GTR and BNY Mellon gathered a group of experts in the transaction banking business to discuss key concerns facing the market today. The debate served as a follow up to a survey conducted by the two institutions which tested the market on a number of different points including trade, liquidity, foreign exchange and regulations.
- Dominic Broom, head of sales and relationship management, Emea, BNY Mellon (Chair)
- Michael Gilham, director, trade product management, Lloyds
- Kutan Kudret, specialist, financial institutions, corporate loans, Isbank
- Manoj Menon, global head of trade services, innovation and customer proposition, RBS
- Colin Robertson, treasury services, head of sales, Emea, BNY Mellon
- Sameer Sehgal, managing director, Emea trade head, Europe, Middle East & Africa, global transaction services, Citi
- Nihan Turgay, chief representative, London rep office, Garanti Bank
- Phil West, head of product management, transactional products and services, Standard Bank
Broom: The availability of funding and new sources of liquidity are hot topics in the industry right now. Thinking about this at both the institutional level and the client level, I think it would be instructive to get the views from around the table as to whether it is felt that there is still considerable constriction in terms of the availability of liquidity. Indeed, given that we are represented by financial institutions around the table from four or five different countries, is the situation different market by market?
Sehgal: There are various aspects to the availability of liquidity. Firstly the actual quantum of liquidity available in the market has ebbed and flowed in the last 18 to 24 months. Lately, debt markets are bouncing back and equities markets are adding to the options available to the corporate sector. Until recently, this sector was largely reliant on trade financing. That said, accessing liquidity availability is very different and yet critical. From a corporate perspective, it then depends on the price at which liquidity is available and whether it makes economic sense given the current macro-economic situation to borrow. As an American institution, US dollars continue to be our natural currency and hence advantage. All throughout the last few years, we have had ample US dollar liquidity. 85% of international trade is still dollar-denominated, so we still see excellent opportunities to deploy our liquidity into the trade markets.
Menon: I would second that. Since 2008, for larger banks, such as RBS, the funding and liquidity position has been considerably strengthened since the financial crisis and whilst it is always an area of focus, it is not the most significant constraint for larger banks undertaking business. The availability of capital tends to drive business decisions as banks look to further strengthen capital ratios in light of changing regulation.
Another challenge is the low rate given on deposits and low demand environment for cash, as yields continue to compress.
Given the regulatory changes, banks are looking really at strengthening their capital. The main question is not the availability of liquidity, but a question of deployment of capital which will determine the flow of liquidity in the market.
West: For us, as a South African financial institution, funding has remained consistent over this period, notwithstanding any downgrades to South Africa. There is still an appetite for risk participation that we see, but in terms of the marketplace, what we are seeing is the episodic availability of trades in the market, rather than anybody looking at shifting whole portfolios.
Gilham: When we talk about liquidity I think banks are largely in a better position now; certainly, our bank is, and many others are too. When you look at the emerging markets, you will see that many of those banks are far more liquid than they were three to five years ago, particularly in dollars. That is a point that Sameer made, which is very relevant to the trade topic too. That is part of what is driving margins down. Because these banks are far more liquid, there is a smaller requirement for them to look for support through some of the trade structures that we have seen in the past. We see that as a clear shift in the market.
In terms of the internal discussion too, the reality is that business units are competing with each other for the investment in capital, and resources and infrastructure. It is absolutely key that we have the appropriate regulatory treatment so that we reflect the risks and the dynamics of our business and can compete effectively against those other businesses within the banking world.
Broom: I recently met with one of the well-known business consultants, and they were saying that, from a study that they are undertaking on transaction banking, their belief is that, as a business within global and regional financial institutions, it needs to be ‘self funding’. To your point, Mike, at the top of organisations, funding is seen to be more urgently needed elsewhere and, therefore, a transactional business needs to be profitable so that it generates the returns that permit continued investment. Would anyone agree?
Turgay: As a Turkish bank, the story is a little different from what we have discussed up to now. Of course, the amount of liquidity based on trade transactions has decreased a little first. Terms might have changed but they came back to normal from the start of 2010. We were lucky that we were not too dependent on international liquidity, due to our balance sheet strength. We were able to obtain liquidity from the deposit base thanks to the unsaturated banking environment in Turkey. That is why we were not affected that much and the strong capital levels of the banking system helped as well.
