Leading bankers from Asian financial institutions answered J.P. Morgan’s call in late August to exchange insights on how the business has changed and discuss what opportunities are on the horizon.
Attendees:
Chairman: Matthew Cox, partner, Denton Wilde Sapte
Wilson Chan, senior vice-president, regional trade product management, global transaction services, DBS
Jonathan Heuser, managing director, trade advisory, global trade services, J.P. Morgan
Anil Kishora, chief executive officer, State Bank of India (SBI), Singapore
Loke Poh Lam, general manager, PT Bank Mandiri (Persero), Singapore
Neo Bock Cheng, head, group transaction banking, OCBC
Idana Salim, executive director, global trade services, Asia Pacific, Treasury Services, J.P. Morgan
Sanjeev Sharma, vice-president, financial institutions, treasury services, J.P. Morgan
Anne Tin, head, trade & factoring, business operations & support, Maybank
Banking transformed?
Cox: How has banking in Asia changed as a result of the financial crisis and what challenges do you think Asian banks are facing?
Loke: Opportunities in the region have grown beyond simply lending to surrounding Southeast Asian countries. In the past, we were involved in lending activities, but after 2008 the key issue that most banks face is liquidity. As a foreign bank, in the past it was quite easy to go out to the interbank market and say, “I need money market lines.” Today, the response is, “We can only provide you with trade-related financing.”
For banks, funding resources represent their bread and butter, but if readily accessible funding is not available, how can they grow their business simply through lending? This is one dilemma faced by offshore foreign banks, which may have to review their business model and what they should focus on. Although offshore banks can borrow from their head office, they also have to take care of their own funding needs.
Neo: A key transformation was bank consolidation. A second theme is the retreat of multinational banks from Asia, given their preoccupation with issues faced at head offices. The third trend relates to the increasing importance of liquidity following the crisis.
Many banks are starting to focus on fee-based business, as a result of which there is a huge focus on transaction banking. We can see certain Malaysian and Indonesian banks beefing up transaction banking; in some cases it has even been set up as a distinct division that never existed in the past. This leads to greater competition.
Chan: During the crisis, DBS did not stop supporting customers. The loan spread in general was higher reflecting the higher risk and tight liquidity and this was somehow quite rewarding for banks. Now loan spreads have come down significantly, the challenge for banks is to strive for higher volumes of business to maintain sustainable growth in their bottom line. In Asia, trade volumes have been growing. Banks are all looking at growing markets such as China and India so that regional banks like DBS can achieve growth targets.
Kishora: India was not affected to that extent; we were lucky enough to escape the extreme forms of contraction. Now it’s more or less behind us, Indian corporates are quite active in terms of capital investment and trade, and this has been gaining momentum. Given India’s plans to invest in infrastructure to the tune of over US$1tn in the next five years, and assuming even just 50% is implemented, this is going to generate a huge demand.
The challenge is resource allocation. Perhaps we have become choosy in terms of whether to lend to company x in Singapore or Indonesia or to another company in India. Spreads have dropped here too. If you get the same spreads in India and you know the risks better, maybe it is more advisable to lend to those companies. These are some challenges and choices we have to exercise.
Going forward, in terms of trade and other banking requirements, I see huge demand emanating from India. Singapore plays an important role there, because it is increasingly becoming a hub of major Indian corporates.
The India-Singapore corridor has seen a lot of flows both ways, specifically in terms of trade financing requirements, where demand has been rising. Singapore has been catering not only to Singapore-India trade, but also trade between Indonesia and India, or Malaysia and India, all of which is routed through Singapore. India is a major importer of palm oil and many deals are done in Singapore.
There are many opportunities for collaboration. It depends on the comfort level of individual banks.
Sharma: We have also seen good momentum in terms of originations from India – it is evident from our relationships with banks such as State Bank of India at both head office and branch level. The financial crisis resulted in risk aversion and a collapse in liquidity, which was available for only very short tenors.
Now, we are seeing an increase in longer tenor requirements from India especially from the infrastructure sector.
From a J.P. Morgan perspective, we have been in a better position relative to some of our peers in the global banking space. We continue to leverage our strong balance sheet to support FI clients. In addition, we have strong tie-ups with multilateral agencies such as the ADB and IFC, and other export credit agency (ECA) structures that we used, even during the crisis, to keep liquidity flowing and help our FI clients support their corporate clients, thereby ensuring that projects underway were, to a great extent, not hampered.
