With the advent of Basel II and III, the motivation for venturing out into the insurance market has changed. But do the benefits remain the same? And how are banks and insurers increasingly working together to facilitate trade flows? GTR and Swiss Re Corporate Solutions gathered together trade finance experts in Singapore to discuss.
Roundtable participants
- Kenneth Tay, head, global transaction management, HSBC
- Parvaiz Dalal, head of structured trade Asean, commodity financing and asset distribution Asia, Citi
- Caspar Jonk, head of trade South & South East Asia, National Australia Bank
- Devpriya Misra, senior credit originator, vice-president, Swiss Re Corporate Solutions (chair)
- Andy Dyer, managing director, transaction banking, APEA, ANZ
- Robert Perry, deputy managing director, financial solutions Asia Pacific, Willis
- Michael Hogan, head of trade, Asia, National Australia Bank
- Masahiro Goda, general manager, global trade finance division, Mizuho
- Adrian Ow, executive director, group risk management, credit and country risk, UOB
- Goh Hock Choon, head of commodity structured finance, BTMU
- Albert Lim, head, credit and surety hub, Asia Pacific, Swiss Re Corporate Solutions
- Andreas Hillebrand, head of credit underwriting, Swiss Re Corporate Solutions
- Mark Wong, managing director, credit, political and security risks, Asia, JLT
- Steven Beck, head of trade finance, Asian Development Bank (ADB)
- Esther Xu, divisional director, financing management division, IE Singapore
- Clara Hang, head of global trade finance, OCBC
- Viresh Mathur, director, capital and portfolio management, RBS International Banking
Misra: I would like to welcome everyone to our first Asian insurance-banking roundtable discussion on: ‘How are banks in emerging Asia coping with increased regulations and a shift in global trade activities?’ The first piece in the puzzle that we want to talk about is how Basel II and Basel III is going to impact banks operating in Asia. It has two interesting dimensions, the first relates to the competitiveness of banks in the region and the second to how regulators implement it locally to manage risk.
Beck: We were all very concerned, especially at the height of the global financial crisis, about the impact of Basel III on trade. A lot of banks were, of course, concerned and complaining about this. What we did at the ADB is said to the banking community, through the World Trade Organisation (WTO) forum, that, rather than just complaining about it, we need to substantiate what we all intuitively know, which is that trade carries a relatively low probability of default and loss.
As you know, we have worked together to create the trade finance register, housed at the International Chamber of Commerce (ICC). We created statistics that demonstrated empirically that, in fact, trade is a relatively low-risk business. I think most of you know that we took those figures to the Basel Committee and were able to substantiate our arguments, and have managed to get considerable concessions from Basel since then.
In terms of the impact of Basel on trade, I do not think it is as much of a concern now as it was before. I think we could still discuss whether or not we should look for even better capital treatments, given the probability of default that we are able to demonstrate through the register, but there is no question that it is much less threatening to trade and in terms of contributing to gaps in trade finance.
Where there is more concern now and where we have to take a similar coordinated approach is on the financial crimes/compliance piece, where there is a great deal of concern that a lot of relationships are being exited as a result of these cumbersome, onerous and costly requirements. It is really contributing to widening the gap, especially in some of the more challenging markets.
Dyer: It also depends, in terms of Basel III, on how individual regulators then enforce what the in-country interpretations of Basel III are and how that impacts capital. There will also be a flipside in that some parts of Basel III make it more attractive to do trade financing as the liquidity requirements for trade are a lot easier than many other banking products.
On financial crimes and sanctions, at a recent roundtable in New York this theme came up, as well as the fact that the cost of compliance could start driving a lot of people out of trade finance. This is also an unquantifiable risk that a relatively small business for many banks could end up with a huge fine if they get it wrong.
Ow: Increasingly, banks are pursuing ‘balance sheet lite’ strategies by banking large corporates, broadening their transaction banking relationships with clients and moving out of businesses that require high levels of capital and funding. It is unfortunate that small and medium-size enterprises (SMEs) are assigned relatively higher risk weights as compared to their large corporate counterparties.
Combined with rising capital requirements over the next few years under Basel III, we are going to see increasing conservation buffers being added to banks on top of their minimum capital requirements. This results in disproportionately high costs of capital for banks when lending to SMEs. If we are not careful, this may force banks towards a gradual shift of their business model away from SMEs and towards a greater focus on large corporates as we have seen in developed markets in UK and Europe.
