European banks appear to be increasing lending, including via letter of credit (L/C) support, to commodity trading firms which are facing unprecedented liquidity needs due to extreme price volatility, Fitch Ratings says.

The ratings agency expects the banks to continue to fund the firms' margin calls because the liquidity pressure, although serious, should be temporary, and commodity traders are a good source of profit for the banks in normal times.

Top-tier preference

Much of the lending is to top-tier firms such as Trafigura, Glencore, Gunvor and Vitol that have sound business models and operate with large liquidity buffers and diverse financing pools, which mitigates the risks to the banks.

Banks are typically exposed to commodity traders through L/Cs, syndicated credit facilities, project finance lending, and derivatives says Fitch.

Record highsCommodity prices reached record highs in March, leading to increased margin requirements from central clearing counterparties.

This resulted in higher liquidity needs at commodity trading firms. However, the risks have eased as prices have moderated and Fitch does not expect the exposure to put material pressure on major banks' asset quality or revenue.

The full version of Fitch Ratings' analysis, European Banks Support Commodity Traders Amid Liquidity Squeeze, can be found here.

This article represents the views of the author and not necessarily those of the ICC or Coastline Solutions.