Kishora: J.P. Morgan was very supportive throughout the entire period, and continues to be so. We appreciate that. This is perhaps because J.P. Morgan has a better understanding of the region and its inherent strengths. This has strengthened our relationship. Increasingly, banks will need to meet requirements for three to five years.
Tin: I am from the operations support side, so I can give a different view on what the crisis has meant to us. We noticed a shift in risk awareness. During the past two years, traditional products such as general trade financing have not been quite so successful. The crisis exposed the strengths and weaknesses of traditional products without a structure.
For structured trades, we tend to be more successful and we have no defaults for this type of trade. Moving forward, this is something we want to do more of. Structured trade exposure can be big but the risks can be ring fenced and mitigated.
Neo: Customers do have an awareness of risk. Two key themes emerged from the crisis; liquidity and risk mitigation, from the standpoint of country and counterparty risk. In good times, it is more difficult for corporate customers – particularly large ones – to go into a structured trade, because they bring with them tighter terms and conditions. During the crisis, we found they were more receptive.
Tin: Certainly they were more willing to accept structured terms and conditions.
Neo: They also realised it worked to their advantage. Given the tightness of terms, having those transactions liquidated was more certain. We have seen a huge growth in structured trades, notwithstanding the crisis. In fact, as a result of the crisis, we have seen requirements for structured trade transactions increasing vis-à-vis plain vanilla trade finance.
Cox: Trade finance transactions are quite robust and statistically default less often than other types of financing. Has that been your experience during the past couple of years?
Neo: Definitely. As a commercial bank, we have working capital loans and structured trade loans. We see our degree of default being a lot lower in structured trades.
Chan: During the crisis, I also saw the mindset change, particularly from the risk management perspective. Customers are more aware of counterparty and country risks that need some form of mitigation solution. From the bank’s perspective, credit management strongly views trade finance as one of the safest forms of business we should go after.
We have successfully converted quite a number of customers who have been borrowing on term loan basis into trade finance basis. With trade finance, at least you know the purpose of the financing, given the customer has to provide evidence of the trade, and this lowers the number of NPLs. Look at the positive side of the crisis, it did help banks build a more balanced financial portfolio. Banks did not lend to customers just in terms of term loans, but also built up their trade finance business.
Sharma: That connects well with the earlier point on banks moving from a pure money market loan scenario and more towards trade-backed financing structures. Going forward, I can see providers asking for more details of the underlying deal to ensure they are financing the underlying flow, which is better from a risk-taker’s perspective.
Neo: From the customer standpoint, the key learning was around availability of liquidity. When liquidity is tight, banks find it difficult to lend more. Customers realise they have to leverage their own transactions to free up liquidity.
There is a lot of so-called trapped cashflow within their own transactions. Working with the bank to tighten their collection and payment cycles works to their advantage. It provides certainty of funding and greater timeliness and predictability of those funds. It is a winner both for the bank, from a risk standpoint, and for the customer in terms of liquidity, certainty and timeliness of cashflows.
Tin: In the past we have seen banks very keen to do working capital lending. Banks now prefer to package some form of trade facilities into the lending because there is visibility and some form of control. Trade financing is felt to be more genuine and visible and with potentially less risk of default. If a bank simply provides an overdraft, they can’t see what it is used for, even if the customer says it is for trading. If they provide a trade financing line, they can see the letters of credit and trust receipts coming in.
From my operations angle, we see many SME customers who, in the past, enjoyed only an overdraft or term loan; now, no matter how small, we accord them a small trade line. It not only provides some fee income for the bank but also visibility of, and control over, the way in which they conduct their business.
Loke: Similarly, I see two types of trade clients. Because of the crisis, we see all major commodity houses – Louis Dreyfus, Mercuria and Noble etc – coming to the market to tap into new funds. Trading is such that you can see most trading companies requiring high borrowing against low capitalisation, which throws up problems for many banks. If they are established global commodities firms, you can look at their balance sheet and decide to lend to them. That is one way of structuring.
For tier-two names, this is a time when you can say that things have to be done more on a structured basis and thereby provide greater protection to the bank. Over the years, however many banks have lent to tier-two names on the pretext of trade simply by granting letter of credit and trust receipt financing. This may be just simply working capital financing, which is not secure because once the goods are released, they are no longer under your control.