I hardly think this is the intent of regulations because in Singapore, 90% of enterprises are SMEs, which hire seven out of 10 workers in Singapore and are responsible for almost half of our national GDP. It is a key sector of our economy and it is important that, whatever regulations we adopt, SMEs can still have access to affordable financing, not just in trade but also for their working capital requirements.
Hogan: Costs will definitely go up: capital costs, compliance costs and the costs of infrastructure and servicing those clients will definitely make it a higher-cost business. The only way you can offset that from a strategic point of view is to have a much broader and deeper relationship with your clients. I do not think everybody can continue to try to service all clients in all places, so there will be a shakeup.
I think that this is already being seen in terms of some European competitors: banks have already started to move back to Europe and are reshaping the things that they are doing. They used to have large investment banks; now, they are largely retail banks back in their home countries. That has already started and will continue. There will be a shake up in terms of who is providing trade where. There is a risk, as you point out, that some clients are potentially left out in the cold but, over time, I think that will sort itself out as the industry shakes itself up. I think the shape of the industry and the participants in different regions will definitely change over time.
Goda: How many of our customer counterparties understand banks’ regulations in all of this? Trade will never die, people have to eat. But, on the other hand, we have many regulations – not only Basel III but those in China and India. There is some reason behind regulation, but the key point is how we fight and how we help our customers understand the nature of our business.
Mathur: There is another issue: somebody mentioned regulators, and risk-weighted assets are a function of loss given default rates coming from the regulators, based on their view of recovery rates on emerging market risk. Trade is an emerging market business coming out of, essentially, emerging markets into emerged markets, so regulators view emerging markets across the board. For example, from an Asia Pacific perspective, the track record has been pretty good in terms of defaults. Even through the financial crisis in 2007/08, we have seen that banks and large corporates, as well as some mid corporates, have been very resilient.
Today, we are applying an emerging market loss given default which is very high, and banks are really challenged in terms of doing this kind of business because of the high solvency that they are required to provide. I think it is going to be very challenging now for banks in terms of going ahead with this business, as long as margins do not improve.
Dalal: When we look at trade financing, we talk about corporate financing, but a large part of the business is also financing flows of other banks. Basel III regulations increase the cost to support this model. How is this going to be priced going forward is a key question.
International banks support other financial institutions (FIs) by funding them in US dollars for cross-border flows generated by their clients. This business will have an impact under Basel III. With the recalibration of liquidity coverage ratio (LCR) and net stable funding ratio (NSFR), the cross-sell revenues generated on floats/balances parked by FIs will have less consideration in determining financing to the banks. For example 100% of non-operating deposits from FIs are assumed to run-off within 30 days under the new LCR. FI deposits cannot be used as stable funding for the NSFR. New liquidity ratio reduces value of FI deposits.
Misra: We observe that while there is significant growth in trade flows or demand for trade finance, we are also confronted with the challenge of changing regulations. Banks are best placed to answer how they confront this dilemma; the second piece of our puzzle, do banks have sufficient capital and risk appetite to deal with the expected growth to support the market? We have regulation which is becoming more demanding; on the other hand, we also have a great need in terms of trade growth that needs to be supported. May I ask bankers, how do you marry these requirements, and how do you see your own risk appetite and your ability to support that through capital?
Ow: I do not think it is a question of sufficiency. Following the last global financial crisis, there is no doubt that regulations are coming in to beef up capital and liquidity buffers. This is absolutely necessary for the recovery and stability of the international financial system. What banks need to focus on is quality growth and how to use their balance sheet to support key clients.
That is why you see a lot of banks going back to their core businesses and markets. It is really about quality growth in the coming years, rather than overreaching and going into all markets and trying to be everything to every client.
Dalal: I have a contrary view here. If we look at historical data since 2008, the top 10 banks have grown three times over the overall market size. That is one data point. They have also grown eight times more than other banks. The top banks are consolidating and getting an increasingly bigger piece of the business. They are playing a consolidator role by providing technology and network solutions, and that has been evident from the last five years’ data. The bigger banks are well-equipped to cater to complex and diverse needs of smaller banks, complying to regulatory complexity and capital rules with easy access to US dollar funding. This way the local banks can continue to focus on their core businesses.
Hang: Basel III is a new dimension to regulatory requirements that essentially demands a more stringent definition of capital, new RWA calculation, new liquidity standards and so on. Inherently the cost of doing business is going up, but banks have to do more than just grumble about the fact. My view is to look at what the implications are for how best to allocate scarce resources across business units and or products.