What we have done to reach a different type of liquidity was to work more with multilateral institutions. The transactions that have been concluded with exim banks, in addition to correspondent banks, have increased too. We were also able to tap the debt capital markets. So far, touch wood, emerging markets have enjoyed a liquidity flow and we have not faced any major concerns. This is also a result of our strong balance sheets. Our aim is to grow our balance sheets whereas the banks in the developed markets are trying to strengthen their capital levels.
Kudret: At a country level, Turkey is an emerging market and a developing country, so we need capital, funds and liquidity. The good thing is that Turkey is now an outlier in the emerging markets. There is a huge capital inflow into Turkey. From an institutional perspective, we have the biggest deposit base in Turkey, so we rely on our deposits. That is why we do not see liquidity as a concern. As Nihan mentioned, there is a great focus on Turkey nowadays. The volume of issued security has increased by almost 175%. Last year, we saw only seven or eight bonds in the market; now, there are more than 14 or 15, and more are coming. In terms of corporates, 30 new bond issues are due. The situation has never been like that before. At a country level, liquidity is a concern; at the institutional level, it is not a concern for Isbank at the moment.
Broom: Are you all seeing a greater diversity of sources of funding? Certainly one of the points that the market survey touched on was the possibility that the era of the money-centre bank was drawing to a close. As investors become more savvy, even down to a retail level, they are placing monies with different types of institutions. That means, regulatory pressure or otherwise, there is probably less capital with the large global financial institutions; certainly as a percentage of overall capital available, than there might have been in the past. This is forcing businesses and institutions to look across a more diverse spectrum of liquidity providers.
Sehgal: You are right. A few things seem to be happening contemporaneously. To start, trade remains essentially a cross-border business. However, at the same time, we are seeing what we call ‘sovereign nationalism’, namely countries creating embargoes that prevent the cross-border use of fungible liquidity. In both Asian and developed markets we have seen central banks backstopping the economy and using the liquidity generated onshore for onshore use. Therefore the desire to protect one’s country is taking precedence, and in the process creating barriers for flow of liquidity. That then interestingly creates pockets of surplus and deficits, which cannot be balanced out. It also raises interesting aspects around legal vehicles and bookings of trade transactions.
The other aspect is availability of credit. Liquidity is available, but we also see a flight to quality right to the top. If you are right at the top of the credit quality pyramid, you may see 50 to 70 banks bidding for your business, while if you happen to be at the bottom or even middle at times, there is significantly less interest. Liquidity is relative: at the top end, liquidity is accessible; otherwise banks often conserve their risk and regulatory capital.
Therefore, there could be a predilection to put that money with the central bank as opposed to lending it in the market. To some extent that has forced a squeeze toward alternative sources of funding other than the bank market and trade products. With recent, expansionary monetary policy across markets, since there are reduced options to invest in government paper, we do see insurance, hedge funds and money market investors seeking to buy trade paper. It’s still early days but going forward we do see that liquidity coming into the trade business from unconventional quarters.
Menon: You cannot look at liquidity in isolation. We need to consider the impact of Basel and the approaches banks have taken in implementing capital and credit models for trade. Basel has been punitive for investment grade-and-below countries. Basically, the issue is, do banks want to deploy capital in those markets and what are the returns.
In 2008, there was a liquidity problem, with banks not lending to each other; that is no longer the case and since then banks have strengthened their liquidity position. It is a question of picking and choosing where you want to deploy those funds to support your core client franchise.
West: This has forced every bank to look at what its strategic markets and clients are, and to make sure that they utilise their balance sheet to satisfy those clients. In the past, all of us may have been guilty of leaving fallow credit lines sitting around within our organisation, and what we have tended to do now is to make sure that we identify those and that we make sure that we can utilise that available credit elsewhere in our business.
Robertson: As you were saying, Sameer, the have-nots have to find alternatives. Do you think there is a momentum now for other forms of funding? I think you alluded to pensions and other players. Has the momentum built up in that respect yet?
Sehgal: It is really early days for the MMEs and SMEs. There are banks that focus on that segment and, for some time to come, that will continue to be the major source of their liquidity. If you go up in the credit chain and look at the more acceptable investment-grade names, we are seeing diversification there. Lenders avoid a concentration risk of being too exposed to one market as a source of liquidity. So the more diversification – CPs, bonds, equity, trade markets etc – the lesser the risk of running out of liquidity.
