By Mark ford

Greece edged back from the brink of falling from the eurozone in mid-June when Greek voters chose austerity over life outside the European currency. But the relief that followed the election result was fleeting and unlikely to restore confidence in Greek letters of credit, which had been lost before the polls. At the time of this writing, scepticism remained over the country's ability to sustain eurozone membership.

But now the focus has broadened, dwelling on the debts of Portugal, Ireland, Italy, Greece and Spain (the PIIGS). A handful of smaller eurozone members and banks also have the potential to further shake the foundations Europe's financial system on which L/C business is written.

It looks like time to brace for change. If the impact of Greece's tribulations on its L/C market was devastating, it will be more so if confidence in Europe's larger economies to pay their debts fails, while the most serious impacts of the European currency crisis on the L/C market may have yet to be revealed.

Politicians are hopeful that steps taken at the June EU meeting - which included allowing direct fund injections into Spanish banks and a plan to set up a central EU banking regulatory authority

- will turn things around. But full details have yet to be worked out and uncertainties remain concerning where the money is coming from.

Meanwhile, the repercussions of the crisis are already being felt or anticipated in L/C markets from the US and Latin America to Africa and Asia.

L/C system short-circuited

An L/C shortage has forced Greece into tight corners, and despite the election result, it is hard to see how the country's former L/C users will find a way back from the cash up front or open account arrangements with hefty premiums now demanded by suppliers.

Greece's largest oil refining company, Hellenic Petroleum, which has long relied on Iranian oil paid for on L/C terms, can no longer do so and has to look elsewhere for oil owing to international sanctions and payment terms because of the lack of L/Cs.

Glencore and Vitol are reportedly stepping into the breach, but due to the shortage of L/Cs, Hellenic will have to pay hefty premiums on the oil they buy from the Swiss commodity houses that have extended about EUR 300 million credit and are prepared to deal on open account terms with no L/Cs or bank guarantees. Hellenic's fuel bill will increase dramatically.

Even established and profitable traders are stymied. Unable to obtain L/Cs, they are forced to pay cash up front. Successful traders who have explored the option of moving to non-Greek banks say financial institutions in safer European countries refuse to write L/C business because they can issue no kind of guarantee on businesses incorporated in Greece. This raises the prospect of owners of profitable businesses with customers waiting, selling up to buyers in countries not barred from the L/C market.

Bankers canvassed by DCInsight say the election result will not make a substantial difference in this situation, since confidence in Greek banks' ability to back the credit of even sound Greek businesses is already lost.

"The system has already shortcircuited, and the revolving trade finance that kept Greek companies in the game is gone unless and until the issuer of the currency, the European Central Bank (ECB) steps in to underwrite the [currency] union, regardless of whether this is in Greece, Spain, Italy or any other country in the eurozone," according to one Dutch banker.

If the Greek experience is replicated in the much larger economies of Italy and Spain, the impact on the European L/C market will be huge. But problems could come from less likely places. It is easy to overlook countries such as Slovakia and Cyprus, which have very high debt relative to the size of their economies.

Impacts beyond Europe

One successful Irish company's experience shows how wider problems in the PIIGS banking system impact on global L/C flows. Dublin-based Cush'n Shade was supplying some of the US' largest retailers, but says it has been forced into voluntary liquidation. It cannot obtain credit from the Bank of Ireland for the working capital needed to manufacture its products despite having L/Cs from its US buyers ready and waiting.

In terms of trade finance, it is now clear from the example of Greece what happens to countries that could drop out of the eurozone. But a systemic failure in the European financial sector on the L/C market would impact way beyond the basic buyer-seller transactions already discussed. A key question is whether failures to meet debt obligations amongst the PIIGS (or elsewhere) could cause major European bank failures.

For this to come about, two things would probably have to happen: an EU member state would have to default on its debt and withdraw from the eurozone, and the ECB would have to refuse support for European banks that would almost certainly be left reeling if any member state withdrew from the zone.

Spanish bank collapses could be perilous for Latin American as well as European banks in the same way as Portuguese bank failures could affect banks in Brazil and Angola. A crisis in the European banking sector could also prompt credit downgrades on US banks. This could push up the price of L/Cs that currently support US variable-rate demand bonds.

Chinese exporters are seeing fewer L/Cs available from European banks and are taking into account the prospect of Italian and Spanish banks exiting the Sino-European trade finance market if serious financial sector restructuring in those countries is needed.

New suppliers and market dynamics

The eurozone crisis may precipitate changes in the players in the global L/C market as well as the way business is conducted in that market.

The International Finance Corporation (IFC) says it will expand its existing L/C programmes to replace European banks withdrawing from emerging markets. As the IFC's outgoing CEO, Lars Thunnel, points out, less-developed countries are particularly reliant on banks for trade support because they depend on bank-financed L/Cs.

European banks will also see the pace of erosion of their dominant role financing Asia's trade accelerated by the fast growth of renminbi (RMB)- denominated L/C trades. According to SWIFT, the RMB and not the Japanese yen is now the third-largest currency in the global issuance of L/Cs by value, after the US dollar and the euro. Chinese, Korean and Japanese financial institutions are seeing the opportunity to step in to replace European banks in Asia and other emerging markets. They have trade finance in their sights.

If economies such as Greece pull back from the brink and banks are bailed out at the eleventh hour, the eurozone may muddle on. In this scenario, negative impacts on the L/C market may be severe only in highly indebted countries, although global L/C flows will be affected too.

A continuation of European banks ceding market positions in global trade finance to other players can be anticipated, and this process will accelerate if the eurozone crisis worsens. But if more economies suffer the fate of Greece and its L/C market, then the scale of the problem for the documentary credit industry could well reflect the size of the economies affected. Worse still, if a country exits the eurozone and major banks are allowed to fail, it would almost certainly be time to brace for unprecedented change in L/C markets

Mark Ford's e-mail is