After heavy lobbying, the European Union has recognized trade finance is an inherently low-risk business, and in April made exemptions that should make it easier for corporates to borrow. A report by the International Chamber of Commerce found short-term trade finance transactions have a default rate of only 0.2% compared with 0.6% for one-year, single A-rated corporate loans.
CRD IV has lowered its capital requirement for trade financing for medium/low risk and medium risk off-balance sheet trade finance instruments to 20% and 50% respectively under the Basel III leverage ratio calculation.
By freeing banks from the requirement to hold the full amount of a loan in reserve, the rules make it cheaper for banks to provide this type of financing.
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| Sharon Bowles, MEP |
“Helping banks to lend to small businesses and incentivizing trade finance will be key to securing Europe’s recovery,” says Sharon Bowles, MEP and chair of the European Parliament’s Economic and Monetary Affairs Committee. “With growth scarce, it is the wrong time to treat trade unfavourably and so we have recognized the lower risk of short-term trade finance loans that are underpinned by the traded goods and services.”
The measure was well received by the banking industry. “This is a positive outcome for the real economy,” says Tod Burwell, president and CEO, Baft-IFSA, the association for organizations actively engaged in international transaction banking.
“We ask the G20 and the Basel Committee to recommend that these Basel III changes be adopted in all member jurisdictions around the world.”
However, there is scepticism in some quarters about how much difference the concession will make.
“What Basel or the European Union do barely filters down to businesses,” says Roderick Sutcliffe, principal at Trade Finance Services (TFS), a consultancy.
The benefits of this concession will be passed on by the clearing banks to FTSE 100 companies, but for SMEs the reality of the credit crunch is that it remains very difficult to secure trade finance, he says.
The outlook for SMEs is crucial. “SMEs are special,” Benoît Cœuré, member of the executive board of the ECB, told a conference in Dublin in April. “They are the backbone of the euro-area economy: they constitute about 98% of all euro-area firms, employ around three-quarters of the euro-area’s employees, and they generate around 60% of value added.”
The figures are even higher in the jurisdictions most affected by the crisis, he said.
So while the changes to CRD IV are welcome news for the biggest corporates looking to organize large-scale commodities deals, for example, the overall impact on UK or European growth is likely to be limited.
It will not incentivize banks to increase lending to smaller companies, but only make it cheaper to lend to the bigger companies.
For those that can secure trade finance from a bank, it will certainly bring the cost of a loan down, by perhaps 0.5% approximately, on a rate that might be 8% to 10%.
“You could argue that those levels don’t make much difference, but it does add up,” says Martin O’Donovan, deputy policy and technical director at the Association of Corporate Treasurers. “Over-regulation does flow through and the economic effect is felt across the economy.”
Where banks do provide trade financing, it often comes at the expense of existing overdraft facilities, adds Sutcliffe of TFS, with banks unwilling to increase their exposure to specific companies.
Many businesses looking for trade finance are turning to smaller, independent providers, he says. However, these lenders operate at a disadvantage, lacking the global reach and international networks the banks can offer – invaluable for many businesses engaged in cross-border trade.
One such UK-based lender, Legion Trade Finance (LTF), makes loans of between £100,000 and £1 million, and is seeing business soaring. It expects to see its business treble in 2013 year-on-year, and then double again in two years, says Gavin Maitland-Smith, director at LTF.
This growth is not entirely due to bank unwillingness to lend, but it is certainly a catalyst, he says.
Smaller lenders such as LTF are more hands on, using the goods being traded as security, with a willingness to repossess and sell them, if necessary, to avoid formal insolvency. This is in contrast to the more detached model of the banks, which makes it more difficult for them to take on the credit risk on SMEs.
“We are also seeing better credit-quality clients, clients with much stronger balance sheets, come to us than would have in the past,” says Maitland-Smith. “Once they would have been able to get their financing from the banks – now they have to be more creative.”
That is not only via specialist lenders but peer-to-peer lending and online platforms, he says.
The situation also varies according to where you are in the country, says Sutcliffe. A business might be able to secure a £100 million facility in London or the south east, whereas a similar business based in Yorkshire or Scotland might struggle to get £25 million, he says.
More innovative financing solutions for SMEs will be needed unless and until the European banking sector is re-capitalized.