From an investor point of view, I think the opportunity for people to be able to invest and come out with the returns that they were coming out with between 2008 to 2010 has diminished. We know where interest rates are. If I were a money manager looking to invest my money, as opposed to getting the thin spreads available today, I might be motivated to look at trade, with its low loss given defaults history, short-term self liquidating nature to invest in, with a trifle more risk but definitely very solid returns. That said, at the moment, trade paper is distributable only in select markets. If we could build the technology to make trade paper more liquid, wherein money managers could move assets around, I think that would be the leap that needs to be taken.
Gilham: Building on that point, whether you are looking at the corporate aspect or at the banks, both, since 2008, are looking far more closely at diversifying their liquidity streams. From a corporate perspective, you have seen the corporate treasurer go from almost a peripheral role within the company to being at the absolute forefront of driving their strategy, looking at where and how they are investing their cash, looking at where they are taking their own funding from, making sure that they do not have a concentration of risk on one funding type or jurisdiction, and making sure that they are protecting their business. The same applies to the banks too.
In terms of the additional partners coming in and whether we see new participants, we do see that trend, and I agree with you that it is in its infancy. I can see that regulation in the insurance sector is likely to encourage some insurers to more closely match the term of their assets and liabilities. I do see this creating new opportunities for all market participants.
Back to this question around competing for investment and liquidity internally, I saw a piece of research by three independent analysts recently that suggested that the book-price multiples on the TB business is about 2.5%, whereas the nearest comparable business was about 1.5%.
Clearly, there are strengths that we can leverage internally. To your point, Sameer, about how we bring in some of these investors, I think there will be opportunities through market developments such as BPO and URF. Ultimately, we need to make the business more transparent and more visible, and that will be absolutely key to bringing in those new investors.
Broom: Considering the topic of client behaviours and picking up on the point of transparency, there is an ever-increasing requirement for greater transparency, being imposed on the industry from above, but I think it is probably also fair to say that clients are asking us to help them understand their business flows and to create what I would call greater transactional transparency within their businesses. We are certainly seeing that at BNY Mellon, not only from a classical correspondent banking viewpoint, but also from a broader financial institution standpoint. Is there greater focus from clients on what I would call cash as an asset class – both in the context of it being used as an instrument for settling transactions as well as it being a key, useful commodity from a longer-term investment angle?
Turgay: Locally from a trade finance perspective, cash became more critical following the global trend. The customers are looking for structures to discount the trade transactions with best terms on the table. Additional to banks, corporates started to issue their bonds, something new in the market. Cash management business and products and capabilities became more important and there is an increasing appetite from the customers.
Robertson: On the corporate side, there is a pressure for transparency for risk mitigation and particularly from the have-nots that have problems getting credit and availability. It is also coming top-down from the regulators. We are getting that pressure from both sides, really.
Gilham: I think you see it across a number of aspects: If you look at where the logistics market is going, there is far more automation and transparency in that space. There is increasing visibility of where the goods are. And we should move on from thinking about the business in a traditional way and look beyond established competitors and challenges. We have a golden opportunity now. The crisis has pushed us as an industry to the forefront of banking. We have an opportunity to make sure that we are not only relevant now for our clients and our businesses but that we remain at the very top level going forward too.
We need to innovate in the areas of greatest benefit to our clients. They are looking at more innovative solutions: For example, where companies may have just taken straightforward working capital lines for in the past, they are now also looking at traditional forfaiting structures around bills of exchange, where it can give the better balance sheet treatment, as well as new solutions providing greater efficiency as well. It all comes down to corporates’ needs for working capital, control and visibility.
Broom: Do you think the transaction banking industry is doing a good enough job at explaining what we do, how we do it and the benefits that we bring? I am thinking in terms of that dialogue up to regulators, because I am a little sceptical as to whether the industry has done that effectively enough. Second, it is about explaining that there are, to your point, Mike, very well-established tools that have possibly gone a little bit out of vogue, which can be brought back into use to provide exactly what the markets that we are seeking to serve the corporate market need.
Menon: Engagement with regulators is definitely required. For example, in respect of ring-fencing we expect progress in the UK this year as legislation and details are firmed-up. UK ring-fencing proposals currently pose some issues and questions for trade given restrictions on a ring-fenced bank’s ability to transact with other FIs and in non-EEA jurisdictions. RBS is engaged with the regulators in addressing those challenges and the impact it would have on trade business. From a UK perspective, the FSA allows trade finance transactions to be exempted from the one-year maturity floor. Exposures eligible to be covered are LC imports and exports; trade-related guarantees relating to sales of goods and services, and import and export loans collateralised by underlying goods up to maximum maturity of 180 days. This certainly has helped trade as less capital is required for these exposures.