There are also ways of looking at how to do business differently. For example, offering uncommitted facilities vs committed facilities, shorter-tenor transactions vs long-tenor transactions, pro-actively managing utilisation against limits.
Misra: Steven, as the ADB, a lot of banks approach you to support emerging market risk which has led to phenomenal growth of the ADB Trade Finance Programme. I read in a recently published ADB study on the gaps in trade finance: the demand being extremely high but not enough capital being around to support it. Would you like to share some thoughts?
Beck: We put out a study last year where we tried to quantify any gaps in trade finance and to understand what those gaps meant for growth and jobs. The conclusion was that we observed a US$1.6tn gap globally, of which US$425bn was in developing Asia. Companies basically said, ‘If you gave us more access to trade finance, we would be able to increase production and we would need to hire more people’. We are doing that study again this year, with the help of a lot of people around this table, so thank you for that.
To Adrian’s point, I think there is a tendency, for the reasons that have been mentioned, especially among those banks that are having issues on the capital adequacy side, to focus on core clients and markets. Typically, that leaves out the SMEs and the more challenging countries, which, of course, are, in large part, our concern.
To Parvaiz’s point, I think we do see more of a consolidation in the market among the big players, especially as it becomes more and more costly for medium and smaller-sized FIs to be active in emerging markets. I wonder how much that is going to contribute to the gap, if the gap is going to be increasing. We are doing a second study this year to see where the gap is, and we are going to continue doing this kind of study so that we can impress upon governments and, ultimately, regulators the importance of dealing with impediments to providing trade finance, like the financial crimes, compliance piece and others.
Misra: Moving to the next question, what should be the regulators’ approach? For example, they could follow the international framework or they could adopt a more regional framework, which is different from the international one, to support the emerging growth requirements as well as making sure, from a risk perspective, that everything is in good order.
I was recently at a Moody’s talk which covered how Asean and Indian bank capital requirements differ from what the Basel Committee has recommended and how this plays into the balance sheets of those regional banks. When you look at their capital adequacies, they look very good now but once you factor in the changed regulation scenario, the capital adequacy ratios look very different. It also plays back into competitiveness. Perhaps some of the financial institutions can comment on this topic. In the end, Esther would you share some thoughts as you work closely with regulators and have an interest in the SME market in Singapore being well supported.
Dalal: If banks in Asia have the aspiration to become global, adopting a global standard of capital treatment is the way forward, because that is the natural way in which they would be eventually scrutinised. Most Indian and Asean banks have aspirations to become global players, and adopting a global standard is the way forward because that is the way in which regulators will evaluate them in whichever geographies they expand and grow their businesses. Being an international bank, we are driven by a global standard.
Tay: I agree. Global trade crosses international borders, from Asia Pacific to Europe and to the Americas. Global rules and regulations make for efficient business for banks and companies, which in turn drives greater productivity and growth in the real economy. Today there is a lack of regulatory coherence, which inevitably leads to inefficiencies in global trade and commerce. So, as more and more business is conducted cross border, having a set of global rules is imperative and will benefit both the banking system and those companies who are looking for financing, resulting in greater efficiencies.
Dyer: Certainly, global standards are key. The flipside is that, in terms of global and regional banks, the big trend towards requiring subsidiarisation ultimately makes the models that we try to run evermore complex. Think about what Singapore is proposing now together with what is already going into place in India and China: subsidiarisation is becoming the norm as opposed to the exception.
Hogan: Basel regulations, at their heart, are common sense: do not overspend and make sure you have enough cash for a rainy day, in a banking context. The more standardisation you can have globally, the better, fundamentally. To the earlier point, I do not think banks should be encouraged to compete on arbitraging capital positions; they should be competing on providing clients with services they need. If it is better for somebody else to provide it in that market, let them do that; if it is better for you to provide it, and if you can provide a whole range of services, do that too. Competing on balance sheet arbitrage, however, is probably not the best way to go.
Dyer: Picking up on Steven’s point, a great piece of work was done by the ADB in terms of showing how trade is a safer product. It is also slightly beholden on the banking industry not to corrupt trade too much, so that that picture is still true. The letter of credit (LC), in some places, virtually becomes a tool for financial speculation and we do need to make sure that we do not shift more risky business into trade just because it will have better capital treatment. Ultimately, that will corrupt the work we have done.
