Banks push G20 to reform trade finance regulation

April 22nd, 2010 Leave a comment Go to comments

Trade finance banks are stepping up pressure on the G20 to ease regulation of the credits that keep global commerce flowing, after a new survey showed credit tightness is still hampering the flow of trade.

The survey, conducted by the International Chamber of Commerce (ICC), shows that the supply of trade finance remains constrained both in value and volume, and that banks have cut credit lines even though almost all of them say losses in trade finance are less than in banking generally.

The survey, commissioned by the World Trade Organization to be presented to the G20 summit in Toronto on June 26-27, also highlights banks’ concerns that the tougher regulation of financial markets following the crisis does not recognize the safer nature of traditional trade finance instruments.

This could drive up the price of the credits and constrain their availability for some exporters — a trend already indicated in the survey, which offers an unprecedented snapshot of the industry by tapping 161 banks in 75 countries.

In letters to the Basel Committee on Banking Supervision last week, the international banking association BAFT-IFSA recalled the G20 had recognized trade finance as the lifeblood of commerce and a key engine of growth and development.

“Restricting the flow of credit to this area… means essential goods cannot be traded, posing a threat to importers in emerging countries, with smaller banks and small- and medium-sized enterprises being disproportionately affected,” it told the Basel regulators.

DRIVER OF ECONOMIC RECOVERY

Essentially, trade finance enables exporters to be paid if they document that they have delivered the goods as agreed, rather than having to chase the importer once the shipment has arrived. It is this confidence that keeps goods moving.

According to the ICC, trade finance secures about 90 percent of global merchandise trade, which the WTO put at about $12 trillion last year.

It is one of the oldest forms of banking, dating back to the Middle Ages. Major players include Deutsche Bank, HSBC, and ING.

Trade finance dried up as banks stopped lending to each other after the financial crisis broke in late 2008.

Economists now believe the shortage of trade finance accounted for only a small part of the 12.2 percent contraction in world trade volumes last year — the biggest fall since World War Two — with most due to slumping demand. But the availability of affordable trade finance is crucial to underpin the revival in trade — forecast this year by the WTO at 9.5 percent, and a core driver of economic recovery.

The ICC survey shows that 84 percent of respondents expect an increase in demand for trade finance this year.

But the price has gone up, and for longer-term transactions over a year, insurance cover from a government-backed export-credit agency — with the extra cost of additional premiums — is now virtually mandatory.

Trade finance practitioners say their instruments, such as documentary letters of credit, have several characteristics making them less risky than other forms of lending.

– they are short-term loans, mostly running for less than 180 days, and they are self-liquidating — closing when the underlying goods are delivered and paid for.

– they are secured on the exports that they fund.

– in contrast to derivatives such as collateralized debt obligations where counterparties are unknown, banks handling trade finance know each other and their exporting and importing customers, and only allow the transaction to go ahead after painstaking checks and paperwork.

Practitioners have two main complaints about regulation.

The current “Basel II” rules assume all credits have a minimum maturity of one year, and do not recognize the shorter-term — and hence less risky — nature of most trade finance. National regulators can waive the one-year minimum maturity, but only the UK’s FSA has chosen to do so.

Proposed new rules, known as “Basel III,” intended to deal with liquidity and leverage risks in the wake of the crisis, would treat letters of credit as “off balance sheet,” requiring banks to set aside funds to cover their full value, instead of only about 20 percent as at present.

The Basel III proposals will be discussed at the G20 Toronto summit.

At a commodities forum hosted in March by the United Nations Conference on Trade and Development (UNCTAD), bankers and lawyers acknowledged the trade finance industry had been slow to lobby regulators and ensure the sector was properly understood.

In fact a survey prepared for the G20 London summit in April last year, highlighting tensions in the sector, led to the G20 approving a $250 billion two-year package of trade finance from multilateral institutions like the World Bank and from export credit agencies, which succeeded in easing strains.

The ICC and the Asian Development Bank are now building a database to document that default rates in trade finance are lower than in riskier forms of credit, and to make the case to regulators that trade finance needs special consideration.

“What is important for us is that it gets fair treatment and for that they need the data,” Kimberly Wiehl, secretary-general of the Berne Union of private credit insurers and government export credit agencies.

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