Trade Finance in Latin America: Constraint to Opportunity
Trade and trade finance is growing in Latin America spurred by the opening up of the economies in the 1990s by regional government policies and new trade treaties. It has also been fuelled by the realization of businesses that the local markets are not sufficient to guarantee growth and that exporting is a great source of revenue and diversification.
Discussing trade finance in Latin America is as complex as describing Latin America itself. To the unsuspecting, Latin America can be divided between those who speak Spanish and those who speak Portuguese. Others may bundle the Caribbean with Latin America since everything south of the Rio Grande ‘falls under the Latin American label’. However, to the trained eye, Latin America is a composite of diverse sub-regions that for the most part have a common history, culture, language and challenges. Each sub-region has its own unique characteristics, whether it is language and sheer size in the case of Brazil, or geographic location in the case Mexico; the presence on its northern border of the mighty US, makes its position singularly unique.
As I travel Latin America, I am impressed by the emphasis placed by bankers on trade and trade finance. In numerous meetings with Chilean bankers, I regularly hear them explain how Chilean companies are no longer producing exclusively for the local market. Bankers in Chile point to the fact that their customers are looking to export. In fact, most banks in the country are heavily investing in trade related technologies and processes as they see a significant increase in the demand for LCs, collections and pre-export financing.
Argentina is also focusing heavily on trade. With a depressed, albeit recovering, internal market and spurred by the government, businesses in Argentina see international trade as an important avenue out of the current economic doldrums and an essential source of hard currency. The devalued peso gives this focus additional impetus.
Brazil, the giant of Latin America, is also involved in an extraordinary expansion of trade. This time, however, the leading factor is the voracious Chinese appetite for natural resources that a country the size of the continental US readily provides. It is widely believed that by 2050 the BRIC consortium – Brazil, Russia, India and China – with their large and growing population bases, large natural resources coupled with seemingly unending technical talents and large demanding consumer bases, will be the dominant commercial and financial centres of the world at the expense of the US and Europe.
Moving to the west of Brazil you reach the periphery of the Andean region and find Peru. The country is witnessing intense competition for trade finance customers by banks. With the rapid growth of trade, exporters and importers are becoming more demanding, but so are the opportunities for the banks. For example, Banco Interamericano de Finanzas (BIF) – a local bank with just 3 per cent of the country’s deposits – ranks in the top five in terms of trade services market share and it is looking for further growth.
Further north at the intersection of South America and Central America is Colombia. A country long stereotyped, Colombia is seeing a tremendous growth in intra-regional trade. Its exports to Venezuela have soared in the past year and its trade with Ecuador has also grown at a significant pace. President Alvaro Uribe is intent on signing a free trade agreement with the US to spur trade and economic development in January or February 2006. Colombia’s internal market of 45 million people, along with its decentralized economic and production centres around the country have created numerous mid-sized companies that are poised to benefit from free access to more developed and mature markets. Companies there are eagerly working on enhancing their current production and marketing capabilities to export their products.
Central America’s trade has also been growing as economies have become more stable and this tendency is expected to continue as a result of the signing this year of the CAFTA-DR that commercially links five Central American nations and the Dominican Republic with the US. However, the region still lags in the production of capital goods and most countries there still suffer from a plethora of financial institutions. Therefore, trade finance volumes are still low compared to other Latin American countries and there are very few banks in the region that have significant trade finance critical mass or trade departments.
In terms of trade finance banking products and practices, Latin American companies still depend heavily on LCs. This is a result of the need to mitigate risk – the Latin Americans’ tendency to play it safe (LCs provide much desired risk mitigation) as well as the need for quick access to funds. Latin American capital markets provide inadequate financing both in terms of access to funds as well as the cost of funds. Thus, exporters as well as importers rely heavily on trade related loans to finance their working capital needs. It is common practice in Latin America for most LCs and collections to be converted into trade related loans.
