Trade finance survey 2010: In world trade, banks turn out not to be the villains


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Their problems have highlighted the importance of trade finance in maintaining the flow of goods. Laurence Neville reports on what is being done to sustain a vital economic function

Global overall and regional overall results
Service category satisfaction ratings
Wallet share by region

Banks keep the economy’s lifeblood flowing
Corporate perspective: Office Depot
Rise of the multilaterals


About the trade finance survey

The survey is designed to give our readers valuable information on the trade finance market and the opportunity to rank trade finance providers across a selection of service categories and an overall global ranking of providers as rated by their clients.

Clients nominated their top-three trade finance providers globally and by regions. Providers received four points for a first-place nomination, three points for a second place and two points for a third place. These scores were then summed to produce a ranking.

UNTIL THE FINANCIAL crisis, trade finance was the oxygen of world trade: an essential ingredient to sustain life but one rarely given much consideration because of its elemental nature. Once the crisis began, the consequences of a lack of oxygen became painfully apparent. Banks, governments, supranational bodies and corporates have had to reassess how trade finance should function and how it can be made more sustainable.

“The years 2008 and 2009 have been a watershed in trade finance,” says Tan Kah Chye, global head of trade finance at Standard Chartered. “For the first time, there is public awareness of the importance of supporting short-term trade finance: once President Obama and George Soros start talking about it, you know it’s arrived.”

Support for short-term trade finance is crucial for obvious reasons. As he attempted to rally governments to bolster their support of trade finance, Pascal Lamy, director general of the World Trade Organization, highlighted the fact that it (credit and insurance) facilitated around 80% of the world’s trade flows of $15 trillion in 2008. Moreover, it is important to remember that 95% of trade flows through ports are the vanilla products that support daily living, according to Kah Chye.

Yet the credit crunch caused trade finance pricing to go up – footwear exporters in India or LCD-screen exporters in South Korea might have paid 0.3% for 90-day financing before the crisis and 6% at its peak, according to Kah Chye – and prompted banks (and multilaterals) to reduce their counterparty limits. Are banks therefore the villains in the decline of world trade?

In defence of banks

The Organization for Economic Cooperation and Development estimates that world trade flows contracted by 12.5% in 2009 while global GDP declined by only around 2.9% in the same period, according to the World Bank. That disparity appears to indicate that reduced availability of finance was a contributory factor in declining trade.

However, it is unfair to blame banks wholly for the decline in trade. Indeed, even the harshest analysis, by the World Bank, estimates that the fall in the supply of trade finance has contributed just 10% to 15% of the decrease in world trade since the second half of 2008.

Banks’ responsibility for contributing to the trade slump can be convincingly refuted on two grounds. First, the WTO notes that just as growth of world GDP is associated with an even higher growth in international trade, declines also show the same tendency (largely because income elasticity of manufactured exports is higher than that of total merchandise exports).

Consequently, the scale of the decline in trade is predictable given the contraction of the global economy. “The decline in trade finance usage is more a result of the decline in worldwide demand – not the capital constraints of banks,” says Jean-Francois Lambert, global head of trade sales at HSBC. “Reports from both the WTO and G20 confirm the industry has been prepared to serve businesses that required trade credit.”

A survey by the IMF and the Bankers Association for Finance & Trade in March 2009 showed that 73% of the 44 banks that participated cited a fall in the demand for trade activities to account for the decline in value of trade finance.

Secondly – and crucially – trade finance demonstrably continued to work during the crisis. Of course, proving that banks continued to make trade finance available is difficult because there are no league tables, benchmarks or complete statistics. However, Daniel Schmand, head of trade finance, EMEA, at Deutsche Bank, notes that if trade finance had not continued, “the crisis would have become a much more severe global recession”.

HSBC’s Lambert says that, as trade finance is a fundamental function of any internationally minded bank, it should come as no surprise that global banks did not stop serving the short-term financing needs of their customers during the crisis.

Certainly from a client perspective, there have been some shortcomings in the provision of trade finance to small and mid-cap companies and, most especially, to emerging markets. “In some markets, trade finance almost disappeared as the syndication market dried up – some banks distributed as much as 40% of their risk,” notes Paul Simpson, global head, treasury and trade solutions at Citi. “If capacity falls by 60% and trade falls by 20% clearly there is a gap. Nevertheless, the availability of trade finance was never the number-one issue for clients.”

Moreover, even in some emerging markets – most notably where there is a strong local bank sector, as in Turkey – many corporates have received the support they needed, albeit not from international banks. And in the final analysis, the reaction of trade finance banks – increased caution – to the crisis was natural, says Lambert. “What happened is not a failure of the banking industry but rather a reflection of a renewed focus on risk management.”

Searching for safety

Of the roughly 80% of world trade that involves some form of trade finance such as credit or insurance, the vast majority – probably around 80%, although again no definitive figures are published – is conducted under open account. For exporters, open account – where exporters effectively provide trade credit to their customers – is the most risky option on a continuum that runs from cash in advance to letters of credit (LCs) to documentary collections to open account.

Over the past decade, the dominant trend has been for a move away from LCs, which provide exporters with an assurance that they will be paid before their goods reach their destination, towards open account. This has been driven by a number of factors: first, importers, many of which are in the developed world, have been eager to remove the cost and complexity of LCs, and exporters, which typically operate in cut-throat markets, have had to comply or risk losing business.

