The financial world is suffering from crisis lethargy. Any positive signs of global recovery, be it an increase in bank profits or an upsurge in export volumes, are leapt upon as proof that the credit crunch might be over. In trade finance, markets are also beginning to show potential signs of recovery, with the sluggish secondary market slowly returning. The latest data from a joint survey conducted by Bankers’ Association for Finance and Trade (Baft) and the IMF in September suggests that there have been small improvements in the availability of credit and a stabilisation in pricing.
However, the more buoyant pre-crisis days are yet to return, and caution still rules over banks’ lending policies, even when it comes to trade. Donna Alexander, president of Baft, warns, “although trends show improvement, we have in no way achieved a full recovery yet.”
Since the credit crisis really took a hold of the trade finance markets towards the end of 2008, various global initiatives have been launched by multilaterals and development banks to reactivate trade finance.
The newest and most well-known programme is the US$50bn global trade liquidity programme set up by the IFC. This initiative is part of the US$250bn pledged by the G-20 countries at their April meetings in London to be used to revive world trade. The programme is designed to address shortages of liquidity in the trade finance market via leading international banks in collaboration with development banks and multilateral institutions.
The plethora of new and expanded trade facilitation programmes are all similar in that they aim to bring private sector and public sector players together to share the risks, and in some cases, share the funding responsibilities involved in trade finance transactions. Yet, since the G-20 meeting in April, the market is still waiting to see early signs of the positive impact of the pledged US$250bn.
Of course, this is only just over six months on, but Baft’s most recent survey on trade finance conditions suggests that the majority of these public-private sector partnership programmes have had “beneficial but limited” effects.
Alexander says that the demand for these programmes is still very high, and that the momentum that drove their establishment in April needs to be maintained. “I can not stress enough that we still need global coordinated public-private partnership.” She adds: “If we don’t maintain a steady course of improvement, I am concerned by what might happen. We need G-20 leaders and other leaders around the world to stay very focused on market trends and what is happening.”
Baft’s latest report of the state of trade finance markets published in September, entitled “The Road to Recovery”, outlined the key challenges still facing the market: a lack of liquidity and high cost of funds; a lack of risk appetite; a global drop in demand for exports and imports, and the implications of Basel II regulation. Although there have been some improvements in these areas, these fundamental problems persist.
To bring these concerns to the attention of key stakeholders, copies of the survey have been sent to the G-20 ministers, multilaterals, and other key leaders and institutions.
The survey found that close to two-thirds of banks saw a drop in the total value of trade finance activities between the fourth quarter of 2008 and the second quarter of 2009. The value of trade finance activities dropped an average of 11% for six out of 10 respondents in Q2 2009 compared to Q2 in 2008.
Banks also estimated that open account transactions shrank, making up 40% of total business volumes in the second quarter of 2009, as opposed to 45% at the end of 2008.
According to the majority of replies, the drop in trade transaction values is more a reaction to the overall global fall in world trade and the lessened demand for trade finance, rather than internal constraints on capital.
However, although over 75% of banks reported that they could meet the increased demand for trade finance, 41% of respondents noted that less credit availability in their own bank or institution has prevented them for partaking in as much trade finance business as they may wish to do.
The report also found that the price of trade instruments has continued to rise, though at a slower pace. The majority of respondents indicated that the increase in pricing is mainly due to their own institution’s increased cost of funds.
This latest report from Baft and IMF is the third released this year, and with Alexander at the helm, Baft has been at the forefront of lobbying for a global, coordinated approach to solving the crisis in trade.
The organisation has also been heavily involved in educating those not familiar with trade finance, such as government ministers who are now finding a lack of trade finance moving higher up their agendas.
In January, Baft pulled together all the major players in the trade finance world, including bankers, representatives from government ministries, export credit agencies and multilaterals such as the IFC and the World Bank, to a summit. This event was mainly educational, ensuring the key decision-makers were informed of the mechanics of how trade finance banks operate, and how the various regional markets were being affected. The summit also identified some key problems and developed some action points.
“We knew that Basel II was a problem, we knew we needed ECAs to inject more opportunities and set up new programmes and do more trade facilitation work in short-term trade finance, and we knew we needed public/private-sector partnerships at that juncture to advance solutions to market dislocations,” Alexander explains.
Baft then set about organising a second follow-up summit which was held in April in California, with the aim of discussing announcements made by the G-20 leaders to inject US$250bn into global trade.
“We used our first summit, in part, to allow banks to educate stakeholders and then the second summit to get the other stakeholders to tell banks what initiatives they have taken,” explains Alexander.
A follow-up report is in progress, and aims to find out where the gaps are in the market, what problem areas of the market have been missed or not sufficiently tackled by the policies and programmes implemented to date.
This report will further investigate the proposed multilateral programmes, and find out how the G-20 committed funds – US$250bn over five years – are been spent.
Indeed, this would be timely as a report from the WTO has highlighted complaints by bankers that the schemes were too bureaucratic. The report was issued after a WTO meeting in September called by director general Pascal Lamy.
