The ICC Banking Commission said a recent survey of major international banks found that the Basel II charter “has eroded the incentive of banks” to provide trade finance.
This report was released amid concerns about a large gap in the availability of trade credit. Some trade experts have estimated that banks are now lending at least US $100 billion less than they were last summer.
Basel II, which was agreed in 2004, aims to make each bank’s capital holdings more closely aligned with potential credit losses. However, the ICC study found that a number of difficulties arise when applying the Basel II framework to trade finance facilities. As a result, implementation of Basel II has significantly increased the “capital cost” of trade financing in spite of the low-risk nature of products such as letters of credit, which are vital to international trade.
The startling plunge in global trade in recent months has been accompanied by a substantial shortfall in the availability of cost-effective trade credit. The World Trade Organization (WTO) estimated this week that world trade would plunge by 9% this year, its sharpest decline since World War II. The expected drop is in sharp contrast to the 2% growth in trade last year and 6% increase registered in 2007.
The ICC Banking Commission said the proposed measures would not require amendments to the Basel II framework but only the introduction of “small yet significant changes to the way in which the existing rules are implemented.” The report said the suggested revisions should be coordinated initially through the G20 to increase world trade flows and to insure a level-playing field for banks operating internationally.
The ICC Banking Commission estimated that these steps could potentially reduce capital requirements for typical trade finance obligations by about 20% to 30%.
“We believe that the financial crisis has brought into sharp relief an ongoing trend whereby the implementation of the Basel II charter has eroded the incentive of banks to lend trade finance due to pronounced capital weightings that are not fully reflective of the low risk level of the activity,” the ICC Banking Commission said in its report.
“The results of our consultations indicate that these increases in capital requirements have had particularly adverse consequences on trade lending to small and medium-sized enterprises and counterparties in developing economies,” the commission added.
The ICC Banking Commission pointed out that many banks report having experienced relatively few losses on trade lending during the past several decades. This is due to the fixed, short-term maturity of trade finance products and the fact that exposures are liquidated in cash upon maturity.
“Even in times of severe difficulty, companies will generally try to avoid defaulting on trade obligations, as continual access to trade finance is a lifeline for most firms,” the ICC Banking Commission said.