Article

In the autumn of 2009, the ICC Banking Commission, following a study commissioned by the Asian Development Bank (ADB), identified issues related to the lack of empirical data on losses related to trade transactions in communicating with banking regulators about the safety and soundness of these transactions. With the sponsorship of the ADB, the Commission embarked on a project termed the Default Registry Working Group to gather and quantify banks' actual loss experience in these transactions.

Why is this important and why is this significant for the future of trade? As those involved in trade finance know, as a result of the short-term self-liquidating nature of most trade finance transactions, the losses that banks have historically sustained for these products have been very low compared with other types of commercial and industrial loans. Those involved in the industry on a day-to- day basis understand this, but the problem is that while individual banks, for the most part, track their losses resulting from trade, the industry as a whole has never quantified this information. As a result, when discussing trade transactions with regulators, representatives speaking on behalf of the industry only have anecdotal information to use as examples. What the regulators need, however, is real data, not anecdotal evidence.

This issue came into focus during the financial crisis when banks and those who promote trade, such as the World Trade Organization, began to consider ways to stimulate trade as a means to accelerate financial recovery. This led to questions concerning current impediments to trade. In this context, Basel II's one-year maturity floor for trade transactions became part of the debate. ICC's Global Survey, "Rethinking Trade Finance", put it this way: "The Basel II framework applies a one-year maturity floor for all lending facilities. Since capital requirements (naturally) increase with maturity length, the capital costs of trade financing are artificially inflated as a result."

ICC has also been concerned about Basel II proposals to increase capital requirements for trade transactions. The proposals group trade products with a number of other instruments which exhibit significantly different characteristics, effectively categorizing some trade products (such as letters of credit) as "risky" asset classes. The Basel Consultative paper on capital, for instance, proposes to increase the capital allocation for traditional trade transactions by a factor of five times to 100 percent - a level likely to stifle trade and that may result in some traditional providers looking to other less capital intensive transactions or to raise prices significantly for these services to offset the increased capital costs.

The best case the industry has to defend the current capital treatment for trade is to be in a position to prove, through actual data, that these transactions have very low loss rates compared with other types of lending. To do this, real empirical data is needed. That is the reason behind the Trade Finance Default Registry.

The pilot for this project has involved a number of large financial institutions, and the initial analysis of the data reveals loss ratios even lower than might have been expected. The Working Group is awaiting data from more banks before presenting the data to the Basel Committee. In recent meetings, the Basel Committee have shown little desire to change their proposals, but they are still under discussion so we will have to see what the final rules actually propose. If ICC is armed with actual data, a better case can be made not to increase capital requirements for trade transactions and, at best, to retain the current levels.

The stakes are very high. The future of this business may be at risk unless the industry can make a factual case for better capital treatment for traditional trade transactions.

An update on Default Registry developments will be published in future issues of DCInsight. In the meantime, banks interested in providing concrete data on losses from trade finance transactions in the next phase of the Default Registry should be in contact with Thierry Senechal at ICC (e-mail: tsl@iccwbo.org).

Dan Taylor, Vice-Chairman, ICC Banking Commission
E-mail: Dan.Taylor@baft-ifsa.com