Commercial banks argued that the additional capacity for trade finance put in place by the multilaterals had not been fully utilised partly due to “procedures in place, the distribution of risk sharing, a lack of flexibility and at times red tape”.
Alexander comments: “There will always be bureaucracy to deal with – crisis or no crisis – but in this current situation, such hurdles are the last thing one should have to deal with. Our hope is that the agencies administering these key programmes will find a way to expedite the process and ensure that the resources find their way in a timely fashion to the markets.”
However, she emphasises that the architects behind these schemes genuinely want to improve market conditions, and the next report from Baft will be able to provide a clearer picture regarding the success of these schemes as they have time to penetrate the markets.
Alexander spends much of her time travelling speaking to banking regulators and helping build bridges between local regulators, and those working at a regional or multilateral level.
“There needs to be a high level of communication so that the local entities know what programmes are available,” she explains.
“Ensuring that there is communication flow from the local level that moves up to a regional and then global level, as well as the reverse, is key to building consensus and preserving the safe and efficient conduct of the financial system worldwide.
“In emerging markets there needs to be more exchange between banks and regulators. Our job is to help build relationships with regulators, and educate them on new developments in the industry, including industry guidelines and best practices.”
The issue with the potentially negative effects of Basel II on trade finance illustrates the need for this type of regular communication with regulatory authorities.
Alexander believes that the advocacy effort by Baft and other industry bodies is now taking effect, with banking regulators suggesting that they are beginning to understand the implications of Basel II on trade. “We have every indication that they are reviewing this issue closely. We encourage them to take the necessary action – timing is critical,” Alexander comments.
Baft prepared a separate paper in September on the impact of Basel II on trade, which essentially argues that Basel II’s pro-cyclical nature damages banks’ ability to extend trade finance in recessionary times, when it is most needed. Basel II is more risk sensitive than Basel I, and therefore its risk assessment methodologies make trade finance assets look riskier than they should be, according to groups such as Baft as well as other industry bodies, including the ICC and the Asian Development Bank.
For example, under Basel II, the regulations require a minimum of five years of default data to calculate default probabilities. However, Baft proposes that in trade finance it is hard to meet these minimum data requirements, as default, loss severity and exposure data on trade finance is sparse, partly due to the limited loss history on these credits.
It is also argued that under Basel II’s capital framework banks are required to treat trade finance as a one-year loan, when in reality the majority of trade finance instruments are very short-term, often for no more than 90 or 120 days.
Banks’ inabilities or difficulties in meeting data requirements for Basel II could result in great uncertainty for banks active in trade finance as to what the capital requirements should be. According to Baft’s survey, out of the banks that reported a rise in their capital requirements, 43% said Basel II has had a negative impact on their ability to provide trade finance.
Baft’s argument is that as trade finance has historically maintained a low risk profile compared to other financial instruments, due to its short-term nature, exposures are liquidated by cash upon maturity. Furthermore in stress situations, countries and banks have traditionally continued to prioritise the repayment of short-term trade obligations as they fall due.
With this in mind, Baft calls for trade finance to be exempt from some requirements of Basel II, or for the interpretation of Basel II applied by regulators to take into consideration the differing and low risk nature of trade finance assets compared to other assets. Alexander explains that the issue with Basel II and trade finance comes down to interpretation in some jurisdictions. “It may not be necessary to go through massive regulatory changes in all jurisdictions,” she says.
“In certain jurisdictions, regulators may need to simply clarify their interpretation of Basel II.”
Another top concern for Alexander are the events unravelling in Kazakhstan, the debt restructuring plans of BTA Bank, and the impact this will have on the reputation of trade finance as an historically low risk form of financing.
The Kazakh bank is still in the process of restructuring over US$10bn-worth of debt, and there are fears that trade finance will be subject to the same restructuring as other forms of debt. Traditionally trade assets have been paid back when they are due, despite wider economic or political problems.
She believes that if trade finance is not repaid properly, it could set a dangerous precedent. “If they do not honour the trade finance obligations that generally are honoured regardless of other circumstances, there could be negative implications for future business in the Kazakhstan banking sector.”
“Historically, trade finance is a low risk transaction and for Kazakhstan to contemplate acting outside the accepted international standards is not good,” she adds.
“It presents a bigger problem for the banking community as a whole, particularly in this crisis –we hope that the Kazakh officials can appreciate this.”
She notes the irony of various Kazakh officials’ visits to the US recently to speak at investment forums about opportunities in Kazakhstan, when the country has not yet indicated that it will pay back these basic obligations.
“Questions were being raised in the audience at some investment forums about how the country is treating basic trade finance,” she remarks.
The outcome of BTA’s restructuring and its treatment of trade is as yet unknown. Similarly, the success of the efforts by multilaterals, ECAs, governments and banks to revive trade finance markets remain unknown, or at least not fully quantifiable.
The market is showing signs of confidence, but as Alexander warns, “we are not out of the woods yet, a lot of advancement still needs to be made”.