Basel III LCR relaxation to ease trade finance woes

The recent modification of Basel III’s liquidity coverage ratio (LCR) circulating trade-related products is likely to relieve the pains faced by transaction bankers but not permanently, say experts.

  • 24 Jan 2013
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Basel III recently announced that the treatment of trade products in the LCR will be different from riskier, highly-leverage banking instruments like derivatives, easing transaction bankers’ woes temporarily.

A new category has just been added onto Basel III’s treatment of trade finance products in the LCR. In the case of contingent funding obligations stemming from trade finance instruments, national authorities can now apply a relatively low run-off rate between 0% and 5%, according to the Bank of International Settlements (BIS) in early January.

A run-off rate reflects the amount of funding maturing in the 30-day window that would not rollover.

This is a positive development to the treatment of trade instruments, which were previously bundled up together with other longer-duration, riskier and complex banking products. For example, the run-off rate for unsecured wholesale funding from financial institutions is currently at 100% – a very conservative figure that the Basel III committee has imposed on highly-leveraged instruments.

“The Basel III committee has recognised the fact that these are trade finance exposures which do not result in a large liquidity requirement in the scenario of a stress,” said Ashutosh Kumar, global head of corporate cash and trade at Standard Chartered (StanChart) to Asiamoney PLUS in a telephone interview on January 16. “These are small changes, and will result in a somewhat harmonised implementation.”

As a result of this new development, national supervisors are required to work with the supervised financial institutions in their jurisdictions to determine the liquidity risk impact of these contingent liabilities and the resulting stock of high quality liquid assets (HQLA) that should accordingly be maintained.

“Banks have done a very in-depth analysis on their respective business performances and this analysis goes over a five- to eight-year period. Over time, banks will come back with the loss-driven default parameters relating to different products and that’s where you will find that trade will get a preferred treatment because the losses related to trade lending like LCs [letters of credit] and guarantees will be much smaller in a stressed scenario unlike direct loans or long-term loans,” said Sanjay Tandon, Asia head of trade services at Citi to Asiamoney PLUS on January 18.

This is considered a fair treatment given that the default rates for trade-related instruments are very low, note experts. For example, the default rate for LCs is only 0.077% while its rate of loss is 0.007% from 2008 to 2010, according to the International Chamber of Commerce (ICC) at the ICC Banking Commission meeting in Beijing in October 2011.

Trade finance instruments consist of trade-related obligations directly underpinned by the movement of goods or the provision of services, such as documentary trade letters of credit, documentary and clean collection, import and export bills, as well as guarantees directly related to trade finance obligations such as shipping guarantees, highlights BIS.

Despite these new adjustments, some sceptics believe that these changes are not meaningful enough to help with the rising costs of trade products that have already plagued the transaction banking industry and will continue to post-adoption of Basel III requirements.

“[The recent BIS changes on Basel III’s LCR] provides the ability for more transparency and consistency around how trade sources of funding can be viewed from a regulatory-to-regulatory perspective,” said a Hong Kong-based Asia Pacific product head of trade finance at a US bank to Asiamoney PLUS. “This provides some a bit of consistency but it doesn’t provide any specific relief per say.”

There are, however, parts of Basel III that are now getting pushed to a later stage or being relaxed.

For example, changes to Basel III’s LCR include extending the timeline, where the minimum LCR in 2015 will be 60% versus 100% previously and increase of 10% per annum to reach 100% by 2019.

Additionally, a bank’s high quality liquid assets (HQLA) can now include corporate debt rated ‘A+’ to ‘BBB-’ with a 50% haircut versus only corporate debt rated ‘AA-’ or above previously, and residential mortgage-backed securities (RMBS) rated ‘AA’ or above with 25% haircut.

“These new developments delaying the implementation of the liquidity ratio give banks a breather but it doesn’t take away the nuances of the new risk weights allotted to trade products,” said Citi’s Tandon. “That remains unchanged. Treating LCs and guarantees as any other form of lending is quite stringent because these instruments are certainly less prone to these liquidity pressures versus the other forms.”

One threat to the transaction banking industry remains in the rules. This is how Basel III assumes that inflows tend to be around 50% for all corporate exposures in a distressed scenario.

  • 24 Jan 2013

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