Trade finance default rates expected to rise with Covid-19 disruption

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By:
Kanika Saigal
Published on:

Naveed Sultan, head of treasury and trade solutions at Citi, says the overall default risk from coronavirus will remain low and will be limited to the SME sector.

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Leaders are making uncompromising decisions to close national and regional boundaries to limit the spread of the coronavirus. Sudden limits to freedom of movement have slashed trade volumes and ruptured supply chains, forcing businesses to overhaul treasury functions at lightning speed to stay afloat.

Some banks are stepping up, supporting clients in their search for liquidity and credit to prop up their working capital. But trade finance – which was building momentum as a safe and solid asset class over the last few years – will become riskier as default rates inevitably rise, says Naveed Sultan, global head of treasury and trade solutions at Citi.

According to the International Chamber of Commerce (ICC), default rates between 2008 and 2018 across all trade finance products and regions were low, averaging 0.37% for import letters of credit, 0.05% for export letters of credit, 0.76% for import and export loans and 0.47% for performance guarantees.

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Naveed Sultan,
Citi

"This will be especially the case for small to medium businesses that may not have the capacity to deploy working capital," says Sultan. "Nevertheless, I am confident that the risk will still remain relatively low.

"There is always risk when the environment is uncertain, but if you look at the nature of trade, which is short term and linked to underlying transactions – so self-liquidating in nature – the risk exposure is still much more limited than other asset classes.

"Moreover, trade finance securities are linked to commercial flows, which can be tracked, and payments are made once a trade is complete, so for now it will be mainly around adjusting the terms so that suppliers can fulfil their contract."

Governments across the globe have announced a number of fiscal stimulus packages that will help small to medium-sized enterprises in the coming months, which will also ease some of the pressure.  For global transaction banks, the risk will remain negligible, given the clients they serve generally have much higher credit scores.

"Our target market consists of well-regarded multinational corporations, selective sovereigns, and when we do deal with commercial clients and local players, they are in the top tier or well collateralized," says Sultan. "Then it comes down to the way you structure the loan: they can be collateralized, restructured, or adapted in other ways – and we are confident that investor appetite will remain.

"Yes, there will be some systemic risk, but again I believe this will be low. We just need to keep mitigating the risk," he says.

Well capitalized

Large transaction banks have the capacity to mitigate against additional this risk because they have excess liquidity in the banking system.

"A really important point to make is that the banks and the global financial system are in very good shape," says Sultan. "Banks are well capitalized and can deploy funds to our corporate clients in need."

Following the global financial crisis, regulation forced banks to strengthen capital and liquidity buffers. Since 2008, bank tier-1 capital ratios have risen from 8.1% to 12.7% on average in the US.

At Citi, CET1 stands at 11.8%, while the bank ended 2019 with $438 billion in liquid assets – both figures well in excess of current regulatory requirements.

Citi’s Treasury and Trade Solutions business made $9.9 billion in revenue in 2018, rising to $10.3 billion in 2019 – 14% of revenues of $74.3 billion for the bank as a whole.


We have already been able to deploy liquidity and credit for our corporate clients, and have come up with a number of solutions to help them manage their treasury functions 
 - Naveed Sultan, Citi

Asked if banks would make decisions that may not be in their best economic or financial interests, Sultan would only say that Citi is in the business of supporting their clients throughout this time.

"Because of our strong financial position, we have already been able to deploy liquidity and credit for our corporate clients, and have come up with a number of solutions to help them manage their treasury functions," he says. 

Some of these measures include extending credit from 60 to 90 days if clients have issues on the sell side, distribution on the buy side and access to liquidity to support working-capital. 

"Given our clients' main focus is the well-being of their staff, many of them are having to work remotely; this can create a number of challenges for businesses that still run on paper," says Sultan.

"But given the need to adapt, we have launched a solution that digitizes the account opening process through our online on-boarding platform, CitiDirect Digital," says Sultan.

Through the portal, Citi's clients can scan in original documentation and sign – where legally accepted – so that remote working doesn't create obstacles to treasury. This service is available in 36 countries and will continue to be rolled out throughout the year.

Payment solutions

In fact, with the vast number of people at multinational companies now working from home, Citi has found that a number of their corporate clients have approached them to help with their digital adoption.

"The digital investments we have made over the last five years are proving invaluable right now," Sultan says.

In 2019, Citi spent $8 billion on upgrades and new technology across the bank.

There have been a number of tailor-made solutions to help with specific problems at some of the bank's customers across the globe.

One Citi customer found their manufacturing site in an impacted region in China completely out of bounds once the city was in lockdown.

"Our client had difficulty receiving cross-border incoming funds for payroll, as local banks were also closed, which meant that they were unable to pay their employees," says Sultan.

Given the urgency of the payroll payments, Citi leveraged the bank's own paperless setup so that the client could access funding for their payroll digitally.

"As a result, our client was able to meet their payment obligations to their employees, many of whom would have been vulnerable if their income had been delayed," says Sultan.