Co-operation and partnership are essential if banks are to prosper and meet the needs of their corporate clients in the new world of trade finance, writes Anurag Chaudhary, Global Head of Trade Distribution at Citi.
During the 1990s and early 2000s, most trade banks focused on growth. In their quest to expand, both geographically and in terms of products and markets, efficiency was inevitably a secondary consideration. As banks became bigger, there was some wasting of resources. Nevertheless, the imperative to grow trumped all other considerations: banks dismissed collaboration as offering little value and therefore allocated few, if any, resources to it.
In the post-crisis period, market conditions have changed dramatically. Regulatory and compliance requirements have significantly increased the costs and challenges associated with the global trade business. Banks have had to invest in technology to meet these requirements while Basel III, for example, has required them to source higher cost deposits that benefit their net stable funding and liquidity coverage ratios.
These factors are prompting a rethink by management at most banks about the shape and nature of their operations. Many banks are conducting reviews to weed out those businesses with low returns or poor prospects: reductions of branch networks and the exiting of business segments, asset classes or countries have followed in some cases.
Meanwhile, the trade business faces significant headwinds, including falling commodity prices and volumes, geopolitical instability in Greece, the Middle East, Ukraine and elsewhere, which has increased volatility and reduced demand. Combined with surplus market liquidity, these factors have caused a gap between trade finance supply and demand that is driving down pricing.
The need for a new model
Despite the challenges facing banks, trade remains attractive. Indeed, there has been a post-crisis shift towards shorter tenor products such as trade services and finance. Regulations such as Basel III encourage banks to embed themselves into clients’ end-to-end working capital cycle. Expanding the trade business is a key part of this strategy.
However, the need for stringent expense management, the increased importance of returns on capital (given regulatory imperatives) and limited increases in resources (including personnel) mean that many banks are struggling to invest sufficiently in trade to achieve the required economies of scale. Moreover, in some instances, reductions in branch networks or product offerings have compromised banks’ ability to service their clients’ trade needs effectively.
Corporates increasingly want to work with a core bank that offers an extensive international branch network and can provide a comprehensive trade solution. But faced with the challenges outlined above, many banks are unable to meet these requirements – and could therefore lose business. In short, many banks require a new trade model if they are to remain competitive.
The answer to this challenge is collaboration, which has become a buzzword as banks have sought to balance their credit and cross-border appetites, straightened resources and desire to meet clients’ trade requirements. By piggy-backing on a global bank’s infrastructure, banks can offer competitive pricing and solutions to clients. Freed from the need to invest in infrastructure, including branches and products, banks can focus on their core activities and relationships.
Moreover, collaboration opens up new opportunities for banks. In product areas or geographies where a bank intends to expand, collaboration enables it to learn about new markets while using another bank’s existing network and capabilities – and without making a significant investment. For many banks, the move from competition to collaboration makes clear strategic and financial sense.
Potential areas of collaboration
Some opportunities arising from bank collaboration include:
1. Reduction of correspondent banks and SWIFT keys: Banks are required to undertake costly, detailed Know-Your-Customer (KYC) audits for each branch/subsidiary of their correspondent banks in order to exchange or maintain existing SWIFT keys. By routing trade flows via the branch network of a global bank, banks can rationalise their SWIFT keys and lower their compliance costs while still meeting their client’s requirements.
2. Use of branch networks: Banks without a presence in a country can route traditional trade business, such as letters of credit (LC) confirmation, LC discounting, local issuance of standby LCs, guarantees and raising trade financing for their local subsidiaries, via their correspondent bank’s branches. This is also convenient for LC beneficiaries, which often prefer to deal with a local branch rather than an offshore negotiating bank (there is therefore the potential for a fundamental shift from LC Relay to the use of a local branch network).
3. Technology solutions: Clients are migrating from traditional trade financing solutions to complex products, such as supplier finance and account receivables programmes, as part of the move to open account trading from LCs. Many banks do not have the technology and operating platforms to offer these products to clients and may not have the resources to build such solutions.
4. New product launches: Companies have extended their supply chains to exploit low-cost geographies while selling their products in global markets to expand their customer base. This has increased complexity and risks and led to a demand for new trade solutions: banks need to meet this demand cost-effectively and can approach the prominent segment players for possible collaborations and to gain product knowledge and market intelligence.
5. Club structures: These are used for large-ticket one-off trade transactions, including commodity and capital goods flows, and have no commitment fees. Ticket sizes are usually between US$50mn and US$250mn. The club of banks work with the importer or exporter, or a letter of credit (LC) issuing bank: all banks in the club are disclosed to the client. By involving multiple banks, clients benefit from increased capacity but only have to interact with a single bank.
The role of global banks
Global banks have a major role to play in encouraging greater trade finance collaboration. They can provide branch infrastructure and liquidity. They are also increasingly making their technology and operational platforms available in order to leverage their economies of scale and reduce costs, not only for themselves but for the industry as a whole.
Global banks should take the lead in developing new models to help solve client needs. In the syndicated lending markets, large banks created a standardised format with banks participating as mandated lead arrangers (MLAs) or lenders. While MLAs have in-house infrastructures, lenders focus on funding only and cut other ancillary costs – thereby improving their overall returns. Similar developments are likely in trade, with global banks playing an aggregator role.
Global banks also have the expertise and resources to set up infrastructure for multi-bank global trade programmes. These allow groups of banks to originate trade paper and fund it through the issuance of structured trade-backed paper, providing capital, risk and liquidity relief on their trade portfolio.
Improving communication in the trade industry
The key requirement for trade banks to move from competition to collaboration is greater communication. Global banks must invest to boost their financial institution relationship and trade sales teams in order to increase their interaction with banks. They must also recognise that trade partnerships will reduce costs and generate revenue.
At the same time, smaller regional and local banks need to conduct a detailed audit to determine which parts of their organisation are core and non-core, where they add value for their clients and how they differentiate their offering. This should be accompanied by an assessment of costs, returns, incremental demands, and future client requirements.
The results of banks’ analyses of their existing operations and future needs should inform plans for re-engineering and re-structuring aimed at improving efficiency and lowering costs. These analyses can also guide banks in their interaction with global banks: where opportunities are identified to collaborate with global banks in order to reduce costs, improve efficiency or better service clients, banks can begin a dialogue with the goal of improving their trade business through strategic or infrastructure partnerships.
The benefits of collaboration – both for global banks, by enabling them to gain economies of scale, and to smaller banks, by helping them grow their trade business – are clear. The increasing cost of branch networks and the continued requirement to invest in technology and compliance mean that global banks must leverage their resources more effectively. Meanwhile, client expectations are growing: smaller banks will only be able to meet them if they are able to maximise efficiencies and cost-effectiveness through partnerships.