The problem is how to tie in to the export leg such that the trade transaction becomes self-liquidating. During good times, many companies will try to resist that and threaten to move their facilities to other banks if the structure is too restrictive. Hence, it depends on market conditions. If the market is buoyant and everyone relaxes, you return to unstructured general working capital financing.
For trade in commodities and big-ticket items, you can lose money because brokers may have over-hedged, and one bad transaction will probably wipe them out. Of course, it depends on market conditions. Because of the crisis there are no greater opportunities. In the past, mainly only European banks dealt in structured lending but today all banks in various countries are looking at this market, which has a statistically much lower default rate.
Partnership proves positive
Cox: How have you experienced competition from international banks?
Kishora: I don’t see it as competition between regional and international banks. We are more often on the same side; it is more often collaboration.
In India the focus was always on end use and on visibility of the transaction.
Following liberalisation and the arrival of foreign banks, for some time before the crisis there was general resistance to going into issues of visibility and transaction analysis, so there was some pressure on regional banks to fall in line and lend without looking into these areas. Now, however, there is some convergence. We always wanted visibility and now do the international banks.
In terms of funding, there is greater uniformity in the way we look at transactions and consequently better and greater opportunities for cooperation. That is happening in terms of funding. International banks are also comfortable, because we understand the risks better, given that we know the client and transaction. If we partner together, it is good for the system.
Chan: In the last couple of years particularly during the crisis, I have seen more global corporate names looking at regional banks like DBS for risk mitigation solutions for their exports.
Some more sophisticated global exporters who are proactively managing their counterparty and payment risks have switched back to LCs so their export payment can be secured through LC confirmation and non-recourse discounting. Since the trade volume is generally very big for such global exporters, and no single bank can meet 100% of their requirements in terms of bank limits, they are adopting a multi-bank approach.
I see a growing trend of global names adopting a multi-bank approach for trade finance requirements. This is one area which I see regional banks like DBS are building up their capabilities and competing with global banks in this global client segment for trade finance business.
Salim: I agree with Mr Kishora’s point about competition versus partnership. For J.P. Morgan as a global bank, that is definitely our view in terms of how we have been working with FI clients and partners, both in this region and globally. As Poh Lam said, it was easier pre-crisis to focus on balance sheet lending. Post crisis, however, there is much greater pressure in terms of looking at not only the import but also the export side.
As Bock Cheng said, there is much greater emphasis on fee-based business, which is how we have been working with our FI partners and clients who are regional Asian banks in terms of exports, where we can leverage each others’ strengths. For example, in terms of our international capability, we can bring value to the table for our Asian and regional bank partners in terms of risk and efficiency aspects such as achieving greater transparency of transactions and quicker turnaround in terms of tracking export proceeds.
Loke: The co-operation is definitely there. Today, major trading companies can no longer act as simply a commission agent or trader; they have to cover the entire value chain from sourcing to the final product. There is no way any bank could simply finance all their needs from start to finish.
In Indonesia, there are many big palm oil plantation companies. When it comes to their upstream activities, such as greenfield plantations, long-term financing is normally obtained from domestic banks like Mandiri.
When they start selling the CPO to Bangladesh or Pakistan, we have to co-operate with international banks that have the capability to confirm or discount letters of credit from such emerging markets. There will always be the need to collaborate as no one bank is able to provide financing throughout the whole value chain.
Heuser: One of the keys to successfully competing and engaging in partnerships is for an institution to really understand what it is good at and where its strengths lie, and to be able to acknowledge where it might benefit from working with partners.
Neo: We have a very good working partnership with J.P. Morgan. One key advantage we can take from J.P. Morgan is its international network. This is important to us in terms of providing visibility as well as market insight and domain knowledge. For example, we do not have a branch in India. We are seeing a lot of flows, with many Indian companies setting up shop.
For a bank like OCBC selling into India, we would value J.P. Morgan’s market insight in that domain. Market insight is an area where we need to mitigate risks, which J.P. Morgan can provide because it knows the market, the players and FIs there.
Opportunities ahead
Cox: Has there has been a shift in the types of trade finance structures you have been looking at?
Loke: Many international banks have been using trade structures for years. But in the current market, where there are bountiful opportunities, everybody is trying to break into transactional banking, which they find safer, and the volume of such transactions is increasing, particularly in terms of intra-Asia trade.
Chan: Riding on the growing intra-Asia commodity trade flow, many banks are now going into structured commodity trade finance business such as collateral management (CMA). The target markets have never been the top-tier commodity traders as they are able to enjoy clean facilities from their bankers for their trade activities and would not want so much restrictions and documentations.