Another example, the ILAA liquidity buffer, is a UK local requirement of holding liquidity buffers for the total trade portfolio which could result in increased costs for trade. This is again specific to the UK and engagement with the FSA is required to address these challenges. An example of trade business impacted is in fronting transactions, especially in situations where there is the inclusion of downward triggers for bank ratings.
RBS is indeed engaged in providing proactive advice to regulators on the impact to trade banks. There is more work to be done in order to determine impacts of the regulatory pipeline on trade facilities, the costs associated and impacts to pricing.
Broom: In South Africa there has been a very close relationship, with the big four financial institutions and the regulators in a very well-regulated market – a market that has emerged strongly in the financial sense post-crisis. It is also a very sophisticated market in terms of how both corporates and retail customers look to interact with their banks. Have you seen changing client behaviours as a result of top-down or bottom-up pressures?
West: In terms of changing client behaviours, from a corporate perspective we see far more multinational corporates wanting to come to the table and talk to us. We are much more front-of-mind, because they are looking for regional solutions. They tend to want to look at non-proprietary-type solutions that will enable them to operate on a multibank basis. In a lot of cases, they are generally looking for integrated cash and trade solutions across the whole supply chain, from end to end.
Sehgal: To the point about transparency, faith and trust, it’s not just the regulators or customers, but all constituents that are seeking more information from the banking community. Some of it is purely from a commercial perspective where corporates need faster online real-time information. However a lot of it is owing to a need for higher disclosure of financials and liquidity. In that regard, banks are fully aware of the enhanced data and disclosure they need to provide and are focusing extensively on complying with the raised standards of disclosure.
The concern is that due to enhanced capital requirements for trade products, there might be a dilution in the trade credit that’s offered to clients, with an increase in financing costs – this in turn might lead to an unintended consequence of hurting international trade as opposed to helping it.
Menon: One of the challenges facing trade is a lack of default data. The banking industry is addressing this issue together. This issue was discussed at the WTO trade expert meeting during 2009, which enabled us to make significant progress in building an ICC trade default register. The Basel Committee reviewed the ICC trade default register and concluded that the register does not provide sufficient analytical evidence for reducing the CCF for LCs. The data presented is more relevant for the probability of default of a trade finance instrument rather than its likelihood of becoming on-balance sheet. The Basel Committee, however, supports further work by the ICC trade working group, to strengthen data on trade finance.
The ICC trade register working group met last year in December to address the issues and to improve the data being captured on the register. We need to capture data based on recovery rates at trade product and trade facility level, to enable us to demonstrate to the regulators that trade is very low-risk. We need favourable capital treatment for trade that will enable banks to deploy more capital to support growth of trade, which will have an impact on how we price trade finance facilities.
Turgay: Do you think developed banks need more investment in technology to be able to drive that information? Developed banks are trying to minimise their costs and manage their capital, but in order to comply with regulations there is a need to invest in technology in order to be able to track those items in closer detail and to be more constructive and convincing.
Menon: I think you are right. Technology plays a key role for customers as a way to view transactions, a feedback loop, and will continue to play a role in developing communication channels that corporates can use to interact with their banks. It is a key future component in companies’ ability to react to and mitigate risks caused by disruptions to their operations and supply chains. Banks have a role and vested interest in the safety and security of customer information and the general health of global financial systems.
Technology spend is important and in some areas focused more on transformational initiatives and long-term views. Trade has traditionally been a manual and document-driven area and automation over the last decade has succeeded in dematerialising and modernising the way trade is conducted globally. Banks are keeping control over costs, focusing on serving clients better and hence investment in technology is required. Product and customer propositions will also determine the investment required.
Technology enables efficiency and cost-reduction in the long run; it also allows banks to develop new and niche products, particularly in trade. The bank payment obligation (BPO) is an example of this kind of innovation in the marketplace. Without this, we cannot innovate or bring in new products or solutions for our clients; for example, bringing together e-invoicing and supply chain financing.
On the other hand, in the trade space we see smaller and regional banks looking to outsource trade processing to larger banks, given the costs and barriers to entry involved in investing in technology.
Sehgal: I think some of this investment in technology is not determined by us, but by the trends in the marketplace. To give you an example, in Africa, the number of mobile users outstrip the bank account holders by possibly a factor of 10. There is a clear convergence of the banking and telecom sector in the continent, with mobiles becoming an effective channel of payment and communication.