Mathur: I just wanted to bring up a point in terms of different regulations as far as partnerships are concerned. For most international and local banks, our objective is not to compete but to work with one another. If we can take advantage of the different regulatory requirements, that will really lead to more partnerships. As a European bank, we can probably help local banks in developed markets, whereas some local banks here can help international banks in fronting in emerging markets. That is where I was coming from, so perhaps there is an opportunity to work together in terms of this difference in regulation.
Lim: Coming from the perspective of an insurer, I would be curious to hear further thoughts from the banking community regarding standardisation. What some of you just mentioned is fine but, I think the reality is that Asia is growing differently. Asia is a fragmented market: it is not homogeneous, rather, more heterogeneous and is very different in many aspects. I am not too sure how practical it would be in terms of having a global standardised regulatory framework, such as Basel II or III, to be applied across all Asian banks vis-a-vis global banks when each market environment is very different and at various stages of maturity, challenges and developments. Would it make more sense to adopt a different model to meet the region’s local requirements?
Jonk: I think regulators are applying different nuances to reflect the strategy for their local economy and the different structure of the economy. Maybe some regulators are more proactive than others at this. In Singapore, the regulator is very proactive and also very transparent in its communications. It thinks forward in a very simple and understanding way for the non-trained reader. Other regulators make things a little more complex and are less proactive. Working for an Australian bank, if you see the volume of trade flow between Australia and Asia, the way the regulator is currently operating, there may be a risk of more and more of the international business being done outside of the home country in places like Singapore and other jurisdictions.
Dalal: I agree with you because, if local banks apply different sets of standards and offer financing which is cheaper than international to their corporate clients, when businesses of such clients either become international or grow sizeably, resulting in higher and complex financing needs. Such clients are then forced to pay a much higher financing cost because local banks will not be able to cater to all their needs. That would result in their operating margins going down. From the outset, if the same sets of rules are applied, they have parity when they grow their businesses and their EBITs are not affected negatively with their growing needs.
It is a very basic mind-set of treating differently. Asia has been living in this mind-set for a while, and they need to come out of it. If Asia is the way forward and if it is growing and becoming the largest emerging player then they need to adopt international standards. We see large emerging market champions, continue to demand the same pricing after becoming global players which they were used to getting in their home country, which is not a sustainable model.
Misra: Maybe, we should also look into what Asian governments, export credit agencies (ECAs) and multilaterals are doing to support trade finance in the region? In an effort to support the market, sometimes ECAs end up disrupting some of the market dynamics. Would ECAs adopt the model of multilaterals like the ADB and the International Finance Corporation (IFC), whose private sector division works on commercial terms to help establish a commercial market in emerging market countries or alternatively simply provide liquidity at subsidised pricing to support the transactions at the cost of commercial banks? Diverse approaches exist, and we have also observed some governments’ taking a proactive role. Esther, would you like to begin?
Xu: Earlier on, you asked the question of how we view this from a regulator’s perspective. I note that there are no regulators at the table today, but the general principle is that we are mindful that the implementation of rules by the regulators should minimise regulatory arbitrage across financial institutions operating in different jurisdictions. That is the first point.
The role of a trade promotion agency like IE is then to understand what the implications of these regulations mean to banks’ businesses, what risk issues they would encounter, and how the government can step in to increase the capacity as well as the risk appetite of FIs to support the corporates.
I think one of the points that Adrian mentioned earlier was around whether Basel would necessarily encourage banks to pursue more corporate versus SME business. There is clearly the intent that players like us, from a government perspective, want to work with financial institutions to ensure that these classes of companies are not marginalised because of the impact of the regulations.
Some of the examples of initiatives that we have in working with players like the ADB or the IFC is in recognising the fact that emerging markets are the way to go, yet it being a challenging market means to say that it requires some form of partnership to facilitate private banks into supporting such trade flows. That is why I think it is very important that we see a lot more of these collaborations between banks, governments and multilateral agencies coming together to support such global trade patterns.
Beck: We see ourselves as filling market gaps, where the private sector has a difficult time filling those gaps in areas that are important for growth and job creation which, ultimately, brings people out of poverty. Trade is seen, of course, as one of those, so there are these trade plans and programmes for those reasons. Our programme focuses on the more challenging markets: we do not assume risk in China, India or Thailand; we focus on the most challenging markets, where we see the gaps being proportionally the largest.
