Banks battle against the trade finance gap with a lack of credit risk mitigants, new research finds

Every year, $2.5 trillion in global trade deals fail to materialise due to a lack of funding. This funding gap, representing a tenth of all global merchandise trade, persists not because solutions don’t exist, but because banks systematically ignore risk management tools that are easily available and accessible, says the research article published in Global Policy.

The article is authored by researchers Elvira Bobillo-Carballo and Alfredo Arahuetes García, who conducted extensive interviews with 38 senior trade finance bankers across 4 continents, uncovering regulatory hurdles, organisational challenges, and human bias that leaves trillions in potential business unfunded.

The researchers documented dozens of cases where financial institutions rejected viable transactions despite having tools to mitigate the associated risks, concluding that banks consistently fail to use Credit Risk Mitigants (CRM) efficiently.

The implications extend far beyond banking. For manufacturers in Bangladesh, farmers in Nigeria, and exporters in Pakistan, this financing gap translates directly to stalled economic development, unrealised job creation, and poverty in regions most desperate for growth.

Developing economies shoulder the global trade burden

The research article notes that the trade finance gap carves deepest trenches across developing regions. Asia and the Pacific absorb 34% of global trade finance rejections, with the Asian Development Bank estimating the regional gap at hundreds of billions of dollars. 

Africa and the Middle East face another 24% of rejections, creating economic dead zones where trade withers for lack of financing.

West African nations face particularly stark challenges. The Economic Community of West African States, including Côte d’Ivoire, Ghana, Nigeria and Senegal contend with a staggering $14 billion annual trade finance shortfall. Rejection rates reach 21% of requests and 25% of their total value, effectively slamming doors on economic development.

Region	Share of Global Trade Finance Rejections	Commonly Cited Problematic Countries
Asia and the Pacific	34%	Bangladesh, Pakistan
Africa and the Middle East	24%	Nigeria, Egypt
West Africa (ECOWAS)	21%	Ghana, Côte d’Ivoire, Senegal

Bankers have repeatedly flagged Bangladesh, Egypt, Nigeria, and Pakistan as problematic for trade finance. Senior bankers revealed a pattern of casual dismissal that hampers developing economies, with many simply declining transactions when they lack established credit lines. Others admitted focusing exclusively on larger transactions while ignoring smaller deals from small and medium enterprises (SMEs).

This geographic inequity creates a self-reinforcing cycle, as these nations have the potential to contribute to global economic growth. Many of these countries feature younger populations, expanding consumer markets, and untapped resources. Yet the trade finance gap effectively locks them out of full participation in global commerce.

Banks are rejecting the golden touch of risk 

According to the Bank for International Settlements, approximately 15% of global merchandise trade relies on letters of credit (LoC), with this percentage substantially higher in emerging economies. However, despite their proven track record, confirming banks increasingly reject these instruments in precisely the markets where they are most vital. They cite unacceptable credit and country risks, more like a financial euphemism that often masks institutional inertia rather than genuine risk assessment.

However, there is no doubt that the banking industry possesses risk mitigation tools for trade finance risk, but most of them remain unutilised. Some of these tools are specifically marked in the research article. It includes:

1. Export Credit Agencies (ECAs): They offer the strongest protection, government guarantees covering 95-100% of payment risk, but only 15% of bankers use them. As per the research article, many veteran bankers admitted complete ignorance that ECAs even offer short-term products, while Berne Union data shows ECAs underwrote 45% of the $2.78 trillion in global credit insurance last year.

2. Trade credit insurance: They provide a market alternative, with 60 commercial players ready to absorb up to 90% of risk. Though 42% of bankers use this option, most resist, citing cost concerns. Trade finance heads complain about insurers taking margin slices, missing the bigger picture: more deals, even at lower margins, mean more revenue. ICISA reports private insurers backed 72% of short-term trade credit coverage in 2023, a capacity that sits largely unused.

3. Multilateral Development Banks (MDBs): For frontier markets, multilateral development banks offer specialised guarantees through the World Bank’s IFC and regional institutions. Only 25% of bankers tap these resources, with barely a third aware they exist. Bureaucracy kills these deals as approval processes stretch six to eighteen months, outlasting commercial opportunities. MDBs contributed just $7.3 billion to trade finance in 2022, far below their potential.

4. Bank-to-bank risk sharing: This emerges as the industry favourite, with 48% distributing risk to peers using standardised agreements. Yet even here, image concerns trump business sense. Bankers routinely keep 10% of deals they’d rather fully offload, fearing market whispers about their risk appetite.

Banks volunteering themselves as tributes for pushing the boulder uphill

As per the research article, the banking industry seems to have voluntarily chosen to struggle unnecessarily with risk mitigation when easier paths exist. 

