Is commodities financing still profitable for African banks? (1)

That African banks have had their fingers burnt in their trade financing business is not surprising. For most of the second quarter of 2020, there was little or no international trade across many fronts. Ports and borders were closed globally, ships were stuck on the high seas, and those close to shore languished at the sights of deserted ports close by. So like their global counterparts, African banks suffered immense losses owing to grossly reduced trade activities.

As things have begun to ease a little, with borders being reopened and ports back online, some of the lost activity have begun to recover. It is important not to generalise. Yes, there have been a great reduction in international trade with financiers suffering losses in tandem. But the specific commodities in question are also important. This is because the general losses owing to reduced trade have been compounded by commodity-specific losses. Bank exposed to oil & gas trading firms suffered additional losses due to bearish markets. Those who hedged adequately were able to recoup some losses. But many did not do so adequately enough to make a significant difference.

Foreign exchange scarcity and depreciating currencies have also been huge impediments. Correspondent banks, which had hitherto been scaling back their African relationships, doubled down on their distancing once the pandemic hit. In any case, reduced demand also meant that even if all were ideal, banks, merchants, and others, had goods they could not sell. The unpleasant experience has pushed some European banks to decide they would give up the commodity trade financing business entirely. Some of the motivations relate to structural issues. An increasing trend towards green energy is one. Increasingly thinner margins amid rising risks in tandem are another.

African trade finance suffers from other constraints that predate the pandemic but have been exacerbated by it.

Temporary troubles

According to research by the African Development Bank (AfDB), the continent’s trade with top partner China decreased by 14 percent in the first quarter of 2020. It likely fell much more in the subsequent quarter, when African countries began to lock down as well. International prices of the continent’s top five exports, namely, crude oil, natural gas, coal, gold, diamond, have been volatile and mostly lower; albeit gold and crude oil have since recovered.

Read Also: Hope rises for female owned business that suffered losses during the COVID-19 pandemic

African trade finance approval rates have been hit by COVID-19 restrictions on physical contact and large gatherings. Consequently, Africa’s already wide trade financing gap, estimated by the AfDB and African Export-Import Bank (Afreximbank) to be about $82 billion in 2019, is expected to widen even further this year to as much as $120 billion, according to the AfDB and International Chamber of Commerce, owing to COVID-19 constraints.

African trade finance suffer from other constraints that predate the pandemic but have been exacerbated by it. According to a recent AfDB-Afrexim bank trade finance survey, more than half of the constraints on the supply of trade finance by African banks are related to correspondent banks, foreign exchange liquidity and regulatory restrictions.

“Close to 20 percent of African-based banks cite inadequate foreign exchange liquidity as a key constraint to increasing trade finance supply”, according to the AfDB. This has always been a major source of friction in African banks’ correspondent banking relationships with their global counterparts. With dollar liquidity further constrained owing to the pandemic, global banks may be forced to reduce correspondent banking lines.

Global banks had hitherto also worried about the robustness of money laundering and terrorist financing curbs by African banks. There has been some progress in this regard, though, says Moody’s senior vice president and banking analyst, Constantinos Kypreos, who says that they had not witnessed an escalation of such issues during the pandemic. Add to that the specific challenges of the African business environment like its huge infrastructure deficit, dearth of skilled labour, and so on, it would be understandable if some of the continent’s banks are similarly mulling whether it is really worth all the trouble.

In any case, small and medium-sized enterprises (SMEs), which are the key drivers of jobs and growth on the continent, do not enjoy the kind of support from African banks that is commensurate with the key role they play. In fact, the AfDB finds that African banks currently support only about a third of the continent’s trade, with less than a third of banks’ total trade finance portfolio benefiting SMEs. Large companies tend to be the major beneficiaries.

Some development finance institutions (DFIs) and global banks are taking on the challenge. In early July, CDC and Societe Generale announced a $100 million risk-sharing facility to facilitate trade in what it called “hard-to-reach African markets.” The goal is to “stimulate trade and supply chain efficiency in Africa by supporting banks and smaller financial institutions in providing capital and increasing credit that businesses need for their continued growth.”