The target markets are mostly those second-tier names where name lending is not possible. As a result, banks like DBS who provide commodity trade finance need to put up various structures and control measures on an end-to-end basis to protect their interest.
Cox: In terms of those borrowers, would you previously have had credit lines that were not structured? Are these new borrowers you are lending to in terms of a warehouse financing structure?
Chan: It’s a mixture of both. For those names that the bank has credit appetite, we could offer trade finance facilities on clean basis. But if the size of the credit facility required is too big for the bank to take on clean basis, we need to bring in appropriate structures and control measures so as to box in the risks. Top-tier companies normally will not look at structured trade finance because they can obtain clean facilities without any problem from their bankers.
Tin: CMA is something new to our bank and we are proceeding with some caution, because many of these bonded warehouses and yards are not located in Singapore; typically, they are in Malaysia, Korea, Japan or China.
You need very good logistics managers to help manage inventories in these ports and bonded warehouses. You need to do audits and due diligence. It is a new type of trade financing which our bank has started and it has proved to be quite profitable and successful.
Loke: There are new challenges as more banks embark into structured trade finance. Structure comes in various forms and, ultimately, it is also about the resources and capabilities of lending officers to really understand the nature of the trade, shipment terms, documentary requirements, etc. Many bankers – me included – are generalists.
If you want to finance this type of transactional trade, you really need to have a good understanding of the products and associated risks.
Tin: The challenge is attracting and retaining talent, and especially trade specialists, within the bank. Now that the economy has recovered, banks are on a hiring spree again. It can be very disruptive if your CMA specialists move away and you have to train a new batch of people.
Neo: More banks are seeing the value of structured trades, and this sort of expertise is relatively new. In the past, it used to be related to the commodity banks, and mostly those from France and the Netherlands. A structure is only as good as the people monitoring it. It requires a lot of expertise.
Heuser: You will find some variation between institutions based on what their individual strengths and challenges are and what their global network looks like.
We have a very strong base within the US, but we see a key strength as being our global reach. When you look at how different global institutions are orienting their trade growth going forward, it really depends on the individual circumstances of each institution.
Salim: The other point is the growth in intra-Asia trade, which is a trend we have seen in the last eight to 10 years. It is very interesting to look at the statistics, which show China becoming a major market for practically every country in the region. When we talk to FI partners and clients, we always receive a lot of enquiries, because this is what you see on the corporate side in terms of growth in trade flows – both import and export – into and out of China.
That is where we have also focused effort in terms of leveraging our investments in China and working with many Asian banks.
Neo: Asia is interesting because the region has the two largest consumers – China and India – as well as a lot of producers, such as Malaysia, Indonesia and, to a lesser extent, Thailand and Vietnam.
One trend we also need to monitor is the internationalisation of the renminbi (Rmb). The Chinese authorities are adamant this will happen. It is early days, simply because there is a lack of investment opportunities to those people holding the Rmb. With recent regulatory changes, they are opening up to more regions and companies in China to anybody that has a genuine trade transaction.
Chan: In terms of internationalisation of the Rmb, we see a growing interest from our customers in Singapore and Hong Kong which is probably because of the appreciating trend of the Rmb against the dollar. In the last one or two months, the Chinese government has further liberalised the Rmb Trade Settlement Scheme and technically any corporate outside China can now take part in it.
We are seeing the business opportunities and have been facilitating our customers’ trade business by offering them our value added trade finance solutions such as discounting their Rmb receivables in dollar.
In the latest development, Hong Kong has further liberalised to allow corporates to use Rmb for non-trade related settlement such as investment in bonds, etc. This is paving the way towards further liberalisation of the Rmb as one of the international settlement currencies.
In Singapore, before May or June this year, most international traders did not show interest in switching their trade with China into Rmb as they have been using dollar for both their purchases and sales where there is no exchange risk.
Until they saw the strong Rmb appreciating trend in the recent months, and banks are ready to offer FX derivative structures to help customers manage their FX exposure, many traders have started switching their trade with China in Rmb, and the interest is growing.
Neo: A lot depends on the company’s internal corporate policy. Directionally, the general consensus is for the Rmb to appreciate against the dollar. Most trade commodity business coming out of China is denominated in US dollars. If you sell into China, historically you trade in dollars and you naturally hedge, but suddenly you will receive payment in Rmb.
