HEARD ON THE STREET
OCTOBER 28, 2011, 11:54 A.M. ET
Global Trade Faces a Financing Crunch
By ANDREW PEAPLE
If trade is the engine of the global economy, then trade finance is the oil that keeps the engine running smoothly. But this $10 trillion to $12 trillion business, which underpins world trade by providing exporters and importers products like letters of credit, loans and guarantees, is under pressure, a victim of both the European banking crisis and the global regulatory reform effort. At a time when the global economy is already slowing, that's worrying.
The situation isn't yet as bad as it was during the U.S. subprime crisis, when world trade fell 19% in the 12 months to May 2009; about 10%-15% of that slump was attributable to a drop in the availability of trade finance, the World Trade Organization estimates. But prices have been rising since the summer and could reach post-financial crisis levels in the coming weeks, according to the International Chamber of Commerce. That is especially bad news for small and midsize exporters that rely on the cash flow insurance trade finance provides. Estimates of the cost of trade finance as a proportion of doing business are hard to find, but margins above risk-free rates on letters of credit issued in developing countries rose nearly 30-fold in 2008-2009, the WTO estimates.
The current problem lies with European banks, traditionally important players in trade finance, which support an estimated 80% to 90% of trade. But they are struggling to obtain the dollar funding they need, given that around 75% of world trade is greenback-denominated. Some, notably BNP Paribas and Societe Generale, are also reducing their trade lending as part of their broader de-leveraging. Overall trade finance lending is down 6% year-on-year, according to Dealogic figures. As a result, prices are rising.
That should create opportunities for other banks to increase market share. Instead, the supply of funding risks being further curtailed by the new Basel III capital rules. Despite the low-risk nature of the business—only 3,000 out of 11.4 million trade finance transactions worth more than $5 trillion defaulted between 2005 and 2010, according to the International Chamber of Commerce—it is likely to be hit by higher risk weights and new bank leverage ratios. That could encourage banks to switch to more profitable lines, pushing up prices even higher.
True, the industry has wrung some concessions from the Basel Committee this week, which agreed to cut the risk weights for short-dated trade finance deals and those with low-income countries. But higher risk weights remain for other trade deals. Meanwhile, the committee has refused to budge on exempting trade finance from the leverage ratio: Since it is a low-margin, high-volume, balance sheet-intensive business, those banks subject to a leverage ratio are less likely to participate, one reason why the industry is dominated by European banks.
Regulators are right to argue that if they start watering down the rules for one line of business, it could open a can of worms. Besides, the industry has provided little precise detail on what extra costs Basel III will impose. But one thing is certain: The cost of doing trade internationally is set to rise—another unwelcome headwind for the global economy.
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