During the global financial crisis, there was concern that there was not enough finance to support trade, so I think there is a general consensus among the private sector that ECAs, the public sector and the multilaterals really did step up pretty quickly to fill that gap. For us to work with all of you around the table – with Swiss Re Corporate Solutions and the banks – and to share risk in these more challenging markets is important.
Multilaterals and ECAs need to charge market rates to provide additional incentive for the private sector to move into challenging markets more aggressively, not to rely on public sector programs so that trade finance gaps are increasingly closed by the private sector, not the public sector. I think that is how we see our role, to promote the private sector and try doing ourselves out of a job.
Just briefly on the previous discussion with respect to harmonisation, I heard something very interesting a few weeks ago, where someone was saying that what banks should do is have the same systems and that the systems should be developed among the banking community, with regulators, which would not only harmonise and facilitate compliance with regulation but also facilitate the whole process of us being able to have better statistics for defaults and losses as well as in other areas. That was very interesting.
Misra: You mentioned charging commercial pricing in trying to establish a market in some of these frontier markets. Could I request our colleagues from the Japanese banks to share some views? The Japanese ECA is flush with liquidity, as are the Japanese banks and in some observers’ view that this distorts pricing and commercial terms. What are your views? How do you see it from the point of view of a commercial bank?
Goda: Today, ECAs are not the cheapest funding solution. There are always very detailed discussions. Another issue is how they support the projects or transactions done by private banks or corporates. Basically, the biggest mission and function is to support the country’s government. Many transactions and projects are run by private banks. The Japan Bank for International Cooperation (JBIC) long-term loan is based on the G2G agreement. JBIC is very happy to support and can lower its prices but once private banks are involved, it is a different story. As a core financier, maybe Hock Choon can add something more. When commercial banks are involved, we have to look at the risk versus return, which is always an issue.
The issue is how to utilise those funds, not only deposits from individuals but also funds from institutional investors too. That is not a government fund. The issue is how we utilise that liquidity.
Goh: Goda san is the ECA expert here and he is right that the ECAs are not necessarily the cheapest source of financing available. ECAs are sometimes not as price competitive as commercial banks in certain areas. For example, borrowers looking for short to medium tenor facilities might decide to choose commercial banks as they can provide such financing at cheaper rates. I think where we can strongly feel the presence and contribution from ECA and multilateral agencies are in the new emerging markets. In countries like Mongolia, you will find the likes of ADB, IFC, ECAs and other multilateral agencies filling much of the gap as there are not many large foreign commercial lenders and there is only so much the local banks can do. You will also see G20 arrangements with involvements of ECAs, etc. trying to cover the financing need for trade between countries. Maybe in the old emerging markets in Asia, one does not see that or feel such presence as much because there are many commercial players in these markets. In the really new emerging markets where deals from commercial banks are much less, the work of the ECAs and multilaterals are much more prominent.
Wong: I would echo what Hock Choon is saying in the sense that we do see a lot of collaboration between the public and private market. Right now, we are working on deals in Myanmar, a new frontier market, and we do see that collaboration, with ECAs and multilaterals coming in. With anchor participation from ECAs, investments on infrastructure are getting supported, and we do see the commercial markets coming in to fill those gaps and participating on B loan structures for these types of private investments.
Misra: We have talked about some of the challenges we face including the regulatory environment. In an insurance/bankers’ roundtable, it would be apt to introduce the topic of how the insurance market can help in this changing environment and hear some of your thoughts. At the same time, how are Asian banks stepping up and using insurance? The third piece is: what are the key drivers? When and why do you use it? What can the industry do? Perhaps we could start with the topic of what the market can do and how you are using it.
Dalal: I think insurance is a key solution. Today, all large corporates are looking at balance sheet efficiencies, especially on the receivables side. Their banks find it difficult to provide a holistic solution as the corporates are looking at global and regional solutions.
Insurance does play a critical role in helping define a packaged solution. In my mind, it is not a credit substitution. A lot of banks treat it differently: some treat it as a credit substitution; others treat it as a credit enhancement. It certainly does provide, a one-stop solution especially when clients are looking at a portfolio solution. It is a great value-add when you are looking at creating efficiencies in corporate balance sheets. It is an important tool which can work well jointly by FIs having liquidity and capital, with risk mitigation provided by insurers. That’s the way forward.
