (TF COP) core mission, we propose an innovative solution comprising three elements:
- Aggregation – solving the scale and complexity problem. Individual SME transactions are too small for international FIs to handle directly, but when aggregated into portfolios, they become viable investment propositions while maintaining self-liquidating characteristics. Funding is provided to African bank aggregators based on portfolio-level risk assessment rather than individual transaction analysis. Aggregators maintain responsibility for individual credit decisions and trade verification, while international FIs benefit from diversified exposure and the underlying trade flows’ self-liquidating nature. This leverages existing local bank infrastructure and expertise while providing capital and liquidity needed to serve SME clients effectively, ultimately creating a scalable model that is replicable across African markets.
- Inclusion – embracing MSMEs, SMEs, trade financiers and all products used to fund trade cycles. This means moving beyond traditional documentary credit mindsets to recognise modern trade finance’s broad spectrum of instruments.
- Incentivisation – encouraging MSMEs, SMEs, trade financiers to request more funding, reducing cost barriers and developing trade products. This requires creating economic incentives, ensuring additional liquidity translates into genuine additionality.
FX management is crucial, as it addresses the primary constraints faced by African banks serving trade clients. Managing currency exposure at the portfolio level allows aggregators to offer competitive pricing while providing international FIs with natural hedging opportunities.
To achieve this, we must relook at:
- The sustainability qualification: Recent breakthroughs, including the TF COP Washington Declaration (October 2024) and the Seville Commitment (July 2025), have formally positioned trade finance gaps as sustainability issues directly linked to the achievement of the UN Sustainable Development Goals (SDGs). Building on this momentum, trade finance in developing markets should be automatically classified as directly contributing to the UN SDGs because it’s the most potent practical method for implementing sustainable, broad-based socio-economic development in developing African economies.
- DFI guarantee programmes and technical assistance grants: Improving coordination and access to neutralise capital and liquidity costs imposed by regulation on African banks.
Change is needed
In January, The Economist reported that in the 1990s, 14% of the world’s poor lived in Africa. Tragically, by 2030 – the UN SDGs’ delivery date – this figure is estimated to rise closer to 80%.
What we’re currently doing in sustainable development for Africa is not working. Current trade finance approaches have failed to address the fundamental access and affordability challenges that prevent African SMEs from participating fully in global trade.
The statistics are stark: Africa accounts for only 3% of global trade despite representing 17% of the world’s population. Africa’s trade finance gap exceeds US$120bn annually, with SMEs bearing the brunt.
The proposed FI trade 3.0 model offers a path forward, building on existing infrastructure while reimagining trade finance for development. It recognises that sustainable development cannot be achieved through charity alone, but requires commercially viable solutions that create genuine economic opportunities.
By aggregating SME trade portfolios, we achieve the scale needed to attract international capital while maintaining local expertise for effective risk management. By embracing broader trade finance definitions, we serve the full spectrum of legitimate trade activities. By providing appropriate incentives, we encourage additionality that transforms financial access into genuine economic growth.
Unless we change our approach, set aside politics, and work together using an FI trade finance solution like the one outlined above, Africans will be ‘Scrooged’…. The time for incremental improvements has passed – we need fundamental innovation that matches the scale of the challenges faced.
The choice is ours: continue business as usual and watch Africa’s global poverty share rise or embrace the transformational potential of new trade finance approaches that can finally close the development gap. The technology exists, market needs are clear and institutional frameworks are in place. What remains is the will to change.
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