The rising cost of commodities is having a significant impact on the availability of credit and will force corporate treasurers to work more collaboratively with their banks to secure financing, writes Christoph Gugelmann, Co-Founder and CEO, Tradeteq.
The war in Ukraine continues to devastate global trade and development as well as human life. A report compiled by the United Nations Conference on Trade and Development (UNCTAD) concluded that the war had contributed to a “rapidly worsening outlook for the world economy”.
Alongside heightened financial volatility, sustainable development divestment, disruption to global supply chains and mounting trade costs, is a clear rise in the cost of commodities. The concern of UNCTAD and other economists centres on two critical commodities – food and fuel.
Both Ukraine and Russia are major players in the global food-agri market. Known as the bread basket of Europe, Ukraine is among the top three exporters of grain. Together, the two of them account for more than half (53%) of the global trade in sunflower oil and seeds and more than a quarter (27%) of the wheat market.
Meanwhile, sanctions on Russian gas have exacerbated a global energy crisis. The USD value of crude oil has increased to more than $100 per barrel having begun the year at just over $75 per barrel. Russian oil and gas condensate also dropped to less than 10 million barrels per day (the lowest level since July 2020) as the impact of sanctions took effect. Meanwhile the Organization of the Petroleum Exporting Countries (Opec) has warned that it will be unable to replace potential supply losses from Russia, news that led to a 6% rise in Brent Crude futures.
UNCTAD warns that the soaring food and fuel prices will affect the most vulnerable in developing countries. There will also be a major impact on global trade, especially in terms of financing for SMEs that are reliant on banks’ credit lines.
One of the main impacts of the rising commodity costs is on the availability of credit. Many suppliers will find that their current credit lines do not cover an inflated cost for the same volume of goods. Take fuel, for example. The increased cost of crude oil so far this year equates to a $100m for an average cargo.
If there are firms in the supply chain with lower credit quality that are unable to meet their cargo costs, then some goods might not move at all. Other buyers may exit regions where credit is scarce.
At the end of 2021, the trade finance gap between supply and demand widened from $1.5tr. in 2018 to $1.7tr., an increase of 15%. Again, it is SMEs that have been hardest hit. An Asian Development Bank report states that despite accounting for just 23% of trade finance applications, SMEs experience 40% of the rejections. And almost one-fifth of SMEs reported not being able to find a financing alternative.
SMEs already face several barriers in the trade finance market – the need to provide collateral; AML and KYC compliance measures; and the lack of digital processes to name but three. The gap is likely to increase further given corporates’ need for more financing at a time when banks’ lending activity is so stretched.
Banks under pressure
Banks’ lending books have been under pressure for some time. One cause is regulation. Successive Basel Accords have placed increased capital requirements on banks. With Basel IV waiting in the wings, this is likely to increase further. Consequently, banks in the global trade finance market have reduced their standardised risk weights and become more circumspect in terms of to which companies they lend.
Some banks have taken to the capital markets to try to reduce the trade finance gap. They have adopted an ‘originate and distribute’ model for their trade books, whereby trade finance instruments are distributed to other banks or to the capital markets.
Credit has emerged as a popular asset class with investors looking for returns in a low-yield and low interest rate market. It also enables banks to make more efficient use of their trade books and opens up additional sources of funding for corporates dependent on trade finance.
Better use of technology has also helped. For example, some banks have applied AI to their credit scoring to obtain a more accurate risk profile of their clients. The use of more granular analytics enables banks to assess the risk of funding a single transaction, which also opens more opportunities for financing for those corporates that would otherwise be overlooked for trade finance.
It is a challenging time for global trade, but companies should seek to work more closely and collaboratively with their banks to explore the full range of financing options that may be available.