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African banks face rejection of letters of credit from international lenders – Report

...as correspondent banking relationships decline

Trade finance activities of banks across the African continent were affected by Covid-19 as Letters of Credit (L/C) business and correspondent banking operations witnessed a significant slump. This could exacerbate the continent’s trade financing gap, while reversing gains in the expansion of African trade during the preceding few years, according to African Trade Finance Survey Report.

A letter of credit is a mode of payment used for the importation of visible goods, according to GTBank.

It is a written undertaking given by a bank (issuing bank) at the request of its customer (applicant), in which the bank obligates itself to pay the exporter (seller/beneficiary) up to a stated amount within a prescribed timeframe upon presentation of stipulated documents that conform to the terms and conditions of the documentary credit.

According to the African Trade Finance Survey Report released earlier in April, the number of correspondent banking relationships fell across the region, and the rejection of L/C requests increased, with about 38 percent of local/privately-owned banks and 30 percent of foreign banks reporting an increase in rejection rates, respectively.

The report, which was released by African Export-Import Bank (Afreximbank) in collaboration with the United Nations Economic Commission for Africa (ECA), the African Development Bank (AfDB) and Making Finance Work for Africa Partnership (MFW4A), revealed that almost 37 percent of respondents surveyed reported an increase in demand from their export clients.

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By region, Southern Africa and Western Africa reported the largest increases in demand for trade finance, and by size of bank, smaller banks reported the greatest increase in demand.

While 27 percent of banks surveyed saw an increase in demand for L/Cs, 39 percent of banks indicated a decrease in demand for L/Cs, and 34 percent indicated no change. From a regional perspective, banks in North Africa reported the highest number of documentary credit applications on the continent, followed by banks in Anglophone West Africa.

The survey showed a substantial increase in L/C request rejections in the first four months of 2020 compared with the first four months of 2019, with 30 percent of respondents indicating an increase in rejection rates.

Regarding correspondent banking relationships, major international banks and financiers cancelled and/or reduced their lines of credit limits for African banks, with Europe accounting for about 50 percent of the development.

Benedict Oramah, president of Afreximbank, highlighted how the tightening global financial conditions triggered massive capital outflows from Africa, exceeding $5 billion in the first quarter of 2020.

“These massive capital outflows strained African banks, many of which recorded sharp drops in their net foreign assets. This further exacerbated liquidity constraints and undermined the capacity of banks to finance African trade,” Oramah said.

The report pointed out that African trade amounts to $1,077 billion but that banks intermediate $417 billion of this, approximately 40 percent, whilst the global average is 80 percent.

Bola Adesola, senior vice chairman for Africa at Standard Chartered, stressed the need to increase businesses on the continent to help drive trade both extra- and intra-African trade and banks’ intermediation. The African Continental Free Trade Agreement (AfCFTA), she said, can provide a platform to help drive greater businesses.

Africa suffered its first recession in more than 25 years, and African trade contracted by 11.9 percent in 2020. Between January and August 2020, Africa’s merchandise trade contracted by 12 percent compared with the same period the previous year. Although the contraction was synchronised across the whole region, the greatest impact was on economies dependent on tourism and commodities, and especially leading oil-producing countries where oil exports account for more than 90 percent of foreign exchange earnings and more than 60 percent of fiscal revenues.

A joint survey undertaken by the African Development Bank (AfDB) and the Afreximbank covering the 10-year period 2011-2019, titled “Trade finance in Africa: Trends over the past decade and opportunities ahead”, was published in September 2020.

The report revealed that Africa’s trade financing gap decreased steadily from US$120 billion in 2011 to US$70 billion at the end of 2016, with the downward trend reversing in 2019, when the continent’s trade financing gap increased to an estimated US$81.80 billion; while average unmet trade financing demand in Africa was estimated at US$82.5 billion (which represents 5.5 percent of the global trade financing gap during the 10-year period).

The average size of bank-intermediated trade financing in Africa was estimated at US$417 billion, even though total African trade averaged US$1.077 trillion during the same period. This suggests that banks intermediated only 40 percent of Africa’s trade compared with 80 percent of world trade—which indicates that African trade is significantly underserved.

Hippolyte Fofack, chief economist at Afreximbank, reiterated the need to sustainably grow the supply of trade finance across the region.

“Trade finance is the lifeblood of commerce and will play a key role in the recovery and structural transformation of African economies to better prepare the region to future global crises,” he said.

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