ICC Commission on Banking discusses trade finance problems at WTO

Participating in the meeting were 30 representatives from 19 international and regional financing institutions, private banks, credit insurance agencies and the WTO secretariat. The ICC Commission on Banking was invited to attend the meeting and was represented by commission member Vincent O’Brien, Director, Electronic Business School of Ireland. Upon the request of WTO Secretary General Pascal Lamy, ICC prepared a report entitled Trade Finance in the Current Financial Crisis: Preliminary Assessment of Key Issues.

The report, submitted to Mr Lamy by ICC Chairman Victor K. Fung, indicated that the credit crunch is entering a new phase where it is increasingly difficult to predict the timing and magnitude of events. What is clear is that we are now facing a period when it will be even more difficult to raise money and in the weeks to come, financial markets will continue to deteriorate due to continued deleveraging and lack of liquidity.

“The current environment is creating a risk-averse culture, both amongst banks and traders. With regard to the latter, banks report customers asking for confirmed letters of credit (LCs) where they previously dealt on cash against delivery (CAD) or open account. However, bank perception of risk is leading to tightening liquidity in some instances and therefore greater difficulty in getting bank confirmations and export finance,” said the ICC report.

Participants at the WTO meeting agreed, indicating that the main problem is the shortage of liquidity to finance trade credits. The market currently estimates the liquidity gap in trade finance at about US$25 billion. Risk assessment is also a very acute problem faced by financial institutions and the global impact is being felt most acutely by traders and banks in the emerging market economies. The ICC report clearly pointed to the growing evidence of trade credit shortage being a threat to world trade as a whole and to emerging markets in particular. The global credit crunch, combined with the sharp decline in asset prices and the increase in the cost of trade credit on a sustained basis, is raising widespread concern about the availability of trade finance over the next few months.

The ICC report also highlighted growing concerns in the pricing of trade including evidence of trade finance deals offered at 300-400 basis points above interbank refinancing rates – two to three times more than the going rate a year earlier. ICC is also very concerned by an increase in the number of court injunctions barring payment under letters of credit on unsound technical grounds. Some of our members also reported intense scrutiny from some banks, eventually leading to higher rates of rejection of trade documents on the basis of minor discrepancies. The commission is monitoring the situation closely.

The fact that traditional LC markets may benefit in some ways from the current situation is also noted in the report. “Traders now want their banks to guarantee each transaction. As a result, the LC sector may prove to be more resilient than other forms of lending. Around 90 % of the US$13.6 trillion in world merchandise trade is funded by trade finance, with a large part of emerging market business financed through LCs.”

Finally, the ICC report stressed the need to improve the resilience of emerging market economies: “Structural measures could include an expanded use of asset-backed securitization funding structures, risk-sharing, and greater risk differentiation by banks and public authorities… Short-term guaranteeing of trade finance facilities by governments and multilaterals is seen as a priority. If the crisis worsens, ICC suggests that, in cases where solvent   enterprises and exporters in a crisis country are unable to access trade finance, and/or the relevant sovereign’s ability to provide credible guarantees required by external trade finance providers is limited, targeted support should be made available from multilateral agencies to facilitate a resumption of private sector financing.” The report also indicated that it is important for export credit agencies to resume the practice of providing short-term cover.

Participants at the WTO meeting of 12 November also stressed the importance of filling liquidity gap by increasing the opportunity for commercial banks to co-share risks with international financial institutions and export credit agencies.

ICC urged that such measures be taken forward with the minimum of delay, preferably within the next six months. In the longer term, ICC believes that governments should explore how trade policy reforms can enable short-term finance to flow better, and create deeper and more liquid markets.

The ICC Commission on Banking will continue exploring the impacts of the current situation. An updated report will be made available to delegates at the upcoming banking commission meeting on 11-12 March 2009 in Dubai.