Banks and insurance companies are gearing up for another battle over capital requirements regulation, this time in the US.

Three powerful US regulators last year unveiled their planned implementation of the latest tranche of Basel reforms on banking supervision, known as Basel 3.1 and designed by a committee of central bankers to minimise risk in the global financial system.

Banks say the mooted reforms, referred to in the US as “Basel endgame”, may drive up the cost of providing trade finance and make lenders less willing to offer such products to customers, particularly SMEs.

Insurance industry groups have also lamented that the draft rules fail to consider the role credit insurance can play as a risk mitigation tool for lenders.

The US plans will, in some cases, add a heavier capital burden to banks than the EU and proposed UK interpretations of the updated Basel framework.

These are some of the top issues highlighted by trade finance and credit insurance industry groups in their responses to the proposal put forward jointly by the Federal Reserve, Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation.


A potential problem for supply chain finance

The regulatory trio have said that under the revised capital rules, any bank debt more than 90 days overdue would be deemed a defaulted exposure.

The Bankers Association for Finance and Trade (Baft) wants trade finance exposures to be carved out of that rule in cases when payment is overdue for operational, rather than credit reasons.

For example, its response letter says that a trade finance exposure might be subject to a legal dispute which could continue for much longer than 90 days, but not otherwise meet the criteria of a default.

If enacted, Baft argues, this rule could be particularly problematic for supply chain finance programmes, in which repayment terms can be stretched out and banks deal with very high volumes of often low-value receipts.

“Industry data globally confirms that trade product defaults are very low risk and history has shown that corporations try to work through their trade business even in instances where they are having financial difficulty,” its submission says.

Baft is concerned that the rule would apply not only to an exposure the bank has to its client, but any overdue debt that client has to another one of its other lenders. For example, Bank of America would have to somehow become aware if a corporate client has an outstanding invoice payable under a separate supply chain programme it has with JP Morgan.


Capital for services

Another aspect of the draft rules which distinguish the US from the EU and UK is the proposal that banks’ fee-earning activities be subject to capital requirements.

While many Wall Street banking giants earn hefty fees from their investment banking arms, trade finance fees are much more modest. They typically consist of documentary credit activities such as issuing and confirming letters of credit and guarantees, and basic wire transfer or collection charges.

Baft says these should be exempted from capital requirements because actual losses from the fees “are next to zero” and they are a small part of most lenders’ overall fee mix, typically comprising around 4% of their largest member banks’ fee earnings.


Credit conversions

As in the first EU draft and the current UK plans, the US regulators have proposed applying a credit conversion factor (CCF) of 50% for performance guarantees, standby letters of credit and similar products.

CCFs are used to calculate the risk that the guarantee or letter of credit will convert onto the bank’s balance sheet and be paid out.

Baft says that a 50% CCF overestimates the risk such products pose to banks. Industry data not used by the Basel committee shows that a CCF of 20% is sufficient, its letter says.

Because the EU was last year swayed by arguments from banks and is set to continue with a 20% CCF for these products, Baft argues that American institutions may lose business when competing against European banks.

“The continuation of the 50% CCF means that a US bank will be allocated a capital charge that is 150% higher than an EU bank, and a US corporate will be at a cost disadvantage to an EU corporate,” the industry group says.

“When competing for business internationally, this means US companies may lose deals specifically because their financing costs are higher than their competitors in other geographies. On a cost basis, it may be advantageous for a US company to seek their trade financing requirements from a non-bank/grey market alternative.”


Recognition for credit insurance

In the US, credit insurance has always played second or third fiddle to other credit risk mitigation tools such as loan sales or credit default swaps. Advocates for the insurance product, which protects lenders and corporates from non-payment by counterparties, argue that the implementation of Basel 3.1 is an opportunity for the US market to make better use of insurance for risk mitigation.

“Banks are using it worldwide on this basis more regularly. So the US is another market where this could also be done,” Daniel de Búrca, head of policy and regulatory affairs at the International Credit Insurance and Surety Association (ICISA), tells GTR.

The forthcoming US regulations, according to a comment letter by three insurance industry bodies, specifically exclude credit insurance providers as “eligible guarantors” for the purposes of banks’ credit risk mitigation.

ICISA, the International Underwriting Association and Lloyd’s Market Association point out in a joint comment letter that the European Banking Authority and the UK Prudential Regulation Authority have both recognised credit insurance as a valid form of credit risk mitigation under their respective capital rules.

“One of the things that it would do is signal to the market that here’s a product that is eligible, that is safe,” says de Búrca. “So, in that sense, it would signal that it’s a product that you can use and raise some more awareness of it.”

The insurance sector is also encouraged by what de Búrca says are a growing number of requests being fielded by insurance brokers from US banks keen to learn about credit insurance products.

In their letter, the three bodies call for more favourable risk weightings for banks’ exposure to insurers through policies, and for insurance claims to receive preferential treatment in the case of an insurer becoming insolvent, giving further comfort to policyholders.