The Basel Committee on Banking Supervision announced on Tuesday that letters of credit will not be subject to the one year maturity floor applicable to loans — and that banks using the standardised approach to credit risk will not be subject to the sovereign floor.
The first change means that the risk weighting for letters of credit will reflect the deal’s actual maturity rather than a false minimum tenor of one year, avoiding a potential increase in costs for companies using letters of credit for cross-border trade.
By waiving the sovereign floor on certain trade finance instruments, Basel III will allow banks using the standardised credit rating system will be able to deal with unrated banks or banks based in unrated sovereigns.
Banks with large trade finance businesses warned that the changes were too limited and did not address the biggest problems in Basel III that threaten trade finance.
"You cannot claim that these two changes are going to save emerging markets because the bigger problem is the overall cost that will come with Basel III implementation," said Ruth Wandhofer, head of regulatory and market strategy for Citi’s Global Transaction Services.
The International Chamber of Commerce (ICC), the World Bank and the World Trade Organisation, along with banks involved in trade finance, had lobbied for a lower credit conversion factor (CCF) to be used in calculating the leverage ratio for trade finance exposures. Basel III requires banks to use a 100% CCF versus 20% or 50% under Basel II.
"In the past, trade finance was encouraged by the [regulatory] regime because under Basel II you were allowed to have a 20% or 50% credit conversion, but now under Basel III the regulator is trying to simplify the regime," said Wandhofer. "As a consequence, trade instruments are being treated in the same way as all other types of loans, removing the preferential treatment of trade finance."
Bad timing
Banks have also argued that by including trade finance on balance sheet amounts to an extra capital charge. They argue that trade finance default rates are low and that keeping it off balance sheet allows greater leverage and facilitates trade.
"If you put everything 100% onto banks’ balance sheets then the impact of the leverage ratio and the overall enhanced capital regime will result in trade instruments becoming more costly at a time when countries need it more," said Wandhofer. "Banks are already putting more capital and liquidity aside and we’ve already seen in a number of markets and players that pricing has increased."
The committee said in its statement that it decided not to change the CCF for calculating the leverage ratio because it did not want to dilute the new simplified mechanism. "The calculation of the leverage ratio was intentionally designed to be simple and not based on any differential risk weighting," the committee said.
It held out some hope to opponents, however, saying that if the new rules adversely affected the trade finance market they would be reviewed. The ICC and other lobbyists said they would continue to prepare evidence for the committee.
On Thursday, Fitch Ratings welcomed the committee’s ruling, saying that it would lower trade finance costs. It also welcomed the maintenance of the 100% CCF rule.