Up until a few years back, a lot of the technology investment was being directed to the back offices. With the bar being raised on regulation, a lot of the investments are now going towards getting banks compliant with the new rules. That is dipping into the investment dollars available and hence limiting what goes towards product development. In some forms that could also be an unintended consequence of wider regulation.
Broom: As we look at the pricing model of this activity and at what we have to spend in order to invest and to keep the businesses up and running and credible in terms of both regulators and end-users, I am reminded of the earlier comments by the industry analysts who said that transaction banking has to generate its own returns in order to be able to invest. As you said, at the top of the house the investment is necessarily going to have to go towards those regulatory pressures, making, in some cases, those short and possibly longer-term fixes in order to meet those demands. That begs the question of whether we have the right pricing model.
The survey seemed to indicate to me, when I read through the results, that we are looking to charge for transaction processing, which is largely shown little value by our clients, but we are possibly giving away the data for free. We are trying to charge for something that is not wanted, or at least not valued, but we are giving away value. Does that statement resonate with anybody else around the table?
Sehgal: Yes, and it is going to force some model change. We are witnessing rampant change across the banking industry and business models are being changed to keep pace. One of the key things I have already mentioned is our correspondent banking model, whereby you give money to emerging market banks in the form of trade advances, and you get the cash deposits and liquidity in the form of cross-sell. That model worked well for many years. Under Basel III, however that model might not work given the differential treatment to the assets and liabilities. That is one model that is being questioned at the moment.
The other model is that, as was rightly mentioned earlier, if deposits and interest rates are so low, fee-based activities would need to be priced upwards to make up for the costs of extending those products. The unfortunate thing is that this is a radical change and first movers might not always have an advantage.
Gilham: As an industry, we are much clearer on what the costs of liquidity and capital are. In terms of our pricing models, this is well understood and factored in now. As we seek, between us, to build sustainable, viable business models going forward, with regulatory changes and increasing compliance requirements driving up operational costs significantly, we have to ask ourselves: Are we really factoring in the true cost of transacting? As an industry, we have a little way to go on that, and the first mover will be very unpopular – you are absolutely right.
Menon: I do not think it is a question of being unpopular but is it sustainable for banks? If you offer services through channels that benefit clients, are we factoring these costs into our products and services? There is a cost to the bank for providing a better service through continued investment in technology, this helps client’s with more transparency in managing their trade business, risks and working capital. The service provided should be priced accordingly. Would clients object to the charges? Perhaps not, we hope to see a change in how banks price their products and services.
West: Historically, a lot of investment from banks has focused on the cash space, because that was where the greatest levels of automation were. The traditional trade finance products did not lend themselves to that kind of automation, so there was perhaps not a requirement for the investment. That refocus of the business model on the supply chain means that you are now focusing on different parts of that business. Alongside the cost of meeting regulation from a systems perspective, which can be vast, particularly with the amount of data that you have to maintain all the time, banks are also having to spend on the innovative ends of the trade business too.
Gilham: This creates an opportunity for us. The reality is that, to the detriment of trade, we have subsidised other businesses in the past, and transaction banking has not had its fair allocation of investment and capital coming into the businesses. When we consider the external environment and in particular due diligence aspects of trade, there is an opportunity for us to think about how we leverage these activities, rather than just seeing them as additional cost. As regulators and governments are looking at banks to act in areas such as compliance, enforcement of financial sanctions and similar aspects in respect of trade finance, could the visibility created through trade finance and its strong performance be part of the script to keep trade and transaction banking at the forefront of the banking industry?
Broom: What is going to be your hottest market – geographic or segment – in 2013?
Robertson: I would say, for us, it will be the non-bank FI segment.
Sehgal: The commodities space. We are entering that space in trade and see a lot of opportunities to leverage our reach, processing capabilities and network.
Menon: For us, it will be to continue supporting our core client franchise in corporate, banks and non-bank financial institutions segments.
West: We will focus on Africa and where some of the strategic geographic gaps are, but also making sure that we absolutely trap the trade flows in and out of Africa more effectively.
Gilham: We are committed to supporting the UK economy and our core UK client base. Naturally, the emphasis will be on providing the services to meet our clients’ needs, particularly in the SME segment.
Turgay: Turkey, SME and retail banking.
Kudret: Turkey, corporates and SMEs.