In an exclusive interview with GTR, Marc Auboin, economic counsellor at the World Trade Organisation, assesses the impact that the severance of correspondent banking relationships is having on trade. He also discusses the progress of new developments, including a recent dialogue that the WTO and IFC have struck up with the Financial Stability Board (FSB).
GTR: What long-term effect is derisking having on the trade finance gap?
Auboin: It makes the gap persistent. Normally, the gap is mostly developmental and hence supposed to be transitory. Contrary to the perception that finance always flows and adapts quicker than the real economy, trade actually moves faster into new frontier countries than the ability of the local financial sector to support that new trade.
Think of the countries currently taking over some labour-intensive industries that China is delocalising: Cambodia, Myanmar, Vietnam, Bangladesh and so on. At the beginning of the process, the growth of production and trade in these countries is faster than the capacity of local banks to support it – either in terms of human capacity or in terms of banks’ balance sheet, risk management capacity, etc. This normal transitory stage lasts until the local financial sector catches up: for some time, such countries will need to ‘import’ trade finance and know-how. Multilateral development banks’ trade finance programmes are designed to help in this process.
With derisking, supply channels for such ‘imports’ are being severely constrained. With less active bank relationships, trade finance flows and guarantees are concentrated locally on fewer banks and hence reach fewer traders. Persistent derisking reduces the chances of successful integration of emerging economies in global trade by starving their new traders of the finance they need to be successful.
GTR: Are we seeing heightened concerns regarding financial exclusion?
Auboin: Yes, because this is a global phenomenon affecting all cross-border banking flows and all regions.
Concerns have been voiced since 2015 in several documents of the World Bank and the International Monetary Fund. Based on such analyses, a work programme was established in 2016 by the FSB to address some aspects of the reduction of correspondent banking relationships (CBRs), with regular progress reports to the G20 finance ministers.
We have been discussing the impact of derisking on trade finance for some time now at the WTO, including at the ‘expert group on trade finance’, with the support of the Asian Development Bank’s global trade finance gap studies. The WTO director-general has been personally involved in raising the issues.
We agree with the general diagnosis of the bank that the impact of the withdrawal of CBRs on certain countries is systemic for them if left unaddressed. Derisking disrupts the few but nevertheless essential cross-border financial services that they may have with the rest of the world, such as trade finance and remittances. It leads to financial exclusion for certain categories of customers, particularly SMEs, money or value transfer services and non-profit organisations, which provide important services for the livelihood of large segments of the population.
According to the FSB, some of the most affected countries are in the Caribbean, the Pacific Islands, the Middle East, some sub-regions of Africa, and in Central and developing East Asia, for example. As derisking affects trade finance, financial exclusion leads to trade exclusion as well. In extreme cases, its endangers the supply of essential imports and the shipment of essential exports in the affected countries – when they are left with only a handful of correspondent banking relationship and/or when no one wishes to clear the dollars necessary to complete the trade transactions.
One important dimension to understand the impact of derisking on trade is the fact that trade finance in the affected countries is distributed almost exclusively through banks; the alternatives which might exist in more developed countries, such as factoring and credit insurance, and which might allow for inter-company lending, do not exist in the poorer countries.
GTR: How are emerging market banks coping with derisking in this new environment?
Auboin: Situations vary across regions and countries.
In the Caribbean, some institutions have reportedly been able to find replacement correspondent banking relationships or to rely on remaining ones. Of course, the ‘selection effect’ on end-user clients is quite strong.
In other regions, local financial institutions have been calling on larger financial institutions, including regional development banks, to clear the US dollars needed for trade as US banks have disappeared from their landscape. There are several of such examples in Africa.
In the most extreme cases, some financial institutions have been virtually disenfranchised from the international financial system. We have heard stories in some countries of Central Asia and Africa, in which there is no other alternative left to traders than to pay for their merchandises in cash.
In all these cases, the greater selectivity by banks on their customers is affecting mainly SMEs and new traders, because they have less credit history, less background information to share with their banks, and less collateral.
The bulk of derisking has apparently taken place in the period 2011-14, but there are regions in which this continued until 2016, according to the FSB. In some regions, the situation may be stabilising. In others, there may be even ‘rerisking’: in dynamic African economies, for example, new correspondent banking relationships are being created within Africa itself.
The jury is still out as to whether derisking will stop or continue. We also hear that, with monetary policy tightening and tighter rules on AML/KYC/CFT, some large emerging market financial institutions may themselves start cutting down on their CBRs.
GTR: What is the root cause of derisking, according to the WTO? What role does the perception of regulatory risk play in these decisions?
Auboin: FSB-related institutions have put in place a relatively comprehensive analytical system for monitoring CBRs, based on a strong co-operation with Swift. They have analysed the initial causes in the documents I mentioned, and are producing further analyses which are reviewed at each meeting of the G20 finance ministers.
As you can imagine, the CBR problem is multi-faceted. At the macroeconomic level, it was caused by the need for some global financial institutions which had over-grown to deleverage and resized their balance sheets. While fewer global banks wished to remain global, even fewer regional ones wished to become global. The ‘entry cost’ of becoming global, in terms of expanding existing distribution networks and setting up complex back-office infrastructures, had become very capital-intensive.
At the micro-economic level, reasons given for terminating CBRs have indeed been associated with regulatory risks, albeit not only. Reasons included the risks associated with the presence of offshore sectors in some of these countries and the inclusion of higher-risk categories of customers in respondent banks’ customer base, a change in the correspondent bank’s risk appetite, and perceived lack of profitability of certain correspondent banking services. Facing pressure on their CBRs, some respondent banks have tried to mitigate the risk of losing access to such relationships by closing local accounts with their higher-risk customers. Besides the heightened perception of a regulatory risk, banks have been having a hard look, in the context of deleveraging, at the cost-to-benefit structure of their cross-border businesses.
