Trade finance, vital to keep the wheels of international trade turning, remains a concern for poor countries in Africa and other regions, even as global commerce rebounds in the recovery, trade finance sources say.
Practitioners in the $10 trillion market are now talking to regulators to ensure that efforts to stop banks hiding toxic assets do not make it harder and costlier to extend trade finance, traditionally one of the safest forms of credit.
The World Trade Organization will host a meeting of trade finance bankers, international financial institutions and regulators on May 18 (today) to monitor the state of the market ahead of the G20 summit in Toronto next month.
That follows a progress report on the $250 billion trade finance package agreed at the G20 summit in London in April last year that was submitted to G20 finance ministers at last month’s International Monetary Fund/World Bank meetings in Washington.
“There is continuous concern about this issue,” said one trade finance expert.
The Toronto summit will be asked to target remaining resources in the package at African and other borrowers still cut off from trade finance, he said.
Some 90% of the $12 trillion in trade in merchandise goods is underpinned by trade finance — typically short-term self-liquidating credits in use for centuries that have much lower default rates than other types of loan.
The credit crunch in 2008 caused trade finance to dry up too, spurring a slump in trade, although the 12.2% contraction in trade in 2009 reflected lower demand rather than a shortage of funding over the year as a whole.
The WTO now forecasts trade will rebound by 9.5% this year. Surveys show finance is available for trade between rich nations and countries around the Pacific, including China.
The concern is that this recovery has not yet reached smaller banks in Africa, Eastern Europe, Central Asia and Latin America, with 30-40 countries still having difficulties.
One problem is that many countries have suffered credit rating downgrades, forcing banks to set aside more capital under prudential regulations to cover loans to borrowers in those countries. The rules state that an individual borrower’s creditworthiness can never be better than the country’s rating.
Trade finance deals for oil-rich Angola are paying 40-50% interest at an annual rate, and Mexico is paying 20% after a downgrade, the trade finance expert said.
Looked at another way, one major trade finance bank is now charging for a three-month trade finance deal in Kenya — Africa’s best credit risk — a spread of 320 basis points, or 3.2% points, over banks’ costs of borrowing, plus requiring export credit insurance adding another 300 basis points, and requiring cash collateral of 50%, he said.
Before the crisis a Kenyan borrower would have paid a spread of less than 100 basis points over interbank rates.
Studies by the WTO and African Development Bank suggest that export financing is available for African countries from institutions such as pan-African lender Ecobank Transnational or South Africa’s Standard Bank, although at higher costs and for smaller volumes than before the crisis.
But trade financing — often the only form of international credit available to African countries — to cover imports from fuel to machinery has dried up for smaller banks.
The risk is that firms in these countries that entered the formal economy with access to bank credit will be forced back into the informal sector, hitting the state’s tax base.
The G20 report found that halfway through the two-year life of the $250 billion package, $188 billion has been mobilised and $110 billion disbursed, with banks unable to find enough creditworthy borrowers to use all the money available.
“They’re telling you the problem is less one of liquidity than of risk,” the trade finance expert said.
Besides counterparty risk, one question that bankers will want to discuss at the May 18 meeting with regulators from the Basel Committee on Banking Supervision is the treatment of trade finance instruments, such as letters of credit.
These are traditionally held off banks’ balance sheets while the details of importer, exporter and shipper are being checked because they are not a firm commitment until the last minute — and some 75 percent are rejected during verification.
But proposed new banking regulations to prevent banks hiding toxic assets off their balance sheets would cover unconfirmed trade finance instruments too, driving up their cost.
“Clearly trade finance is not at the root of the financial crisis — you are not leveraging by using standby letters of credit,” the trade finance expert said.
Together with the International Chamber of Commerce, the 10 biggest banks in the sector with portfolios of up to $300-400 billion are preparing a database of trade finance default rates to demonstrate to regulators the relative safety of the credits.
Banks invited to the May 18 meeting include HSBC, BNP Paribas, Standard Chartered and Brazilian development bank BNDES.