Perry: The most important question about insurance is: what are the benefits to banks? Why buy insurance? Historically, the insurance market has always been a secondary way to get rid of risk. Historically, a bank would come to us usually to get rid of the country risk via insurance or they would want to get rid of the obligor risk, which would be driven by credit. The motivation for coming to the insurance market was those two factors but, over the last couple of years, with the development of Basel II and Basel III, the motivation has changed. The motivation now is to get capital relief and to use insurance as more of a way to partner with the insurance market rather than just to get rid of risks that the banks do not want to take.
The real question to ask is: what is the benefit? Ultimately, an insurance product has to look more like a bank guarantee because, in reality, bankers are used to dealing with unconditional instruments. Your bank guarantees are irrevocable. Historically, the insurance market was full of terms and conditions and warranties, which just did not work for banks. Over the last four or five years, then, the insurance market has spent a lot of time moving the insurance policy from being very conditional to being very unconditional. From a logistical point of view, that is watering down the terms, conditions and warranties and, instead of making them conditions, they are now conditions precedent to liability.
The proof of the pudding is whether it works and, if you look at the dark cloud that was the financial crisis, the insurance market has paid about US$2.5bn of claims. Willis has collected about US$700mn of claims, and they were not disputed. Another motivation, then, is that it works and it has a track record of working.
Misra: Clara and Adrian, from a local bank perspective, how do you see this? Will it form part of your strategies going forward?
Hang: Yes, right now we are working on this piece, not so much as a credit substitution but more as a solution to credit enhancement and increasing capacity. Essentially, we have been tapping credit insurance but we do not buy the credit insurance directly ourselves. Most of the credit insurance is bought by our customers, so it is assigned to us as a second way out. Of course getting the insurance cover in the bank’s name vs that in the customer’s name requires a different kind of reporting, tracking and feed into MIS. This then brings us to the questions of what kind of systems we need to have, what kind of reporting, format, frequency, resources, etc. To answer your question, yes, it is a tool and it is something that we are actively pursuing. It is getting closer to concluding deals on a credit insurance basis.
Hogan: I agree with Clara’s point here. There has been a lot of focus in terms of how you use insurance for credit relief and capital relief, which is great as far as a risk control department, balance sheet managers or a regulator is concerned, but we cannot forget that customers are at the front of this. To Clara’s point, we can use it as a proactive business development tool to speed up turnaround times and offer a wider range of products and services to the client in the first instance, and help them develop their business too. There are, then, two sides to that coin, really; it points to a good future for insurance companies.
Perry: You are absolutely right. It is a very good story because, ultimately, the motivation for buying insurance is not because we think: ‘This is going to be a loss’, but to enable us to keep trading. If you are a bank and you are looking at insurance as a way of getting rid of risk, it is to keep you trading. Turning the clock back 15 years, the banking market used insurance but it was really to dump the poorer risks. Now, however, we certainly feel that it is more of a partnership. A lot of the insurers, such as our colleagues here, look at insurance almost as sitting behind the curtain of a deal but not funding it.
I agree, then, that the world of insurance and banking is merging and there is a good future. The most important point for us as a broker, however, is to make sure that the product keeps developing, because we cannot stick to the product that we have. As your products develop, ours must too, but they also have to develop on pricing. Historically, pricing has been 70% of gross margin, your costs of funds then shoot up, so that does not work. The insurance market then says: ‘It is 70% of net margin,’ so all those aspects have to keep evolving. It is crucial.
Lim: As insurers, we are definitely gratified to note that the interaction between banks and insurance is increasingly seen as that of a partnership. From our perspective, there has certainly been a big convergence between the insurance and banking sectors. Previously, from an insurance point of view, banks tend to use insurance as a dumping ground for risk, whilst insurance tends to be viewed by the bank suspiciously as one who does not pay claims, which is not great.
Tay: Certainly banks and insurance companies are increasingly collaborating to facilitate global trade. One of the key considerations is whether insurance coverage provides credit substitution or mitigation relief. This is important, because a bank will not benefit from credit relief if it adopts a mitigation approach to insurance. From a trade finance perspective, if an insurer is able to offer an irrevocable and unconditional payment guarantee against the first claim from a bank, that insurer will be in a better position to capture more trade finance flows with the banking sector.
This type of insurance also helps banks to grow their trade business, as it enables them to substitute credit risks. While these solutions are available from a few insurance companies at the moment, we anticipate more will begin offering them, reaching a critical mass in the near future, which will be of benefit to the wider finance community.
Dalal: I think that helps both regulators and the credit chain internally to make things move more quickly. The shorter your terms and conditions of the policy, the quicker it finds acceptability with approvers and eventually it can be looked as credit substitution.