The researchers have covered three major challenges:     

1. Regulatory roadblocks becoming the compliance straitjacket

KYC requirements have morphed from safeguards into burdens, with nearly half of bankers citing them as major obstacles. The price tag is very high. One global bank shells out $75,000 annually per correspondent relationship, slashing its banking network from 8,000 to just 2,000 since 2009.

The research exposed a catch-22 that even when risk mitigants cover 100% of exposure, banks still demand full KYC processes. No KYC, no transaction, regardless of protection. This compliance obsession has decimated correspondent banking networks globally, down 20% since the financial crisis.

Basel capital requirements add another layer of confusion. Some banks get zero capital relief from insurance but full relief from bank-to-bank agreements. Others find credit relief varies by insurance provider based on internal risk models. These accounting inconsistencies turn profitable deals into rejected opportunities.

2. Organisational obstacles leading to banks defeating themselves

Banks’ internal structures actively undermine risk mitigation. Business strategy emerges as the dominant obstacle, with 46% of bankers admitting that trade finance lacks priority within their institutions despite its growth potential.

Institutional memory creates further barriers. Failed distribution attempts by predecessors breed resistance to change. Many banks require case-by-case approval through multiple committees for any risk mitigation. Some bankers candidly admit they decline transactions rather than navigate this bureaucratic maze.

Smaller banks face infrastructure limitations, with back-office operations that would collapse under increased volume. Meanwhile, legacy IT systems can’t properly register credit relief for certain mitigants, forcing transaction rejection even when solutions exist.

3. The human factor becoming banking’s weakest link

Most surprisingly, individual banker traits frequently override financial logic in risk decisions. Compensation structures create perverse incentives, with 32% of participants identifying them as influential factors, with bankers avoiding mitigants that would require sharing profits with other departments.

Additionally, knowledge gaps limit options, with 35% acknowledging blind spots. Many institutions rely entirely on whether specific individuals have prior experience with insurance from previous employers.

The research article also states that personal relationships dictate choices for 38% of participants. Bankers with strong contacts in certain markets stick with familiar channels regardless of economics. Several candidly confessed that convenience drives decisions; they avoid exploring mitigants simply because other deals require less work.

Credit Risk Mitigant	What They Cover	Active Users	Occasional Users	Never Use
Bank-to-Bank Market	Risk participation agreements	48%	23%	29%
Private Insurance	Up to 90% of default risk	42%	10%	48%
MDB Guarantees	Partial or full guarantees	26%	8%	66%
ECA Insurance	95-100% of LC confirmation risk	15%	0%	85%

Among 38 senior bankers interviewed, just one deploys all four mitigation tools. This bank maintains relationships with 35 insurers, participates in six development bank programs, leverages ECA guarantees and actively trades risk between banks. For each transaction, they evaluate all options and choose the most profitable approach.

Their competitive advantage is obvious and raises questions about why other banks don’t follow suit. Also, unlike Sisyphus, banks have a choice.

Cutting the red tape and adopting a comprehensive solution framework 

Based on their exhaustive analysis, the researchers propose a comprehensive framework to address this massive market failure. This framework includes several solutions. 

The first solution is to harmonise global banking regulations. The current regulatory patchwork discourages the adoption of risk mitigants and creates unnecessary complexity. By establishing consistent treatment across jurisdictions, banks can finally operate with clarity and confidence.

The second solution is to establish centralised KYC repositories to reduce compliance costs and streamline due diligence processes, potentially saving banks millions while expanding their ability to serve more markets. 

Additionally, the research states that there is a need to develop standardised bank procedures to assess and apply credit risk mitigants, replacing the current ad hoc approaches that create unnecessary friction and delays. 

Researchers stress on investing in modern IT infrastructure to track and account for risk mitigation, as legacy systems currently block innovation in many institutions. They have also mentioned implementing accounting systems that can accurately reflect the benefits of risk mitigants in departmental performance metrics, aligning incentives across organizational silos. 

Another line of suggested solutions is to create public-private partnerships that would improve data sharing across the trade finance ecosystem, enabling better risk assessment and more efficient mitigation. Lastly, the article says that expanding banker education programs is crucial as that would address critical knowledge gaps about available solutions, particularly focusing on senior decision-makers who may lack familiarity with newer risk mitigation tools.

What does it mean for trade finance?

The $2.5 trillion trade finance gap isn’t merely a footnote in banking reports; it’s strangling development across emerging economies where capital access determines survival. The researchers conclude that more effective management of credit risk mitigants could approve significantly more transactions, helping to close the trade finance gap. 

The timing couldn’t be more critical. With trade routes fracturing amid geopolitical tensions and supply chains buckling under repeated shocks, efficient trade financing has become an economic imperative, not a banking nicety. The challenge now lies in removing the regulatory, organisational, and human barriers that prevent their effective use. 

Read the full research article here.