Basel III: Cool heads needed to ease trade finance fears

Trade finance banks are asking for equitable treatment as regulators seek to rein in riskier lending activities.
Tan Kah Chye, global head of corporate cash and trade, Standard Chartered
Tan Kah Chye, global head of corporate cash and trade, Standard Chartered

A hardening of positions between the proponents and critics of the updated Basel Accords, commonly known as Basel III, could be highly damaging to trade finance and the global economy. Rather, a more rational approach is needed, says Tan Kah Chye, transaction banking global head of corporate cash and trade at Standard Chartered. “This is not the time to dig in on positions; we need dialogue,” he said.”We need to cut emotions aside and focus on the issues and have a constructive discussion on how to resolve the matter.”

Critics of Basel III -- and there are many (according to sources, the European Commission promised last month in writing to take the case up with the Bank for International Settlements (BIS)) -- say that global trade finance capacity will be hit by as much as 6% if the rules are implemented as they stand. One bank has estimated that it will have to hive off as much as $270 billion from its international trade and commerce activities based on today’s trade value.

The stakes are high, but a random survey of a few trade finance bankers by FinanceAsia shows that they are hopeful that some kind of compromise will be reached. As Karen Fawcett, Standard Chartered’s senior managing director & group head of transaction banking, wholesale banking, said during October’s Sibos conference: “If the regulations are implemented as currently written, we could be seeing a 2% fall in global trade and a 0.5% fall in global GDP.” 

BIS, however, is not convinced and wants the current rules to be implemented on a trial basis to run between 2015 and 2018. The problem is that this may not work in reality, as banks must raise incremental capital far in advance of any trial run, as Deutsche Bank and Standard Chartered have already done. “From a regulator’s perspective, it may be a trial run, but for a practitioner banker it is not,” notes Tan, who is also the chairman of the International Chamber of Commerce’s (ICC) commission of banking technique and practice. “BIS has the right intention not to discriminate and treat every banking product equally. Unfortunately, the impact has been felt inequitably across the various banking products.”

These concerns over Basel III have compounded some of the complaints that banks already had over Basel II. “The reality is that Basel III is the straw that broke the camel’s back, as these problems existed under Basel II,” said one trade finance banker. For instance, it is under Basel II that the minimum maturity tenor for all trade transactions is 360 days, even though the average maturity tenor is 90 days, according to an ICC survey. The average bank must therefore put up four times more capital than is needed. The consequence for customers is that they must pay four times more than is needed, say proponents of revision to the Basel rules.

Basel II also has two different methodologies that determine the credit risk on a credit card versus risks in the housing loan mortgage business. This is because it recognises that the former is a 30-day exposure and the latter is a 30-year exposure with hugely divergent average exposures.

However, and in stark contrast, BIS treats credit risk for a 90-day $100,000 trade transaction the same way it does a 10-year multi-million dollar project finance transaction, and in the same way as it treats highly risky derivative transactions. Critics maintain that this asset value correlation, or R2, is simply not the correct one for trade finance. “Trade finance does not need favourable treatment; it needs a different asset value correlation,” noted one.

The straw that broke the camel’s back

Basel III is the straw that breaks the camel’s back because it increases leverage and liquidity ratios. Basel III assumes a leverage conversion factor of 100%, up from 20% under Basel II and 10% under Basel I. In other words, Basel III assumes that a bank must maintain adequate capital to cover every standard performance guarantee it makes. In reality, the probability of having to pay is around 50% according to an ICC survey, and some trade bankers believe a more accurate ratio to be as little as 10% or less. As one trade finance banker noted: “Basel II set the leverage ratio at 20%, but Basel III is increasing this fivefold to 100%. Banks have been operating on 20% for ages and nothing is broken, so why fix it?”

More conservative regulators may demand that any leverage is 100% covered by liquidity, while others will not be so stringent. “But even 10% will have a detrimental impact on every trade bank out there,” said another trade finance banker. “This would amount to billions of dollars per bank, and trillions would be removed from the banking sector to keep as capital reserve.” Hence fears for global GDP.

Those seeking revision of the rules point out that Basel III was created principally to rein in bank exposures to highly risky structured financial products, which bought about the collapse in the US mortgage business. It was not designed to penalise a short-term and self-liquidating linchpin of the global economy, such as trade finance. “A lot of people seem to be asking for ‘favourable treatment’ for trade. I don’t think it is right for us to ask the regulators for favourable treatment for any one of our businesses. What we are looking for is equitable treatment,” said Tan at Standard Chartered.

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