In the trade finance area, for example, banks have been more prone to develop their supply chain solutions, which are less intensive in CBRs. Supply chain finance solutions have been in high demand by customers. There may also have been at some point a perception that trade business’ growth, which had outpaced GDP by a factor of two for most of the 2000s, was slowing down and was no longer a source of growth of revenue. Still, in developing countries, trade growth has continued to outpace GDP significantly since 2010, and trade grew twice as fast as in developed countries.
GTR: What’s new in the conversation? Tell us about the recent communications that the WTO and IFC are having with the FSB?
Auboin: We realised that trade finance had become an unintended consequence of CBRs’ reduction. After having encouraged multilateral development banks (MDBs) to step in more forcefully in supporting trade finance in poor countries, MDBs said to us that, while they would step in, the lasting solution was to bring the private sector back into these markets. One of the ways to do this was to have a dialogue with international regulators, in the same way as we had once engaged with the Basel Committee on prudential issues, from 2011-13. In doing so, we also realised that international professional organisations, despite some claims on the contrary, lacked a dialogue with global regulators, namely the Basel Committee and the Financial Action Task Force (FATF). So the director-general of the WTO decided to take the lead, along with the CEO of the IFC, in reaching the FSB chair, to work together towards including trade finance within the FSB work programme on correspondent banks.
GTR: How does this fit in to the FSB’s existing work programme on correspondent banking?
Auboin: The FSB 2016 work programme comprise four elements: understanding the problem of reduced CBRs by collecting data and analyses; clarifying regulatory expectations; increasing capacity building of authorities in FSB members countries so as to allow a better implementation of minimum guidelines; and promote technical solutions to facilitate due diligence, ie the promotion of ‘utilities’.
We saw that a group had been created on CBRs and remittances. We thought that there was also a case for having the WTO and IFC collaborating with the FSB on CBRs and trade finance.
GTR: What does this work entail and can you outline the progress thus far?
Auboin: The FSB correspondent banking relations’ group committed to the G20 to consider how its work could be adapted or expanded to better address the trade finance components of correspondent banking. In particular, the March 2018 correspondent banking progress report delivered to the G20 discusses next steps and states:
“The reduction in correspondent banking relationships may affect trade finance transactions that rely on correspondent banking arrangements to be processed and may thereby impact some countries, especially those that depend on trade for their development or the access to basic supplies. The FSB, with inputs from the World Trade Organisation and International Financial Corporation, will therefore explore whether and how some of the solutions already developed can be further elaborated to better capture the trade finance components of correspondent banking.”
In concrete terms, this means that we are looking into the four areas of the FSB work, with a view to identifying concrete steps that can address the trade finance dimension. For example, on the clarification of regulatory expectations, we first realised that the trade finance community had only a limited knowledge of the updates issued by the FATF and Basel Committee on how to implement AML/KYC/CFT guidelines in the context of financial inclusion, how to avoid KYCC (know your customer’s customer) and how to promote utilities. So with the FSB, we brought the revised guidelines to the attention of the WTO ‘expert group on trade finance’ and invited the FSB to communicate directly – a rare event – with the private sector. The discussion was constructive and helpful. It contributed, exactly like in our dialogue with the Basel Committee a few years ago, to raising awareness about issues on both sides. For example, one of the problems with AML/KYC/CFT is over-compliance. The perception of the regulatory risk had become more important than the actual regulatory risk itself. It is important that proper and accurate information, notably on regulatory expectations, be delivered on both sides, to reduce the costs of over-compliance.
Another important thing is to increase awareness of regulatory expectations on the side of developing countries. The FSB has an important capacity building programme, while multilateral development banks, in the context of their trade finance facilitation programmes’ technical assistance, incorporate teaching on compliance. One of our current challenges is to define how priority countries in both institutions could support one another’s technical assistance, in a trade finance context.
Also, we believe that all these actors have a role to play in the promotion of utilities in trade finance transactions. The Wolfsberg common questionnaire on due diligence and the legal identity identifier are tools clearly supported by the trade finance community. There is a lot that the trade finance community can do to promote utilities.
GTR: What is the importance of this dialogue and what are you hoping will be achieved?
Auboin: The dialogue is underway. We invited representatives of the main global banking associations to the expert group meeting, so that they could exchange with the FSB representatives. The WTO and IFC are co-ordinating the MDBs’ inputs in the different FSB work streams. There are conference calls on details, and inter-institutional co-operation is all about details.
In my view, there are going to be visible outcomes, such as potential common WTO-MDBs-FSB missions in the field, or high-profile promotion of utilities. But equally important are the invisible outcomes, whereby the industry acquires knowledge and regulators understand problems taking place in the field. A lot of the extra cost borne from over-compliance is currently linked to asymmetries of information and wrong perceptions.
GTR: What, ultimately, do you think needs to be done to bring the private sector back into challenging markets?
Auboin: A lot of what is being currently done is likely to be helpful – promoting utilities and compliance by counterparty banks. The latter will be important, because at the present moment, even though it was made clear by the Basel Committee that KYCC checks were not required, the reality on the ground is that global banks often feel that they have to collect information for their counterparties. Counterparty banks should see compliance as a way to be attractive again.
There should also be recognition within the industry that besides the ups and downs of trade in value and the slowdown of trade in volume, it is worth investing into trade even in challenging markets, which are also markets of the future. MDBs show every day that operating in these markets is not a money-losing proposition and doing proper due diligence at reasonable cost is possible.
Finally, ‘rerisking’ would be in the banks’ interest. In the past decade, credit insurance and factoring, wherever it has been available, have been gaining market share in trade finance relative to bank-intermediated products. Non-bank competition is likely to grow in growth markets, that is, in the developing world.