Ow: The key point goes back to what is the motivation for banks to purchase credit insurance? What makes the banks want to pay the insurance premiums? What is the risk return exchange that the banks get from paying the premiums? That is the key component because, in the end, this may translate into the eventual pricing for customers. What the insurance industry could do to help is to come up with standardised wording, similar to the bank unfunded sell-down using the master risk participation agreement (MRPA). A more standardised document that is aligned to Basel risk mitigation requirements would increase the adoption of credit insurance across the banking industry.
Dyer: Again, we do not seem to be able to get through a subject without talking about regulation. The credit insurance industry needs to work with regulators to make sure they understand what the products are and their value so that they take comfort when banks use these.
Perry: You are right. The experience we have had in the last couple of years with our banking clients is that behind everything we say to our clients and they say to themselves is a regulator. For you, the Australian Prudential Regulation Authority (Apra) has been very difficult. I think we are getting there in terms of the insurance market providing more and more enhancement, but you are absolutely right in terms of standardised wording. The insurance market has more than 40 wordings. The challenge is that we have a spectrum of 40 insurers who underwrite credit risk, but a lot of insurers have different appetites for different risks: countries, obligors and types of insurance. What we tend to do, then, is to put them into pools: our friends at Swiss Re Corporate Solutions are right at the top end; at the other end are the Lloyd’s of London underwriters who have stricter underwriting guidelines.
Ultimately, however, there is definitely a seam within the insurance market to move towards helping banks underwrite more of this stuff, the simple reason being – and this picks up the very first point that Steven made – that the loss ratio for a short-term trade is fantastic. If you are an underwriter and you model it, the loss ratio is fantastic. Do you underwrite windstorm cat in North America, where, every two years, there will be a typhoon that tears through the US, or do you underwrite trade finance, where the loss ratio is extremely low or whatever it is. I think the more communication between the banking and insurance markets about the losses and how few there are will lead us towards a product that is now ready to part with the insurers.
Hogan: Is that well understood?
Perry: It is mixed, because you always get doubters within the insurance market; normally, at high altitude in an insurance company. If you take someone like Zurich, who underwrote a fantastic book of credit business, at altitude within Zurich in Washington DC they just looked at the financial crisis and said: ‘We have had a huge amount of claims but the exposure we had was phenomenal,’ so they feel that they missed the bullet. In reality, however, the level of losses for this business was tiny. On top of that, of course, the insurers get the opportunity to recover. Again, if you are an insurer, you underwrite property insurance and the building burns down, there is no recovery; if you underwrite credit risk, there is recovery.
Mathur: From a banker’s perspective, I do not know whether the bankers at the table agree with me but insurance has been around for many years. We know that and we know what sorts of benefits it can bring to banks in terms of financing relationships and providing more capacity. There have, however, been a lot of grey areas in terms of whether it provides credit or capital relief. Over the years, the banks have worked with the regulators in terms of internal and regulatory guidelines. We saw a lot more of those guidelines now in black and white, but they were not there a couple of years ago and a lot of banks have struggled with that, especially after the financial crisis. I think it is poised to take off because it is very much now in black and white. I do not know if the other bankers would agree with me but it is very clear: can we or can we not do this? Do we get credit risk mitigation and enhancement? It is very much a formula-driven approach now, and the capital models are also very complicated.
Misra: We have observed that every bank adopts a very different approach. Just to close, I will invite three people to comment. Mark, as an insurance broker, how do you see the market? Hock Choon, could you share what you look for from insurance, your market expectations and what are your drivers for buying insurance? Finally, I will request Albert to share his thoughts on what else can insurers do.
Wong: The credit insurance market has been adapting to the requirements of the banking market. Over the last 18 months, we have seen quite a bit of medium-term business on private obligors coming into the market. These were mainly revolving credit facilities (RCFs) and medium-term loans coming in. I think the market has responded and we have seen quite a few facilities being closed in the medium to long-term insurance market.
We do see new capacity coming in, especially with Lloyd’s coming in earlier this year on RCFs, and we do see significant capacity and it has helped banks underwrite larger lines on RCFs in the market. Over the last 12 months, we had a lot of commodity traders coming through Asia for their roadshows in Singapore and we have seen our banking clients being able to respond in terms of underwriting higher lines on these RCFs, generally due to the credit market coming in to underwrite 30 to 40% of the net take in those facilities. We do see more development in terms of additional markets coming in for medium-term transactions.