Notwithstanding the appreciating trend in the Rmb, the question is whether the company allows you to take an FX exposure – is that an integral part of your company’s mandate? A second point is the availability of investment to those companies that hold Rmb.
Tin: We receive a lot of enquiries about the Rmb, but mainly for remittances and not so much for trading. We do a lot of commodity trades, when our customers buy, they do so in US dollars. When they sell the commodities, it is also in US dollars, so it is naturally hedged. The demand for Rmb for trading is not high at the moment.
Loke: I would also make enquiries with our head office because the flow of trade is such that, in the past, some of this trade with China comes through Singapore. Increasingly, however, many trades go direct to the source. The volume of trade between Indonesia and China is quite large. Mandiri is interested in opening a branch in China. We have a representative office in Shanghai to service our clients, particularly in the area of trade business.
In terms of the Rmb, we are one of the first banks to sign the agreement with Bank of China, but the interest is still not there. Everybody is saying, “Let someone else try it first”.
Chan: Since July last year, when the Rmb scheme was first launched, we prepared ourselves and made ourselves ready, but not much business came along until about two months ago. China has done its part in liberalising further to allow more eligible corporates in China and overseas countries to participate in the scheme. It has now opened up to 16 provinces and four main cities and all overseas countries outside China. I am positive about this and foresee more trade settlement with China in Rmb.
Lasting lessons
Heuser: In terms of the lessons learned and changes we have made in the way we do business, how much is likely to stick?
Neo: As long as companies or banks see there is going to be a cost to liquidity, it will continue to shape behaviour, at least from the banking regulation standpoint. With Basel III and other regulations, and their constraint on capital, banks that provide liquidity are going to see getting the right price for their risk and returns as very important.
From a customer standpoint, when liquidity is available, it will continue to shape their behaviour. When liquidity is free-flowing, old behaviour will return.
Cox: Were Asian banks less exposed to riskier assets, even in the boom times, and so have they come through the crisis with balance sheets in a healthier position than some competitors?
Neo: Asian banks were spared from the last financial crisis because they were not involved in many products that brought other banks down. Asian banks have been lending quite extensively to the local SME community and large companies.
The trend that changed after the financial crisis, because of liquidity and risk awareness, is in the kind of business that banks do in the commercial space.
There is a balance of traditional lending against balance sheet, with overdrafts and short term loans, with more transaction-based lending when you see the whole visibility of the transaction. You also ensure that money you lend to the company is used for the purpose you wrote in the credit paper.
Loke: All these years before the financial crisis, we normally saw only a reduction in margin in lending to established borrowers. You didn’t have much chance to increase the spread but for the first time ever, because of the liquidity crisis, they have no choice but to pay more. For once, spreads have widened so much.
However due to the quick upturn, we notice that margins are again narrowing, but the question is whether they can revert to the good old days so quickly. That would happen when competition intensifies and banks with short memories revert to more aggressive lending and cut-throat pricing.
The regulators will play a part perhaps to slow down the process. Today, they are much more aware of liquidity risk.
Tin: We have always been a conservative bank. Even if bankers have short memories, regulators are unlikely to forget lessons learnt from this crisis. Basel I is in place and will be followed by Basel II, whereby we are supposed to have risk-based pricing. Basel II will force a lot of banks to look again at risk and price accordingly.
Many banks are Basel II-ready and, moving forward; some lessons that we learned from the crisis will be around pricing according to risk and capital provisions for some trade products.
Chan: The regulators usually are just looking at the overall bank’s portfolio. Individual customer pricing is up to the bank to quote. I have been seeing many occasions where some banks quoting very low pricing that we cannot match based on our loan pricing model. This kind of aggressive pricing quoted by such banks is probably because of the aggressive KPIs of their sales people which makes them behave aggressively to bring in the business at very low pricing without looking at the risk profile of the obligor. This is not a healthy trend.
Neo: When new players enter the market, in Singapore they need to build market share. The easiest way to do this is to lower your pricing margin. But as far as banks are going to be looking at their return on capital very closely, that would have a bearing on the traditional working capital/liquidity available to companies. As a result, companies have no choice but to look at how they manage and finance working capital.
Cox: What has come through loud and clear is that the sentiments you have expressed are broadly positive for the trade finance market in Asia. There are challenges, but you have said that borrowers are increasingly considering trade finance structures, there is scope for increased co-operation between international and regional banks and Singapore is well placed to benefit from the boost in trade between China and India. GTR