Secondly, and importantly, the relatively benign economic and credit environment created a sense that the greater security offered by LCs was less important than in the past.

Unsurprisingly, the credit crisis and economic downturn undermined that sense of security. “The need for greater security has seen an increase in demand for LCs and confirmation LCs,” explains Karsten Sieber, head of cash management and international business at Commerzbank. LCs transfer the payment risk of a buyer to its bank. An LC can also be confirmed by a bank of the seller’s choice, normally in their own country, transferring the payment risk of the buyer’s bank to the confirming bank

“The power dynamic between a buyer and seller often means that a powerful buyer can still insist on open-account payment terms but there are also instances where the power balance is less marked and a seller can demand payment by LC – and may even offer to pay some of the charges associated with them,” notes Iain MacDonald, global head of trade product at Barclays. It is difficult to quantify the move away from open account to documentary trade because volumes have fallen in absolute terms and many open-account payments are received as a cash payment and are therefore hard to track.

“For the first time, there is public awareness of the importance of supporting short-term trade finance: once President Obama and George Soros start talking about it, you know it’s arrived”

Tan Kah Chye, Standard Chartered

LCs have been written off as an anachronism many times in recent decades but have proved a remarkably resilient form of finance in the millennium since they first appeared. “LCs are a business that naturally moves to the least developed markets: 10 years ago there was a thriving LC business in China, now it has become more focused on open account,” says Deutsche Bank’s Schmand.

LCs do have a role to play even in an open-account world. “The trend towards open-account business will be dependent most of all on established instruments to secure transactions and payments via open accounts,” explains Sieber. So-called standby LCs are most frequently used in support of open-account trading. However, the industry consensus is that overall LCs’ brief resurgence as a result of the credit crisis is likely to be short-lived and that open account, whether supported by standby LCs or not, will regain momentum. LCs will never disappear but neither are they about to make a widespread return in global trade.

An alternative future

While the debate about a partial resurgence of interest in LCs highlights a real concern among companies, it obscures the broader needs of global trade – around 80% of which operates under open account. The great hope of the banking industry in recent years in addressing the needs of companies using open account is supply chain finance. “The future of trade finance is the financial supply chain and the ability to do accounts payable and receivable on a short-term basis,” says Schmand at Deutsche Bank. “Ultimately, the trade finance industry must create schemes that are recession-resistant.”

According to Chris Baker, head of trade sales at Bank of America Merrill Lynch, in the past 18 months interest in supply-chain finance to support open-account trading has continued to increase despite the weakening economic environment. “The ability to extend payables for buyers and facilitate cost-effective financing for sellers has been a powerful proposition,” says Baker.

“Trade is becoming a scale business and inevitably that means a few large banks will take more of the volume”

Adnan Ghani, RBS 
Baker concedes that there has been a migration back to LCs in certain segments and for specific risks, such as smaller corporates or those with performance challenges, but highlights the fact that the vast majority of international trade is still conducted on open terms. “We have seen double-digit growth in open-account processing volumes and supply-chain finance is growing at hundreds of per cent a year despite the environment,” he says.

Supply-chain finance poses a number of challenges for banks. As it typically involves unsecured lending, appropriate underwriting is critical, according to Baker. “As the size of these programmes continues to increase, the need for non-bank financial institutions to support trade flows and distribute risk continues to increase,” he says.

The most straightforward – and traditional – model to share risk is syndication. “Trade is becoming a scale business and inevitably that means a few large banks will take more of the volume,” says Ghani at RBS. At the same time, the ability of those banks to take on risks cannot increase at the same pace.

“So capabilities to share and syndicate risk will have to increase,” says Ghani. The trade syndication world is widening to include not only banks but also hedge funds, insurance companies and multilaterals, and there is increasing demand for trade assets even in secondary markets.

One competitor for syndication is securitization, which in 2009 shook off expectations of a premature death. The most enthusiastic proponent of trade finance securitization is Standard Chartered – possibly because while trade finance is usually about 1% of total revenue at major banks, at Standard Chartered it accounts for more than 10% of wholesale banking revenue. “That gives us the experience to manage our trade balance sheet effectively through securitization – $4.5 billion a year – which creates balance sheet support for trade finance,” says the bank’s Kah Chye.

“The need for greater security has seen an increase in demand for LCs and confirmation LCs”

Karsten Sieber, Commerzbank

Kah Chye says that as world trade totals around $15 trillion it is impossible to capture part of it without innovative financing. “In 2008 our trade balance sheet grew 50% and our capital base couldn’t grow that fast,” he says. “So securitization filled the gap. Lots of banks want the credit risk associated with trade but can’t originate so we sell it on to them.”

However, not everyone is convinced that securitization is effective for the broader market. “Syndication is a cheaper and faster way to distribute risk than securitization and also makes more sense given the size of the majority of trade finance deals,” says Ghani.

While distributing risk is central to successfully creating a model for supply-chain finance, equally important is understanding the risk profile of the buyer, according to Baker. Of course, banks have always made counterparty assessments. However, supply-chain finance will necessitate a new level of understanding. Consequently, the development of suitable IT platforms by banks for their customers will be critical to understand and capture what Lambert at HSBC calls “all the events in a client’s sales process”.