Another interesting development in the market is structured surety products. We do see that part of the market evolving and have seen offtake guarantees coming into play in terms of project finance. That seems to be a new market emerging in the credit space and it is typically underwritten by the surety market. In terms of the documentation, the guarantees that we see coming out of that market are fairly standardised guarantees and will enable banks to undertake more project finance risk in the market. In the first six months of this year, we saw a lot of development there and this trend will continue as we see more structured transactions originating in Asia.
Misra: Hock Choon, what are your thoughts on the drivers and what you would like to see from the market as a bank?
Goh: We would definitely like to see more risk participation by insurers. Typical insurance policy language on terms such as exclusions and accelerations continues to be an issue because different regulators have different requirements. Capital relief would therefore be much more easily achieved for risk participation compared to typical insurance. The banks are also very used to risk participation and the concept is familiar to banking regulators and the banks internally.
I think there are two key drivers for using insurance: One is capacity. Because of the new regulations and so on, we have seen a general shift of lenders’ interest towards certain products like trade financing, but for each obligor there is only so much capacity that each bank is able to put up. As the banks make their push towards certain product areas, increase in risk capacity for key obligors that uses such products are necessary. Additional capacity from the market would therefore be very helpful.
The other driver is product structuring. Increasingly, we are seeing more collaboration between insurers and lenders in this area. In general, the ways in which insurers and banks approach risks are different. Insurers are more focused on risk diversification whereas banks are more focused on in-depth analysis of each credit. For example, insurers are able to consider coverage for a diversified pool of obligors whereas lenders are much less likely to extend financing to such a pool without detailed due diligence on each and every obligor. Collaborative structures will enable the lender to extend financing by leveraging on the insurers’ ability to take such risk while allowing the lender to anchor its risk and recourse on highly rated insurers. I think this is complementary and
benefits everyone.
Misra: Albert, you have heard the panellists’ thoughts on what they want from the insurance market. Do you want to share what insurers could do? You have also been on the other side of the fence in the past, so maybe you could share both insights?
Lim: I fully understand the banks’ requirements. As a major user of insurance in my previous life working in the bank, it is just the way banks operate when they do syndications or sell-down of transactions. Banks are more familiar and comfortable with forms of guarantee as opposed to insurance, which is conditional and a promise-to-pay. To the point on standardisation of insurance wording, I noticed that comment comes ever so quickly in any discussion about the insurance market in this regard; whilst it is a common practice in the bank syndication market as well as the secondary sell-down market to use standardised market wording, the reality is that there is still some way to go regarding the standardisation of wording in the insurance market. Having said that, insurers do work together to syndicate or co-insure a risk and I have seen many instances whereby insurers participate in the same common wordings. However, to expect insurers to operate like the bank syndication market with industry-wide standardised wording, I don’t think that will happen anytime soon.
We have also heard from today’s panel about the increasing requirements and the gap in trade finance, as mentioned by the ADB. In this regard, our observation is that there are increasingly more requirements to cover structured trade credit transaction for both corporate and FI bank risk, including surety, bonds and guarantee for banks. As Swiss Re Corporate Solutions, I would like to think that we have brought in a product that is very relevant and valuable to our bank clients. Whilst that is working very well to support the trade business and is a product that is working extremely well for the bank, we are just one insurance provider in Asia Pacific to offer this unique value proposition. With all the challenges and shift in global trade, I guess everyone in the industry would have to step up to work together.
To the point on funded solutions, the main challenge faced by insurers is that we are not a bank, hence providing a funded solution is really not an option. While the bank provides financing, the closest we can offer is our unfunded risk participation product to support bank trade finance. Here at Swiss Re Corporate Solutions, we are always thinking of product enhancement and innovation. While we have a product that is fully Basel-compliant to enable banks to recognise it as an effective credit risk mitigant to take credit and capital relief, we also need to always remind banks that we are not able to do product financing. In the absence of us providing hard cash, one may think of solutions to support the bank to attract liquidity, as an example. We certainly hope to be able to come up with something in the near future to further complement our offerings to support our partner banks.
Misra: We have had a very engaging, constructive discussion and it’s fair to observe a divergence in opinion on some topics. We can address some of the trade finance growth needs and the changing regulatory environment by adopting a partnership based approach between banks and insurers. Doing it the right way, there is a lot of opportunity for everyone.
