Article

By Steven Beck

At the Asian Development Bank (ADB) it has been a fascinating few years to work in trade finance, and 2012 promises to be just as challenging, possibly more so.

Demand for the ADB's Trade Finance Program (TFP) to fill market gaps in 2012 is anticipated to be bigger than ever. The shortage in US dollars has created problems - especially given that over 25% of global trade is in USD - and when this will end, ideally with the implementation of a convincing firewall on European sovereign debt and possibly with recapitalization of many of the EU's banks, is anyone's guess. If the USD shortage persists for a much longer time, presumably trade will be conducted increasingly in currencies other than the dollar.

But there's a confluence of developments which may be more troubling and which could result in a serious credit crunch:

- First, global deleveraging spurred by real estate bubbles in various markets means that credit is evaporating from the global economy.

- Second, Basel III - as important as it is to help place the global financial system on a more sound footing - cannot come at a worse time and has unintended consequences, especially for trade (see "The Insight interview" and "Discussion point" in this issue). By treating the cost of capital the same for a high-risk, high-margin activity, compared with a relatively low-risk lower-margin activity, Basel III encourages financial institutions toward higher risk/higher margins and away from trade finance. This is the antithesis of Basel's objective and will hit the trade finance market.

Trade finance defaults

ADB's TFP initiated the creation of the first statistics on trade finance defaults with ICC to prove that trade finance carries a relatively low probability of default and loss. The ICC-ADB Trade Finance Default Register demonstrated that in more than five million trade finance transactions going back over five years - including during the global financial crisis - the probability of default was only 0.02%. A second study conducted by ICC with a larger data set of over 11 million transactions shows only three thousand transactions defaulting.

This statistical information is important for two reasons: to convince Basel and regulators to treat trade finance appropriately as a separate asset class, and to convince the private sector to assume more trade finance risk in "frontier"' markets.

In October 2011, days before the G-20 meeting in Cannes, Basel made some concessions - waiving the one-year maturity floor and loser requirements on sovereign risk weightings - for trade finance. But as welcome as these concessions are, they have no impact on the credit conversion factor (CCF), which is projected to be 100% and which should be lowered. This request is supported by the statistical work described above, which was presented to and discussed with the Basel Committee. Previously, the CCF for trade finance was generally 20%.

By lowering the CCF to previous levels, Basel would not only correct the unintended consequence of encouraging financial institutions toward higher risk and away from trade finance, it would also free more capital to support trade, a critical component of economic growth and job creation. We hope the dialogue with Basel will continue. We will continue working with ICC to develop statistics and will continue to provide Basel and others with the hard evidence they need to treat trade finance appropriately.

Pressure on banks

The third development that may contribute to a credit crunch in 2012 - in addition to deleveraging and tougher Basel requirements - is the pressure on banks to increase their capital. This can be done in two ways: raising more capital and shedding (trade finance) assets. Both ways of increasing capital will mean less capacity in the market.

The confluence of these three developments will mean tighter credit. When there is a finite amount of capital, financial institutions will naturally focus on core clients and core markets, not on SMEs or frontier markets. Given that much of global growth is in frontier markets, where American and European business is increasingly finding markets for their products, the result of this impending squeeze on emerging markets is of pronounced concern. The weakness of traditional markets provides a strong imperative for business to look at new markets for growth, and ADB's TFP is well positioned to support expanded growth into developing Asian markets.

The TFP

ADB's TFP will continue to work with its partners - possibly enhancing its capability to do so if these concerns do materialize - to help fill trade finance gaps, to ensure that trade flows and that it provides more opportunities to create jobs and economic growth.

ADB is a triple A-rated multilateral development bank owned by 67 shareholder government and territories, including the G7, Australia, China, India, Singapore and South Korea. The bank is mandated to support development in Asia and reduce poverty.

ADB has coined the phrase "the two faces of Asia" to describe the dichotomy between the exuberance of rapidly developing Asia and the fact that most of the world's poor live on the continent, barely surviving on less than $1.25 a day.

The TFP is an important part of the bank's strategy to support more trade and all the job-creation and elevation from poverty that comes from it. One only need look at the development patterns of Japan, South Korea, China or arguably any developed country to see the link between trade and poverty alleviation.

The TFP provides guarantees and loans in USD, euros and yen within 24 hours through over 200 partner banks to support trade. It has not assumed any risk in relatively developed markets such as China, India and Thailand, but has focused on less-developed markets. Its largest markets have been Bangladesh, Nepal, Pakistan, Sri Lanka and Viet Nam, but it is active in 12 other markets as well. And it continues to expand.

TFP fills persistent market gaps - ones that become more pronounced during a crisis - in the more challenging countries and seeks to bring the private sector into frontier emerging markets. Attracting the private sector into these markets is accomplished in a number of ways, including through co-financing and risk-distribution agreements which are important elements to TFP's support for more than $6 billion in trade.

There is little doubt that 2012 will bring great challenges to trade worldwide. Developing Asia is an important source of global growth and demand. ADB's TFP will continue to work with its partners, enhancing its capacity if necessary, to help ensure that finance is available to support job creation and opportunity through trade.

Steven Beck is Head of Trade Finance at the Asian Development Bank. His e-mail is sbeck@adb.org