Another interesting tendency in Latin America is the emergence of factoring. While this is a product highly established in markets like Chile, it is apparent from discussions with bankers all across the continent that more and more banks are looking to offer a factoring service. It will be interesting to see how quickly, if at all, domestic factoring services will be complemented with international factoring services and thus allow exporters improved access to funds and to selling to importers that trade only on open account.
A similar interest in invoice discounting in the developed world by the global banking community may have an impact on trade finance in Latin America. In their quest to increase their intermediation of international trade, global banks are looking to fill the gap in the ever-growing open account trade market. This could have positive effects for Latin American trade finance and for Latin exporters, as global banks look to finance exporters’ receivables based upon the credit risk of buyers. For example, a Central American exporter could receive financing from a US bank based solely upon its export receivables from the supermarket, Wal-Mart. The discount rate would be more competitive than that provided by the domestic financial institutions and the foreign bank would also be receiving a higher yield than if it were lending at home.
Other factors affecting Latin American trade finance include automation and the use of the Internet. As a general rule, it can be said that most Latin American banks have automated trade finance departments. In the 1990s local banks invested heavily in technology thanks to the fall of import barriers and a comparatively small burden of legacy systems as compared to their North American and European counterparts. Latin American banks leapfrogged in the banking technology sector and many international vendors found that the early adopters of new technologies at the time were the region’s leading banks. This appetite for technology also benefited the trade finance areas of banks.
Today, most banks in the region have some degree of automation ranging from specialized applications to in-house developments to trade finance modules derived from the bank’s core banking platforms. Of the banks currently processing trade, only small and newly created banks are manually processing trade. As a result, the market for trade finance solutions is very competitive. Banks are savvier buyers and there is a host of technologies and trade finance solutions of varying degrees of quality and functionality available for their selection. However, many banks are graduating from non-specialized trade finance systems to specialized trade finance solutions from global trade finance providers as the competition for customers intensifies.
One cannot mention banking technology without referring to Internet banking. Worldwide, trade finance Internet banking generally resulted from a second wave of Internet automation in banks. Most banks invested initially in retail products before turning their attention to more complex products such as trade finance. In Latin America, this was also the case and the penetration of trade finance Internet offerings is as diverse as the countries that make the region. Corporations in Chile, Peru and Mexico have access to these Internet banking services. Banks in these countries are pitted against each other in a market where companies are demanding superior trade services, lower prices and added value.
A growing number of corporations, as in Europe and North America, are refusing to work with banks that do not provide Internet based trade finance technology. Other countries such as Panama and Costa Rica are beginning to catch up, while countries such as Colombia and Ecuador remain lethargic in the offering of these products, as both banks and corporates seem reluctant to undertake this type of required change. Another interesting case is Argentina, which was an early adopter and had a fairly good offering of Internet trade finance services; however, most of them were dismantled during the financial crisis.
From the corporate side, companies in the region are becoming more adept at international trade; in many industries in the region there is growing and effective integration of the trade and production chains. However, there is still a long way to go before we see in Latin America unity of the trade and financial supply chain as we see in the developed economies of the world. While Latin American importers and exporters are more demanding and are asking for improved turn around times and flatter fees, they have yet to stress the need to improve their productivity by receiving superior technology from banks and added value services such as purchase order processing and ERP integration. Barriers to the adoption of these services range from simply not knowing that these products exist to the know-how that these types of solutions require from both banks and corporations.
Even though Latin America is less heterogeneous than most people think and each country and region in the continent has specific trade finance scenarios, common threads can be found among the different countries in order to approach the market from a financial services company’s or trade finance technology vendor’s point of view. One thing is certain; trade finance will continue to play a growing role in Latin America. For example, last year at the Latin American Congress for Foreign Trade (CLACE) in Mexico City (April 2005) and at the Latin American Federation of Banks (FELABAN) annual meeting in Miami (November 2005), I witnessed hundreds of bankers come together to discuss inter-bank services and significantly trade services.
The annual FELABAN meeting drew more than 1500 delegates of which 300 were from the US, Canada and Europe looking to strengthen ties with Latin American banks. If a sign is needed as to the potential of trade finance in Latin America, this is surely one.